Multinationals in countries with a territorial tax system are at an advantage according to new research from Rotterdam School of Management, Erasmus University (RSM) and Erasmus School of Economics (ESE).
International taxation is an ongoing concern of policy makers around the world, however according to Dr Saskia Kohlhase of RSM and Dr Jochen Pierk from ESE a worldwide tax system reduces the incentives of multinational corporations (MNCs) to engage in tax management in their foreign subsidiaries.
Dr Kohlhase: “We wanted to know whether tax systems influence multinational companies to engage in tax management in their foreign subsidiaries as many countries have introduced a territorial tax system since 2000.
“We found that subsidiaries of MNCs headquartered in countries with a worldwide tax system may be disadvantaged compared to subsidiaries of MNCs headquartered in countries with a territorial tax system because of the taxes that apply to dividend repatriations under a worldwide tax system.”
Dr Kohlhase and Dr Pierk studied the tax management behaviour of worldwide-parent and territorial-parent subsidiaries by investigating the switch of Japan and the UK from a worldwide to a territorial tax system. Their sample consisted of 39,496 subsidiary–year observations in 19 European countries.
“Our analysis showed that Japanese- and UK-owned subsidiaries reduced their effective tax rates depending on different control groups, between 1.2 and 3.5 percentage points after switching to territorial tax system.We provide evidence on the magnitude by which tax management in foreign subsidiaries increases after the switch to a territorial system,” Dr Kohlhase said.
These results are useful for countries that still operate a worldwide tax system or recently switched to a territorial tax system, and for countries with a large volume of foreign direct investments from countries that recently switched to territorial tax system.
As tax laws vary, the costs and opportunities to reduce taxes in the respective subsidiary countries differ from country to country. As respective laws and regulations are often only available in the local language, the researchers encourage local researchers and policymakers to conduct thorough investigations into country-specific tax legislation.
The study, The Effect of a Worldwide Tax System on Tax Management of Foreign Subsidiaries, was published in, Journal of International Business Studies: