Debt and Taxes: Evidence from Foreign versus Domestic Subsidiaries in an Emerging Market

Abstract

AbstractForeign subsidiaries in Korea operate under a classical system where double taxation of corporate and personal income provides interest tax shields, while domestic subsidiaries are under an imputation system where preference for debt is largely eliminated. We find that foreign subsidiaries’ overall leverage is not higher than domestic subsidiaries, while the former's internal leverage is higher than the latter's. Moreover, foreign subsidiaries with excess foreign tax credit use more internal debt when home corporate tax rate is low. These findings suggest that taxes have a first order impact on internal debt when parent companies hold both debt and equity, but not on external debt.