The effect of foreign dividend exemption on profit repatriation through dividends, royalties, and interest: evidence from Japan

Abstract

Multinational corporations repatriate foreign profits through dividends, royalties, and interest paid by foreign affiliates to their parent firms. International tax rules that govern the taxation of repatriated foreign earnings thus influence decisions on profit repatriation. In 2009, Japan introduced a foreign dividend exemption system (the so-called territorial tax system) that exempted dividends received by Japanese firms from their foreign affiliates from home-country taxation. This paper examines the effects of this tax reform on profit repatriation through dividends, royalties, and interest. The enactment of the foreign dividend exemption system reduced the effective tax rate on foreign income repatriated through dividends by an average of 6.8 percentage points in 2009. We find that, in response to this tax rate reduction, Japanese-owned foreign affiliates increased dividend payments but did not alter royalty or interest payments. As a result, these affiliates increased total payments to their Japanese parents.