ANOTHER LOOK AT THE LOW TAXABLE INCOME

OF FOREIGN-CONTROLLED COMPANIES

IN THE UNITED STATES

by

Harry Grubert*

U.S. Treasury Department

Ota Paper 74 October 1997

OTA Papers and Briefs are circulated so that the preliminary findings of tax research 

conducted by staff members and others associated with the Office of Tax Analysis may reach 

a wider audience. The views expressed are those of the authors, and do not reflect Treasury 

policy. Comments are invited, but OTA Papers and Briefs should not be quoted without 

permission from the authors. Additional copies of this publication may be purchased from the 

National Technical Information Service 5285 Port Royal Road, Springfield, VA 22161. 

Office of Tax Analysis 

U.S. Treasury Department 

Washington, DC 20220 

_____________________

*Without implicating them, I would like to thank Lowell Dworin, Scott Newlon, Bill

Randolph, Barbara Rollinson, Douglas Shackleford, and Karl Scholz for comments on an

earlier version of this paper. Paul Dobbins and Gordon Wilson prepared the data files.

Melanie Rogers provided very helpful research assistance. Nothing in this paper should be

construed as representing the views of the U.S. Treasury Department.
ABSTRACT 

Another Look at the Low Taxable Income of Foreign-Controlled Companies 

in the United States 

This paper takes another look at the differential in the profitability of foreign-controlled 

and domestic companies. It both uses more recent data and extends previous work. One 

feature is the recognition of U.S. based companies. The sensitivity of the results to weighting 

observations by size to reduce the role of small firms also receives more attention. This paper 

also relies more on company sales rather than assets to scale net income because of the 

valuation and other problems associated with assets reported on corporate tax returns. 

The paper concludes that more than 50 percent, and perhaps as much as 75 percent, 

of the foreign-domestic profitability differential can be explained by systematic differences 

between foreign-controlled and domestic companies. This is greater than the share attributed 

to measurable differences in the earlier paper by Grubert, Goodspeed and Swenson (GGS) 

published in 1993. The suggestion that income shifting does not explain most of the 

differential is reinforced by the finding that companies with foreign ownership of between 25 

and 50 percent exhibit the same low profitability as 100 percent foreign-owned companies. 

Income shifting would seem less likely when there are other shareholders, particularly since 

majority seem to be either domestic companies or public stockholders. 

A panel of companies from 1987 to 1993 revealed growing profitability over time for 

foreign-controlled manufacturing companies compared to domestic companies. A comparable 

“maturation” effect was also found in the earlier study by GGS. 

The paper also presents an analysis of the data from Form 5472, on which foreign 

owned companies report on transactions with offshore affiliates. There is some suggestion that 

greater purchases from foreign affiliates, particularly from those in low-tax countries, are 

associated with lower U.S. income. But the statistical results are not robust and, at best, 

would explain only about 15 percent of the profitability differential. 
1 

Another Look at the Low Taxable Income of Foreign-Controlled Companies 

in the United States 

I. Introduction and Summary 

In response to growing concern about the low taxable income reported by foreigncontrolled companies in the United States, Grubert, Goodspeed and Swenson (1993) used 

the Treasury corporate tax files to estimate how much of the foreign-controlled income 

differential could be attributed to identifiable measurable sources such as debt or startup 

costs. They examined both a 1987 cross-section of foreign and domestic non-financial 

companies and a (smaller) panel consisting of companies that had filed returns in each year 

from 1980 through 1987. Grubert, Goodspeed and Swenson (GGS) concluded that about 

50 percent of the foreign-domestic income differential could be explained by systematic 

differences between foreign and domestic companies. 

Before proceeding to take another look at the issue, including data from 1987 to 

1993, it may be useful to review some important recent developments. First, the late 1980s 

were periods of very heavy investment by foreigners in the United States. Survey of 

Current Business data indicate that the foreign direct investment position in the United 

States increased by more than 100 percent from 1987 to 1993. From 1987 through 1989, 

the position increased by an average of about 20 percent per year. Accordingly, a major 

portion of foreign-controlled assets in 1993 must have been acquired in the recent past. 

Another development worth noting is the increasing importance of dividends and 

royalties as sources of income for U.S.-controlled manufacturing companies. Almost all of 

this investment income is from abroad. Dividends and royalties were equal to 40 percent of 

the net income of U.S.-controlled manufacturing companies in 1987 and 53 percent in 

1993. 

There were also developments in the statutes and regulations governing foreigncontrolled companies. One was the enactment in 1989 of section 6038A in the Internal 

Revenue Code specifying the reporting and recordkeeping requirements of foreigncontrolled companies. (However, the final revised transfer pricing regulations were not 
2 

issued until 1994, and the final penalty regulations applying to transfer price adjustments 

appeared even more recently.) 

This paper uses both a 1993 cross-section and a 1987-1993 panel. In addition to 

using more recent data, it introduces some new features into the analysis. One is the 

recognition of the importance of investment income, particularly dividends and royalties, 

when comparing foreign-controlled and domestic companies. Income from operations in 

the United States is the issue. Another feature is that this paper relies much more on sales 

rather than assets in comparing profitability because of uncertainty over how closely the 

book value of assets reported on corporate tax returns correspond to the market value of 

assets used in the United States. In addition to the discrepancy between book values and 

market values, there seems to be no consistency in the way companies report on important 

segments of their assets, such as those located abroad. 

The importance of weighting observations by size in order to reduce the role of 

“noisy” small firms is also emphasized. The results turn out to depend on whether 

observations are weighted or not, particularly when attempting to take into account items 

of income and expense such as dividends received and interest paid. The importance of 

weighting became apparent when some of the unweighted analysis produced anomalies that 

were conceptually impossible or clearly inconsistent with the aggregate data. Accordingly, 

in order to increase the comparability of results across different tables, observations are 

consistently weighted by total sales reported on company tax returns. 

In addition, some new types of data were available for 1993. One is a file 

containing information from Form 5472, on which foreign-controlled companies report on 

transactions with offshore affiliates. It is, therefore, possible to compare companies that 

engage in extensive dealings with their offshore related parties those having more limited 

inter-firm involvement. In 1993, it is also possible to identify U.S. companies with 25 to 50 

percent foreign ownership. Comparing them with 100 percent owned companies can yield 

some insight into the sources of the foreign-domestic income differential. 

The objective of the analysis is to see how much of the aggregate profitability 

differential can be accounted for by identifiable, measurable, systematic differences between 
3 

foreign and domestic companies unrelated to transfer price distortions. Any “unexplained” 

residual differential cannot, of course, be attributed definitely to transfer price 

manipulation. At best, it is an upper bound. The intent is to see if we can narrow the range 

of uncertainty. 

As discussed in GGS, there are potential explanations other than transfer price 

distortions for the “unexplained” difference in profitability after all measurable identifiable 

causes have been considered. One is the possibility that foreign companies have a lower 

cost of capital and are, therefore, willing to accept lower returns. The evidence in GGS 

that foreign parent companies seemed to be very profitable on the worldwide basis did not 

seem to support this explanation. Another possibility is that foreign companies 

systematically tend to acquire “losing” U.S. companies with initially low profitability. A 

sample of foreign acquisitions studied in GGS did not seem to bear this out. Foreigners 

may also acquire U.S. companies at turn out to be “lemons” even though they may have 

appeared profitable to start with. (See Gordon and Bovenberg (1996) for a model based 

on the “lemons” hypothesis.) 

Foreign-controlled companies may also have less U.S. developed intangibles than 

U.S.- controlled companies. This might be particularly true for U.S. companies 

established by foreign owners, but less true for U.S. companies that have been acquired by 

foreign owners, which account by a disproportionate share of the universe of foreigncontrolled companies. Royalties paid to foreign parents are small. Nevertheless, this is a 

serious issue, related to the earlier question about the acquisition of “losers” and lemons.” 

It is one reason why in some of the analyses, royalties received are taken out of income to 

put foreign-controlled and domestic companies on a more comparable basis. An attempt is 

also made to see if the foreign differential is larger in high-technology industries. 

This intangibles issue is also closely linked to the issue of the proper domestic 

“control group” for the comparison of foreign-controlled and U.S. companies. In this 

paper, all U.S.-controlled companies are used as the control group, in part because the 

controversy over foreign companies has started with comparisons of the type given in 

Table 1 in which all U.S. companies are included. Some have suggested that multinational 
4 

companies should be excluded because their income is distorted by income shifted abroad 

to low-tax countries. But the purely “domestic” companies left may be systematically less 

profitable companies than either foreign or U.S.-controlled multinational companies. Some 

have suggested using only MNCs in the control group because they are more comparable 

to the foreign MNCs operating in the United States. In the analysis, a multinational 

corporation (MNC) indicator is occasionally introduced to test the importance of the issue. 

As we will see, its role depends on what adjustment has been made for “non-operating” 

income in the form of (largely foreign) dividends and royalties. In any case, it usually does 

not have a major effect on the foreign differential. 

Summary of GGS 

Grubert, Goodspeed and Swenson found that about 25 percent of the 1987 

differential could be explained purely from the information in the 1987 cross-section. This 

seemed to hold both when taxable income was expressed in relation to total assets and in 

relation to sales. When income was measured relative to assets, the differing incorporation 

date of the companies was the source of almost all of the 25 percent explained. A recent 

incorporation date appeared to indicate a recent merger or acquisition when corporate 

assets are adjusted upwards to market value, lowering the measured ratio of income to 

assets. Differences in debt did not seem to be important. Measuring income relative to 

sales, which tends to reduce the effect of the valuation problems associated with assets, 

required other adjustments. In particular, differences in investment (non-operating) income 

and companies’ reliance on outside suppliers had to be taken into account. 

The 1980-1987 panel suggested that there seemed to be a “maturation” effect in 

foreign-controlled companies in manufacturing in that their profitability increased over 

time. Foreign owners might, therefore, be willing to take a lower return in the short-run 

when establishing or acquiring a U.S. company. The profitability of foreign-controlled 

companies in wholesaling seemed to be affected by the real price of the dollar relative to 

other currencies. These considerations, derived from the panel, seemed to explain about 

another 25 percent of the differential, mostly because of the maturation effect. The 50 

percent of the differential attributed to measurable differences between the companies in 
5

GGS was, thus, based on both the 1987 cross-section and the 1980-1987 panel. Finally, 

the 1987 cross-section indicated that the profitability of companies tended to concentrate 

near zero, which is consistent with the pattern resulting from the manipulation of transfer 

prices. They would benefit from shifting profits to low-tax countries and losses to 

locations where they have positive taxable income. 

Conclusions After Another Look 

Table 1 is the starting point for the analysis in this paper, presenting the aggregate 

profitability differentials before estimating the amount that is attributable to systematic 

differences between the foreign and domestic companies. Taxable income is defined as 

total receipts less total deductions, i.e., line 28 of the corporate tax return, before the net 

operating loss and dividends received deductions. We should note that these data are 

based on returns as filed before audit adjustments. Table 1 shows that the profitability 

difference between foreign-controlled and domestic companies has remained remarkably 

stable from 1987 through 1993. It indicates that in 1993 non-financial foreign-controlled 

companies had a ratio of taxable income to assets 2.79 percentage points lower than 

domestic companies. The disparity was 2.77 percentage points in 1987. The differential 

for manufacturing companies fell slightly, from 3.33 to 2.92 percentage points in 1993.1 

In the 1993 cross-section, the analysis of the ratio of taxable income to assets 

initially does not seem much different from the earlier analysis of the 1987 cross-section, 

even when observations are weighted by company sales, although the relative importance 

of debt and age are changed. The corporate age variables explains about 11 percent of the 

differential in the sample. Greater foreign-controlled debt is more important than in 1987. 

When the debt-asset ratio is added as an explanatory variable, the overall reduction in the 

initial differential is 27 percent. 

When the ratio of income to sales is used as the profitability measure, the results 

seem much different from the analysis using assets, but it is important to note how the two 

1

These ratios may differ slightly from data published annually in the Statistics of Income 

Bulletin because of differences in exactly what type of corporations are included. For example, 

SOI includes investment companies, which are not included in Table 1. 
6 

estimates differ. While the rate of return on assets seems the most relevant for comparing 

profitability, sales have an advantage as a capital proxy in that they are not subject to the 

valuation problems associated with the book values that appear on corporate balance 

sheets. In addition, it is not completely clear how companies report on their worldwide 

assets in the balance sheets included in their returns. But, if sales margins are used to 

abstract completely from valuation distortions, other adjustments in the numerator are 

appropriate. Depreciation expense may in part reflect the valuation of depreciable assets 

that have recently been acquired. Furthermore, interest expense may be distorted because, 

if assets have been recently acquired, debt may not appear to be high in relation to the 

book value of assets although it is high in relation to the company’s real activity. 

Accordingly, one step in the analysis of sales margins is adding depreciation and interest 

expense to income. Furthermore, the sales used as a capital proxy are only related to 

operating “in-house” assets, not assets that generate investment income. Thus, it seems 

correct to remove investment income in the form of dividends, royalties and interest 

received from the numerator in order to approximate operating income. 

When all of these adjustments are made, adding back depreciation and interest 

deduction to income and remove dividends, interest and royalties from income, only about 

25 percent of the original foreign-domestic differential in sales margins remains when 

observations are weighted by sales to better replicate the aggregate differential. A similar 

result obtains when other “real activity” scaling factors such as total wages paid are used. 

But all of these adjustments seem to go too far, as will be discussed in more detail 

in Section II. Some domestic expenses incurred in earning the investment income should 

also, perhaps, be taken out. Whether royalties should be taken out of operating income is 

not clear because they are in some ways comparable to product sales. (Net profit margin 

regressions in which royalties are an independent variable seem to suggest this.) 

Nevertheless, the sales margin results raise the question as to why the analysis 

based on assets seems so different. The profit measure in the asset based results was not 

adjusted for depreciation and interest expense. As noted above, foreign-controlled 

companies’ depreciation and interest expense seem higher in relation to sales than assets. 
7

This may reflect valuation differences that the age (incorporation date) variables do not 

adequately control for.2 As far as taking out investment income is concerned, this does not 

seem appropriate in this context when assets are used because presumably the assets that 

earn this investment income are included in total assets. Taking out net investment income 

without taking out the investment assets did not seem correct. 

But the relationship between assets and sales seems surprising when foreigncontrolled and U.S.-controlled companies are compared. Since U.S. companies receive 

relatively large amounts of investment income, they might be expected to have a greater 

amount of total assets in relation to U.S. sales than foreign-controlled companies. But the 

contrary is the case, possibly because the book value of foreign-controlled assets are much 

closer to market value than U.S.-controlled assets. It may also reflect some “startup” 

process in which sales are, perhaps temporarily, low in relation to assets. When 

adjustments to income and expense comparable to the ones made on sales margins are 

made to the measure of income in relation to assets, the initial differential is reduced by 

more than 50 percent when observations are weighted by size. Other attempts to recognize 

the importance, in particular, of dividends result in reductions of the differential of at least 

40 percent. 

Accordingly, it appears that the construction of operating earnings goes too far in 

adjusting for differences between foreign-controlled companies and U.S.-controlled ones, 

while the asset based analysis of the 1993 cross-section that “explains” 27 percent of the 

differential doesn’t go far enough in recognizing differences in interest and depreciation 

expense and dividends. It seems fair to say that perhaps 50-60 percent of the differential 

can be explained on the basis of the 1993 cross-section. 

One further aspect of the analysis of the 1993 cross-section tends to suggest that 

2

When U.S. companies, in whole or part, are acquired there is no requirement for a 

reincorporation, which are matters of state law. For example, the foreign company may already 

have a holding company vehicle. In the 1993 sample, foreign companies incorporated from 1986 

through 1993 account for less than 30 percent of all foreign assets. Incorporations in the 1986-

1993 interval account for almost 20 percent of domestic assets, so the age variables may not fully 

reflect the huge wave of foreign acquisitions that took place. 
8 

perhaps income shifting or transfer price manipulation is not the major explanation for the 

large foreign-domestic income differential. In the 1993 file, companies with foreign 

ownership between 25 and 50 percent could also be identified. Somewhat surprisingly, the 

profitability of these less-than-majority-owned-by-foreigners companies appeared similar to 

“controlled” companies, most of which are 100 percent owned. It would appear that 

transfer price manipulation is less likely to be an explanation of the low profitability of 

these “non-controlled” companies because of the resistance by other shareholders. (In 

some cases, they may be public companies.) This similarly between controlled and noncontrolled companies indicates that there may be something systematic about the kind of 

companies that foreigners invest in. Perhaps it is the up-front investments that an infusion 

of foreign capital makes possible. It may be that foreign companies, having less 

information; are prone to buy “lemon” companies. 

Turning to the 1987-1993 panel, foreign-controlled companies, particularly in 

manufacturing, seem as before to exhibit a maturation pattern in the form of a rising rate of 

return on gross assets over time. Rather than foreign companies increasing their 

profitability over time in absolute terms, they seem not to have suffered the same decline as 

domestic manufacturing companies in the latter part of the 7 year period. The 

“maturation” effect is also much smaller when observations are weighted by size. It may 

not, therefore, be on very firm ground. In addition, any influence of real exchange rates on 

wholesaling is difficult to detect, in part because there were not the major swings in 

exchange rates that occurred in 1980 to 1987. The analysis of the Form 5471 file, reporting 

on transactions between foreign-controlled companies and their offshore affiliates, suggests 

that foreign-controlled companies that buy more from offshore affiliate, particularly those 

in low-tax countries, have somewhat lower U.S. taxable income. But the results are not 

very robust statistically, so that no firm conclusions can be drawn. Furthermore, these 

results would only account for about 15 percent of the overall differential. 

II. The 1993 Cross-Section 

The Data 

The 1993 cross-section included all non-financial corporations in the Statistics of 
9

Income (SOI) file with total assets in excess of $50 million. The information was obtained 

from Form 1120, the basic corporate tax return. A foreign-controlled company is defined 

as one which is more than 50 percent owned by foreigners. Altogether, in the 1993 crosssection there were 4,610 domestic companies and 1,208 foreign-controlled companies.3 

Taxable income is defined as total income less total deductions (line 28 on the Form 1120) 

before deductions for dividends received and net operating losses (NOLs). (SOI reports 

refer to this as “net income.”) As emphasized in the introduction, these data are based on 

returns as filed before audit adjustments. 

As noted in the introduction, the regressions in Table 2, as well as most of the 

regressions in the tables that follow, are weighted by company sales to reduce the impact of 

small companies whose rates of return and profit margins tend to be “noisy.” The 

importance of weighting was revealed by some of the unweighted analysis that produced 

anomalous results. For example, taking dividends and royalty income out of total net 

income increased the foreign differential in unweighted regressions even though the 

aggregate data clearly indicate that foreign-controlled companies receive much less 

investment income. Also, in the analysis using sales margins as the profitability indicator, 

purchases sometimes had a positive coefficient in the unweighted regressions, even though 

reliance on outside suppliers means that the company needs less capital in relation to sales. 

The weighted results did not seem to be sensitive to which size indicator, sales, assets, 

value added or wages paid, was used for the weights. Analysis based on sales is presented 

in all cases, even when the profitability measure is scaled by assets, to make the results in 

different tables more comparable. 

In Table 2, the measure of profitability is the ratio of taxable income to total assets. 

Assets are taken from the balance sheet on Schedule L filed with the corporate tax return. 

The first column of Table 2 presents the basic benchmark regression for the relationship 

between the foreign ownership and profitability. Only dummy variables identifying industry 

and foreign ownership are used. Foreign control, in these sales weighted regressions, is 

3

As in the earlier paper, the analysis was restricted to consolidated returns, which reduced 

the sample by 17 percent. This did not seem to affect the results. 
10

associated with a return on total assets that is 4.23 percentage points less than domestic 

companies, which is consistent with the large aggregate differential in Table 1. The next 

two regressions attempt to see to what extent the foreign coefficient is reduced, in absolute 

value, when other explanatory variables are added. 

The second column in Table 2 adds five age categories based on the date of 

incorporation of the companies. The foreign coefficient declines by 11 percent. The last 

column of Table 2 adds two variables: the company’s debt-to-asset ratio and the share of 

total assets accounted for by intangible assets and “other assets.” The latter variable is an 

indicator of the significance of recent acquisitions because it includes “goodwill” in the 

form of the excess of the acquisition price over the book value of tangible assets. They 

lower the differential by 16 percent of its original value in column 1. Adding both the age 

categories and the debt and intangible variables lowers the foreign coefficient by 27 

percent.4 (Note the decline in the absolute size of the age coefficient from column 2 to 

column 3 because of the correlation between debt, as well as intangible assets, and date of 

incorporation.) 

Table 3 scales taxable income by sales, rather than assets, in part to avoid the 

valuation problems associated with assets. Another reason for using sales is that the way in 

which different companies report on their worldwide assets on their Form 1120 balance 

sheets may vary. The first two regressions use the ratio of taxable income to sales as the 

dependent variable. The first regression, using only industry dummies, has a foreign 

profitability gap of 3.52 percentage points. The question again is the extent to which this 

differential is reduced when age and other explanatory variables are added. One variable is 

a size indicator that seems significant in the sales margin regressions. It is expressed as the 

inverse of total assets because the effect is likely to be non-linear. Purchases are 

introduced because, to the extent that the company relies on other suppliers, its sales are a 

4

Should we be concerned about the generally low R squared in this and other tables? 

Apparently not. The question is the standard error of the aggregate differential when adjusting 

for systematic differences between foreign and domestic companies. Given the size of the sample 

and the t values in the critical variables, the noise intrinsic to measuring rates of return is likely to 

be unimportant. 
11 

less accurate proxy for total assets. A given amount of sales would correspond to less “in 

house” value added. The added explanatory variables, including age and debt, explain 

about 24 percent of the original 3.52 percentage point differential, which is very similar to 

the 1987 results. 

The second group of regressions in Table 3 adjust taxable income by adding 

depreciation and interest expenses back to income, because they may also be affected by 

asset valuations. Depreciation can be high in relation to sales if investments were made 

recently. Also, a given ratio of debt to assets can result in larger interest expenses relative 

to sales if the assets were recently acquired at market value. This adjusted version of 

income results in a substantially smaller foreign differential in column 3, which suggests 

that interest expenses and depreciation are higher (in relation to sales) for foreigncontrolled companies. Table 4 will show that is the case. Comparing the foreign 

coefficients in columns 1 and 4, we see that adjusting for interest and depreciation expense 

and adding the other explanatory variables results in a reduction of the foreign-domestic 

differential of 39 percent. 

The last two regressions on Table 3 attempt to construct a measure of operating 

income by starting with the adjusted income in columns 3 and 4 and then taking out interest 

income, dividends and royalties. The justification for taking investment income out is that 

it is not associated with the sales in the denominator that are used as the capacity proxy. 

Sales are an indicator of “in house” capital used directly by the company. 

Taking out dividends, interest and royalties in columns 5 and 6 in order to 

approximate “operating” income has a large impact. The foreign differential is reduced, as 

expected, and the extent of the reduction is very substantial. The final 0.86 percentage 

point differential in column 6 is only about 25 percent of the original 3.52 percentage point 

gap in column 1. 

Table 4 attempts to explain the large quantitative impact of the adjustments of 

income and expense in Table 3. It presents (weighted) regressions for depreciation, 

interest paid, dividends, royalties and interest received, all in relation to sales. Foreigncontrolled companies receive much less dividends and royalties. They also have much 
12 

higher interest and depreciation expenses in relation to sales. (Interest expenses per dollar 

of sales are 20 percent higher than the mean and depreciation is 10 percent higher.) The 

sum of the foreign coefficients indicates that these differences in income and expense 

account for 2.49 percentage points of the sales margin differential. 

Table 5 shows that most of the conclusions derived from Table 3 can be obtained 

more simply from aggregate tabulations. The top row of Table 3B repeats the taxable 

income to sales ratios in Table 1 for manufacturing, which accounts for more than 50 

percent of a foreign-controlled non-financial companies’ assets. The second row presents 

the ratio of operating income to sales, in which operating income is constructed by adding 

interest and depreciation expense to net income and subtracting interest, dividends and 

royalties received. In 1993, the foreign-domestic differential declines by 2.12 percentage 

points or 59 percent going from net income to operating income. (It declines by 1.50 

percentage points or 53 percent in 1987.) 

As mentioned in the introduction, results similar to Table 3 are derived by using 

other “real U.S. activity” measures to scale income. For example, when the Table 3 

regressions are repeated with the ratio of income to total compensation as the profitability 

measure, the initial differential using net income is greater than 18 percentage points. 

When operating income is used in the numerator, the differential virtually disappears. 

When “real capital” in the form of net plant and equipment and inventories is used, the 

foreign-domestic differential is reduced by 70 percent after going from net income to 

operating income. 

Accordingly, if using sales as a proxy for capital eliminates valuation and other 

balance sheet accounting problems without introducing major problems of its own, the 

above analysis suggests that a large part of the income differential, perhaps three-quarters, 

is attributable to systematic differences in interest and depreciation expenses on the one 

hand and in dividends and royalties paid on the other. 

But some of the adjustments to create operating income may be questioned. For 

example, adding depreciation expense to income to remove valuation distortions may 

“over-adjust” for foreign differences if foreign companies in an industry use systematically 
13 

more short-lived plant and equipment. If all income is measured perfectly and only true 

economic depreciation is deducted, then there should be no relationship between net 

income and the amount of depreciation charged. Accelerated depreciation and inflation can 

disturb this expectation of independence between depreciation and net income. The 

differing relationship between depreciation and net profitability in foreign and U.S.-

controlled companies provides some insight into the validity of adding depreciation back to 

income. 

In regressions with the net unadjusted profit margin as the dependent variable, as in 

the first two columns of Table 3, the amount of depreciation in general has a positive 

coefficient when it is added as an explanatory variable. High depreciation may indicate a 

profitable, rapidly growing company. Perhaps high-technology industries use more shortlived equipment. But when, in addition, the depreciation variable is interacted with the 

foreign identifier, the coefficient of the interacted variable is negative and almost twice the 

general variable in absolute value. For foreign companies, in contrast to domestic 

companies, greater depreciation expense is associated with lower measured net income. 

Adding these depreciation variables to a net margin regression reduces the basic foreign 

coefficient by more than 20 percent. 

Another possible qualification is that when investment income is removed from total 

net income, some domestic expense associated with earning this income should also be 

removed. Perhaps some of the deduction for domestic R&D should be added back to 

income. (Recall that we have added back all interest expense already.) The 1992 data on 

foreign source income indicates that deductions, including interest, are about 30 percent of 

the foreign gross income in the general basket. (See Grubert, Randolph and Rousslang 

(1996).) 

Whether royalties are or are not part of operating income is also an issue. Royalties 

may in many ways be comparable to the proceeds from the sales of machines or other 

products. They represent the production of intangible capital instead of tangible capital 

goods. Computer software sales are also frequently classified as royalties and these seem 

similar to product sales. A regression of net profit margins on the investment income items 
14

suggest that royalties make less of a contribution to net profits than dividends, presumably 

because of the “in house” expenses of producing them. Indeed, in 1993 the royalties 

coefficient is sometimes negative. When royalties are not removed from “operating” 

income in Table 6, the reduction in the initial differential is about 65 percent, compared to 

more than 75 percent with royalties taken out. 

It might be claimed that the large amount of foreign dividends reflect U.S. 

operating income shifted to foreign countries and they should, therefore, not be subtracted 

from net U.S. income. Note that the foreign income deferred abroad, perhaps in low-tax 

countries, has not been subtracted because it is not in the U.S. tax base to start with. The 

extent of outbound income shifting by U.S. based companies cannot be explored in any 

depth in this paper but the use of an MNC indicator in the regression is discussed below. 

In any case, even a substantial amount of income shifting would not appear to invalidate 

subtracting most of the dividends received. As we will see, the coefficient for dividends 

when it is used as an independent variable in a net income regression seems to confirm this 

judgment.5 

What happens if the income and expense adjustments made in sales margin 

regressions are made when the income measure is expressed relative to assets? A measure 

of operating income was not introduced in the basic asset-based regressions in Table 2 

because, in principle, the assets in the denominator include investments that yield “nonoperating” income. Perhaps making the operating income adjustment is justified because 

U.S. companies do not report additional assets (in relation to sales) consistent with their 

large amount of investment income. When the log of total assets is regressed on the log of 

sales, along with other variables, dividend and royalty income do not seem to require much 

additional assets. In addition, foreign-controlled companies have significantly higher 

assets in relation to sales even when the age variables are included. (These regressions are 

shown in Appendix Table A1.) 

5

This is related to the control group issue discussed earlier. If any outbound income 

shifting takes place, it would probably be based largely on U.S. created intangibles, which may be 

less relevant for the domestic-foreign controlled comparison. 
15

A possible explanation for foreign-controlled companies having a surprisingly large 

amount of assets in relation to sales is that they carry an inflated amount of accounts 

receivable that they offer to related parties at “favorable” terms. In fact, foreign-controlled 

companies do not have larger accounts receivable than domestic-controlled companies, 

either in relation to assets or sales. Foreign companies do seem to receive significantly less 

interest on their receivables than U.S. controlled companies, but foreign companies that 

have more receivables do not have significantly lower overall net income. 

Table 6 presents regressions in which adjustments are made to income when assets 

are used to scale profitability comparisons. The first column, when compared with the last 

column of Table 2, shows that simply removing dividends from income increases the 

amount of the differential “explained” from 27 percent to 43 percent. Column 2 of Table 6 

indicates that when the ratio of operating income to assets is used as the dependent 

variable in an sales-weighted regression the foreign differential declines by 53 percent 

compared to the initial unadjusted net income-to-asset ratio regression in Table 2. There is 

a 67 percent reduction when the ratio of net income to assets is regressed on the other 

variables plus the income and expense items and a foreign interaction for depreciation as 

independent variables. In this regression, dividends have a coefficient greater than one, 

confirming that they do not seem to be associated with any additional assets in the 

denominator of the profit rate.6 This contrasts with interest received which, in fact, has a 

small negative coefficient, indicating that interest-earning assets yield less than average 

returns in relation to assets that appear to be on the balance sheet at close to current 

market value. 

Instead of adjusting income directly by adding depreciation and interest expenses 

6

Indeed, foreign-controlled companies seem to have greater “other investments” on their 

balance sheets than domestic companies. Presumably investments in foreign affiliates would be 

included in this category. 

The coefficient greater than one for dividends suggests that dividends received do not 

seem to be associated with a great deal of outward profit shifting by U.S. based companies. If 

they were, the coefficient should presumably be much less than one. 
16

and subtracting investment income, an alternative would be to add these items as 

explanatory variables in a net income regression. Regressions of this type have already 

been referred to in interpreting the operating earnings results. We do not rely on them 

exclusively because: (a) Interaction terms have to be introduced because some of the 

variables may mean one thing for domestic companies and another for foreign-controlled 

ones. Depreciation expense, discussed earlier, is one important example. Besides 

complicating the analysis, the results becomes difficult to interpret. (b) While some of the 

coefficients are plausible, such as a coefficient just greater than one for dividends, others 

are inexplicable. For example, royalties have a negative coefficient, suggesting that foreign 

companies had an advantage in not receiving much royalties.7 (c) The operating and 

adjusted income margin regressions produce more plausible results for some of the 

subsidiary variables. In particular, the results for purchases, the extent of reliance on other 

suppliers, conform to the expectation that income goes down approximately 

proportionately with in-house value added. Operating income seems a “truer” income 

indicator. This seems due to the addition of depreciation expense back to income. In an 

adjusted margin regression, after adding both depreciation and interest expense, with the 

investment income items as independent variables, the reduction in the foreign differential is 

only modestly smaller than in table 3. Royalties in this regression have a positive 

coefficient. In any case, both types of analysis are useful and point in the same direction 

when their strength and weaknesses are taken into consideration. . 

In the introduction, we discussed the “control group” issue, in particular the role of 

intangibles and U.S. multinational corporations in the income comparison. When an MNC 

dummy is constructed based on whether a company receives foreign tax credits or foreign 

dividends or reports having a controlled foreign corporation abroad, its impact is related to 

the income and expense adjustments we have been discussing. In the net margin regression 

it has a large positive significant coefficient, of about 2 percentage points, and lowers the 

7

Some major U.S. MNCs that receive substantial royalties may have undergone 

downsizing adjustments in 1993. In the foreign-domestic comparison, the negative correlation 

between net income and royalties would be spurious. 
17

foreign differential modestly, by about 15 percent. In the operating income margin 

regression, the MNC dummy has a negative but not significant coefficient. (These 

regressions are given in Appendix Table A2.). This seems to confirm that we have overadjusted for investment income in constructing operating earnings. An alternate 

explanation is that U.S.-based MNCs understate their domestic income. In any case, the 

foreign coefficient in the final operating income margin regressions is not much affected by 

the inclusion of the MNC dummy.8 Taking out investment income and royalties seems to 

extract the advantages that U.S. MNCs enjoy in terms of intangibles. 

Another test of whether asymmetry in intangibles explain much of the foreigndomestic differential was to interact the foreign dummy with high-technology industry 

dummies. Is the foreign differential higher in these intangible intensive industries? There 

was no consistent pattern in the interaction terms. The basic foreign coefficient in the 

various profitability regressions was hardly affected. 

Companies With 25-50 Percent Foreign Ownership 

The 1993 corporate file identifies companies that have 25 percent or more foreign 

ownership because they are the ones covered by the reporting requirements under section 

6038A. We have defined “foreign control” as ownership of greater than 50 percent. But 

looking at the profitability of companies with only 25-50 percent foreign ownership may 

provide some insight into the explanation for the low-profitability of controlled companies. 

If the two groups are similar, then explanations other than transfer price manipulation seem 

more plausible because income shifting would seem difficult with other shareholders in the 

picture. 

Table 7 introduces a variable identifying companies with foreign ownership between 

25 and 50 percent. It is identical to Table 3 except for the addition of this identifier. In the 

first column, for net profit margins with only industry dummies, the coefficients for 

foreign-controlled and 25-50 percent owned companies are very close. Indeed, the 25-50 

8

Including the MNC dummy has little effect on the foreign coefficient in the taxable 

income-to-asset regressions. More domestic companies are classified as MNCs than foreigncontrolled ones, but the discrepancy is not very large. 
18

percent owned coefficient is slightly larger in absolute value. In columns 3 and 5, for

adjusted income margins and operating income margins with only industry identifiers, the

coefficients for 25-50 percent ownership are substantially larger in absolute value than the

basic foreign coefficient. In columns 2, 4 and 6, the addition of age, debt and the other

explanatory variables reduces the 25-50 percent ownership profit differential to a greater

extent than the 

foreign-controlled dummy. Nevertheless, in the adjusted income and operating income 

regressions, the 25-50 percent differential remains larger than for the basic foreigncontrolled group.9

As an alternative, a more continuous “partial” foreign ownership variable was 

created, equal to zero both above 50 percent and below 25 percent, and the actual percent 

owned between 25 and 50 percent otherwise. It turned out to be significant in simple net 

profit rate and net profit margin weighted regressions including only the industry dummies 

and the normal foreign control identifier. Furthermore, at 50 percent foreign ownership, 

the coefficient suggests a foreign effect virtually identical to the “foreign control” effect. 

This similarity between foreign-controlled and 25-50 percent foreign owned 

companies suggests explanations for the foreign differential that are common to both 

groups of firms, not income shifting which would appear unlikely for the less than 100 

percent foreign owned companies. It was impossible to tell from the Treasury file whether 

the other shareholders were foreign or domestic. Examination of the names indicated that 

many were still publicly traded companies. But even if the shareholders are other 

foreigners, which seems rare, arranging mutually agreeable income stripping would seem 

difficult. 

Perhaps it is true that foreign companies tend to acquire “losing” companies, 

although the evidence in GGS did not seem to confirm this. It may also be that the U.S. 

9

There were 80 “partial control” companies in the sample. The “partial control” variable is 

sometimes not significant in unweighted regressions. In the normal foreign-controlled companies, 

ownership averaged 97 percent. When less than 100 percent, but more than 50 percent, owned 

companies are put in a separate dummy variable, they seem to be indistinguishable from the 100 

percent owned companies. 
19 

companies that are acquired turn out to be “lemons” because of foreign investors’ 

disadvantages in obtaining information. Also, an infusion of foreign capital may enable the 

U.S. company to make long term investments that result in a short term penalty to profits. 

The Gordon-Bovenberg (1996) “lemons” hypothesis would on the surface, at least, 

appear to be implausible. Why don’t foreign investors simply throw darts at the stock 

market pages and obtain at least the average U.S. equity return? Perhaps large or 

controlling interests have to be bought at a premium. (Why they have to pay more than 

U.S. acquirers is something of a mystery.) It may be that they are seeking specific U.S. 

assets complementary to their worldwide assets, e.g., markets to which they can apply their 

foreign developed technology. This, of course, raises the issue as to the amount of their 

worldwide income that should be attributed to their U.S. activities. 

Kinney and Lawrence (1996) have also found that U.S. companies with substantial, 

but not controlling, foreign ownership have profitability lower than comparable domestic 

companies, although they seem to believe that income shifting is a possible explanation. 

Their data is based on financial reports for companies that continue to be publicly traded. 

(Very few of the foreign ownership interests exceeded 50 percent.) They could not, 

therefore, compare their sample with 100 percent foreign owned companies. One 

interesting aspect of the Kinney-Lawrence results is that they claim that low profitability 

only shows up two years after the foreign investment, which seems to be more consistent 

with the “lemons” than the “initial losers” hypothesis. 

An attempt was made, in our sample, to see what identifiable characteristics 

foreign-controlled and 25-50 percent foreign owned companies had in common. What 

seemed to stand out was the fact that both groups received very few royalties compared to 

domestic companies in the same industry. Foreigners appear to invest in companies 

without many U.S. developed intangibles. Their investments may initiate the development 

of U.S. intangible assets with greater value. 

Debt and Earning Stripping 

Table 8 explores the debt issue in greater detail: Do foreign-controlled companies 

have more debt? Do they pay higher interest rates on their debt, particularly if they have 
20 

large loans from shareholders? The (sales weighted) regressions in column one shows that 

foreign-controlled companies have a debt-to-asset ratio 6.75 percent points higher than 

domestic companies that are comparable in terms of industry and date of incorporation. 

This greater than average debt is consistent with the reduction in the foreign differential in 

Table 2 when the debt-asset ratio is added as an independent variable in a profit rate 

regression. 

Column 2 in Table 8 examines the effect of loans from shareholders on company 

leverage. Do shareholder loans contribute to greater overall leverage or do they simply 

replace third party borrowing? The coefficient for shareholder loans indicates that a dollar 

of additional shareholder loans increases overall debt by 51 cents, and perhaps somewhat 

less for foreign companies in view of the negative (but insignificant) coefficient for the 

foreign-controlled company shareholders loans. In any case, shareholder loans do not seem 

to be very large, 4.7 percent of assets for all companies and 3.9 percent for foreign, so they 

do not have a large effect on overall debt. This can be seen from the small charge in the 

foreign coefficient and intercept going from column 1 to column 2 in Table 8. 

The last column of Table 8 attempts to see if foreign-controlled companies have 

higher interest costs than domestic companies, holding total debt, industry and age 

category constant. The virtually zero foreign coefficient show that there is no difference in 

interest costs. Also, loans from shareholders do not raise average interest costs. If 

anything, for foreign-controlled companies, the foreign interaction with shareholder loans 

indicates that they lower interest costs. 

Country Differentials 

Tables 9 divides the overall foreign identifier into the specific home country of the 

foreign owners. The first column of Table 9 repeats the first debt-asset regression in Table 

8 with these additional country dummy variables. Some countries stand out as having 

unusually high debt. The average debt-to-asset ratio of Korean owned companies is 
21

extraordinary.10 Companies controlled by Japanese, Netherlands, U.K., Swiss and French 

owners have a debt-to-asset ratio more than 10 percentage points higher than comparable 

domestic companies. 

The second column of Table 9 presents the relationship between the ratio of taxable 

income to assets and the country dummies, holding industry, age and leverage constant. 

The profitability differentials for Japan, Canada and The Netherlands are close to the 

average for all foreign-controlled companies in Table 2. Companies based in Germany, 

France and Australia, as well as those from low tax countries such as Switzerland, Panama 

and Bermuda, appear very unprofitable. On the other hand, companies based in the United 

Kingdom seem to be as profitable as comparable U.S. controlled companies.11 

The last column of Table 9 provides country differentials when the ratio of 

“operating” income to sales is used as the profitability indicator in regression comparable to 

the last column of Table 3. In some respects the relative position of different investing 

countries are similar to column 2, the large differentials for France, Italy and some tax 

havens, for example. But the relative performance of some investors change. For example, 

Japanese controlled companies now have a positive (although insignificant) differential 

similar to U.K. controlled companies. The reason for this shift in the position of Japanesecontrolled companies appears to be their large depreciation expenses in relation to sales, 

which may reflect the large investments they undertake after establishing operations in the 

United States. 

Summary of This Section 

Summing up this admittedly rather discursive section, it appears that a significant 

amount of the foreign-domestic income differential in the 1993 cross-section can be 

explained by the adjustments and variables that have been considered. It is not possible to 

10The debt-to-asset ratio can be more than 100 percent. The book value of assets used in 

the denominator may be much smaller than the market value. A company with persistent losses 

can also have negative equity. 

11It would be interesting to know the extent to which these differentials are related to the 

severity of home country CFC (Subpart F) rules. 
22 

be precise because of the difference between the asset based and sales based results, and 

the possibility that constructing operating income has “over-adjusted” for systematic 

differences between the two groups of companies. Nevertheless, after all the ways we have 

used to look at the issue, scaling by sales or assets and either directly adjusting income or 

adding income and expense items as explanatory variables, it appears that 50 percent or 

more of the differential is attributable to differences in age, debt, depreciation and 

dividends. 

III. Trend and Exchange Rate Effects in the 1987-1993 Panel 

Examining a fixed group of companies is useful because it is then possible to 

identify whether foreign-controlled companies “mature” over time after possibly passing 

through an unprofitable phase when the business is started or acquired. Any cross-section 

for a single year will be affected by new entries of foreign-controlled companies which may 

have specific characteristics such as startup (or post-acquisition) losses. A panel can also 

be used to identify whether foreign company profitability is affected by the real value of the 

dollar relative to other currencies. It has been claimed that one reason for the low profits 

of foreign-controlled companies is the fall in the price of the dollar since 1985, which has 

made prices of foreign products more expensive. 

The 1987-1993 panel is made up of all non-financial companies that are in the SOI 

corporate data file for each of the 7 years with the identical EIN (identification number). 

All companies had to have at least $25 million in assets each year. The sample had 344 

foreign-controlled companies and 1588 domestic companies. 

Table 10 reports on the determinants of profitability the panel over the 7 year 

period. In addition to basic industry, age, debt, and foreign-controlled status, it introduces 

variables that the panel makes possible. One is a trend variable which is interacted with 

foreign manufacturing and foreign wholesaling dummies to see if there is a maturation 

effect in these industries. These foreign-controlled categories are also interacted with an 

index of the real value of the dollar relative to other currencies produced by the Federal 

Reserve Board. In addition, there are year dummies to control for cyclical effects over the 

time period. 
23

The Table 10 panel results indicates that there appears to be a continuing 

maturation effect in foreign manufacturing companies, both when the ratio of net income to 

assets and the ratio of operating income to sales are used a profitability indicators. For 

example, in the second column, their profitability seems to grow by .53 percentage points 

per year as shown by the foreign manufacturing trend coefficient. There is also a positive 

but smaller trend for foreign-controlled wholesaling companies. 

Changes in real exchange rates seem to be much less important in the 1987-1993 

panel than in the 1980-1987 panel. In the earlier analysis, the profitability of foreigncontrol companies in wholesaling increased when the dollar increased in value, presumably 

because they could import foreign products more cheaply and competitive pressures did 

not cause them to pass along all of the savings to their customers. Conversely, they may 

have absorbed some of the increased cost of foreign goods after 1985 because they wanted 

to protect their market share. In the 1987-93 panel, the foreign wholesaling exchange rate 

coefficient is negative, not positive as earlier, and statistically significant.12 The interaction 

of the real exchange rate with the foreign manufacturing dummy also has the unexpected 

negative sign and is statistically significant.13 

One possible reason for the differing impact of changes in the exchange rate in the 

current panel is the much narrower swings in the dollar over the period. The Federal 

Reserve Board index of the real value of the dollar averaged 88.48 over the 7 years, with a 

high of 94.39 in 1989 and a low of 83.45 in 1992. This is in contrast to the increase from 

84.8 in 1980 to 132.0 in 1985 and then the fall back to 90.6 in 1987. 

We should note that the foreign maturation effect does not mean that foreigncontrolled manufacturing company profits rose over the time period, just that they didn’t 

12It is possible that foreign wholesaling companies are still suffering from the decline in the 

dollar after 1985, but this is difficult to investigate because the panel does not go back that far. 

We also might have identified a clear exchange rate effect if more disaggregated country exchange 

rates had been used. 

13The positive sign on the basic foreign variable has to be interpreted in light of the foreign 

interaction variables, in particular the negative coefficient for the exchange rate interaction. 
24

fall as much as domestic companies’ profits fell in the same period. The decline in 

domestic manufacturing profits is apparent in the negative and significant general 

manufacturing trend coefficient in Table 10.14 The year dummies also show a general 

decline of profits in 1991 and 1992. If the general manufacturing trend and year dummies 

are not included in the equation, the trend in foreign manufacturing profits is essentially 

flat. 

Finally, the estimated maturation effect is sensitive to whether the observations are 

weighted by size. When they are weighted, the trend effects fall to less than half of their 

former magnitude. This might suggest that it is the smaller foreign companies that tend to 

increase their profitability over time.15 

IV. Concentration of Foreign-Controlled Companies’ Taxable Income Near Zero? 

The 1991 analysis of the 1987 corporate cross-section examined the distribution of 

foreign-controlled company profitability to see if it was consistent with income shifting. 

The distributions might indicate whether at least a portion of the “unexplained” differential 

could be attributed to transfer price distortions. Foreign-controlled companies would have 

the incentive and opportunity to shift positive taxable income to low-tax countries. Indeed, 

companies with high intrinsic U.S. profitability would have the greatest opportunity to shift 

income without arousing the suspicion of tax authorities. Conversely, unprofitable foreigncontrolled companies would have the incentive to transfer losses to jurisdictions in which 

they have positive taxable income. Accordingly, income shifting would make the 

distribution of foreign-controlled company profitability more concentrated than domestic 

companies, and in addition, the peak of the foreign distribution would be near zero. 

14The 1991 analysis of the 1980-87 panel did not include a general manufacturing trend 

variable. It seems appropriate to include it to evaluate the relative performance of foreign 

companies. If it is not included, the foreign manufacturing improvement per year is .44 

percentage points per year rather than .65 percentage points. 

15One reason for not reporting weighted regressions in Table 12 is that it is not absolutely 

clear how the weight for the panel should be constructed. The weighted regression discussed in 

the text used the current level of sales for each observation. Perhaps a constant seven-year 

average for each company should be used. 
25 

The 1987 data exhibited a pattern consistent with some income shifting by foreigncontrolled companies. The ratio of taxable income to assets distribution of foreigncontrolled companies displayed a very clear concentration near zero. The domestic 

distribution had a higher mean, as expected, and was flatter in the central range than the 

foreign distribution. 

Table 11 presents the profitability distribution of all non-financial foreign and 

domestic companies in the sample. The 1993 pattern is similar to 1987. Foreigncontrolled profitability is again concentrated near zero with a higher mode than the 

domestic distribution. There is a particular disparity in the number of very profitable 

companies. 

Because the intrinsic profitability of manufacturing companies, which presumably 

have developed valuable intangibles, may be different from wholesaling and other 

companies, their distributions were examined separately. The distributions for 

manufacturing companies, which make up 47 percent of the sample, present an even clearer 

picture than the sample of all firms in the first two columns of Table 11. Foreign 

companies are again concentrated near zero. Domestic companies have a very flat 

distribution over a wide range of profitability, with a mode only about 60 percent of the 

foreign-controlled mode. There is also a more dramatic disparity in the frequency of very 

profitable companies. 

On the other hand, the wholesale distributions in Table 11 are not as different from 

each other as the manufacturing distributions. (Wholesaling companies accounted for 12 

percent of the entire sample and 24 percent of the foreign-controlled companies.) Both the 

foreign and domestic distributions are concentrated near zero and the domestic mode is 

only slightly smaller than the foreign mode. Yet, there continues to be a large disparity at 

the highly profitable end of the distribution. 

When profits are scaled by sales, there is a similar difference in the distribution of 

foreign and domestic companies, but it is not as dramatic. (These are not shown on the 

tables.) For example, in manufacturing, the domestic mode is above zero and it is about 20 

percent lower than the foreign mode, compared to 40 percent lower when the ratio of 
26

taxable income to assets is used. If dividends are taken out of income on the grounds that 

they would largely be shielded by either dividends received deductions or foreign tax 

credits, the distributions are not much affected. 

Summing up, foreign companies’ profitability continued to be concentrated near 

zero in 1993, similar to the 1987 pattern. The difference in profitability distributions was 

particularly notable in manufacturing. 

V. Analysis of the Form 5472 File for 1992 

On Form 5472, U.S. companies that are at least 25 percent owned by foreigners 

report on various types of transactions with affiliates offshore. (Since it may have 

transactions with many related parties offshore, a single U.S. company may file many Form 

5472s.) In recent years the Statistics of Income Division of the IRS has compiled data 

from Form 5472s filed by 

foreign-controlled companies with assets in excess of $500 million. In 1992, there were 

270 non-financial corporations that were used in the analysis in this section. 

The 5472 file provides the opportunity for comparing foreign-controlled companies 

that have extensive transactions with their offshore related parties with those that have 

relatively limited dealings. It might be hypothesized that companies with a greater number 

of transactions with their affiliates have more opportunities to shift income abroad. The 

5472 file also makes it possible to distinguish transactions with affiliates in high tax 

countries from those in low tax countries. 

Table 12 presents the relationship between various types of transactions and the 

foreign-controlled U.S. company’s profitability. The transactions are classified into four 

types: (1) payments for tangible property, (2) payments for intangible property, (3) 

receipts from the sale of tangible property, and (4) receipts from the sale of intangible 

property. Tangible property includes both stock in trade and tangible property other than 

stock in trade. Receipts from intangibles include rents and royalties, proceeds from sales of 

intangible property and “payments for technical, managerial or like services.”16 

16Alternative classifications, such as restricting tangible transactions only to stock in trade, 

did not affect the statistical results. Including commissions received and paid, which are very 
27

In Table 12, all transactions of a given type are first aggregated across all of the 

company’s foreign affiliates. The transactions variables are then transformed into 

thresholds of inter-company activity in order to reduce the problems of outliers in this 

relatively small sample. In column 1, for example, the tangible transactions threshold is 

total payments in excess of 10 percent of total assets and the intangible transactions 

threshold is total payments in excess of 1 percent of total assets. Of the companies in the 

sample, 37 percent had purchases of tangible property in excess of 10 percent of assets and 

16 percent were above the tangible sales threshold. With respect to intangible transactions, 

20 percent were above the purchases threshold and 19 percent above the sales threshold. 

In addition to the transactions variables, the Table 12 regressions for company 

profitability included basic industry dummies and the ratio of interest expense to assets, the 

measure of leverage available on the file. 

The results in Table 12 an at most be regarded as suggestive. Companies that buy 

substantial tangible property from affiliates abroad seem to have lower U.S. taxable 

income, but the transactions coefficients are not consistently different from zero at the 5 

percent level of significance, the common standard for evaluating statistical results. For 

example, the first column indicates that companies that make annual purchases of tangible 

property from foreign affiliates amounting to more than 10 percent of assets have a ratio of 

taxable income to assets that is 1.5 percentage points lower than other foreign-controlled 

companies. But the -.015 coefficient is just slightly larger than its standard error. 

The fourth column indicates that the companies above the tangible sales threshold 

have a ratio of taxable income to sales that is 2.6 percentage points lower than other 

foreign companies. Here the -.026 coefficient is significant at the 10 percent level. Still, 

even though these statistics indicate that a zero effect cannot be rejected using the normal 5 

percent standard, the hypothesis that there is a notable negative effect associated with more 

extensive transactions also cannot be rejected with any confidence. If forced to choose 

between the two hypotheses, the negative effect hypothesis would probably be chosen. 

small, also had little effect. Stock in trade is by far the largest item. 
28

In the second set of regressions, in columns 2 and 5, the transactions thresholds are 

lowered to half the level in the first set. The coefficients for purchases of tangible property 

become larger (in absolute value) and statistically more significant. The -.033 coefficient in 

column 5 is significant at the 5 percent level. None of the other transactions categories are 

close to being statistically significant. 

In Tables 13 and 14 transactions with tax affiliates in “high” tax countries are 

distinguished from transactions with affiliates in “other” or “low tax” countries. The 

country classification was based on a tabulation of effective tax rates on U.S. controlled 

corporations in 60 countries. These are taken from Form 5471's that U.S. parents file on 

each of their controlled foreign corporations (CFCs). Countries with an effective tax rate 

in 1992 above 10 percent were classified in the “high” tax group. All other countries, 

including those not among the 60 countries for which effective tax rate data was available, 

were classified in the other or “low” tax group.17 Purchases of tangible property from lowtax countries accounted for about 10 percent of total purchases from foreign related 

parties. 

Tables 13 and 14 indicate that, to the extent larger purchases of tangible property 

from offshore affiliates are associated with low profitability in the United States, it is 

transactions with affiliates in the “low-tax” grouping that seem to be important. Table 13 

uses the same transactions thresholds as the first set of regressions in Table 12, except that 

they now apply to transactions with each of the two country groupings. The first column 

of Table 13 shows that foreign-controlled companies that have more than the threshold 

level of purchases of tangible property from affiliates in “low-tax” countries have a rate of 

return on gross assets 4.7 percentage points less than other foreign companies. But the 

coefficient is significant only at the 10 percent level. (About 5 percent of the 270 company 

sample is above the low-tax country threshold.) 

17The 60 countries were all those that had 5 or more U.S. CFCs in manufacturing in 1990. 

The small countries outside the 60 had to be assigned arbitrarily to one group or the other 

because it is very difficult to obtain information on many of them. The presumption was that they 

are low tax. 
29 

Note that some of the coefficients of the transactions variables in Table 13 are 

positive. In particular, receipts from intangibles sold to “low” tax countries are associated 

with much higher U.S. profitability. This may reflect highly successful U.S. companies 

with valuable intangibles that have been acquired by foreign companies. (Only about 2 

percent of the sample is above this intangible sales threshold.) 

Table 14 uses the foreign-controlled U.S. company’s sales to scale the importance 

of transactions with foreign affiliates. It also sets a lower threshold for transactions with 

low-tax countries than with the high-tax group. Purchases of tangible property from 

affiliates in low-tax countries again seem to be associated with lower U.S. profitability. 

Furthermore, the -.050 coefficient, in the second column using the ratio of taxable income 

to sales as the profitability measure, is significant at the 5 percent level. 

Finally, if we take the coefficients in Tables 12-14 at face value, overlooking their 

general low statistical significance, how much of the foreign-domestic profitability 

differential can they explain. For example, consider the -.015 coefficient for purchases of 

tangible property in the first column of Table 12. About 37 percent of the sample is above 

the purchases threshold. Accordingly, these offshore transactions would “explain” about .5 

percentage points of the overall total differential, or about 15 percent. 

Summing up this section, there is some indication that more extensive transactions 

with affiliates abroad, particularly those in low-tax countries, are associated with lower 

U.S. 

profitability, but the statistical significance of the results is not very high. 

VI. Conclusions 

The availability of more recent data has provided the opportunity for both an 

update of the 1991 paper by Grubert, Goodspeed and Swenson and another look at some 

issues that may not have received enough attention. One feature is the recognition of the 

growing importance of investment income, particularly foreign dividends, as a contributor 

to the net income of U.S.- controlled companies. The statistical analysis in this paper also 

highlights the importance of weighting observations by size to reduce the role of small 

“noisy” companies that can often produce anomalous results if they are given a weight 
30 

equal to large companies. Furthermore, the results are also sensitive to whether net income 

is scaled by total assets or sales in comparing profitability. In particular, foreign companies 

have higher interest and depreciation expense when expressed in relation to sales than when 

measured in relation to assets. Because of the problems associated with asset valuations, 

including uncertainty over exactly what companies put on the balance sheet in their 

corporate tax return, this paper tends to put more reliance on sales based comparisons than 

the earlier study. 

The analysis of the 1987 cross-section in the earlier paper indicated that about 25 

percent of the foreign-domestic profitability differential could be explained purely by the 

cross-sectional variables, principally corporate age in the asset-based results and investment 

income and reliance on outside suppliers in the sales based results. The results in this paper 

suggest that this should be closer to 50 percent. One reason is the importance of dividends 

mentioned above, which, for example, account for more than 30 percent of the net income 

of U.S.-controlled manufacturing industries. Another is the greater depreciation and 

interest expense incurred by foreign-controlled companies. 

The possibility that systematic differences between foreign-controlled and U.S.-

controlled companies, rather than income shifting, explains most of the differential is 

reinforced by the finding that companies with foreign ownership between 25 and 50 percent 

have low profitability similar to 100 percent owned companies. Since income shifting 

would seem more difficult when other shareholders are involved, this suggests that the 

investments that foreign companies make in the United States may have distinctive 

features. 

In the earlier paper, a 1980-1987 panel of U.S. and foreign-controlled companies 

revealed that foreign-controlled manufacturing companies had an improving trend in 

profitability, suggesting a “maturation” effect. Foreign-controlled companies would, 

therefore, be willing to accept lower returns in the short run, soon after starting a U.S. 

enterprise, because of the expectation of higher profits in the future. In view of the 

importance of recent investments by foreigners, approximately another 20 percent of the 

foreign-domestic differential was attributed to this “maturation” effect. There was also a 
31 

small component of the differential attributed to the effect of exchange rate changes on 

wholesaling companies. 

The 1987-1993 panel examined in the present paper shows a similar positive trend 

for foreign-controlled manufacturing companies compared to domestic ones. But we 

cannot be very confident about the size of the “maturation” effect because it becomes much 

smaller when the observations are weighted by size. Exchange rates did not seem to have a 

noticeable effect on 1993 profit levels, perhaps because there were much smaller 

fluctuations in real exchange rates between 1987 and 1993 compared to the earlier period. 

Finally, the analysis of the Form 5472 file, which reports on the transactions 

foreign-controlled companies engage in with offshore affiliates, produced relatively 

inconclusive results. (The file had not been available for 1987.) There was some 

suggestion that companies which purchased more goods from offshore affiliates, 

particularly those in low-tax countries, had lower taxable income, but the statistical results 

were not very robust. Furthermore, even if we overlooked the generally low statistical 

significance of the results, the estimated coefficients would explain only about 15 percent 

of the differential. 
32 

REFERENCES 

Gordon, Roger H. and Lans Bovenberg (1996). Why is Capital So Immobile 

Internationally? Possible Explanation and Implications for Capital Income 

Taxation, American Economic Review, Vol. 86, No. 5, 1057-1075. 

Grubert, Harry, Timothy Goodspeed, and Deborah Swenson (1993). Explaining the Low 

Taxable Income of Foreign-Controlled Companies in the United States, in Alberto 

Giovannini, R. Glen Hubbard, and Joel Slemrod, eds., Studies in International 

Taxation. Chicago: University of Chicago Press, 237-70. 

Grubert, Harry, William Randolph and Donald Rousslang (1996). Country and 

Multinational Company Responses to the Tax Reform Act of 1986, National Tax 

Journal, Volume XLIX, No. 3, 341-358. 

Kinney, Michael and Janice Lawrence (1996). An Analysis of the Relative U.S. Tax 

Burden of U.S. Corporations Having Substantial Foreign Ownership, unpublished 

manuscript. 
TABLE 1

PROFITABILITY OF FOREIGN-CONTROLLED AND 

DOMESTIC COMPANIES 1987-1995

1987 1988 1989 1990 1991 1992 1993 1994 1995 

Ratio of Taxable Income to Assets 

All Industries 

Foreign-Controlled .58 1.15 .57 .24 -.22 .30 .54 .95 1.49 

U.S.-Controlled 2.14 2.51 2.26 2.14 1.95 2.03 2.32 2.45 2.70 

Non-Financial 

Foreign-Controlled 1.01 1.85 .90 .49 -.24 .48 .77 1.66 2.60 

U.S.-Controlled 3.78 4.60 3.84 3.47 394 3.04 3.56 4.23 4.33 

Manufacturing 

Foreign-Controlled 1.60 2.61 1.28 1.43 .33 .91 1.39 2.08 3.89 

U.S.-Controlled 4.93 6.18 5.28 4.71 3.63 3.69 4.31 5.02 5.30 

Wholesale Trade 

Foreign-Controlled .69 1.56 .96 -.64 -.44 .24 .26 1.36 1.06 

U.S.-Controlled 3.24 3.66 2.32 1.75 2.55 2.57 2.56 3.17 2.88 

Ratio of Taxable Income to Gross 

Receipts 

All Industries 

Foreign-Controlled .88 1.81 .94 .42 -.40 .52 1.04 1.79 2.98 

U.S.-Controlled 4.34 5.31 4.9l 4.65 4.42 4.71 5.64 5.85 6.66 

Non-Financial 

Foreign-Controlled 1.00 1.90 .91 .51 -.26 .49 .79 1.70 2.88 

U.S.-Controlled 3.49 4.50 3.80 3.45 3.02 3.14 3.71 4.22 4.31 

Manufacturing 

Foreign-Controlled 2.39 3.63 1.79 1.94 .44 1.17 1.70 2.54 5.22 

U.S.-Controlled 5.20 7.06 6.17 5.57 4.49 4.55 5.31 6.10 6.41 

Wholesale Trade 

Foreign-Controlled .29 .72 .47 -.37 -.26 .13 .15 .78 .61 

U.S.-Controlled 1.40 1.77 1.19 .89 1.13 1.30 1.40 1.71 1.51 
TABLE 2

ALTERNATIVE REGRESSIONS FOR TAXABLE INCOME TO ASSET RATIO*

(1993 FILE NON-FINANCIAL CORPORATIONS)

(OBSERVATIONS WEIGHTED BY SALES)

Intercept .0492 

(23.52) 

.0558 

(22.95) 

.1287 

(40.11) 

Foreign -.0423 

(15.25) 

-.0378 

(13.26) 

-.0308 

(11.66) 

Wholesale -.0034 

(.94) 

-.0067 

(.86) 

-.0029 

(.87) 

Transportation and Utilities -.0167 

(5.15) 

-.0172 

(5.19) 

-.0149 

(4.98) 

Food -.0158 

(3.53) 

-.0150 

(3.34) 

.0169 

(4.07) 

Electronics .0070 

(1.68) 

.0048 

(1.15) 

.0010 

(.26) 

Chemicals .0083 

(1.60) 

.0063 

(1.21) 

.0040 

(.83) 

Drugs .0544 

(6.35) 

.0498 

(5.82) 

.0430 

(5.44) 

Other Manufacturing -.0006 

(.20) 

-.0020 

(.72) 

-.0048 

(1.87) 

Age 1: LE 5 -.0198 

(5.91) 

-.0067 

(2.11) 

Age 2: GT 5 - LE 10 -.0175 

(6.36) 

-.0121 

(4.72) 

Age 3: GT 10 - LE 15 -.0105 

(2.69) 

-0047 

(1.30) 

Age 4: GT 15 - LE 20 -.0073 

(1.73) 

-.0040 

(1.02) 

Age 5: GT 20 - LE 30 .0039 

(1.23) 

.0045 

(1.55) 

Debt/Assets -.1076 

(30.95) 

Intangible Plus Other Assets -.0315 

(4.32) 

R Squared Adjusted .0631 .0745 .2131 

Mean of Dependent Variable .0419 .0419 .0419 

* Regressions are unweighted. 

t values in parenthesis. 
TABLE 3

SALES MARGINS*

(WEIGHTED BY SALES)

(1) (2) (3) (4) (5) (6) 

Taxable Adjusted Operating 

Independent Variables 

Intercept 

Income/Sales 

.0304 

(14.76) 

.1097 

(28.94) 

Income/ Sales 

.0924 

(33.47) 

.1864 

(35.93) 

Income/ Sales 

.0681 

(25.68) 

.1479 

(29.34) 

Foreign -.0352 

(12.90) 

-.0266 

(10.03) 

-.0249 

(6.79) 

-.0216 

(5.95) 

-.0101 

(2.87) 

-.0086 

(2.43) 

Wholesale -.0016 

(.45) 

.0043 

(1.22) 

-.0254 

(5.32) 

.0058 

(1.20) 

-.0325 

(7.09) 

-.0040 

(.86) 

Transportation and Utilities .0296 

(9.25) 

.0230 

(6.86) 

.1296 

(30.16) 

.0892 

(19.46) 

.1325 

(32.11) 

.1011 

(22.70) 

Food .0157 

(3.56) 

.0136 

(3.27) 

.0102 

(1.72) 

.0106 

(1.86) 

.0044 

(.77) 

.0067 

(1.22) 

Electronics .0236 

(5.73) 

.0167 

(4.29) 

-.0459 

(8.30) 

.0442 

(8.29) 

.0206 

(3.87) 

.0226 

(4.37) 

Chemicals .0303 

(5.94) 

.0212 

(4.40) 

.0558 

(8.15) 

.0370 

(5.61) 

.0219 

(3.33) 

.0087 

(1.36) 

Drugs .1086 

(12.88) 

.0936 

(11.81) 

.1012 

(8.95) 

.0821 

(7.57) 

.0356 

(3.28) 

.0238 

(2.26) 

Purchases/Total Expenses -.0125 

(3.44) 

-.0854 

(17.18) 

-.0754 

(15.60) 

Debt/Assets -.0969 

(27.94) 

-.0554 

(11.67) 

-.0601 

(13.03) 

Inverse of Total Assets -1268 

(4.63) 

-4338 

(11.58) 

-1630 

(4.48) 

Age 1 -.0033 

(1.03) 

-.0013 

(.29) 

.0054 

(1.28) 

Age 2 -.0017 

(.69) 

.0110 

(3.16) 

.0156 

(4.58) 

Age 3 -.0110 

(3.03) 

-.0197 

(3.95) 

-.0088 

(1.83) 

Age 4 -.0001 

(.03) 

-.0059 

(1.10) 

.0094 

(1.81) 

Age 5 -.0124 

(4.24) 

-.0166 

(4.14) 

-.0002 

(.06) 

R Squared Adjusted .1006 .2156 .2156 .2892 .2249 .2798 

Mean of Dependent Variable .0400 .0400 .1225 .1225 .0880 .0880 

*t values in parenthesis. 
 TABLE 4 

INCOME AND EXPENSE ITEMS IN RELATION TO SALES* 

(REGRESSIONS WEIGHTED BY SALES) 

Royalties Dividends Interest Deprecia- Interest 

Received Received Received tion Paid 

Foreign -.0043 

(3.20) 

-.0089 

(11.76) 

-.0014 

(.92) 

.0033 

(1.97) 

.0070 

(4.16) 

Wholesale -.0031 

(1.75) 

-.0026 

(2.61) 

.0067 

(3.40) 

-.0146 

(6.71) 

-.0094 

(4.27) 

Transportation and Utilities -.0056 

(3.52) 

-.0017 

(1.94) 

.0045 

(2.55) 

.0648 

(33.11) 

.0352 

(17.81) 

Food .0025 

(1.13) 

-.0056 

(4.54) 

-.0022 

(.90) 

-.0080 

(2.95) 

.0024 

(.89) 

Electronics .0018 

(.86) 

-.0111 

(9.69) 

.0126 

(5.50) 

.0177 

(7.03) 

.0046 

(1.80) 

Chemicals .0075 

(2.96) 

.0214 

(15.11) 

.0050 

(1.76) 

.0134 

(4.31) 

.0119 

(3.79) 

Drugs .0193 

(4.60) 

.0439 

(18.77) 

.0024 

(.51) 

-.0041 

(.80) 

-.0031 

(.60) 

Other Manufacturing .0088 

(6.56) 

.0119 

(15.93) 

.0024 

(1.62) 

-.0042 

(2.53) 

.0086 

(5.19) 

*t values in parenthesis. 
TABLE 5

TOTAL MANUFACTURING NET INCOME AND OPERATING INCOME 

IN RELATION TO SALES - 1987-1993*

1987 1993 

U.S. 

Controlled 

Foreign 

Controlled Difference 

U.S. 

Controlled 

Foreign 

Controlled Difference 

Taxable 

Income/Sales 5.20 2.30 2.81 5.31 1.70 3.61 

Operating 

Income/Sales 8.97 7.66 1.31 7.99 6.50 1.49 
TABLE 6

ADJUSTMENTS TO INCOME WHEN SCALED BY ASSETS*

(OBSERVATIONS WEIGHTED BY SALES)

(1) (2) (3) 

Net Income Operating 

Less Dividends Income Net Income 

Foreign 

-.0243 

(9.67) 

-.0197 

(6.35) 

-.0139 

(3.93) 

Age 1: LE 5 -.0027 

.(89) 

.0036 

(.95) 

-.0020 

(.64) 

Age 2: GT 5 - LE 10 -.0059 

(2.42) 

.0072 

(2.39) 

-.0042 

(1.70) 

Age 3: GT 10 - LE 15 .0005 

(.16) 

.0042 

(.98) 

-.0006 

(.19) 

Age 4: GT 15 - LE 20 .0011 

(.31) 

.0021 

(.46) 

.0020 

(.53) 

Age 5: GT 20 - LE 30 .0113 

(4.09) 

.0197 

(5.77) 

.0119 

(4.29) 

Debt/Assets -.1054 

(31.89) 

-.0464 

(11.39) 

-.1046 

(23.41) 

Intangible Plus Other Assets -.0286 

(4.12) 

-.0518 

(6.07) 

-.0214 

(2.99) 

Interest Paid/Assets .0168 

(.33) 

Depreciation/Assets .1783 

(5.02) 

Depreciation/Assets * Foreign -.2242 

(3.52) 

Dividends/Assets 1.2825 

(25.24) 

Royalties/Assets -.0940 

(2.85) 

Interest Received/Assets -.2216 

(3.44) 

R Squared Adjusted .2010 .0762 .2964 

*Industry dummies not displayed on table. 

t values in parenthesis. 
TABLE 7

SALES MARGINS - INCLUDES VARIABLE FOR 25-50 PERCENT 

FOREIGN OWNERSHIP*

(OBSERVATIONS WEIGHTED BY SALES)

Net Adjusted Operating 

Foreign Control 

Income/Sales 

-.0354 

(13.05) 

-.0267 

(10.10) 

Income/Sales 

-.0253 

(6.92) 

-.0223 

(6.16) 

Income/Sales 

-.0103 

(2.92) 

-.0088 

(2.48) 

25-50 Percent 

Foreign Ownership -.0384 

(3.92) 

-.0116 

(1.25) 

-.0529 

(4.01) 

-.0428 

(3.38) 

-.0279 

(2.20) 

-.0176 

(1.42) 

Age 1 -.0030 

(.96) 

.0023 

(.54) 

.0058 

(1.37) 

Age 2 -.0023 

(.90) 

.0107 

(3.07) 

.0155 

(4.54) 

Age 3 -.0113 

(3.12) 

-.0200 

(4.04) 

-.0900 

(1.87) 

Age 4 .0003 

(.07) 

-.0053 

(1.00) 

.0095 

(1.83) 

Age 5 -.0123 

(4.26) 

-.0166 

(4.17) 

-.0102 

(.05) 

Purchases -.0165 

(4.52) 

-.0908 

(18.30) 

-.0773 

(15.84) 

Inverse of Total Assets -1265 

(4.65) 

-4321 

(11.60) 

-1633 

(4.48) 

Debt/Assets -.0957 

(27.61) 

-.0529 

(11.16) 

-.0597 

(12.85) 

*Industry dummies, included in each regression, are not displayed. 
TABLE 8 

DEBT, INTEREST COSTS. AND SHAREHOLDERS LOANS

(1993 CROSS-SECTION NON-FINANCIAL CORPORATIONS* 

Interest 

Debt/Asset Debt/Asset Expense/Asset 

Intercept .6553 

(76.49) 

.6529 

(76.11) 

-.0155 

(15.61) 

Foreign .0675 

(6.72) 

.0621 

(5.96) 

.0001 

(.12) 

Wholesale .0365 

(2.86) 

-.0385 

(3.03) 

-.0081 

(7.76) 

Chemical -.0367 

(2.01) 

-.0396 

(2.18) 

-.0010 

(.68) 

Food -.0010 

(.06) 

-.0020 

(.13) 

.0008 

(.66) 

Drugs -.0845 

(2.81) 

-.0821 

(2.73) 

-.0045 

(1.82) 

Electronics -.0409 

(2.77) 

-.0424 

(2.71) 

-.0025 

(2.07) 

Transportation and Utilities .0121 

(1.06) 

-0143 

(1.25) 

.0007 

(.76) 

Other Manufacturing -.0372 

(3.84) 

-.0375 

(3.88) 

.0016 

(9.32) 

Age 1 .0933 

(7.90) 

.0900 

(7.63) 

.0090 

(9.32) 

Age 2 .0420 

(4.33) 

.0403 

(4.16) 

.0030 

(3.79) 

Age 3: .0493 

(3.59) 

.0456 

(3.32) 

-0007 

(.65) 

Age 4 .0094 

(.63) 

.0115 

(.77) 

-.0008 

(.63) 

Age 5 .0023 

(.21) 

.0012 

(.11) 

.0008 

(.85) 

Loans from Shareholders/Assets .5123 

(4.85) 

-.0008 

(.09) 

Loans from Shareholders * Foreign 

-.1648 

(1.10) 

-.0227 

(1.87) 

Debt/Asset Ratio .0659 

(61.15) 

R Squared Adjusted .0396 .0450 .4205 

Mean of Dependent Variable 

Weighted .6781 .6781 .0298 

*Weighted by sales. 

t values in parenthesis. 
TABLE 9

COUNTRY EFFECTS FOR DEBT AND PROFITABILITY

(1993 CROSS-SECTION, SALES WEIGHTS)*

Taxable Operating 

Debt/ Income/ Income/ 

Country and Number of Companies Assets Assets Assets

Canada (136) .0026 

(.08) 

-.0351 

(4.22) 

-.0204 

(1.83) 

Japan (246) .1190 

(6.69) 

-.0309 

(6.59) 

.0031 

(.49) 

United Kingdom (202) .1038 

(4.93) 

.0034 

(.62) 

.0089 

(1.19) 

Netherlands (127) -.0177 

(.76) 

-.0267 

(4.35) 

-.0139 

(1.69) 

Netherlands Antilles (11) -.0693 

(.69) 

-.0111 

(.42) 

.0104 

(.30) 

Germany (101) .0292 

(1.09) 

-.0667 

(9.84) 

-.0199 

(2.18) 

France (92) .1182 

(3.64) 

-.0434 

(5.10) 

-.0354 

(3.09) 

Sweden (32) -.0000 

(.00) 

-.0106 

(.72) 

.013 

(.06) 

Italy (11) -.0087 

(.06) 

-.0605 

(1.46) 

-.0848 

(1.53) 

Bermuda and Panama (19) .1620 

(2.42) 

-.1514 

(2.92) 

-.0518 

(2.19) 

Korea (12) .4043 

(4.22) 

-.0170 

(.67) 

-.0252 

(.75) 

Switzerland (59) .1236 

(3.07) 

-.0495 

(4.67) 

-.0212 

(1.50) 

Australia (21) -.1172 

(1.85) 

-.0488 

(2.94) 

.0172 

(.77) 

Other Foreign (13) .0678 

(1.93) 

-.0373 

(4.04) 

-.0118 

(.95) 

Debt/Assets -.1083 

(31.17) 

-.0605 

(13.02) 

R Squared Adjusted .0556 .2222 .2827 

* t dvalues in parenthesis under coefficients. Age and industry coefficients not 

displayed on table. 
TABLE 10

EXCHANGE RATE AND TREND EFFECTS IN 1987-1993 PANEL

(UNWEIGHTED)

Net Operating 

Independent Variables 

Foreign * Manufacturing 

Income/Assets Income/Assets 

.1447 

(1.45) 

.1506 

(1.60) 

Foreign * Wholesale -.0213 

(.19) 

.0622 

(.60) 

Foreign * Manufacturing * Trend .0085 

(4.52) 

.0053 

(2.98) 

Foreign Wholesale * Trend .0058 

(2.85) 

.0038 

(2.00) 

Foreign Manufacturing * Exchange Rate -.0024 

(2.25) 

-.0025 

(2.48) 

Foreign Wholesale * Exchange Rate -.0004 

(.34) 

-.0015 

(1.32) 

Manufacturing * Trend -.0020 

(2.84) 

-.0009 

(1.37) 

Foreign .0042 

(.73) 

.0553 

(9.61) 

Debt/Asset Ratio -.0659 

(47.54) 

-.0001 

(2.05) 

R Squared Adjusted .0886 .0439 

*Year and basic industry dummies not displayed. 

t values in parenthesis. 
TABLE 11

THE DISTRIBUTION OF TAXABLE INCOME

Taxable Income/Assets All Firms Manufacturing Wholesale 

Category Domestic Domestic Domestic

Less than -.150 

Foreign 

.0282 .0247 

Foreign 

.0279 .0252 

Foreign 

.0274 .0180 

-.15 to -.1 0.0336 0.0227 0.0418 0.0203 0.0219 0.0080 

-.1 to -.075 0.0302 0.0207 0.0265 0.0211 0.0192 0.0180 

-.075 to -.05 0.0625 0.0369 0.0516 0.0349 0.0604 0.0220 

-.05 to -.025 0.0998 0.0538 0.0907 0.0544 0.0631 0.0261 

-.025 to 0 0.1687 0.1059 0.1466 0.0878 0.1648 0.1024 

0 to .025 0.2104 0.1541 0.2108 0.1224 .2500 0.2208 

.025 to .05 0.1284 0.1514 0.1187 0.1272 0.1538 0.1706 

.05 to .075 0.0880 0.1283 0.0977 0.1228 0.1126 0.1566 

.075 to .1 0.0457 0.0857 0.0530 0.0947 0.0412 0.0722 

.1 to .15 0.0544 0.1126 0.0642 0.1447 0.0521 0.1004 

.15 to 2 0.0269 0.0547 0.0418 0.0736 0.0082 0.0401 

.2 to .25 .0121 0.0231 0.0139 0.0321 0.0109 0.0281 

Greater than .25 .0114 .0247 .0139 .0382 0.0137 .0160 
TABLE 12

PROFITABILITY AND TRANSACTIONS WITH OFFSHORE AFFILITATES*

(270 COMPANIES)

Manufacturing 

Taxable Income/Assets 

.012 

(.85) 

.014 

(1.02) 

.011 

(.82) 

Taxable Income/Assets 

.008 

(.51) .010 

(.60) 

.008 

(.49) 

Wholesaling .015 

(.89) 

.019 

(1.12) 

.014 

(. 84) 

.007 

(.34) .008 

(.42) 

.006 

(.34) 

Interests Expense/Assets .009 

(.05) 

.014 

(.08) 

.004 

(.02) 

-.478 

(2.45) 

-435 

(2.24) 

-.488 

(2.49) 

Transactions Thresholds 

(a) Tangible Purchases/Assets>.1 -.015 

(1.23) 

-.026 

(1.84) 

Intangible Purchases/Assets>.01 -.003 

(.20) 

-.009 

(.59) 

Tangible Sales/Assets>.1 -.002 

(.14) 

.009 

(.56) 

Intangible Sales/Assets>.01 .003 

(.23) 

.004 

(.23) 

(b) Tangible Purchases/Assets>.05 -.019 

(1.51) 

-.033 

(2.25) 

Intangible Purchases/Assets>.005 .002 

(.16) 

-.009 

(.60) 

Tangible Sales/Assets>.05 -.005 

(.41) 

.018 

(1.21) 

Intangible Sales/Assets>.005 .002 

(.12) 

.004 

(.26) 

(c) Tangible Purchases/Assets>.1 -.010 

(.84) 

-.021 

(1.54) 

Intangible Purchases/Assets>.01 -.006 

(.41) 

-.0003 

(.02) 

Tangible Sales/Sales>.1 -.015 

(1.00) 

-.003 

(.16) 

Intangible Sales/Sales>.01 -.002 

(.16) 

-.012 

(.73) 

*t values in parenthesis. 
TABLE 13

TRANSACTIONS WITH HIGH-TAX AND LOW-TAX COUNTRIES*

(TRANSACTIONS SCALED BY ASSETS)

Taxable Taxable 

Manufacturing 

Income/Assets 

.013 

(.93) 

Income/Sales 

.009 

(.57) 

Wholesaling .013 

(.77) 

.008 

(.40) 

Interest Expense -.107 

(.62) 

-580 

(2.87) 

Transactions Thresholds 

Low-Tax 

Tangible Purchases > .1 -.047 

(1.80) 

-.032 

(1.05) 

Intangible Purchases > .01 .013 

(.27) 

-.032 

(.55) 

Tangible Sales > .1 .042 

(1.31) 

.0000 

(.00) 

Intangible Sales > .01 .068 

(1.83) 

.088 

(2.02) 

High-Tax 

Tangible Purchases > .1 -.003 

(.25) 

-.018 

(1.25) 

Intangible Purchases > .01 -.001 

(.09) 

-.007 

(.40) 

Tangible Sales > .1 -.020 

(1.22) 

-001 

(.08) 

Intangible Sales > .01 -.008 

(.54) 

-.008 

(.49) 

* t values in parenthesis. 
TABLE 14

TRANSACTIONS WITH HIGH-TAX AND LOW-TAX COUNTRIES

(TRANSACTIONS SCALED BY SALES)

Taxable Taxable 

Manufacturing 

Income/Assets Income/Sales 

.012 

(.87) 

.009 

(.58) 

Wholesaling .012 

(.72) 

.008 

(.40) 

Interest Expense -.035 

(.20) 

-.530 

(2.68) 

Transactions Thresholds 

Low-Tax 

Tangible Purchases > .025 -.033 

(1.61) 

-.050 

(2.08) 

Intangible Purchases > .0025 .002 

(.05) 

-.014 

(.29) 

Tangible Sales > .025 .011 

(.43) 

.002 

(.08) 

Intangible Sales > .0025 .047 

(1.59) 

.062 

(1.78) 

High-Tax 

Tangible Purchases > .1 -.005 

(.42) 

-.016 

(1.16) 

Intangible Purchases > .01 -.007 

(.53) 

-.001 

(.06) 

Tangible Sales > .1 -.014 

(.83) 

-.001 

(.04) 

Intangible Sales > .01 -.007 

(.50) 

-.021 

(1.23) 
APPENDIX TABLE A1

THE RELATIONSHIP BETWEEN ASSETS AND SALES

(DEPENDENT VARIABLE IS LOG OF TOTAL ASSETS)

Foreign .2316 

(9.58) 

Wholesale -.1519 

(4.21) 

Chemical .3147 

(6.06) 

Food -.0586 

(1.22) 

Drugs .1382 

(1.38) 

Electronics .0245 

(.65) 

Transportation and Utilities .4353 

(13.35) 

Other Manufacturing .0616 

(2.50) 

Age 1 .0807 

(2.90) 

Age 2 -.0068 

(.25) 

Age 3 -.0265 

(.79) 

Age 4 -.0682 

(1.72) 

Age 5 -.0683 

(2.13) 

Log of Sales .7919 

(115.23) 

Purchases/Total Expenses -.9974 

(26.28) 

Royalties/Assets .0018 

(.01) 

Dividends/Total Assets 2.436 

(4.61) 

Interest Received/Total Assets 3.365 

(6.81) 

R Squared Adjusted .7225