“Basket cases”: Tax incentives and international joint venture participation by American multinational firms

Abstract

This paper examines the impact of the U.S. Tax Reform Act of 1986 (TRA) on international joint ventures by American firms. The TRA mandates the use of separate “baskets” in calculating foreign tax credits on dividends received from each foreign corporation owned 50% or less by Americans – which greatly reduces the attractiveness of joint ventures, especially those in low-tax foreign countries. Since the effect of the TRA on joint ventures varies with foreign tax rates, the country-level pattern of subsequent joint venture activity illustrates the sensitivity of organizational form to tax considerations. The evidence indicates that American participation in international joint ventures fell sharply after 1986, particularly in low-tax countries. Moreover, joint ventures in low-tax countries use more debt and pay greater royalties to their American parents after 1986, reflecting their incentives to economize on dividend payments.