The effects of imputation tax systems on multinationals' investment, financing and tax-accounting strategies

The United States is one of a few remaining countries to tax distributed corporate earnings twice--once at the corporate level, and again at the individual level. In contrast, many other countries have adopted imputation systems which alleviate this double tax. Imputation tax systems work by refunding domestic corporate taxes through dividend tax credits. To ensure that corporate taxes fully fund dividend tax credits, all dividends determined to exceed a corporation's fully-taxed domestic income do not qualify for tax credits. Consequently, foreign-source income, which is often relieved from domestic corporate taxation, is generally disqualified from eligibility for dividend tax credits. This paper focuses on how this discriminatory tax treatment of foreign earnings distributions inherent in imputation systems affects multinational behavior.;The paper develops a model based in optimal control theory to derive the optimal dynamic investment, financing and cross-jurisdictional income shifting incentives of imputation-based multinationals. The model indicates that imputation systems encourage multinationals to restrict their equity stakes in new foreign investments, and ultimately, to expand their domestic investments. The paper also investigates foreign affiliate debt, cross-jurisdictional income shifting, mergers and acquisitions as ways to circumvent the statutory restrictions on dividend tax credits. The results reveal that imputation systems create incentives for multinationals to highly lever their foreign operations, use internal debt over internal equity finance, shift foreign-taxable income into their home jurisdictions, and to merge with or acquire purely-domestic and/or non-resident-owned firms.;These results have significant implications for U.S. and international tax policy and tax planning. Specifically, they may provide an explanation for the usually low taxable-income of foreign-controlled, U.S. corporations. They also provide insight into how a U.S. adoption of an imputation system, as proposed in 1993 by the American Institute of Public Certified Accountants, or the dividend exclusion method, as proposed in 1992 by U.S. Treasury, would affect the activities of U.S. multinationals. The results also complement the accounting and public finance literature which investigates the interdependence between financial and tax-accounting decisions in international accounting regimes.