DEBT SHIFTING RESTRICTIONS AND REAL REALLOCATION OF DEBT

This paper analyses debt reallocation of multinational firms in response to the UK 2010 worldwide debt cap reform, which restricted interest deducibility of UK subsidiaries affiliated to multinationals. We find that firms that were affected by the debt cap reduce the tested debt ratios, i.e. net UK debt over group worldwide debt. Further, multinationals headquartered in the UK reduce the level of the UK net debt without changing their worldwide debt holdings, while foreign headquartered multinationals increase their worldwide debt holdings. Consistent with the tax-motivated debt shifting hypothesis, we find that affected multinationals increase debt ratios in non-UK subsidiaries after the reform, and this increase is more pronounced in subsidiaries located in higher tax countries. Affected multinationals increase the fraction of subsidiaries located in high tax countries but reduce the fraction of subsidiaries located in low tax countries. These findings provide causal evidence on tax incentives for debt shifting among multinational firms. They demonstrate how multinationals circumvent tax regulations via debt reallocation.