Development and Effectiveness of Controlled-Foreign-Company Rules : Empirical evidence from European multinational companies
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This thesis studies the development of CFC rules and assesses the effect that CFC rules have on capital structure decisions of MNCs. CFC rules are an anti-taxavoidance measure that aims to prevent profit shifting. If CFC rules are applied, income of a foreign affiliate is added to the tax base of the parent and, therefore, taxed at the tax rate of the parent’s country of residence. First, we review the development of CFC regimes in Europe, the US, and Canada (2000 - 2015). Second, we create a panel data set of European companies with parents headquartered in Europe, the US, or Canada (2004 - 2015). This data set, which contains financial and historical ownership data that is obtained from Amadeus and Orbis databases, respectively, is further used in econometric analysis. Our empirical analysis suggests that a parent country’s CFC rules have a negative effect on an affiliate’s total debt-to-asset ratio and an increase in the strictness of CFC rules is associated with a further decrease in leverage. These findings also hold when we control for thin-capitalization rules and transfer pricing rules. Therefore, it can be argued that CFC rules make internal lending as a profit shifting channel less attractive for MNCs. Furthermore, the results suggest that also thin-capitalization rules and transfer pricing rules are effective in limiting profit shifting activities by European MNCs. We find that since 2006, when the European Court of Justice issued a landmark decision in the Cadbury-Schweppes (C-196/04) case, the negative effect of CFC rules on an affiliate’s leverage has weakened. Nevertheless, we argue that the role of CFC rules in corporate decision making should not be disregarded.