Foreign Holding Companies and the US Taxation of Foreign Earnings: Evidence from the Tax Increase Prevention and Reconciliation Act of 2005*

Abstract

I analyze US multinationals' (MNCs) use of foreign holding companies in their organizational structures and the impact of holding companies on internal capital markets. The look‐thru rule in the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) reduces the after‐tax cost of foreign intercompany financing transactions. I use TIPRA as a natural experimental setting to test whether a shift in US tax policy that reduces the cost of moving foreign capital increased firms' reliance on foreign holding company subsidiaries. I find that MNCs responded to TIPRA by creating more foreign holding companies. Furthermore, consistent with the policy objectives of TIPRA, I document that MNCs that rely on holding companies gained tax efficiencies in their post‐TIPRA foreign internal capital markets, reducing domestic taxation on foreign earnings and easing financial constraints. Overall, my results expand our understanding of foreign organizational structure decisions and their internal financing benefits. I contribute to the tax literature by documenting a response to TIPRA that sheds light on the growing complexity of foreign subsidiary ownership structures.