International Taxation of Equity Returns An imbroglio of tax laws and the MacDougall Model

Distinction between debt returns and equity returns In most tax structures taxes are levied only on returns on equity. Therefore: –Debt financing is favorable in high-tax environments –Equity financing is favorable in low-tax environments

Host Government Tax Policies FIRST!!! Host country takes first crack –Investor direct rate of return Foreign rate of return * (1-foreign tax rate) Withholding Taxes –Penalty for parent paying

Home Government Tax Policies Policy considerations –Treatment of foreign income and foreign taxes paid Exemption Tax crediting Deduction Double tax –Taxation timing

Assessment of International Tax Policy and Management The dichotomy of interest between host and home countries

Fundamentals Maximize profits by avoiding taxes Equity taxed by host Debt taxed by home

The MacDougall Model of International Capital Flows Fixed supply of capital (k) Downward sloping marginal product of capital (MPK) Real interest rate GDP

Maximum Global Capital Welfare Tax Neutrality –Capital export neutrality violation OO* r r R(1-t) K”K’K R* MPK MPK(1-t) MPK* R* B C D A Taxes Collecte d Loss of World Welfare

The Worldwide Principle –Capital export neutrality corrected OO* r r R(1-t) K’K R* MPK MPK(1-t) MPK* R* B CD A MPK*(1-t) R*(1-t) Total Home Taxes

Capital Import Neutrality –Import neutrality holds OO* r r R(1-t) K”K’K R* MPK MPK(1-t) MPK* R* B C D A

Capital Import Neutrality –Import neutrality does not hold OO* r r K’K R* MPK MPK(1-t) MPK* R* B CD A MPK*(1-t) R*(1-t) K”

Evident Points Dependence of neutrality One or the other Neutrality perfect system