Effects of Territorial and Worldwide Corporation Tax Systems on Outbound M&As

The United States (U.S.) is the last major economy to impose repatriation taxes on international FDI activities. If earnings from foreign subsidiaries are repatriated, the U.S. taxes the dividend at the domestic corporate tax rate of 35 % (plus state taxes), while granting a tax credit for foreign taxes already paid on the profits underlying the dividends (tax credit system). In contrast, all other important economies refrain from imposing such taxes (exemption system).

Repatriation taxes to be paid on a target's profits following international mergers and acquisitions reduce the discounted future cash flows to the investor, which results in a lower valuation of the target and a lower bid price compared to an identical investor from an exemption country. Investors from the U.S. should thus less frequently succeed in acquiring targets. In this paper, we empirically investigate if a foreign tax credit system indeed impedes foreign acquisitions and quantify the implied loss in efficiency.

In 2009, the U.K. and Japan switched from credit to exemption. This is the first time that two major capital exporting economies fundamentally changed their international taxation regimes, which provides us with a very promising quasi-natural experiment to identify the effect of repatriation taxes on international mergers and acquisitions.

We analyze a large sample of cross-border mergers and acquisitions with acquirers from 20 OECD member states in the period from 2004 to 2010. For every target firm, we estimate the probability to observe an acquirer from each of the eventual acquirer-countries in order to infer how the probability to observe an acquirer from the U.K. and Japan changed due to the introduction of the exemption system.

We find empirical evidence for repatriation taxes reducing the competitiveness of investors from tax credit countries in the international market for corporate control. The economic importance of this effect depends on the level of the domestic profit tax rate in place. The larger the domestic profit tax rate, the larger the repatriation taxes due. Since the Japanese profit tax rate (40.69 %) in 2009 is higher than the U.K. profit tax rate (28 %), the reform effect is more pronounced for Japan than for the U.K. We estimate the Japanese 2009 abolishment of the tax credit system to have increased the number of international mergers and acquisitions with a Japanese acquirer by 31.9 %. The estimated effect for the U.K. is only 3.9 %. We finally simulate a U.S. switch from credit to exemption. According to our results, such a reform of the U.S. international tax system would increase the number of international mergers and acquisitions with U.S. acquirers by 17.1 %.

Feld, Lars, Martin Ruf, Uwe Scheuering, Ulrich Schreiber and Johannes Voget (2013), Effects of Territorial and Worldwide Corporation Tax Systems on Outbound M&As, ZEW Discussion Paper No. 13-088, Mannheim.