An Empirical Investigation of the Effect of Imputation Credits on Remittance of Overseas Dividends

Abstract

Overseas dividend remittance is an important vehicle for multinational corporations (MNCs) to move funds among their global subsidiaries. Concerns that residence-based (e.g., U.S.) and territorial (e.g., European countries) tax systems distort dividend repatriations decisions have led countries such as Taiwan to adopt an imputation system. Under this system, double taxation is avoided through a credit for income tax paid at the corporate level to offset shareholders' personal tax. Using firm-level data from 2001-2004 for Taiwan-based MNCs with subsidiaries in China, this paper provides empirical evidence on the effect of imputation credits on overseas dividend remittances. We find that imputation credits have a positive effect on increasing foreign dividend payouts, thereby improving the efficiency loss induced by the tax cost for within-firm dividends. We also document evidence that parent companies' net fund flows from related-party transactions with their subsidiaries are negatively correlated with dividends repatriated from those affiliates, supporting the notion that transfer-pricing may be substituting for within-firm dividend remittance. Our results contribute to understanding the links between taxation and subsidiary dividend repatriation decisions that in turn is important for evaluating the effect of dividend taxes on the cost of capital.