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Currency Denomination of Intercompany Debt and Multinational Taxes

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  • Thomas J. O'Brien

Abstract

For multinational companies (MNCs) with foreign subsidiaries, the currency denomination of intercompany debt can have important effects on both taxes and financial statements. This paper analyzes the choice between an intercompany loan denominated in the home currency and one denominated in the subsidiary's functional currency. Using U.S. rules for financial accounting and taxes, the author demonstrates the expected impact of the loan's currency denomination on the expected level and variability of an MNCs overall taxes in the case where it has excess foreign tax credits. The author's analysis shows that the foreign currency loan denomination leads to lower expected tax if the foreign withholding tax rate on interest is higher than the parent's home income tax rate. At the same time, the parent currency denomination leads to lower expected taxes if the parent's home income tax rate is higher than the foreign withholding tax rate on interest. Moreover, if an MNCs excess foreign tax credits are attributable to the subsidiary, the foreign currency loan denomination leads to lower variability in overall taxes. But in cases where the excess foreign tax credits arise from other foreign operations, the parent currency denomination leads to lower variability of overall tax.

Suggested Citation

  • Thomas J. O'Brien, 2009. "Currency Denomination of Intercompany Debt and Multinational Taxes," Journal of Applied Corporate Finance, Morgan Stanley, vol. 21(3), pages 86-94, June.
    • Handle: RePEc:bla:jacrfn:v:21:y:2009:i:3:p:86-94
    DOI: 10.1111/j.1745-6622.2009.00242.x
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    References listed on IDEAS

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    1. Huizinga, Harry & Laeven, Luc & Nicodeme, Gaetan, 2008. "Capital structure and international debt shifting," Journal of Financial Economics, Elsevier, vol. 88(1), pages 80-118, April.
    2. Chowdhry, Bhagwan & Coval, Joshua D., 1998. "Internal financing of multinational subsidiaries: Debt vs. equity1," Journal of Corporate Finance, Elsevier, vol. 4(1), pages 87-106, March.
    3. Stephen L. Curtis, 2008. "Transfer Pricing for Corporate Treasury in the Multinational Enterprise," Journal of Applied Corporate Finance, Morgan Stanley, vol. 20(2), pages 97-112, March.
    4. repec:bla:jfinan:v:59:y:2004:i:6:p:2451-2487 is not listed on IDEAS
    5. Alan C Shapiro, 1984. "The Impact of Taxation on the Currency-of-Denomination Decision for Long-Term Foreign Borrowing and Lending," Journal of International Business Studies, Palgrave Macmillan;Academy of International Business, vol. 15(1), pages 15-25, March.
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