Taxes and the division of foreign operating income among royalties, interest, dividends and retained earnings

How do taxes influence the way U.S. corporations divide foreign affiliate operating income among royalties, dividends, interest, and retained earnings? The paper goes beyond previous work that focused largely on dividend repatriation behavior, and provides a comprehensive analysis of the disposition of foreign subsidiary operating income. The empirical results show that taxes have a large and statistically significant effect on the composition of payments. Own tax prices discourage the payment of dividends, royalties and interest. But dividend and other repatriation taxes do not increase retained earnings, they only alter the composition of payments. The results are, therefore, consistent with a generalized Hartman-Sinn model of the mature controlled foreign corporation that has various alternative repatriation vehicles. Finally, this paper integrates the choice of payments with income shifting among countries because the latter maybe part of a low-tax strategy for repatriations. In this general framework, conventional composite tax prices are not appropriate because the response to a change in a composite tax price depends on which components changed. (C) 1998 Elsevier Science S.A.