Lessons the United States Can Learn from Other Countries’ Territorial Systems for Taxing Income of Multinational Corporations

In 2009, Japan began to exempt dividends paid by Japanese-owned foreign subsidiaries to their parent firms from home-country taxation. This tax reform switched Japan's corporate tax system to a territorial tax system that exempts foreign income from home-country taxation. In this paper, I examine the impact of the territorial tax reform on the profit-shifting behavior of Japanese multinationals. I analyze the change in the sensitivity of the reported profits of Japanese-owned foreign subsidiaries to host countries' corporate income tax rates after the tax reform, using US-owned foreign subsidiaries as a comparison group. I find that, on average, the profits of US-owned foreign subsidiaries are more sensitive to host countries' tax rates than are those of Japanese-owned foreign subsidiaries over the whole study period from 2004 to 2016 and over the subperiod from 2004 to 2007, when both countries used the worldwide tax system. However, the sensitivity of the pre-tax profits of Japanese-owned foreign subsidiaries, particularly large subsidiaries, to host countries' corporate tax rates significantly increased in response to the announcement of the territorial tax regime in 2008, relative to that of the US-owned foreign subsidiaries. This suggests that the introduction of the territorial tax system facilitated profit shifting by Japanese multinationals.

Section: Profit Shifting By Us and Japanese Multinationalsmentioning

confidence: 99%

Section: Introductionmentioning

confidence: 99%

Territorial Tax Reform and Profit Shifting by US and Japanese Multinationals

Hasegawa

2019

Section: Introductionmentioning

confidence: 99%

“…The Japanese reasons for change were more related to fear over funds being trapped overseas. The idea was that the policy change would result in more funds being brought back to Japan, resulting in higher domestic investment and employment (Altshuler, Shay and Toder, 2015).There has been an ongoing debate in the U.S. in recent years surrounding the need for this potential tax policy change. It is an issue, which has been debated by academics, politicians and the media.…”

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confidence: 99%

Policy Effects of International Taxation on Firm Dynamics and Capital Structure

Spencer

2016

I develop and calibrate an industry equilibrium model with heterogeneous multinational firms to study the impact of a potential policy change from the current U.S. worldwide taxation system to a territorial system on firm investment, capital structure, payout policy and tax revenues. Firms in the model make both intensive and extensive margin decisions in terms of overseas investment. They optimally choose dividend payments to shareholders, holdings of riskless debt securities and earnings repatriations from the subsidiary to the parent in each period. To estimate the impact of the policy change, I solve the model under both worldwide and territorial systems and compare the stationary equilibria. The results show that the policy change causes both domestic and overseas production by U.S. firms to rise. In addition, firms borrow more and pay larger dividends to shareholders. These effects on firm variables are coupled with a rise in U.S. Government tax collections. * I thank Oliver Levine and my advisor, Dean Corbae, for some valuable discussions that helped me to develop this project and to get it off the ground. Comments received by Mark Ready, Michael Gofman and David Brown have also been particularly helpful. I'm grateful to participants at the 2017 Midwest Finance Association Annual Meeting and in particular, thankful to Joseph Farhat for giving a helpful discussion. I'm also appreciative for suggestions during the Spring 2016 Midwest Macro Meeting at Purdue University in addition to those provided during the macroeconomics brownbag, the macro-finance reading group and the finance brownbag all at UW -Madison. I am also thankful for funding provided by the Culbertson Prize, the Richard E. Stockwell Fellowship and a Summer Research Fellowship awarded by the economics department and generous support from the finance department at UW -Madison. I'm also fortunate to have received outstanding computational support from the Center for High Throughput Computing (CHTC). All remaining errors are my own. (HM Government, 2013). The Japanese reasons for change were more related to fear over funds being trapped overseas. The idea was that the policy change would result in more funds being brought back to Japan, resulting in higher domestic investment and employment (Altshuler, Shay and Toder, 2015).There has been an ongoing debate in the U.S. in recent years surrounding the need for this potential tax policy change. It is an issue, which has been debated by academics, politicians and the media. One major point of controversy in the debate surrounds the deferrability of active foreign earnings in the current system, (see section II for more details). This particular aspect of the U.S. tax code has allowed many large firms to hold-off on repatriating their overseas earnings and to accumulate large amounts of funds abroad.U.S. politicians have expressed concern regarding this behaviour by firms along the dimension that it may be serving the firms at the expense of domestic economic activity. In response, the 2004 Ho...

“…Japanese firms arguably had incentive to do so because foreign incomes were taxed at high rates (as high as 40%) upon repatriation. 3 As a means of stimulating dividend repatriation, Japan introduced a foreign dividend exemption system in April 2009 that exempted dividends remitted by foreign affiliates to their Japanese parent firms from home taxation. Thus, with the introduction of the dividend exemption system, the Japanese corporate tax system effectively moved to a territorial tax system.…”

Section: Introductionmentioning

confidence: 99%

The Effect of Moving to a Territorial Tax System on Profit Repatriation: Evidence from Japan

Hasegawa

Kiyota

2015

In an increasingly globalized world, the design of international tax systems in terms of taxation on foreign corporate incomes has received much attention from policymakers and economists alike. In the past, Japan's worldwide tax system taxed foreign source income upon repatriation. However, to stimulate dividend repatriations from Japanese-owned foreign affiliates, Japan introduced a foreign dividend exemption in 2009 that exempts dividends remitted by Japanese-owned foreign affiliates to their parent firms from home taxation. This paper examines the effect of this dividend exemption on profit repatriations by Japanese multinationals. We find that the response of Japanese-owned affiliates to the dividend exemption was heterogeneous. More particularly, foreign affiliates with a large stock of retained earnings were generally more responsive to the reform and significantly increased dividend payments to their parent firms in response to the enactment of the dividend exemption system. Dividend payments by these affiliates also became more sensitive to withholding tax rates on dividends levied by host countries under the new exemption system.