Form Follows Function? Evidence on Tax Savings by Multinational Holding Structures

Form follows function is a principle usually associated with modern architecture and industrial design. According to that principle, the shape of a building or an object should be primarily based on its intended function or purpose. This article analyzes the extent to which the form of multinational groups follows the function of minimizing tax payments.

The paper provides evidence on the group structures of multinationals and analyzes to what extent these structures are tax-efficient. Therefore, the kind of architecture traced in this paper refers to the structuring of multinational groups. While the corporate income tax can hardly be avoided if a subsidiary is active in a country, withholding taxes depend on the structure in which the subsidiary is embedded. By vertically inserting holding companies or adjusting the superior/subordinate relationship of subsidiaries, multinationals can often influence their total tax burden, especially regarding the repatriation of profits by means of dividends. The paper traces group structures on a micro level across 58 countries in the years 1996 to 2008.

The results show that a higher withholding tax between two members of a group located in different countries increases the probability of indirect participation. Put differently, holdings are generally established at positions of the group structure where they can at least potentially cause savings in withholding taxes. Operative subsidiaries tend to be held via subsidiaries located in countries with low withholding taxes towards the country of the superior foreign-based company unit. However, in about half of the observations, the existence of an intermediate subsidiary does not lower the overall tax burden, and in 5% of the cases the tax burden on repatriated profits with such a holding company is even higher than without it. Although group structures generally seem to be tax driven, there are non-tax influencing factors which sometimes prevail. Apart from drivers of the vertical company structure, the paper shows a horizontal driver: once a form of group taxation is available, groups seem to spread their national investments across more subsidiaries.

Taxes do matter for the group structure, but given other influencing factors and especially given the need for hierarchical clarity, their influence has limits. Form follows function holds, but this paper reveals that the function goes beyond saving withholding taxes or netting profits and losses. Multinationals aim at saving taxes by holding structures, but in the setup of their business structure, they remain – maybe irrationally – sovereign. In architecture and multinational groups alike, the credo seems to be that as you are, so are your buildings and as are your buildings, so are you.

Dreßler, Daniel (2012), Form Follows Function? Evidence on Tax Savings by Multinational Holding Structures, ZEW Discussion Paper No. 12-057, Mannheim.