Trade Credit and Taxes

Mihir A Desai,C Fritz Foley,James R Hines

doi:10.1162/rest_a_00534

Mihir A Desai, C Fritz Foley + Show 1 more

Open Access

https://doi.org/10.1162/rest_a_00534

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Abstract

Abstract This paper analyzes the extent to which tax differences affect the use of trade credit. U.S.-owned affiliates in low-tax countries use trade credit to lend, whereas those in high-tax countries use trade credit to borrow: 10% lower local tax rates are associated with net trade credit positions that are 1.4% higher as a fraction of sales. The use of trade credit to get capital out of low-tax, low-return environments is also illustrated by the temporary repatriation tax holiday in 2005, which was used most intensively by affiliates with positive net trade credit positions.

Highlights

BUSINESS transactions are commonly conducted on the basis of credit, as a result of which a seller does not receive cash but instead the promise of a future payment, which it records as an account receivable, and a buyer incurs an obligation, which it records as an account payable
Petersen and Rajan (1997) note that lower-income firms, despite their limited liquidity and high monitoring costs, are more likely than others to lend to unrelated parties via trade credit
One reason may be that lower-income firms, with their greater likelihood of tax losses, in expectation face lower marginal tax rates than others and might find it profitable to use trade credit to reallocate capital to firms with higher tax rates and higher pretax marginal products of capital