Oxford University Centre for Business Taxation
The effects of tax on business
How do taxes affect the location of international mergers and acquisitions?
The growth of international cross-border mergers and acquisitions over the last two decades is well documented. The percentage of all mergers and acquisitions accounted for by cross-border deals rose from 23% in 1998 to 45% in 2007. And the percentage of all foreign direct investment that took the form of cross-border mergers and acquisitions rose from 14% in 1991 to over 50% by 1999. This research examines one aspect of the determination of mergers and acquisitions: the choice of international location of the target company by an acquirer, and in particular, the role of tax in that choice. We show that, in principle, a higher tax rate in the target’s country could make an acquisition there more likely, less likely, or have no effect at all.
This research uses firm-level data combining financial and ownership data for companies in 2005 with domestic and cross-border acquisitions between 2006 and 2008 to analyse the determinants of choices made by 2,623 acquiring corporations from 47 countries across 19 possible locations of domestic and cross-border target corporations. We take into account other important factors determining M&A activity, and also allow for the effects of taxation to differ depending on circumstances of the acquirer and target.
We find that the statutory tax rate in the target country has a negative impact on the probability of an acquisition in that country, with an average elasticity of around 1 – that is, a one percent reduction in the tax rate would imply approximately a 1 percent increase in the probability of a domestic company being acquired by a foreign acquirer. The size of the effect differs (i) between acquirers that were multinational or domestic in 2005; (ii) between domestic and cross-border acquisitions; and (iii) depending on whether the acquirer’s country has a worldwide or territorial tax system.
Do tax burdens depend on whether companies are resident in worldwide or territorial countries?
Since Japan and the UK adopted a territorial system in 2009, the US is the only remaining major country with worldwide system that aims to tax fully foreign source income. This issue is the subject of lively debate in the US, with some arguing for a territorial system while others demand the abolition of deferral to strengthen the US system. One important piece of evidence needed in this debate is the extent to which companies headquartered in countries with worldwide systems systematically face higher tax burdens than those in countries with exemption systems.
This research project addresses this question using consolidated firm-level accounting data for about 3,400 companies in 15 OECD countries between 2003 and 2007 (when the UK and Japan had worldwide systems). The research estimates a marginal effective tax rate (METR) which measures the average rise in the tax liability as a result of an extra £1 of profit in the financial report. The results present clear evidence that this METR was significantly higher for companies headquartered in countries that had a worldwide system.
However, there were other differences in taxes between the countries considered, notably in statutory tax rates. To take account of differences in tax rates, we also estimate a marginal effective tax base (METB) that measures the increase in taxable profit resulting from an extra £1 of profit declared in the financial report. In effect this measure controls for differences in tax rates and therefore permits an assessment of the underlying system independently of the rate. The results are again striking; there is no significant difference in the METB across countries. This indicates strongly that differences in the METR between countries are due primarily to differences in statutory tax rates, rather than in the treatment of foreign income.
This project also investigates the use of tax havens in affecting aggregate tax liabilities. It questions whether having a presence in a tax haven tends to reduce the aggregate tax liability of a company; and more specifically, whether this effect differs according to whether the company is headquartered in a country with a worldwide or territorial system. Consistent with greater opportunities for tax planning, the results suggest that presence in a tax haven reduces the METR and the METB more for companies headquartered in countries with territorial systems.
Corporate Taxation and Capital Accumulation
This research project studies the impact of corporate taxation on investment and capital accumulation. This relationship is central to any evaluation of the effects, and welfare implications, of fiscal incentives that are intended to stimulate private sector investment, such as enhanced capital allowances (accelerated depreciation), an Allowance for Corporate Equity, or a reduction in the statutory corporate income tax rate. We use sectoral data for the USA, Japan, Australia and ten EU countries over the period 1982-2007, which combines data on capital stocks, value-added and relative prices with measures of effective corporate tax rates. Our main findings suggest large effects of tax incentives on long-run capital accumulation. We find broadly similar effects when we decompose the variation in the cost of capital into its tax and non-tax components, so that these results are not simply driven by trends in the relative price of capital goods.
Earnings shocks and tax-motivated income-shifting: evidence from European multinationals
Differences in corporate tax rates across countries create opportunities for tax arbitrage by multinational companies. But identifying the existence and magnitude of such tax-motivated profit shifting is fraught with difficulty. Most studies rely on measuring the effect of variation in corporate tax rates on the profitability of affiliates. This research instead exploits shocks to earnings in the parent firm and analyses how these shocks propagate across the affiliates of a multinational group. Specifically, it assesses the shifting of exogenous earnings shocks to low-tax subsidiaries, relative to high-tax subsidiaries. The study exploits a large European micro dataset which provides detailed accounting and ownership information on 1.6 million firms. The results show strong support for the profit shifting hypothesis. While the effect of earnings shocks at the parent firm on the income of high-tax affiliates is indistinguishable from zero, we find a significantly positive impact on the income of low-tax affiliates. Quantitatively, the estimates suggest that at the margin around 2% of additional parent earnings are shifted to low-tax subsidiaries.