Corporate Taxation and Multinational Activity

NEs in country i exist if their fixed costs are equal to after tax profits including
depreciation allowances (D_iⁿ)

FC_iⁿ ≥

^pi ^Xiⁿii ⁺^Xiⁿij

(1 - ti) + δiti(2wSi + wLi) ⊥ ni ≥ 0.

|----------------{^z----------------}

(13)

^Diⁿ

The fixed costs of MNEs are FC_i^h = (2 + θ)wSi + wLi + (1 + γ)wLj for
a horizontal MNE and FC_i^v = (2 + θ)wSi + (1 + γ)wLj for a vertical MNE,
respectively. The corresponding zero profit conditions are given by

FC_i^h ≥

^pⁱXⁱⁱⁱ- (1 - t_i ) +
σ

pjXi^hjj

(1 - tj)(1 - t_j^M_i )

+ δiti (2wSi + wLi) + δjtj (t_j^M_i

- t_j^w)(1 + γ)wLj
____________________________}

D^hii

+ δjtj (1 + t_j^w)(1 + γ)wLj ⊥ hi ≥ 0

14)

D^hij

FC_i^v ≥

X (i - tj )(i

- t^M)
^-^tji )

+ δj tj (t_j^M_i -t_j^w)(i +γ)wLj

¹----------------------------{^z----------------------------^}

D^v

+ δjtj(i + t_j^w)(i + γ)wLj ⊥

vi ≥ 0,

i5)

D^vij

where D_i^h_j indicates the depreciation allowances of a horizontal MNE with head-
quarters in country i at market j , and similarly for the other depreciation al-
lowances. Our setting implicitly assumes that fixed costs are deductible only in
the country where the investment takes place. We further assume that MNEs
fully repatriate the profits of foreign subsidiaries to the domestic headquarters
(see Hartman, i985; and Sinn, i993, for a discussion). In this case, operat-
ing profits of foreign affiliate firms are subject to corporate taxation in the host
country(tj). Under repatriation, foreign-earned profits are additionally subject
to withholding taxes (t_j^w) and taxation at home (t_j^M_i ), where the first subscript
in t_j^M_i denotes the origin and the latter the destination of the dividend flow.
Hence, if double taxation is not alleviated unilaterally or bilaterally (via tax
treaties), foreign affiliate income is exposed to double taxation. The extent to
which double taxation occurs depends on the method of double taxation relief

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