Discussion of Foreign Tax Credit Limitations and Preferred Stock Issuances

Abstract

In this paper, Professors Collins and Shackelford examine whether the financing decisions of U.S. multinational firms were influenced by interest allocation rules enacted in the Tax Reform Act of 1986 and intended to reduce the foreign tax credits available to such firms. In particular, the authors predict that firms with excess foreign tax credits will shift toward debtlike financing instruments (i.e., preferred stock) that do not negatively affect the foreign tax credit limitation calculation. The authors present results that provide evidence that firms likely to be affected by the new interest allocation rules (large U.S. multinational firms) did increase their issuances of preferred stock after the passage of the Tax Reform Act of 1986. The authors provide two motivations for their study. First, from a tax policy perspective, the study provides evidence that recent U.S. multinational tax law changes increased the capital acquisition costs of U.S. firms. Much debate over U.S. foreign tax policy has centered on the impact of current laws on the international competitiveness of U.S. firms, in particular, their costs of capital (see Joint Committee on Taxation [1991]). To the extent this study documents that recent tax law changes have increased the cost of capital of U.S. multinationals, it contributes to a potential redesign of international tax policy.1