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The Indirect Side of Direct Investment

The Indirect Side of Direct Investment: Multinational Company Finance and Taxation

Jack M. Mintz
Alfons J. Weichenrieder
Copyright Date: 2010
Published by: MIT Press
Pages: 208
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  • Book Info
    The Indirect Side of Direct Investment
    Book Description:

    The recent increase in cross-border flows of foreign direct investment has sharpened the research focus on multinational taxation. In this book, taxation experts Jack Mintz and Alfons Weichenrieder examine how multinational corporations use indirect financing structures--organizing themselves into groups with several tiers of ownership--to reduce worldwide taxes. They spell out in detail how different tax policies affect corporations' choice of financing structures, discussing the issues in both theoretical and empirical terms. Drawing on a unique data set (MiDi) on German multinationals provided by the Deutsche Bundesbank in Frankfurt, Mintz and Weichenrieder confirm the prevalence of indirect financing structures for both outbound and inbound German investment. They find evidence of "treaty shopping" to avoid withholding taxes (using a third country with more favorable tax rates as a conduit through which to route investments) and of "debt shifting." Mintz and Weichenrieder argue that increasing our knowledge of the tax reasons behind conduit investment will lead to a better understanding of how tax policy can affect macroeconomic flows of capital in the global economy. They review the trade-offs that governments face and discuss policy options, considering not only possible changes to corporate income tax policy but also the potential influence of international cooperation on countries' domestic tax policy.

    eISBN: 978-0-262-28965-8
    Subjects: Finance, Business

Table of Contents

  1. Front Matter
    (pp. i-iv)
  2. Table of Contents
    (pp. v-vi)
  3. Series Foreword
    (pp. vii-viii)

    This volume is part of the CESifo Book Series. Each book in the series aims to cover a topical policy issue in economics. The monographs reflect the research agenda of the Ifo Institute for Economic Research and they are typically ʺtandem projectsʺ where internationally renowned economists from the CESifo network cooperate with Ifo researchers. The monographs have been anonymously refereed and revised after being presented and discussed at several workshops hosted by the Ifo Institute....

  4. Acknowledgments
    (pp. ix-x)
  5. 1 Introduction
    (pp. 1-12)

    International taxation is a highly complex subject. For an expert, it is a challenge just to understand the domestic tax system, never mind the meshing of several tax systems at the international level. Although multinational taxation has been studied for decades, including seminal work on foreign direct investment by Hartman (1980), Horst (1971, 1977), and Musgrave (1969), much greater research focus in recent years has been directed at multinational taxation, in part reflecting the demonstrative increase in cross-border flows of foreign direct investment.¹ Numerous researchers have examined the interrelationship between taxation and multinational decision making. While much research has concentrated...

  6. 2 International Corporate Tax Systems at a Glance
    (pp. 13-42)

    International corporate taxation is focused on the treatment of outbound and inbound cross-border investments. Given the interaction of national taxes worldwide, the description of international tax systems can be highly complex. Special rules, regulations, and concepts, such as controlled foreign company legislation, passive income, interest allocation, excess and deficient tax credits, deferral, per-country limitation, and thin-capitalization legislation, to name only a few, make it hard for new entrants to get an easy grasp of the field. The complexity of international tax systems is not accidental. Cross-border investment has to cope with at least two jurisdictions and tax systems. Therefore, conflict...

  7. 3 Indirect Financing Structures
    (pp. 43-62)

    The literature on foreign direct investment (FDI) has identified an ample set of financing structures that may be used by a parent company in one country to finance its subsidiary in another country. These financing arrangements are widely understood in those cases that we call ʺdirectʺ financing structures:¹ a parent corporation finances investments in foreign locations by directly holding a foreign affiliate, choosing to put debt into the parent or subsidiary facing the highest tax rate and shifting income to the entity with the lowest tax rate. Conversely, ʺindirectʺ structures imply that a multinational parent will take advantage of another...

  8. 4 Holding Companies and Ownership Chains
    (pp. 63-110)

    The pervasive economic model of foreign direct investment is one where a parent company in one country holds a production or sales company in another country. At the same time, as we have pointed out in the last chapter, investment strategies are often much more involved and imply not only the existence of several foreign subsidiaries but often quite complicated ownership chains. In this chapter we will empirically identify the scope and the factors behind those more complicated structures.

    A frequent instrument is the setup of holding companies. A first type of holding company may be termed a ʺcountry holding.ʺ...

  9. 5 The Financial Structure of German Outbound FDI
    (pp. 111-126)

    The extent to which taxes influence the financial structure of firms has been subject to debate. In theory, high corporate tax rates invite firms to finance their investment with debt since interest expenses, often unadjusted for inflation, are deductible from corporate taxable income, thereby sheltering income from tax (often referred to as a ʺtax shieldʺ). Until recent years, empirical evidence showing the dependency of financing structures was often lacking, prompting Myers (1984) to raise doubt if there would ever be such evidence.¹

    However, in the past decade and a half several studies of corporations in a domestic context have been...

  10. 6 What Governments May Do: Policy Options
    (pp. 127-156)

    The theoretical and empirical work of the previous chapters suggests that taxes have an impact on financial decisions of German multinationals, leading to tax arbitrage to lower worldwide tax rates. First, differences in corporate income tax rates across jurisdictions impact financing structures of multinationals by encouraging companies to shift income from high to low tax rate countries. Second, tax-efficient structures using conduit entities enable businesses to reduce withholding taxes (ʺtreaty-shoppingʺ) or to claim two or more deductions for interest expense (leasing or other types of expenditures deductible from corporate income), thereby reducing the worldwide tax paid by multinationals and providing...

  11. Appendix: Historic Statutory Corporate Income Tax Rates, 1985–2007
    (pp. 157-162)
  12. Notes
    (pp. 163-172)
  13. References
    (pp. 173-180)
  14. Index
    (pp. 181-192)