Debt shifting in Europe

Abstract

This article aims to analyze the link between subsidiary capital structure and taxation in Europe. First we introduce a trade-o¤ model, which looks at a MNC's …nancial strategy and in particular debt shifting from low-tax to high-tax jurisdictions. By letting the MNC choose both leverage and the pro…t shifting percentage, we depart from the relevant literature which has mainly focused on the latter. Using the AMADEUS dataset we show that: i) in line with the relevant literature, subsidiary leverage increases with its statutory tax rate; ii) contrary to previous work, if a parent company is located in a high-tax country and its subsidiary is making pro…t, an increase in the parent company's tax rate has a positive impact on the subsidiary's leverage.

Debt/Asset Ratio as Evidence of Profit-Shifting Behaviour in the Slovak Republic

“…Profit shifting using debt as a planning technique relies on the deductibility of interest payments under most existing corporate tax systems (an existence of hybrid instruments treated as debt in host country and equity in home country) (Johannesen, 2014;Riedel, 2018). Miniaci, Parisi, and Panteghini (2014) the great impact on debt to total assets ratio of profit making subsidiary has the multinational firm's tax rate. Firstly, the benefits from transferring debt from the parent to its subsidiary are being mitigated by increase in the parent company's tax rate.…”

Impact of Controlled Foreign Corporation Rules on Post-Acquisition Investment and Profit Shifting in Targets

“…The basic idea is that profits generated in high-tax subsidiaries are shifted to low-tax subsidiaries to avoid taxation in high-tax countries. One common profit shifting strategy is locating debt in high-tax subsidiaries (e.g., Newberry and Dhaliwal (2001); Desai et al (2004); ; Buettner and Wamser (2013); Miniaci et al (2014)), which leads to interest expenses in those subsidiaries and corresponding interest income in low-tax subsidiaries. Another profit shifting strategy is setting transfer prices for intragroup transactions in a way that high-tax subsidiaries have to pay high prices to low-tax subsidiaries.…”

Corporate taxation and financial strategies under asymmetric information

“…20 Given this starting point we can say that an economic downturn, proxied by a higher λ, may lead to a separating equilibrium. This occurs if the threshold t • increases above t. In that case, the spread increases from 0 to ρ * L − ρ S > 0.…”

“…More recently, for instance, Graham et al (2011) find that firms with more debt and lower bond ratings in 1928 became financially distressed more frequently during the Depression, consistent with the trade-off theory of leverage and the information production role of credit rating agencies (cross-country works). Further evidence is provided by investigating tax effects on multinationals' capital structure (see e.g., the articles quoted in Miniaci et al, 2014). 2 A useful survey of the effects of corporate finance on capital structure is provided by Harris and Raviv (1991).…”

“…Firstly, we aim to set up a theoretical environment where five pieces of evidence are accounted for: i) the existence of a tax incentive to borrow (see e.g., Miniaci et al, 2014); ii) the negative relationship between leverage and profitability (see e.g., Miniaci et al, 2014); iii) the existence of asymmetric information in credit markets (see Gordon, 2010, and the papers cited herein); iv) the screening activity of lenders (see e.g., Stiglitz and Weiss, 1981) and v) the business cycle effects on the spread between the high-yield and the investment-grade interest rates on corporate loans (see Figure 1). In doing so, we consider both sides of capital markets.…”