1. Egger, Merlo, Ruf, Wamser: Consequences of the New UK Tax Exemption System: Evidence from Micro-level Data ITPF 2014 Washington

2. Introduction  When shaping international tax systems the core decisions is: Should foreign income be taxed at home? (Exemption vs. credit)  Almost all countries (Germany, France, …) exempt foreign income from domestic taxation. Only exception: US  Under an exemption system there is a tax incentive for investors to invest too much in low tax countries. Using a tax credit system this tax incentive disappears, resulting in a efficient worldwide allocation of capital (Musgrave 1969).  New economic argument (Desai and Hines 2003): This is different for international mergers and acquisitions. Repatriation taxes may result in inefficient ownership structures. Still controversial, see Devereux, Fuest and Lockwood (2013).

3. Motivation  Should the US switch to exemption also (Camp proposal)?  How relevant is the domestic taxation of foreign profits empirically with respect to repatriations and foreign direct investment?  Two major countries in 2009 switched from tax credit to exemption: Japan and the UK  This gives ideal conditions for identifying reform effects.

4. First and Second Research Question  Did foreign UK subs repatriate more dividends following the UK switch from exemption to credit in 2009?  Foreign UK subs repatriated 2 mio US-$ dividends more because of the reform resulting in an average dividend payment of 8 mio US-$ in 2009  No effect in 2010  Did foreign UK subs invest more/less abroad following the UK switch from exemption to credit in 2009?  3 mio US-$ less investment in fixed assets per sub resulting in zero investment abroad in 2009  No effect in 2010

5. Roadmap  Expected economic effects of the 2009 UK tax reform  Empirical Approach: Data and econometrics  Results: Repatriations and investment  Conclusion

6. Expected Effects of the 2009 UK Tax Reform  When shaping international tax systems the core decisions is: Should foreign income be subject to tax at home? (Exemption vs. credit) Irish Sub UK mum Before 2009 After 2009 Irish Sub UK mum Dividend 17 % tax0 % tax

7. Expected Effects of the 2009 UK Tax Reform  As a consequence of the reform one should expect increased dividend repatriations.  Counterintuitively this is wrong: Firms do not choose between a world pre and post reform.  Instead they choose between (1) repatriating and investing at home or (2) investing abroad and repatriating tomorrow given a certain tax system.  For such a decision repatriation taxes do not matter, since they have to be paid anyway (Hartmann 1984). Repatriate Pay repatriation tax today Invest at home Invest abroad Repatriate tomorrow Pay repatriation tax tomorrow Choice 1 Choice 2

8. Expected Effects of the 2009 UK Tax Reform  This was different under the tax holiday provided by the Homeland Investment Act.  US firms in 2004 choose between either  For such a decision repatriation taxes do matter (temporary vs. permanent changes). Choice 1 Choice 2

9. Expected Effects of the 2009 UK Tax Reform  UK tax reform: Following Hartman (1984) the reform should not matter for repatriations  But: Real world complexities may change the picture (Foley et al. (2007))  E.g. the repatriation tax today is certain, the repatriation tax tomorrow is not firms tend to postpone repatriation.  There is an announcement effect. Firms in 2007 decide between either  Firms may postpone their repatriation of 2007 and 2008 to 2009. Choice 2 Choice 1

10. Empirical Approach: Data  Amadeus database provided by Bureau van Dijk  In principle should contain all financial statements of European firms on a unconsolidated basis Consolidated financial statement Dividend Unconsolidated financial statement

11. Empirical Approach: Data  Important, since unconsolidated financial statements of e.g. a German corporation contains only the assets of this German corporation  On the contrary consolidated financial statements of multinationals contain all their worldwide assets, including the assets of any other foreign group member  Data on 61,738 European affiliates of multinationals.  Since dividends are not directly observable in the data, we approximate them based on the equity positions of firms.

12.  Despite the reform, dividend payments by foreign UK subs decreased in 2009 as they did for non UK subs.  Taxation is obviously not the only driver of dividend payments.  First intuitive research tool: Descriptive statistic for dividend payments no reform effect.  However, other factors driving repatriation decisions could dominate the reform effect. Empirical Approach: Data

13. Empirical Approach: Econometrics  Isolate the reform effect – or wow would foreign UK subs have behaved without the reform?  Basic problem of social sciences: We do not have laboratory conditions - we can not observe the same firm twice.  Propensity Score Matching: Attempt to approximate such laboratory conditions.  For each UK owned foreign sub find a very similar non UK owned foreign sub.  Estimate the likelihood of being a UK sub for each firm (Selection equation)  Match each foreign UK sub with a non UK sub having a similar probability for being UK owned two identical subs besides for one being UK owned and the other not.  Comparison of these subs allows to isolate the effect of the UK tax reform 2009.

14. Results  Foreign UK owned subs pay in 2009 2.15 Mio US-$ more dividends than otherwise equal non UK owned subs: Reform effect.  Doing the same exercise for 2010, we find no effect.  This points to announcement effects being the main driver of the observed reform effect. 2.15 Mio US-$

15. Results  The UK corporate tax rate in 2009 is 28 % only.  For many foreign subs in countries having higher corporate tax rates (such as the US) the 2009 reform does not matter.  Do we observe this in the data?

16. Results: Investment  Which effect should the switch from credit to exemption in the UK in 2009 have on FDI?  We investigate the reform effect on fixed assets of UK owned foreign subs No Repatriation Tax FDI is more attractive More new equity abroad? Paying Dividends Balance sheet total Fixed Assets?

17. Results: Investment  Foreign UK owned subs in 2009 invested 3.05 US-$ less than otherwise equal non UK owned subs: Reform effect.  Doing the same exercise for 2010, we find no effect.  Cash reductions because of dividend payments results in less fixed assets.  There still may be positive effects on UK FDI from 2011 onwards. 3.05 Mio US-$

18. Results: Robustness  Include additional affiliate-specific regressors post matching.  Only control subs owned either by mums from exemption or credit countries only.  Consider only multinationals groups having a certain number of affiliates

19. Conclusion  We find a rather moderate effect of the UK switch from tax credit to exemption in 2009 on repatriations in 2009 only.  UK switch is permanent (US tax holiday was temporary)  UK tax rate is comparatively low  UK FDI in terms of fixed assets in 2009 decreases.  Less financial means available due to repatriations  We are not able to evaluate long run effects of the reform on UK FDI.