## _wp0739

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---

### Introduction and scope
- Context and motivation
  - Interest expenses are deductible for corporate tax purposes, while dividends must be paid out of net-of-tax corporate income.
  - Most tax systems favor debt finance over equity finance; variation arises from dispersion in top corporate tax rates.
  - Multinational firms allocate debt across parent and subsidiaries in multiple countries; their financial structure reflects tax systems of all countries where they operate.
- Tax mechanics emphasized
  - Dividends face subsidiary-country corporate tax and may face nonresident dividend withholding tax; parent-country taxation and double-tax relief conventions affect ultimate tax costs of equity finance.
  - The analysis uses detailed information on international tax systems for European multinationals, including double taxation and double-tax-relief conventions.
- Non-tax considerations
  - Optimal indebtedness balances bankruptcy risk (cost of excessive leverage) and disciplining benefits of debt (reducing free cash flow available to managers).

### Model insights and theoretical results
- Structure and implications
  - Presents a model of optimal overall capital structure of a multinational that reflects tax and nontax factors.
  - Tax advantages of debt lead firms to choose higher leverage than a nontax-only optimum.
  - A tax change in one country causes rebalancing of capital structure across all countries where the multinational operates:
    - Stronger incentives for debt finance in one country encourage debt finance in that country but discourage debt finance in other countries to preserve overall indebtedness limits.
  - Optimal debt-to-assets ratio at any establishment is positively related to:
    - the national tax rate, and
    - differences between the national and foreign tax rates.
  - Relevant tax rates are effective tax rates that account for double taxation and double-taxation relief.
  - International tax rate differences determine incentives to shift debt internationally within a multinational.

### Empirical approach and headline quantitative results
- Data and sample
  - Firm-level database for 33 European countries over the 1994–2003 period, including financial structure of domestic and multinational firms, parents and subsidiaries; data drawn from Amadeus.
- Key empirical findings (numeric fidelity preserved)
  - Stand-alone domestic firms:
    - A 10 percent increase in the overall tax rate (reflecting corporate income taxes and nonresident dividend withholding taxes) increases the ratio of liabilities to assets by 1.84 percent.
  - Multinational firms (example with two equal-sized establishments in two countries):
    - A 10 percent overall tax increase in one country increases the leverage ratio in that country by 2.44 percent.
    - The leverage ratio in the other country decreases by 0.6 percent.
- Additional empirical observations
  - Corporate debt policy appears to reflect local, source-level taxes rather than residence-level taxes levied on worldwide income, possibly because residence-level taxes can often be deferred.
  - Debt policy appears to reflect corporate income taxation rather than bilateral nonresident dividend withholding; in practice multinationals may avoid bilateral withholding taxes through triangular arbitrage involving a conduit company in a third country.

### Conclusions — main empirical findings (numeric fidelity preserved)
- Sample and scope
  - Large sample of European firms over the 1994–2003 period; parents and subsidiaries from Amadeus; observations cover European operations only.
- Taxation affects leverage through two channels
  - Domestic effect:
    - Estimated full domestic effect β1 = 0.18 (from regression (3)).
    - Example: an increase in the effective tax rate by 0.06 (one standard deviation) raises subsidiary leverage by 1.1 percent (domestic effect).
  - International (debt‑shifting) effect:
    - Estimated international effect β2 = 0.12 (from regression (3)).
    - Example: a 0.06 increase in the subsidiary country effective tax rate raises subsidiary leverage by 0.4 percent via the international effect (for a hypothetical multinational with a single foreign subsidiary of equal asset size to the parent).
    - Total effect of a 0.06 increase in the subsidiary effective tax rate: 1.5 percent increase in subsidiary leverage (1.1% domestic + 0.4% international).
    - By contrast, an increase in the parent country effective tax rate of 0.06 has a negative international effect on subsidiary leverage of -1.5 percent.
- Magnitude and robustness
  - Both domestic and international effects are statistically highly significant but quantitatively small.
  - Results are robust across many specifications and subsamples (manufacturing, foreign subsidiaries only, exclusion of loss-making firms, exclusion of Eastern Europe, controls for firm-specific risk, alternative financial-development controls, clustered standard errors).
  - Instrumental-variables checks (using populations of subsidiary and parent countries as instruments) yield similar results; first-stage indicates effective tax rates tend to be higher in more populous countries.
- Source vs. residence taxation and withholding taxes
  - Source‑level taxation appears more important for leverage than residence‑level taxation; parent-country taxes can often be deferred.
  - Corporate tax rates matter for leverage, whereas nonresident dividend withholding tax rates appear not to matter empirically; withholding taxes may be avoidable via triangular arbitrage using conduit companies.

### Interpretation, welfare, and mechanisms
- International debt‑shifting operates multilaterally:
  - Debt‑shifting reflects a subsidiary’s tax differences vis‑à‑vis the parent firm and vis‑à‑vis other foreign subsidiaries, supporting a multilateral (not purely bilateral) determination of capital structure adjustments.
- Economic incidence and welfare effects:
  - International debt‑shifting lowers average corporate income taxation in high‑tax countries by shifting debt out and reducing taxable profits there.
  - Low‑tax countries may benefit because local establishments will be less leveraged, potentially raising corporate income tax revenues.
  - Debt‑shifting introduces dead-weight losses in the form of implementation costs for multinationals and costs from deviations from nontax optimal financial structures.

### Policy implications and recommendations
- Two routes to eliminate international debt‑shifting:
  - Harmonize top corporate income tax rates internationally.
  - Introduce a common, consolidated tax base for multinational firms.
- Practical outlook:
  - Tax coordination of either kind is unlikely in the near future; therefore, international debt‑shifting will remain an important consideration for multinationals and policymakers.

### Appendix — Variable definitions and data sources (selected)
- Financial leverage: Ratio of total liabilities to total assets. Source: Amadeus.
- Adjusted financial leverage: Ratio of total liabilities minus accounts payable minus cash to assets minus accounts payable minus cash. Source: Amadeus.
- Effective marginal tax rate: Statutory tax rate on dividend income taking into account withholding taxes and international tax system. Source: International Bureau of Fiscal Documentation and various ministries.
- Tax incentive to shift debt: Sum of international tax differences weighed by local asset shares taking into account withholding taxes and international tax system. Source: International Bureau of Fiscal Documentation and various ministries.
- Relative tax of equity and debt: Statutory tax rate on dividend income minus statutory tax rate on interest income taking into account withholding taxes and international tax system. Source: International Bureau of Fiscal Documentation and various ministries.
- Tangibility: Ratio of fixed assets to total assets. Source: Amadeus.
- Log of sales: Logarithm of sales. Source: Amadeus.
- Profitability: Ratio of earnings before interest, taxes, depreciation and amortization to total assets. Source: Amadeus.
- Creditor rights: Annual index of credit rights in the country. Source: Djankov et al. (2005).
- Political risk: Annual (December) index of political risk. On a scale from 0-100 with higher scores indicating greater risk. Source: International Country Risk Guide.
- Inflation: Annual percentage change in the CPI. Source: World Development Indicators.
- Growth opportunities: Median of the annual growth rate of sales per country and industry. Source: Amadeus.
- Volatility of profits: Standard deviation of the firm’s ratio of earnings before interest, taxes, depreciation and amortization (EBITDA) to total assets over the period 1994-2003. Source: Amadeus.
- Private credit to GDP: Ratio of credit to the private sector to GDP. Source: World Development Indicators.

*Source: _wp0739 - References and conclusions (excerpt).*

### References..............................................................................................................

### References

### Tables and Appendix (inventory from source)
- Appendix Table
  - 1. Variable Definitions and Data Sources..........................................................................35
- Tables
  - 1. Corporate Taxation and Double-Tax-Relief Systems for Dividend Received in Selected European Countries in 2003 ..........................................................................................17
  - 2. Bilateral Withholding Tax on Dividend Payments Between Fully Owned Foreign Subsidiary and Parent on January 1, 2003 .....................................................................19
  - 3. Existence of a Bilateral Tax Treaty on January 1, 2003 ................................................20
  - 4. Bilateral Withholding Tax on Interest Payments Between Fully Owned Foreign Subsidiary and Parent on January 1, 2003 .....................................................................21
  - 5. Double-tax-relief Systems for Interest Payments Received in Selected European Countries in 2003...........................................................................................................22
  - 6. Expressions for the Relative Taxation of Equity and Internal Debt of Subsidiaries.23
  - 7. Descriptive Statistics for Subsidiaries of European Multinationals ..............................24
  - 8. The Impact of Domestic and International Taxes on the Financial Leverage of Subsidiaries of Multinational Firms ..............................................................................28
  - 9. The Impact of Taxes on the Financial Leverage of Subsidiaries of Multinational Firms: Robustness Checks ........................................................................................................30
  - 10. The Impact of Taxes on the Financial Leverage of Subsidiaries of Multinational Firms: Additional Robustness Checks ......................................................................................32

### Introduction and scope (excerpted findings and setup)
- Context and motivation
  - Interest expenses are deductible for corporate tax purposes, while dividends must be paid out of net-of-tax corporate income.
  - Most tax systems favor debt finance over equity finance, with variation due to dispersion in top corporate tax rates.
  - Multinational firms face allocation of debts across parent and subsidiaries in multiple countries; their financial structure reflects tax systems of all countries where they operate.
- Tax mechanics highlighted
  - Dividends face subsidiary-country corporate tax and may face nonresident dividend withholding tax in the subsidiary country; parent-country taxation and double-tax relief conventions affect ultimate tax costs of equity finance.
  - The paper collects detailed information on international tax systems for European multinationals, including double taxation and double-tax-relief conventions.
- Nontax considerations
  - Optimal indebtedness balances bankruptcy risk (cost of excessive leverage) and disciplining benefits of debt (reducing free cash flow that could be overspent by managers).

### Model insights and theoretical results (from excerpt)
- Structure and implications
  - Presents a model of optimal overall capital structure of a multinational that reflects tax and nontax factors.
  - Tax advantages of debt lead firms to choose higher leverage than nontax-only optimum.
  - A tax change in one country causes rebalancing of capital structure across all countries where the multinational operates:
    - Stronger incentives for debt finance in one country encourage debt finance in that country but discourage debt finance in other countries to preserve overall indebtedness limits.
  - Optimal debt-to-assets ratio at any establishment is positively related to:
    - the national tax rate, and
    - differences between the national and foreign tax rates.
  - Relevant tax rates are effective tax rates that account for double taxation and double taxation relief.
  - International tax rate differences determine incentives to shift debt internationally within a multinational.

### Empirical approach and headline quantitative results
- Data and sample
  - Firm-level database for 33 European countries over the 1994–2003 period, including financial structure of domestic and multinational firms, parents and subsidiaries.
- Key empirical findings (preserve numeric values exactly)
  - For stand-alone domestic firms:
    - A 10 percent increase in the overall tax rate (reflecting corporate income taxes and nonresident dividend withholding taxes) increases the ratio of liabilities to assets by 1.84 percent.
  - For multinational firms (example with two equal-sized establishments in two countries):
    - A 10 percent overall tax increase in one country increases the leverage ratio in that country by 2.44 percent.
    - The leverage ratio in the other country decreases by 0.6 percent.
- Additional empirical observations
  - Corporate debt policy appears to reflect local, source-level taxes rather than residence-level taxes levied on worldwide income, possibly because residence-level taxes can often be deferred.
  - Debt policy appears to reflect corporate income taxation rather than bilateral nonresident dividend withholding; in practice multinationals may avoid bilateral withholding taxes through triangular arbitrage involving a conduit company in a third country.

### Position relative to existing literature (select citations and contrasts)
- Cross-country and U.S.-based studies cited in the excerpt (authors and themes preserved as presented)
  - MacKie-Mason (1990), Gordon and Lee (2001): identify a tax effect in U.S. data by exploiting differential effective taxation.
  - Graham (2000): calculates the value of tax benefits of debt finance for the U.S. case.
  - Rajan and Zingales (1995), Booth, Aivazian, Demirgüc-Kunt, and Maksimovic (2001): use cross-country data; latter finds a weak effect on leverage for a tax-variable measuring the tax shield of debt.
  - Hines and Hubbard (1990), Collins and Shackelford (1992), Froot and Hines (1992), Grubert (1998): evidence that U.S. multinational financial structures and intrafirm flows are consistent with tax minimization.
  - Newberry and Dhaliwal (2001): debt issuance location of U.S. multinationals is affected by jurisdiction-specific tax-loss carry-forwards and foreign tax credit limitations.
  - Desai, Foley, and Hines (2004): both internal and external financing of outward U.S. FDI is sensitive to foreign tax rates.
  - Mills and Newberry (2004): non-U.S. multinationals from low-tax countries use relatively intensive debt finance of their foreign-controlled corporations in the United States.
  - Jog and Tang (2001): Canadian firms’ leverage sensitivity varies with being part of U.S.-based or Canada-based multinationals.
  - Moore and Ruane (2005): leverage of 8,500 foreign subsidiaries in EU member countries sensitive to local corporate tax rate unless parent country operates a foreign tax credit system.
- Contribution emphasized
  - The paper takes a fully multilateral approach, considering how multinational firm structure and the international tax system jointly affect subsidiary leverage across all countries where the multinational operates.
  - Main contribution: evidence that subsidiary leverage within a multinational responds to bilateral tax rate differences vis-à-vis both the parent firm and other foreign subsidiaries, supporting the multilateral modeling approach.

*Source: _wp0739 - References (excerpt).*

### conclusions.

### _wp0739 - conclusions.

### Main empirical findings
- Sample and scope:
  - Large sample of European firms over the 1994–2003 period.
  - Data on parents and subsidiaries drawn from the Amadeus database; observations cover European operations only.
- Taxation affects leverage through two channels:
  - “Domestic” effect: higher local effective tax rates increase local subsidiary leverage.
    - Estimated full domestic effect β1 = 0.18 (from regression (3)).
    - Example: an increase in the effective tax rate by 0.06 (one standard deviation) raises subsidiary leverage by 1.1 percent (domestic effect).
  - “International” (debt‑shifting) effect: international tax rate differences across all countries where the multinational operates affect subsidiary leverage.
    - Estimated international effect β2 = 0.12 (from regression (3)).
    - Example: a 0.06 increase in the subsidiary country effective tax rate raises subsidiary leverage by 0.4 percent via the international effect (for a hypothetical multinational with a single foreign subsidiary of equal asset size to the parent).
    - Total effect of a 0.06 increase in the subsidiary effective tax rate: 1.5 percent increase in subsidiary leverage (1.1% domestic + 0.4% international).
    - By contrast, an increase in the parent country effective tax rate of 0.06 has a negative international effect on subsidiary leverage of -1.5 percent.
- Magnitude and statistical significance:
  - Both domestic and international effects are statistically highly significant but quantitatively small.
  - Results are robust across many specifications and subsamples (manufacturing, foreign subsidiaries only, exclusion of loss-making firms, exclusion of Eastern Europe, controls for firm-specific risk, alternative financial-development controls, clustered standard errors).
  - Instrumental-variables checks (using populations of subsidiary and parent countries as instruments) yield similar results; first-stage indicates effective tax rates tend to be higher in more populous countries.
- Source vs. residence taxation and withholding taxes:
  - Source‑level taxation (taxation in the country where the subsidiary operates) appears more important in affecting leverage than residence‑level taxation levied by the parent country; parent-country taxes can often be deferred.
  - Corporate tax rates matter for leverage, whereas nonresident dividend withholding tax rates appear not to matter empirically.
    - Interpretation: withholding taxes may be avoidable in practice via triangular arbitrage using conduit companies in third countries.

### Interpretation and mechanisms
- International debt‑shifting operates multilateraly:
  - Debt‑shifting reflects a subsidiary’s tax differences vis‑à‑vis the parent firm and vis‑à‑vis other foreign subsidiaries.
  - This supports the thesis that multilateral—rather than purely bilateral—differences in tax rates determine multinational capital structure adjustments.
- Economic incidence and welfare:
  - International debt‑shifting lowers average corporate income taxation in high‑tax countries (shifting debt out lowers taxable profits there).
  - Low‑tax countries may benefit from international debt‑shifting because local establishments will be less leveraged than otherwise, potentially raising corporate income tax revenues in those countries.
  - Debt‑shifting introduces dead-weight losses in the form of:
    - Implementation costs for multinationals undertaking tax planning.
    - Costs from deviations from the firm’s optimal financial structure based on nontax considerations.

### Policy implications and recommendations
- Two obvious ways to eliminate international debt‑shifting:
  - Harmonize top corporate income tax rates internationally.
  - Introduce a common, consolidated tax base for multinational firms.
- Practical outlook:
  - Tax coordination of either kind is unlikely in the near future; therefore, international debt‑shifting will remain an important consideration for multinationals and policymakers.

*Source: _wp0739 - conclusions.*

### Appendix Table 1. Variable De

### Appendix Table 1. Variable Definitions and Data Sources

### Variable definitions and data sources
- Financial leverage  
  - Definition: Ratio of total liabilities to total assets  
  - Source: Amadeus

- Adjusted financial leverage  
  - Definition: Ratio of total liabilities minus accounts payable minus cash to assets minus accounts payable minus cash  
  - Source: Amadeus

- Effective marginal tax rate  
  - Definition: Statutory tax rate on dividend income taking into account withholding taxes and international tax system  
  - Source: International Bureau of Fiscal Documentation and various ministries

- Tax incentive to shift debt  
  - Definition: Sum of international tax differences weighed by local asset shares taking into account withholding taxes and international tax system  
  - Source: International Bureau of Fiscal Documentation and various ministries

- Relative tax of equity and debt  
  - Definition: Statutory tax rate on dividend income minus statutory tax rate on interest income taking into account withholding taxes and international tax system  
  - Source: International Bureau of Fiscal Documentation and various ministries

- Tangibility  
  - Definition: Ratio of fixed assets to total assets  
  - Source: Amadeus

- Log of sales  
  - Definition: Logarithm of sales  
  - Source: Amadeus

- Profitability  
  - Definition: Ratio of earnings before interest, taxes, depreciation and amortization to total assets  
  - Source: Amadeus

- Intermediate  
  - Definition: Dummy variable flagging subsidiary firm that is also parent firm  
  - Source: Amadeus

- Creditor rights  
  - Definition: Annual index of credit rights in the country  
  - Source: Djankov et al. (2005)

- Political risk  
  - Definition: Annual (December) index of political risk. On a scale from 0-100 with higher scores indicating greater risk  
  - Source: International Country Risk Guide

- Inflation  
  - Definition: Annual percentage change in the CPI  
  - Source: World Development Indicators

- Growth opportunities  
  - Definition: Median of the annual growth rate of sales per country and industry.  
  - Source: Amadeus

- Volatility of profits  
  - Definition: Standard deviation of the firm’s ratio of earnings before interest, taxes, depreciation and amortization (EBITDA) to total assets over the period 1994-2003  
  - Source: Amadeus

- Private credit to GDP  
  - Definition: Ratio of credit to the private sector to GDP  
  - Source: World Development Indicators

*Appendix Table 1. Variable Definitions and Data Sources.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2007/_wp0739.pdf_