The Effect of a Worldwide Tax System on Tax Management of Foreign Subsidiaries

Abstract

Under a worldwide tax system, firms pay taxes on their domestic income and repatriated foreign income, whereas under a territorial tax system repatriated foreign income is exempt from taxation. We examine whether worldwide tax systems reduce the incentives of multinational corporations to engage in tax management in their foreign subsidiaries. Using two quasi-natural experiments, we show that multinationals lower the effective tax rates in their foreign subsidiaries after countries switch from a worldwide to a territorial tax system. Thus, multinationals subject to a worldwide tax system face competitive disadvantages compared to competitors from countries with a territorial tax system.

Keywords: cross-border investments; foreign subsidiaries; dividend repatriation; tax avoidance; territorial tax system; worldwide tax system

JEL Classification: H20; H25; H26; H32