Specifically equity injections in a multinational affiliate

Specifically, equity injections in a multinational affiliate X located in an ACE country can be passed on as lending to another group member Y located in a different country with a high corporate income tax rate. For the group member Y, the interest on the loans is tax deductible, and at the same time member X benefits from the ACE relief in the ACE country. In addition, the scheme can entail double-dipping if the source of equity injection is a loan that is forwarded to X as equity (e.g., cash). In this case, interest expenses are deducted twice. This form of investment is passive in that it does not involve increasing production or tangible assets. Fig. 1 reveals a compelling picture. In line with the tax plan outlined above, following the introduction of the Belgian ACE in 2006, Fig. 1 shows a clear surge in the equity-financed net lending of German investors in Belgium to their affiliated group members in other countries, reaching €10 billion (about 3% of Belgian GDP). There is special interest in the experience of Belgium and the lessons that can be learned from the Belgian reform. Belgium adopted a hard version of ACE that treats the total book value of equity as the CHIR-258 of the allowance. In contrast, a soft ACE system, as in most of the other ACE countries, applies the ACE rate only to incremental (new) equity. Although Fig. 1 signals graphical evidence, one challenge facing the evaluation of macroeconomic policy changes in general and ACE reforms in particular is the lack of a coherent control group. The concern is that the evolution of leverage and investment, or the estimated effect, reflects not only the effect of ACE reforms, but also the effects of pre-reform differences in the determinants of leverage and investment across countries. Second, we use synthetic control methods as developed in Abadie and Gardeazabal, 2003, Abadie et al., 2010. While our regression analysis mentioned above is useful in identifying an average effect and understanding heterogeneous aspects across firms, it is important to compare the ACE country with its counterfactual to address any remaining concerns about the interpretation of regression results and to obtain a country-specific view. As synthetic control techniques require reasonably long time series before and after the treatment, the data enable us to apply this method to Belgium. Consistently with the regression results, the findings from the synthetic control method show that the average leverage ratio in Belgium fell below 45% following the implementation of the ACE. However, in the case of the synthetic control, this ratio remains very close to its previous decade level. Furthermore, for the synthetic control, equity-financed net lending has not increased as it did in Belgium in the period following the implementation of the ACE. This finding confirms the graphical evidence presented in Fig. 1 indicating a tax plan by multinational firms combining the benefit from the ACE with interest deductions. It is also consistent with the idea of rechanneling loans again to Belgium as new equity injections in order to double the benefits from the same genuine new equity. This result is robust to a series of placebo studies on non-ACE countries. In addition, in line with the regression results, we find no effect of the Belgian ACE on investment in fixed assets of multinational affiliates. The paper proceeds as follows. In Section 2, we relate our contribution to the existing literature. In Section 3, we develop our hypotheses and provide a background briefly describing countries' experiences with ACE reforms. In Section 4, we present the data. In Section 5, we explain our identification approaches and present the results. Finally, we conclude in Section 6.
Contribution to the literature The idea of offering an ACE to achieve tax neutrality with respect to financing and investment decisions is certainly not new. The theoretical foundation of ACE systems was developed in the mid-1980s by Boadway and Bruce (1984), among others. The report by the Institute for Fiscal Studies Capital Taxes Group (IFS, 1991) also reached a similar conclusion to that of the Mirrlees review, recommending offering an ACE.