The Effect of Taxes on U.S. Multinationals' Source of Foreign Debt Decisions

Posted: 27 Sep 1998

See all articles by Kaye J. Newberry

Kaye J. Newberry

University of Arizona - Department of Accounting

Dan S. Dhaliwal

University of Arizona - Department of Accounting (deceased)

Abstract

We examine the influence of taxes on where firms source their interest deductions using data on foreign debt offerings by U.S. multinationals during 1987-1997. This unique data not only allows us to identify the location of firms' debt issues, but it allows us to control for non-tax factors related to the decision to issue foreign debt (such as currency hedging). By examining whether U.S. multinationals issue foreign debt through a subsidiary (yielding a deduction against foreign income) or as a direct placement by the U.S. parent (yielding a domestic interest deduction), we are able to construct strong tests of tax incentives to concentrate interest deductions in foreign tax jurisdictions. Our access to data on the location and characteristics of these foreign debt offerings (combined with survey evidence we obtain from U.S. multinationals active in these markets) also allows us to investigate the role of conflicting non-tax incentives to structure these debt offerings as a direct obligation of the U.S. parent.

Our empirical results indicate that taxes have a significant influence on where firms source their interest deductions. Consistent with geographic income-shifting predictions, we find (1) that firms with a domestic tax-loss carryforward are significantly more likely to issue foreign subsidiary debt, and (2) evidence that firms are more likely to issue debt through foreign subsidiaries in 'high' versus 'low' tax rate countries. In terms of the foreign tax credit (FTC) position of firms, we find that U.S. multinationals are significantly more likely to issue debt through a foreign subsidiary if binding FTC limitations adversely affect their ability to use a domestic interest deduction. These tax incentive findings are robust to a variety of sensitivity tests. In addition, our findings suggest that these tax incentives are traded-off against non-tax factors, such as subsidiary firms' higher cost of capital, characteristics of foreign markets that favor direct placements, and internal management control issues.

This study makes several contributions. First, while prior accounting research provides general evidence that U.S. multinationals shift taxable income between geographic locations in response to variations in tax rates, this is the first study to document the use of interest-sourcing decisions as a mechanism to achieve income shifting. Second, this study provides initial evidence on conflicting incentives that moderate the influence of taxes on firms' financing decisions. Third, our finding that taxes influence the way in which U.S. multinationals structure their foreign debt offerings contributes to policy debates regarding tax distortions.

JEL Classification: M41, G15, G32

Suggested Citation

Newberry, Kaye J. and Dhaliwal, Dan S., The Effect of Taxes on U.S. Multinationals' Source of Foreign Debt Decisions. Available at SSRN: https://ssrn.com/abstract=121749

Kaye J. Newberry (Contact Author)

University of Arizona - Department of Accounting ( email )

Tucson, AZ 85721
United States
520-621-1252 (Phone)
520-621-3742 (Fax)

Dan S. Dhaliwal

University of Arizona - Department of Accounting (deceased)

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