An empirical investigation of the effect of imputation credits on remittance of overseas dividends

Journal of Contemporary Accounting & Economics 7 (2011) 18–30

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An empirical investigation of the effect of imputation credits on remittance of overseas dividends Ming-Chin Chen a,1, Sanjay Gupta b,⇑ a b

Department of Accounting, College of Commerce, National Chengchi University, 116, Taipei 11605, Taiwan, ROC Department of Accounting & Information Systems, Eli Broad College of Business, Michigan State University, East Lansing, MI 48824-1122, United States

a r t i c l e

i n f o

Article history: Received 23 July 2010 Revised 7 June 2011 Accepted 8 June 2011 Available online 22 June 2011 Keywords: Dividend remittance Multinational corporations Imputation systems Transfer-pricing transaction

a b s t r a c t Overseas dividend remittance is an important vehicle for multinational corporations (MNCs) to move funds among their global subsidiaries. Using firm-level data from 2001 to 2004 for Taiwan-based MNCs with subsidiaries in China, this paper provides empirical evidence on the effect of imputation credits on overseas dividend remittances. We find that imputation credits have a positive effect on increasing foreign dividend payouts, thereby reducing the efficiency loss induced by the tax cost for within-firm dividends of MNCs. We also document evidence that parent companies’ net fund flows from related-party transactions with their subsidiaries are negatively correlated with dividends repatriated from those affiliates, supporting the notion that transfer-pricing may be substituting for within-firm dividend remittance. Our results contribute to understanding the links between taxation and related-party transactions and subsidiary dividend repatriation decisions of MNCs. Ó 2011 Elsevier Ltd. All rights reserved.

1. Introduction Overseas dividend remittance is an important vehicle for multinational corporations (MNCs) to move funds among their global subsidiaries. A critical factor affecting the remittance decision that has attracted widespread attention is the tax cost imposed at both the corporate and individual shareholder levels associated with repatriation of foreign earnings to the host country (Kopits, 1972; Wolfson, 1992; Wunder, 1999; Desai et al., 2001). These costs have been criticized for distorting the dividend remittance decision and potentially causing a loss of economic efficiency. The purpose of this paper is to provide empirical evidence on overseas dividend remittances under Taiwan’s imputation tax credit regime that alleviates the double taxation at the individual level under a worldwide tax system. Worldwide tax systems, such as that of the United States, tax residents on their overall worldwide income. Thus, dividends remitted from foreign incorporated subsidiaries to parent companies of MNCs may give rise to double taxation at the corporate levels – the subsidiary is taxed on its income in the foreign country and the parent is taxed on the dividend income in the home country. To alleviate the double corporate tax, the US tax laws generally do not tax the foreign earnings of overseas subsidiaries until those earnings are repatriated in the form of dividends, and when repatriated, allow a foreign tax credit (FTC) for income taxes paid overseas [with the exception of certain overseas income of controlled foreign corporations (CFCs)]. Although to some extent FTCs alleviate the double taxation at the corporate levels, they do not relieve the additional taxation at the individual shareholders’ levels.

⇑ Corresponding author. Tel.: +1 517 432 6488. 1

E-mail addresses: [email protected] (M.-C. Chen), [email protected] (S. Gupta). Tel.: +886 2 29393091x81133.

1815-5669/$ - see front matter Ó 2011 Elsevier Ltd. All rights reserved. doi:10.1016/j.jcae.2011.06.001

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Similar to the US, Taiwan uses a worldwide tax system with a deferral of Taiwanese corporate income tax until the foreign subsidiary profits are remitted, at which time the Taiwan parent receives a foreign tax credit. However, Taiwan also has an imputation system that grants credits for taxes paid at the corporate level to alleviate double taxation at the individual shareholder level. This imputation system is similar to the Australian and Canadian systems, but contrasts with the US regime. The US tax system has been criticized for imposing an uncompetitive cost burden on US-based MNCs (Joint Economic Committee, 2005), and for potentially distorting their dividend repatriation decisions (Hines and Hubbard, 1990; Desai et al., 2001). The repatriation tax creates obvious incentives to defer remitting overseas dividends and to cherry-pick dividend repatriations from highly-taxed foreign subsidiaries relative to lightly-taxed ones, causing a loss of economic efficiency for within-firm financing.2 Using a large sample of firms drawn from Compustat over 1982–2004, Foley et al. (2007) find that repatriating tax costs cause US firms to hold more cash domestically and abroad. In addition, they find that higher levels of cash holding on the balance sheet are associated with the organizational forms of affiliates and some firm-specific characteristics. Specifically, because the US tax code does not allow US firms to defer taxes on their earnings in branches located abroad, they do not have a tax incentive to retain earnings in the form of cash in the foreign branches while their incorporated affiliates in lower foreign jurisdictions tend to have higher cash holdings. They also find firms that are financially constrained domestically are less likely to defer the repatriation tax by holding cash abroad while technology-intensive firms appear to have greater flexibility to shift earnings abroad and thus tend to increase affiliate cash holdings in lower tax jurisdictions. Recent research shows that in addition to cash tax costs, financial reporting effects also appear to influence US-based MNCs’ decisions on repatriating foreign earnings and investment location. The US Accounting Principle Board Statement No. 23 (APB 23) allows firms to not accrue US income tax expense on their foreign affiliate earnings provided those earnings are designated as permanently reinvested overseas. Based on survey responses from nearly 600 tax executives, Graham et al. (2009) found that avoiding financial income tax expense is as important as avoiding cash taxes when US firms decide whether to repatriate foreign earnings to the US and where to reinvest the foreign earnings. Their results show that the accounting rules under APB 23 make US firms less likely to repatriate foreign earnings and more likely to reinvest foreign earnings outside the US. They also find that the results are more salient for publicly traded US firms, suggesting the reporting effect of repatriating tax costs has an important role in real corporate decisions. In addition to the loss of efficiency for firms’ investment decisions and cash management, Sullivan argues that the US tax laws induce US-based MNCs to shift income to and retain earnings in tax haven countries, potentially reducing US domestic investments and resulting in loss of American jobs.3 Underscoring the seriousness of these concerns, the US Congress enacted IRC section 965 under the American Jobs Creation Act of 2004 (AJCA) that allowed US corporations a one-time 85 percent deduction for eligible dividends received from their foreign subsidiaries. JP Morgan Chase estimates that this provision led to US MNCs repatriating about US $300 billion in 2005.4 Notwithstanding the recent legislation, there has long been a call for fundamental reform of US international tax laws, including consideration of a territorial tax system to improve efficiency and enhance American firms’ competitiveness in the global market (e.g., Altshuler and Grubert, 2001; Desai et al., 2001; Joint Economic Committee, 2005). However, legislators and researchers criticize territorial tax systems for potentially causing firms to export jobs to foreign countries where overseas subsidiaries reside and causing domestic capital outflows to low-tax countries. These criticisms leave whether and how to tax foreign dividends an unsettled debate. In 1998, Taiwan implemented an imputation system,5 which seven out of 31 OECD countries are currently adopting.6 Under an imputation system, a credit is granted for income tax paid at the corporate level to offset shareholders’ personal income tax. Although the imputation system does not reduce corporate tax rates, it alleviates double taxation on business income at the shareholders’ level7 and thereby may impact many areas of firms’ decision makings on many facets. For example, Babcock (2000) analyzes the effects of imputation systems on multinational investment, financing, income shifting, and merger and acquisition strategies. Her results suggest imputation systems may create an incentive for MNCs to favor domestic investments over foreign investments, to use debt over equity to finance foreign operations, to shift foreign taxable income into home jurisdictions, and to merge with or acquire purely domestic or nonresident-owned firms. Her analyses, however, does not address

2 Desai et al. (2001) estimate that a one percent decrease in the repatriation tax rate is associated with one percent increase in the amount of remitted foreign dividends. For US firms this implies that the repatriation tax reduces aggregate foreign dividend payouts by about 12.8%, and in the process, generates annual efficiency losses equal to about 2.5% of the dividends. Mutti (1981) analyzed 4446 tax information returns filed in 1972 for US CFCs in eleven countries and estimated that a 1% point decrease in the US tax rate will lead to an increase in remitted foreign dividends of about 0.75%. 3 Sullivan (2004) estimates that, between 1999 and 2002, US MNCs’ share of worldwide profits earned in tax haven jurisdictions increased from 42% to 58%, ratios far exceeding the share of economic activity occurring in these tax haven countries. 4 CMA Management 2007 (January), p. 14. 5 Like the American tax system, parent companies of MNCs residing in Taiwan are subject to tax on their worldwide income. However, Taiwan has no tax provision for controlled foreign corporations (CFC). Thus, the tax authority in Taiwan is not allowed to tax CFCs’ unrepatriated earnings. 6 Among the OECD countries, Australia, Canada, Chile, Mexico, and New Zealand have adopted full imputation and Korea and United Kingdom have adopted partial imputation. (data source: http://www.oedc.org/dataoecd/26/56/33717459.xls, accessed on 2011/5/12). 7 The implementation of an imputation system, however, involves additional administrative costs to ensure compliance. For example, companies may incur additional costs to keep track of tax paid and distribute imputation credits to shareholders. Hence, some countries like Singapore and Malaysia have replaced imputation systems with a single-tier system, where corporate profits are taxed only at the corporate level and dividends received by shareholders are exempted from tax (Kasipillai and Rachagan, 2009).

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the potential effect of imputation systems on MNCs’ overseas dividend remittance. Hence, our paper extends the literature by examining the effect of imputation systems on MNCs’ within-firm dividend behavior. In this study, we use data from 2001 to 2004 for a sample of Taiwan-based MNCs listed on the Taiwan Stock Exchange to investigate the dividend remittance from their Chinese subsidiaries.8 We find that imputation credits have a positive effect on increasing dividend payouts from their Chinese subsidiaries, thereby reducing the efficiency loss induced by the tax cost for within-firm dividends. Additionally, our results indicate that dividends remitted from Chinese subsidiaries are positively associated with parent companies’ board of director stock ownership and domestic investments in capital assets, and negatively associated with parent companies’ liquidity. Finally, we also document evidence that parent companies’ net fund flows from related-party transactions with their subsidiaries are negatively correlated with dividends repatriated from those affiliates, supporting the notion that transfer-pricing may be substituting for within-firm dividend remittance. To our knowledge, this is the first study to provide firm-level analysis of the effects of an imputation system on overseas dividend repatriations. In addition, our study contributes to the literature in three other ways. First, we also examine the effect of related-party transactions on MNCs’ foreign dividend remittance to shed light on the role of transfer-pricing transactions in MNCs’ tax planning and within-firm dividend remittance. It is well known that, besides within-firm dividend remittance, MNCs may use alternative mechanisms such as transfer-pricing to move funds among affiliates. Tax authorities in numerous countries have especially targeted and still focus on transfer-pricing among affiliated enterprises due to concerns about MNCs aggressively using such transactions to shift income from high-tax to low-tax countries.9 However, extant literature has not empirically addressed the potential substitution effect of transfer-pricing transactions for dividend remittance among affiliated enterprises. Second, our focus on remittances by Chinese subsidiaries of Taiwanese MNCs has a strong research design and addresses an economically significant set of transactions. Although the prior literature indicates that domestic tax rates relative to foreign tax rates are an important determinant of overseas dividend repatriations, it is difficult to gauge the differences between domestic and foreign tax rates for an MNC because its subsidiaries usually reside in various countries, resulting in heterogeneities in tax rate schedules and macroeconomic environments among MNCs’ affiliates. To improve the research control for such heterogeneities, this study focuses on the repatriation decisions regarding overseas dividends from a single country – China. Focusing on China is also advantageous for studying an economically significant group of transactions that has not been examined in this context. China’s rapid economic development has attracted vast amounts of capital investment from worldwide MNCs. Taiwanese companies have been among China’s largest sources of foreign investment for the past 20 years (Hille, 2006). However, this increasing trend in investment has caused serious concerns regarding whether Taiwan-based companies are draining more and more local capital into Mainland China.10 Pulling capital back to Taiwan has become one of the top priorities of the Taiwanese government. Third, we provide empirical evidence on the effect of shareholder-level taxes on firms’ dividend remittance decisions. Despite the well-known adage that effective tax planning should take into account both corporate and shareholders’ taxes (e.g., Scholes et al., 2009), whether shareholder level taxes affect firms’ financing and investment decisions remains an unanswered empirical question. Although extant literature suggests corporate tax rates may affect MNCs’ overseas dividend remittance decisions, it has not addressed whether shareholder-level taxes will affect this decision. Thus, our study provides an opportunity to examine whether managers of MNCs take into consideration both corporate and shareholder taxes in remitting overseas dividends. The remainder of this paper proceeds as follows: Section 2 constructs and illustrates the theoretical model and develops the research hypothesis. Section 3 depicts empirical models and procedures used to test our hypotheses. Section 4 presents and discusses our empirical findings, and Section 5 concludes with our research results and their implications.

2. Theoretical model and research hypotheses 2.1. Theoretical model Scholes et al. (2009, pp. 120–122) present models to analyze shareholder wealth effects of receiving corporate dividends under the imputation system in Australia. The Australian imputation system requires corporations to keep two-tiered retained earnings accounts. The first is a franked account which accumulates earnings taxed at the corporate level that are eligible for imputation credits to shareholders when dividends are distributed from it, and second, an unfranked account which accumulates earnings that have not been taxed at the corporate level and thus is not eligible for imputation credits to shareholders if dividends are distributed from it. Unlike the Australian system, the Taiwanese imputation system only re8

2001 is the first year that Taiwanese-listed companies were required to file their information on investments in China with the Taiwan Stock Exchange. Based on extensive interviews with revenue authorities in 39 countries, Ernst and Young’s (2006) global transfer pricing surveys found that the vast majority of countries surveyed now have transfer pricing legislation, documentation requirements, and exacting penalties. More importantly, authorities are using increasingly sophisticated approaches to enforce the transfer pricing laws. 10 For example, in 2005 new overseas investments by Taiwanese companies amounted to approximately US$845 million, of which US$601 million was directly invested in China. Including direct and indirect investments, total investments in China would amount to US$738 million, about 87.3% of the total overseas investments. 9

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quires corporations to keep one retained earnings account to accumulate both franked and unfranked earnings and grants shareholders imputation credit rates on all dividend remittances based on the average effective tax rates on the corporate earnings, i.e., income tax paid at the corporate level divided by corporate after-tax earnings. We adapt Scholes et al.’s models to the Taiwanese context and extend the model to analyze the shareholder wealth effects upon receiving corporate earnings derived from repatriated foreign earnings in countries adopting imputation systems. Under worldwide tax systems, dividends remitted from foreign subsidiaries are taxed at the domestic corporate tax rate (tc) and typically allowed a foreign tax credit for tax paid in foreign countries at the foreign tax rate (tf), subject to the credit rate being limited to tc. Thus, the parent company’s after-tax income (Pc) under a worldwide tax system is,

Pc ¼ Y d ð1  t c Þ þ qY f ½1  max :ðt c ; tf Þ

ð1Þ

where Yd is the company’s domestic profits before income tax; Yf is the company’s foreign profits before income tax; q is the percentage of foreign profits remitted as dividends. For simplicity, we assume the company distributes all after-tax income to shareholders as dividends, and the dividends are subject to shareholders’ personal marginal income tax at rate tp. Therefore, shareholders’ income after all taxes, Pp, is,

Pp ¼ fY d ð1  tc Þ þ qY f ½1  max :ðtc ; t f Þgð1  t p Þ:

ð2Þ

Under an imputation system, corporate profits are first assessed in the same manner as under a regular corporate income tax; however, shareholders are granted imputation credits when receiving dividends from the company. For most countries adopting imputation systems, the source of imputation credits depends on the corporate income tax paid domestically. Tax paid to foreign governments is not allowed as the source of imputation credits. Thus, the imputation credit rate a depends on the ratio of domestic income (Yd) to remitted foreign dividends (Yf) and is measured as,

a¼

tc Y d þ qY f ½max :ðt c  t f Þ; 0 : Y d ð1  t c Þ þ qY f ½1  max :ðt c ; t f Þ

ð3Þ

In Eq. (3), the numerator is the income tax paid in the home country and the denominator is the parent company’s worldwide after-tax income, which is the same as that in worldwide tax systems (see Eq. (1)). When the company’s after-tax income is distributed as dividends to shareholders, shareholders receive imputation credits. Thus, shareholders’ income after all taxes Pp under an imputation system is,11

Pp ¼ Y d ð1  t c Þ þ qY f ½1  max :ðt c ; tf Þ þ afY d ð1  tc Þ þ qY f ½1  max :ðtc ; t f Þg  ð1 þ aÞfY d ð1  t c Þ þ qY f ½1  max :ðtc ; t f Þgt p ¼ fð1 þ aÞfY d ð1  t c Þ þ qY f ½1  max :ðt c ; tf Þggð1  t p Þ:

ð4Þ

Since a is nonnegative, Eq. (4) is greater than Eq. (2), implying that at a given percentage of foreign profits remitted as dividends (q), shareholders’ wealth is greater when receiving dividends from repatriated foreign profits under imputation systems as compared to the result under worldwide tax systems. The shareholders’ wealth increase due to moving from a worldwide tax system to an imputation system is the difference between Eqs. (4) and (2) as follows:

Equationð4Þ  Equationð2Þ ¼ afY d ð1  tc Þ þ qY f ½1  max :ðtc ; t f Þgð1  t p Þ

ð5Þ

Eq. (5) captures the difference in the shareholders’ net wealth after all (corporate and personal) income taxes are imposed under a worldwide tax system with and without imputation credits. The difference derives from the imputation credits (a) and the sum of the two sources of corporate after-tax income: (i) the domestic income source (Yd(1  tc)), and (ii) the foreign income source (qYf[1  max(tc, tf)]). Table 1 presents a simple numerical example to illustrate the wealth effects. Assuming a Taiwan-based MNC establishes subsidiaries in China’s Special Economic Zones such as the Pudong New Development Zone in Shanghai or the Economic or Technological Development Zones, the subsidiaries’ qualified corporate profits can enjoy a flat tax rate of 15% (Chan and Mo, 2000). The Taiwanese corporate tax rate is virtually a flat rate of 25% and the highest personal income tax rate is 40% during our sample period. Table 1 illustrates the difference between shareholder’s after-tax income derived from the repatriated dividends of Chinese subsidiaries under a worldwide tax system with or without an imputation credit. In Table 1, the imputation credit rate a = 10/75 = 0.13333. Assume a 100% dividend repatriation and payout ratio.12 Under a worldwide tax system without imputation credit, the repatriated dividends are subject to corporate income tax of $25 and personal income tax of $30, resulting in personal after-tax income of $45. Under imputation systems, because imputation credits are granted to shareholders, the personal after-tax income is increased from $45 to $51. This increased personal net wealth of $6 can be numerically calculated by applying the imputation credit derived from the foreign source income in Eq. 11 Under the Taiwanese imputation system, if a shareholder’s income tax payable is less than the imputation credit received, the shareholder is entitled to a tax refund for the excess of the imputation credit over the tax payable. Also, the shareholders’ personal tax is based on grossed-up dividend income, which includes the imputation credit received from the corporation. Thus, the imputation credit itself does not result in any tax clientele effects. 12 Although this assumption helps simplify the illustration, the effect of the imputation credit rate does not change if it is relaxed because the credit rate does not depend on the payout ratio; rather the credit rate depends on the firm’s effective tax rate.

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Table 1 Effects of imputation credit on shareholders’ personal income under worldwide tax system. Without imputation credit

With imputation credit

1. Chinese subsidiary’s pre-tax income Less: Chinese preferential tax for foreign enterprises (15%) After-tax earnings

$100.00 (15.00) $85.00

$100.00 (15.00) $85.00

2. Repatriation to Taiwanese parent company Grossed-up taxable dividend income Less: Taiwanese corporate income tax (25%) Foreign tax credit Tax payable in Taiwan Corporate net income

$85.00 100.00 (25.00) 15.00 10.00 $75.00

$85.00 100.00 (25.00) 15.00 10.00 $75.00

3. Distribution to Shareholders Net dividend income Add: Imputation credit Grossed-up taxable dividend income Less: Personal income tax (40%) Add: Imputation credit Personal after-tax dividend income

$75.00 0 $75.00 (30.00) 0 $45.00

$75.00 10.00 $85.00 (34.00) 10.00 $51.00

The two columns of numerical examples illustrate the differences in shareholder wealth between a worldwide tax system with and without imputation credits. The examples assume an extreme case where all income is earned in China and no income is earned in Taiwan. We use this extreme case as a situation to analyze the marginal effect on shareholder wealth in deciding whether to repatriate foreign earnings to the host country.

(5) = aYf[1  max(tc, tf)](1  tp) = 0.1333  $100  [1  max(25%, 15%)](1–40%) = $6. Of note, the increased net wealth jointly depends on the imputation credit rate (a) and the dividends paid out to shareholders (Yf[1  max(tc, tf)]). 2.2. Research hypotheses The above analyses show that when foreign dividends are repatriated, shareholders’ wealth is increased under an imputation system, and that this increase is positively related to the imputation credit rate a (see Eq. (5)). However, imputation credits are typically granted to shareholders only when they receive dividends, and thus the tax benefits of imputation credits are conditioned on dividend pay outs to shareholders. As we explained above, under Taiwan’s imputation system, the imputation credit rates are not uniform across firms, but rather they depend on the firms’ effective tax rates. Hence, companies having higher imputation credit rates and paying out greater dividends to shareholders can provide greater tax relief at the shareholder level and thus are more likely to remit dividends from foreign subsidiaries. Accordingly, we propose our hypothesis as follows: Hypothesis 1. Ceteris paribus, parent companies of Taiwan-based MNCs having higher imputation credit rates and distributing greater dividends are more likely to repatriate dividends from their Chinese subsidiaries to the parent companies. In addition to dividend repatriations, MNCs may use transfer-pricing transactions to move funds between their affiliated enterprises. MNCs can benefit from tax-avoidance behavior and transfer funds among affiliates by reducing (raising) withinfirm prices of goods charged by affiliates in relatively high-tax (low-tax) countries. To the extent that within-firm transfer prices of goods can be used to move funds from subsidiaries of foreign countries, MNCs’ reliance on foreign dividend remittance may be reduced. Grubert and Mutti (1991) and Hines and Rice (1994) present evidence that the before-tax profitability of US MNCs’ subsidiaries in foreign countries is negatively correlated with local tax rates. Harris et al. (1993) also find that the US effective tax rates of American firms with tax haven affiliates are significantly lower than their counterparts without such affiliates over the period of 1984–1988. While these studies present indirect evidence suggesting MNCs’ use of aggressive transferpricing transactions with affiliated enterprises to avoid taxes, they have not directly examined whether MNCs use transfer-pricing transactions to substitute for within-firm dividends. Accordingly, we propose the following hypothesis: Hypothesis 2. Ceteris paribus, parent companies of Taiwan-based MNCs use transfer-pricing as a substitute for within-firm dividends from Chinese affiliates.

3. Research methods 3.1. Empirical model In practice, MNCs tend to repatriate foreign dividends in a sporadic and lumpy pattern. For example, Desai et al. (2001) analyzed a large panel of US firms’ dividend repatriation behavior over the period 1982–1997 and found that firms did not

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repatriate foreign dividends annually, but rather in cumulative balances over a few years. Mutti (1981) also documented that only about 24% of his sample of US controlled foreign corporations paid any dividends in 1972. Thus, cross-sectionally, there may be only a small fraction of the sample paying nonzero dividends. The nontrivial fraction of firms’ repatriating zero foreign dividends suggests that the ordinary least squares estimation may yield biased and inconsistent regression results (Greene, 2003). Thus, as in Hines and Hubbard (1990), we use Tobit regression estimation to analyze the censored data of repatriated foreign dividends. Based on our analytical results and prior literature, we specify our empirical regression model in Eq. (6) to examine the effect of imputation credits on Taiwan-based MNCs’ dividends remittance from Chinese subsidiaries as follows:

CFDit ¼ a0 þ a1 DIV it þ a2 ITC it þ a3 DIVITC it þ a4 RT it þ a5 SHit þ a6 SIZEit þ a7 CACLit þ a8 ROAit þ a9 ELECOi þ a10 Y02t þ a11 Y03t þ a12 Y04t þ eit

ð6Þ

The subscripts i and t index the individual firm and the sample year, respectively. The dependent variable CFD = dividends remitted from Chinese subsidiaries/number of the parent’s shares outstanding.13 The main test variables for hypothesis 1 are the dividend remittances (DIV), the imputation tax credit rate (ITC) and the interaction between DIV and ITC. The main test variable for hypothesis 2 is a measure of the related party transactions between parent companies and their affiliates (RT). We also include variables to control for various firm-specific factors that are likely to affect within-firm dividend repatriations of MNCs such as board of director stock ownership, liquidity, profitability, and firm size. We also control for industry membership and macroeconomic influences with dummy variables for year effects. The following are brief definitions of the test and control variables with their expected signs on the regression coefficients in parentheses: DIV (+) ITC (?) DIVITC (+) RT (+) SH (+) SIZE (?) CACL (–) ROA (?) ELECO (?) Y02 (?) Y03 (?) Y04 (?)

total cash dividends paid out to shareholders/number of shares outstanding the imputation credit rate imputation credit for cash dividends per share, measured as the firm’s imputation credit rate (ITC)  cash dividends per share (DIV) net cash flows of related-party’s transactions with Chinese subsidiaries = (related-party sales to Chinese subsidiaries  related-party purchases from Chinese subsidiaries)/number of shares outstanding percentage of shares owned by the board of directors firm size, measured as the natural log value of net sales current ratio at the beginning of the sample year, measured as current assetst1/current liabilitiest1 return on assets, measured as net income/total assets dummy variable for electronics companies dummy variable for the year 2002 dummy variable for the year 2003; and dummy variable for the year 2004

3.1.1. Test variables for hypothesis 1 (DIV, ITC, and DIVITC) DIV is the dollar amount of cash dividends per share paid to the shareholders of parent companies. Parent companies of MNCs with a greater need to pay out cash dividends to their shareholders may need to remit more dividends from their overseas affiliates. Therefore, the relationship between CFD and DIV is expected to be positive if the repatriated earnings from Chinese subsidiaries are used to pay out parent companies’ cash dividends to shareholders. ITC is the imputation credit rate. As discussed before, imputation systems grant shareholders credit for income tax paid at the corporate level, allowing the credits to offset shareholders’ personal income tax. Thus, in countries adopting imputation systems, the higher the credit rate, the lower the tax costs for shareholders receiving dividend income. Yet, imputation credits are granted based on the corporate income tax paid domestically, and high imputation credit rates may also represent high effective tax rates paid by the parent companies in home countries. Parent companies bearing greater effective tax rates domestically may tend to remit fewer overseas dividends to avoid paying extra tax costs on the repatriated overseas dividends. Therefore, we do not have a predicted relationship between ITC and CFD. In addition, ITC can only be used to impute a tax credit if the subsidiary remittance is distributed to shareholders via corporate dividends. Hence, ITC alone may not be representative of shareholders’ tax benefit from foreign dividend repatriation if the repatriated funds are not used to distribute corporate dividends to shareholders. To proxy for shareholders’ tax benefit from foreign dividend repatriation under an imputation system, we construct the variable DIVITC that measures the dollar amount of imputation credits paid to shareholders, along with cash dividends per share. DIVITC is the interaction of the firm’s imputation credit rate (ITC) and the cash dividends per share (DIV). For companies with greater DIVITC, shareholders will incur lower tax costs to receive dividends derived from earnings repatriated from China. According to our hypothesis, parent companies of Taiwan-based MNCs having higher imputation credit rates and dis13

In Taiwan, all common shares are registered and have a par value of NT$10, and the number of shares provides a good proxy for the size of the firm.

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tributing higher amounts of dividends are likely to repatriate more dividends from their Chinese subsidiaries to the parent companies. Hines and Hubbard (1990) also found foreign subsidiaries were more likely to remit dividends to parent companies if the associated tax costs were low and if parent companies also paid sizable dividends to their shareholders. Therefore, our key prediction is the positive relationship between DIVITC and CFD.

3.1.2. Test variable for hypothesis 2 (RT) To test hypothesis 2 regarding related party transactions, we collect our sample firms’ data on parent companies’ transferpricing sales to and purchases from their Chinese subsidiaries.14 RT, measured as (parent companies’ related-party sales to Chinese subsidiaries – related-party purchases from Chinese subsidiaries) divided by the number of shares outstanding, is our proxy for the net funds received by parent companies from their Chinese subsidiaries through related-party transactions. If MNCs move funds through related-party transactions to substitute dividend repatriation from foreign subsidiaries, RT will be negatively related with the level of dividends repatriated from their subsidiaries, and thus we expect the coefficient on RT to be negative.

3.1.3. Control variables SH represents the percentage of total shares owned by the directors of the parent company. In addition to tax costs, nontax factors such as the monitoring of managers of foreign subsidiaries and capital budgeting may also affect foreign repatriation decisions (Desai et al., 2001). The percentage of shares owned by the board of directors represents the ownership stake of directors in parent companies. Variations in the percentage of shares owned by directors may result in differing incentives and may influence the decision of whether to remit dividends from foreign subsidiaries. SIZE, measured as the natural log of net sales, is used to control for the potential firm size effect on firms’ propensities to repatriating foreign dividends. Large firms may have economies of scale in reducing costs of obtaining external funds domestically (Crutchley and Hansen, 1989; Chang and Rhee, 1990; Alli et al., 1993; Thomas et al., 2003), and thus may rely less on funds from the repatriation of foreign dividends. CACL is measured as the current ratio in the beginning of the sample year, and is used to control for the effect of firm liquidity on the demand of funds from foreign-repatriated dividends. Firms with less liquidity may require more dividends to be remitted from foreign subsidiaries, thus we expect CACL to be negatively associated with CFD. ROA is included in the regression model to control for the effect of parent company profitability on the repatriation decision. Parent companies of MNCs with higher profitability are more capable of using funds in profitable projects and thus are more likely to remit dividends from overseas subsidiaries. Yet, profitable parent companies may also have fewer constraints on working capital, which may reduce the need to remit funds from overseas subsidiaries. Therefore, we have no predicted sign for the ROA coefficient. ELECO is the dummy variable for electronics companies. Taiwanese electronics companies play an important role in the global supply chain of the electronics industries and also tend to be more diversified geographically. Thus, we include ELECO to control for the industry effect on foreign dividend remittance. The year dummy variables Y02, Y03 and Y04 are used to control for the potential differences in macro-level factors such as interest rates, exchange rates, etc. during our sample period.

3.2. Data and sample selection To identify whether Taiwanese firms have subsidiaries located in China, we first collect the information on investments in China filed by Taiwanese-listed companies with the Taiwan Stock Exchange Corporation from 2001 to 2004. Our sample excludes financial firms and banks. The information gathered discloses whether Taiwanese-listed companies have set up subsidiaries in China and whether they remitted dividends (and the amounts) from their Chinese subsidiaries. For firms with investments in China, we combine this information with their financial statements and related-party transaction data to construct a complete set of regression variables. However, we cannot obtain detailed information on which Chinese subsidiaries repatriated dividends to the Taiwanese parent and, therefore, we conduct our tests at the aggregate firm level. As most MNCs repatriate foreign dividends in a sporadic and cumulative pattern (Desai et al., 2001; Mutti, 1981), many of the Taiwanese-listed companies have not repatriated any dividends from Chinese subsidiaries since their inception. To deal with the potential econometric problems with censored data, we take the following two measures. First, we use Tobit regression estimation to estimate our empirical model. Second, to be included in our sample, we require that the firms must have repatriated dividends from China in at least 1 year during our sample period.15 Firms that have never repatriated any dividends from their Chinese subsidiaries may be either in the start-up stage of Chinese business operations or have cumulative losses with Chinese subsidiaries, and thus may not be homogenous with those firms having repatriated (or starting repatriating) dividends from Chinese subsidiaries. Accordingly, our final sample consists of 285 firm-year observations. 14

The data are collected from the footnotes of sample firms’ annual reports filed with the Taiwan Stock Exchange Corporation. Ideally, we would like to trace whether firms have remitted dividends from China since their inception of investments in China. But due to the data limitation (see footnote 7), we can only trace whether firms in our sample have remitted dividends from China during our sample period. 15

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4. Results 4.1. Descriptive statistics and univariate analysis Table 2 provides descriptive statistics for the selected variables for our sample firms. The mean CFD is 0.5771, indicating that the dollar amount of earnings remitted from Chinese subsidiaries to Taiwanese parent corporations is equivalent to cash dividends of $0.58 per share. The mean DIVITC is 0.1047, indicating that imputation credit granted to shareholders is close to $0.10 per share, which is about 18.14% of the mean CFD, or about 15.36% of the grossed-up dividends per share.16 Both the magnitudes of CFD and DIVITC appear to be nontrivial. Table 3 presents correlation analyses for the dependent and independent variables. Consistent with our hypothesis, DIVITC is positively related to CFD, suggesting that firms with greater imputation credits and paying out higher amounts of dividends are more likely to repatriate profits from Chinese subsidiaries. Consistent with our predictions, RT is negatively related with CFD, implying that net fund flows from related-party transactions may be a substitute for within-firm dividends. SH is positively related with CFD, suggesting that parent companies whose directors have greater percentages of shares tend to remit higher amounts of dividends from Chinese subsidiaries. 4.2. Tobit regression results Table 4 presents the Tobit regression results of Eq. (6). In Table 4, the estimated coefficients in the third column represent the marginal effects of independent variables on the latent value of desired foreign-repatriated dividends (CFD), and the values of oE(CFD)/oXj in the fourth column are the marginal effects of independent variables on the observed foreign-repatriated dividends (CFD).17 The coefficients on DIV and ITC are not significantly different from zero. However, the coefficient on the interaction of DIV and ITC (DIVICT) is significantly positive, lending support to our hypothesis 1 that, ceteris paribus, Taiwanese parent firms with larger imputation credits and higher dividend payouts are likely to repatriate larger amounts of dividends from their Chinese subsidiaries. The coefficient on RT is significantly negative, indicating that Taiwanese parent companies having greater net fund inflows from transfer-pricing transactions with Chinese subsidiaries remit fewer dividends from those subsidiaries. This result supports hypothesis 2 and provides direct evidence of transfer-pricing being used as a vehicle to substitute for dividend remittances of MNCs’ within-firm financing arrangements among their affiliates. The results of the control variables are also generally consistent with expectations. The coefficient on SH is positive and significant (2.7455, p-value < 0.01), suggesting that when directors have a higher percentage of shares in the parent companies, they tend to repatriate higher amounts of dividends from Chinese subsidiaries. The result supports the notion that when the directors of parent companies have a greater stake in the companies, they tend to hold tighter controls over funds in overseas affiliates. The coefficient on CACL is negative and significant (0.3017, p-value < 0.1), indicating that the decision to repatriate foreign affiliates’ dividends is related to parent companies’ liquidity. Parent companies of MNCs with more liquidity have fewer fund constraints and thus have a reduced need to remit dividends from foreign subsidiaries. The other control variables for firm size, return on assets and industry membership, are not significant. 4.3. Supplemental tests In addition to paying dividends to shareholders, firms may repatriate foreign dividends to meet the needs of other financing and investment needs, e.g., paying off the debt of parent companies or expanding domestic investments. Therefore, we conduct additional analyses to examine the effects of these two motives on the level of dividend remittance from Chinese subsidiaries. 4.3.1. Regression results after controlling for effects of change in debt and investments in R&D and fixed assets We include an additional variable DDEBT in Eq. (6) to examine whether MNCs repatriate foreign dividends to pay off the debt of their parent companies. DDEBT is the change in long-term liabilities, measured as (long-term debtt  long-term debtt1) divided by long-term debtt1. If Taiwan-based MNCs repatriate dividends from Chinese subsidiaries to pay off the debt of their parent companies, we expect a negative relationship between DDEBT and CFD. Further, to examine whether repatriated dividends are used to finance parent companies’ domestic investments, we add R&D expenditures (RD) and changes in fixed assets (DPPE) of the parent companies to Eq. (6). RD, measured as R&D expenditures/number of shares outstanding, is used to proxy for firms’ innovative investments.18 DPPE, measured as (fixed assetst  fixed assetst1)/fixed assetst1, is used to proxy for firms’ investments in capital assets. If Taiwan-based MNCs repatriate 16

The mean imputed tax credit rate for gross dividend income = $0.10469/($0.57707 + $0.10469) = 15.36%. The marginal effects are calculated at the means of the continuous variables. For the dummy variables, the marginal effect is the difference between the effect with the dummy turned off and turned on, one at a time. 18 Although pursuing global business, MNCs tend to preserve core technologies in the hands of parent companies. The need for funds to support parent companies’ R&D activities may require more dividend repatriation from foreign affiliates. 17

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Table 2 Descriptive statistics for selected variables (N = 285). Variables

Mean

Std. dev.

Min.a

Max.b

CFD DIV ITC DIVITC RT SH SIZEc CACL ROA ELECO Y02 Y03 Y04

0.5771 0.8494 0.1178 0.1047 1.3087 0.2713 15.0279 1.8237 0.0488 0.5404 0.2421 0.2596 0.2667

1.9292 1.0734 0.1175 0.1718 4.9094 0.1452 1.4933 1.1628 0.0842

0.0000 0.0000 0.0000 0.0000 14.2154 0.0512 12.3678 0.3610 0.3023 0.0000 0.0000 0.0000 0.0000

20.5917 6.3000 0.4503 1.4111 13.4280 0.8900 19.8597 13.7619 0.2601 1.0000 1.0000 1.0000 1.0000

Variables are defined as follows: CDF = dividends remitted from China/numbers of common and preferred shares outstanding. DIV = total cash dividends paid out to shareholders/numbers of common and preferred shares outstanding; ITC = imputation credit rate; DIVITC = imputation credit for cash dividends per share, measured by the firm’s imputation credit rate (ITC)  distributed cash dividends per share (DIV); RT = net cash flows from related-party transactions, measured as (parent companies’ related-party sales to Chinese affiliates  parent companies’ related-party purchases from Chinese affiliates)/ number of common and preferred shares outstanding; SH = percentage of shares owned by the board of directors; SIZE = firm size, measured by the natural log value of net sales; CACL = current ratio in the beginning of the sample year, measured as current assetst1/current liabilitiest1; ROA = returns on assets, measured as net income/total assets; ELECO = dummy variable for electronics companies; Y02 = dummy variable for the year 2002; Y03 = dummy variable for the year 2003; Y04 = dummy variable for the year 2004. a Minimum value is restrained to the 1% percentile value. b Maximum value is retrained to the 99% percentile value. c The original value of net sales is in 000 NT dollars.

Table 3 Correlation analysis of selected variables (p-value in parentheses). Variables

CFD

CFD DIV

1.000 0.384 (<.001) 0.011 (0.852) 0.293 (<.001) 0.260 (<.001) 0.237 (0.001) 0.140 (0.018) 0.013 (0.833) 0.227 (0.001) 0.080 (0.181)

ITC DIVITC RT SH SIZE CACL ROA ELECO

DIV

ITC

DIVITC

RT

SH

SIZE

CACL

ROA

ELECO

1.000 0.037 (0.539) 0.708 (<.001) 0.173 (0.003) 0.246 (<.001) 0.326 (<.001) 0.158 (0.008) 0.637 (<.001) 0.047 (0.428)

1.000 0.385 (<.001) 0.047 (0.434) 0.168 (0.005) 0.181 (0.002) 0.182 (0.002) 0.276 (<.001) 0.075 (0.206)

1.000 0.191 (0.001) 0.150 (0.012) 0.053 (0.376) 0.221 (0.001) 0.452 (<.001) 0.071 (0.231)

1.000 0.102 (0.086) 0.017 (0.778) 0.088 (0.141) 0.136 (0.022) 0.309 (<.001)

1.000 0.062 (0.301) 0.145 (0.014) 0.187 (0.002) 0.070 (0.242)

1.000 0.194 (0.001) 0.150 (0.011) 0.074 (0.212)

1.000 0.195 (0.001) 0.146 (0.014)

1.000 0.080 (0.181)

1.000

See Table 2 for variable definitions. (N = 285).

dividends from Chinese subsidiaries to expand domestic investments of their parent companies, we expect RD and DPPE to be positively associated with CFD. Table 5 presents the Tobit regression results of the additional tests after controlling for the effects of Change in debt and investments in R&D expenditures and fixed assets of Taiwanese parents. The coefficient on DDEBT is negative but insignificant.19 This result does not support the conjecture that dividends remitted from Chinese subsidiaries are being used to pay off the debt of parent companies. The coefficient on RD is negative but insignificant, however the coefficient on DPPE is positive and significant (2.0717, p-value < 0.05). The results suggest that Taiwan-based MNCs tend to repatriate dividends from Chinese subsidiaries to finance parent companies’ domestic investments in capital assets rather than R&D activities.

19 We also measured DDEBT by taking the difference between the current year’s long-term debt ratio from the previous year’s. The results are qualitatively similar to those presented in Table 5.

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M.-C. Chen, S. Gupta / Journal of Contemporary Accounting & Economics 7 (2011) 18–30 Table 4 Tobit regression results for testing the effect of imputation systems on foreign-repatriated dividends (CFD). Variable Intercept DIV ITC DIVITC RT SH SIZE CACL ROA ELECO Y02 Y03 Y04

Pred. sign

Coefficient

+ ? + – + ? – ? ? ? ? ? N = 285

2.9119 0.1095 2.0309 2.6667 0.1012 2.7455 0.0851 0.3017 2.5083 0.2510 0.6925 1.4714 1.8722 r = 2.1421

@EðCFDÞ @xj

N/A 0.0520 0.9636 1.2652 0.0480 1.3026 0.0404 0.1431 1.1901 0.1196 0.3516 0.7938 1.0370 Log likelihood = 462.74

Chi-square 2.74* 0.16 1.67 3.73** 11.32*** 6.87*** 0.63 3.57* 1.12 0.69 2.51 11.98*** 18.92***

Dependent variable: CFD = dividends remitted from China/numbers of common and preferred shares outstanding. Independent variables are defined as in Table 2. Significant at 0.1 level. ** Significant at 0.05 level. *** Significant at 0.01 level. *

Table 5 Additional Tobit regression results on CFD after controlling for the effects of change in debt and investments in R&D and fixed assets of parent companies. Variable Intercept DIV ITC DIVITC RT SH SIZE CACL ROA ELECO DDEBT RD DPPE Y02 Y03 Y04

Pred. sign.

Coefficient

+ ? +  + ?  ? ?  + + ? ? ? N = 285

2.3752 0.1705 2.0440 2.4496 0.1076 2.4419 0.0569 0.2877 1.4533 0.3263 0.0290 0.0998 2.0717 0.6318 1.4904 1.8392 r = 2.1094

@EðCFDÞ @xj

N/A 0.0813 0.9744 1.1678 0.0513 1.1641 0.0271 0.1372 0.6928 0.1564 0.0138 0.0476 0.9876 0.3206 0.8100 1.0224 Log likelihood = 460.18

Chi-square 1.82 0.39 1.74 3.23* 12.53*** 5.42** 0.28 3.25* 0.36 1.15 0.11 0.15 5.02** 2.14 12.60*** 18.81***

Dependent variable: CFD = dividends remitted from China/numbers of common and preferred shares outstanding. Independent variables: DDEBT = changes in long-term liabilities, measured as (long-term liabilitiest  long-term liabilitiest1)/long-term liabilitiest1; RD = R&D expenditures/numbers of common and preferred shares outstanding; DPPE = changes in fixed assets, measured as (fixed assetst  fixed assetst1)/ fixed assetst1; Other variables are as defined in Table 2. * Significant at 0.1 level. ** Significant at 0.05 level. *** Significant at 0.01 level.

Nevertheless, after controlling for the potential alternative motives for the need to remit dividends from Chinese subsidiaries to pay off the debt of their parent companies and expand domestic investments, the coefficient on DIVITC in Table 5 remains positive and significant (2.4496, p < 0.1) and the coefficient on RT remains negative and significant (0.1076, p < 0.01). The regression results of the coefficient estimate signs and significance levels of the other independent variables are qualitatively similar to those in Table 4.

4.3.2. Alternative measure of DIVITC Our variable of interest DIVITC is the product of DIV and ITC, a nonlinear measure, making it difficult to interpret the results of its estimated coefficient. Hence, we conduct a sensitivity test by specifying an alternative measure for DIVITC. We define DITC as the dummy variable for firms with imputation credit rates (ITC) above the median value, and use DIV  DITC to replace DIV  ITC in our regression models presented in Tables 4 and 5. Because DITC is a dichotomous variable, the variable DIV  DITC is now a linear measure and its coefficient captures the marginal effect of dividends paid by firms

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M.-C. Chen, S. Gupta / Journal of Contemporary Accounting & Economics 7 (2011) 18–30 Table 6 Results of the regression on related-party transactions (RT). Variable

Coefficient

t-Stat.

Intercept DIV ITC DIVITC CFD SH SIZE CACL ROA ELECO DDEBT RD DPPE Y02 Y03 Y04

1.6043 0.1022 0.7366 2.9522 0.5369 1.4515 0.0237 0.1338 5.2233 2.9888 0.1058 1.3081 5.0301 0.0916 0.1435 0.3431 N = 285 Adj. R2 = 0.1713 F value = 4.91 p-Value < 0.0001

0.48 0.19 0.25 1.08 3.44*** 0.71 0.11 0.54 1.11 5.36*** 0.65 2.57*** 2.80*** 0.12 0.19 0.44

Dependent variable: RT = (related-party sales to Chinese subsidiariest  related-party purchases from Chinese subsidiariest)/numbers of common and preferred shares outstanding. Independent variables: CFD = dividends remitted from China/numbers of common and preferred shares outstanding; DDEBT = changes in long-term liabilities, measured as (long-term liabilitiest  long-term liabilitiest1)/long-term liabilitiest1; RD = R&D expenditures/numbers of common and preferred shares outstanding; DPPE = changes in fixed assets, measured as (fixed assetst  fixed assetst1)/fixed assetst1; other variables are as defined in Table 2.  Significant at 0.1 level.  Significant at 0.05 level. *** Significant at 0.01 level.

with high imputation credit rates. The untabulated regression results show that DIV  DITC remains significantly positive and RT remains significantly negative in all the regression models.20 The results of the other variables in the regression models are also similar to those presented in Tables 4 and 5. Therefore, our conclusions are robust to the alternative measure of the test variable. 4.3.3. Examining the substitution effect of transfer-pricing for repatriation of Chinese dividends Our finding of a negative coefficient on RT in the regression models leads to a testable prediction that MNCs’ tax planning strategy may use transfer-pricing as a substitutive mechanism for repatriation of foreign earnings. Given that the payment of Taiwanese corporate income taxes can be fully utilized by the shareholders in the imputation system, it is likely that Taiwanese parents may use transfer-pricing transactions to shift earnings from Chinese subsidiaries to the parent companies allowing the firm to directly pay corporate income taxes in Taiwan to maximize shareholders’ tax benefit. Taiwanese parents can shift income by overpricing (underpricing) the sales (purchases) to (from) their Chinese subsidiaries. This will lead to a reduction in the repatriation of earnings from Chinese subsidiaries (CFD) because the profit has been transferred to Taiwan via related-party transactions. To examine the potential substitution effect between RT and CFD, we run the reverse regression estimation with RT as the dependent variable and CFD as the independent variable.21 To the extent that Taiwanese parents can use related-party transactions as a substitutive mechanism for the repatriation of Chinese earnings, we expect a negative coefficient on CFD in the reverse regression. We also include DDEBT, RD, and DPPE in the regression model to control for the alternative financing and investment purposes to transfer funds from Chinese subsidiaries to Taiwanese parents. Table 6 presents the results of the regression on RT. As expected, the coefficient on CFD is negative and significant (0.5369, p-value < 0.01), supporting a substitution effect between the related-party transaction profits and the repatriation of subsidiaries earnings. The coefficient on CFD is -0.5369. While the substitution is not a perfect one-for-one relationship, the magnitude (0.5369) suggests related-party transaction profits are an important means of substituting for the repatriation of subsidiaries earnings. The results in Table 6 also show that the coefficients on RD and DPPE are significantly positive. The results indicate that Taiwanese parents having greater investment opportunities in Taiwan tend to have higher profits from 20 The coefficients (chi-square statistics) for DIV  DITC in the two regression models (with and without the additional control variables in the above supplemental test) are 0.5124 (5.42) and 0.4598 (4.42), respectively. The coefficients (chi-square statistics) for RT in the two regression models (with and without the additional control variables in the above supplemental test) are 0.1047 (12.29) and 0.1102 (13.34), respectively. All of the chi-square statistics are significant at the 0.01 level. 21 The reverse regression has an advantage of reducing measurement errors in the dependent variable. Since our variable of interest CFD is a set of censored data, we are unable to observe the desired repatriation of earnings from Chinese subsidiaries if the value of the latent variable is below zero. By using RT as the dependent variable, we are able to test our prediction using OLS estimation.

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related-party transactions with their Chinese subsidiaries, suggesting that the investment fund needs of Taiwanese parents may have an impact on their transfer-pricing policies. 5. Conclusions With fast economic growth, China has been drawing vast capital inflows from international MNCs. Yet, few studies have addressed dividend remittance from Chinese affiliates to the parent companies of MNCs. Taiwanese companies have been among the largest sources of foreign investment in China for the past 20 years. The sizable amount of capital flowing from Taiwan to China has caused serious concerns about whether the profits of investments in China have been repatriated to Taiwanese parent companies. By examining Taiwan-based MNCs’ dividend remittance from Chinese subsidiaries, we document that the motives of distributing dividends to shareholders of parent companies and expanding domestic investments in capital assets are positively related with the level of dividends repatriated from Chinese subsidiaries. Additionally, our results indicate that dividends remitted from Chinese subsidiaries are associated with several other firm characteristics, including board of director stock ownership, firm liquidity, tax costs, and net fund flows from related-party transactions. Whether to tax foreign dividends remains an unsettled debate. Taxing foreign-repatriated dividends may impose tax costs on capital flows among affiliated enterprises of MNCs, causing inefficiency in within-firm financing and reducing the optimal volume of dividends. Exempting foreign dividends, as is the case with territorial tax systems, may alleviate the distortion experienced under a worldwide tax system. However, territorial tax systems are often criticized for exporting jobs to countries where foreign subsidiaries reside and may cause substantial domestic capital outflows to low-tax countries. Our results show that by granting shareholders imputation credits based on taxes paid at the corporate level, imputation systems can achieve the same effect of avoiding double taxation on foreign dividends at the corporate level as territorial tax systems and increase MNCs’ foreign dividend payouts. Prior research suggests imputation systems have an impact on MNCs’ decisions on investment and financing policies, income allocation, and acquisition targets. Our paper, however, extends this literature by documenting the effect of imputation systems on MNCs’ overseas dividend remittance behavior. Finally, by directly examining the effect of transfer-pricing transactions on foreign dividend remittance, we provide evidence that parent companies’ net fund flows from related-party transactions with Chinese subsidiaries are negatively associated with dividends repatriated from those subsidiaries, suggesting that transfer-pricing transactions may be used by MNCs as a substitute for within-firm dividend remittance. Acknowledgements This project was generously funded by the National Science Council of Taiwan (NSC 95-2416-H004-030). We thank participants of the 2011 Journal of Contemporary Accounting & Economics conference and especially the paper’s discussant, Eli Bartov. We also acknowledge the helpful comments from the editor (Ferdinand Gul) and an anonymous reviewer. Dan Lynch provided excellent research assistance. References Alli, K.L., Khan, A.Q., Ramirez, G.G., 1993. Determinants of corporate dividend policy: a factorial analysis. The Financial Review 28 (4), 523–547. 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