The vast increase in foreign assets globally has raised interest in how the home country should tax profits flowing from these investments. Broadly speaking, countries have chosen either to exempt foreign income from taxation or to subject foreign income to taxation with credits/deductions given for foreign taxes paid. Recent research has focused on the effect of these foreign income tax rules on the relationship between aggregate FDI flows and corporate tax rates. In this paper we examine how foreign income tax rules can affect the financial structure of subsidiary-level FDI in Europe. The tax-deductibility of interest payments suggests that higher (host-country) corporate tax rates should be associated with a greater proportion of debt-financed FDI, as foreign income tax credit systems should, in theory, limit the benefits of shielding foreign income from host country taxation. Our results indicate that whilst multinationals from tax exemption countries adjust the financial structure of foreign investments in response to corporate tax rates, the effect of corporate tax rates is insignificant for FDI originating from tax credit countries. These results reveal an additional channel through which foreign income tax credit systems attenuate the forces of tax competition.
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Find related papers by JEL classification: F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements F23 - International Economics - - International Factor Movements and International Business - - - Multinational Firms; International Business H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies H87 - Public Economics - - Miscellaneous Issues - - - International Fiscal Issues; International Public Goods F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Capital and Ownership Structure
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