Debt and the Profitability of 

Foreign-Controlled Domestic Corporations 

in the United States 

by 

Harry Grubert* 

OTA Technical Working Paper 1 

The author is grateful to Geraldine Gerardi, Bill Strang and Patrick Driessen for very helpful 

comments. Michael Cooper and Portia Defilippes provided tabulations and prepared the data file. 

The views expressed in this paper are those of the author and do not necessarily represent those of 

the U.S. Treasury Department. 

* U.S. Department of the Treasury. Harry.Grubert@do.treas.gov 

`Office of Tax Analysis 

U.S. Department of the Treasury
 

1500 Pennsylvania Avenue, NW 

Washington, D.C. 20220 

OTA Technical Working Papers is an occasional series of reports on the research, 

models and datasets developed to inform and improve Treasury’s tax policy analysis. 

Views and opinions expressed are those of the authors and do not necessarily 

represent official Treasury positions or policy. OTA Technical Working Papers are 

distributed in order to document OTA analytic methods and data and invite discussion 

and suggestions for revision and improvement. Comments are welcome and should 

be directed to the authors. 

July 2008 
 

Debt and the Profitability of 

Foreign-Controlled Domestic Corporations 

in the United States 

by 

Harry Grubert* 

OTA Technical Working Paper 1 

July 2008 

OTA Technical Working Papers is an occasional series of reports on the research, 

models and datasets developed to inform and improve Treasury’s tax policy analysis. 

Views and opinions expressed are those of the authors and do not necessarily 

represent official Treasury positions or policy. OTA Technical Working Papers are 

distributed in order to document OTA analytic methods and data and invite discussion 

and suggestions for revision and improvement. Comments are welcome and should 

be directed to the authors. 

`Office of Tax Analysis 

U.S. Department of the Treasury
 

1500 Pennsylvania Avenue, NW 

Washington, D.C. 20220 

* U.S. Department of the Treasury. Harry.Grubert@do.treas.gov 

The author is grateful to Geraldine Gerardi, Bill Strang and Patrick Driessen for very helpful 

comments. Michael Cooper and Portia Defilippes provided tabulations and prepared the data file. 

The views expressed in this paper are those of the author and do not necessarily represent those of 

the U.S. Treasury Department. 
 

 

 

 

Abstract 

Abstract: U.S. corporations controlled by foreigners continue to report lower net 

income in relation to total receipts than comparable domestically-controlled 

corporations. But the 2004 tax return data show that, in manufacturing and the 

entire nonfinancial sector, the discrepancy disappears when using a measure of 

operating income that focuses on the corporations’ activities in the United States. 

To determine operating income, dividends, interest and royalties are subtracted 

from net income and interest paid, depreciation, amortization, and depletion are 

added back to net income. Domestically-controlled corporations receive much 

greater dividend and royalty income, mainly from their subsidiaries abroad. 

In the nonfinancial sector, foreign-controlled U.S. corporations do not on 

average pay a larger percentage of their cash flow in interest than their 

domestically-controlled counterparts. They are also less likely to have very high 

levels of interest expense, using 50 percent of cash flow as the threshold. 

Foreign-controlled U.S. corporations in finance, insurance, and real estate 

exhibit a wide range of profitability compared to similar domestically-controlled 

corporations. For example, foreign-controlled corporations in real estate are on 

average much more profitable than domestically-controlled real estate 

corporations. On the other hand, foreign-controlled property and casualty 

insurance corporations and securities dealers and investment banks report 

modest income compared to domestically-controlled corporations. 

In finance, foreign-controlled commercial banks and securities dealers and 

investment banks pay more interest than domestically-controlled corporations as 

a percentage of cash flow. They are also much more likely to have very high 

levels of interest expense relative to cash flow. For example, the probability that 

a domestically-controlled securities dealer and investment bank pays more than 

90 percent of cash flow in interest is less than 5 percent but greater than 40 

percent for comparable foreign-controlled U.S. corporations. 

1
 
 

 

 

 

Debt and the Profitability of Foreign-Controlled Domestic Corporations 

in the United States 

Foreign-controlled domestic corporations (FCDCs) in the United States have the 

opportunity to reduce their U.S. taxable income by increasing their reliance on debt or by 

distorting the prices of intercompany transactions with related parties abroad. Like U.S. 

based multinational corporations, their intercompany transfer prices are governed by 

section 482 of the Internal Revenue Code and its associated regulations. In addition, 

section 163(j) of the Internal Revenue Code may limit the deductibility of “excess 

interest expense” on loans from related parties not subject to U.S. tax if the corporation’s 

ratio of debt to equity exceeds 1.5 to 1. 

The possibility that FCDCs in the United States may be improperly reducing their 

U.S. taxable income is suggested by data that show that, historically, they have been 

relatively unprofitable compared to domestically-controlled corporations (DCCs). The 

persistence of this low relative profitability of FCDCs is shown on Figure 1, which is 

derived from data from corporate income tax returns for 1995 through 2003 and that are 

published in annual articles in the Statistics of Income Bulletin.1

 The profitability 

measure used in the comparison is the ratio of net income to total receipts.2 These data 

show that over this period large FCDCs in manufacturing and the nonfinancial sector as a 

whole were consistently less profitable than large DCCs. For most of these years, 

FCDCs in the financial sector were also less profitable than their domestic counterparts. 

1

 http://www.irs.gov/taxstats/article/0,,id=96311,00.html#2. 

2

 Net income is total income less total deductions before ‘special deductions’ and net operating losses. 

Total receipts include all of the income received by a corporation and reported on its tax return, including 

gross receipts before the deduction for cost of goods sold and business expenses, and interest on tax exempt 

obligations. Large corporations are those with assets of $250 million or more and/or business receipts of 

$50 million or more. Foreign-controlled domestic corporations are those with 50 percent or more foreign 

ownership. The data exclude real estate investment trusts, regulated investment corporations, S 

corporations and corporations with foreign ownership between 25 and 50 percent. 

2
 
 A more detailed examination of the profitability difference in 2004 (the most recent year 

for which tax return information is available) is presented in Table 1. It compares the 

ratio of net income to total receipts in all industries, manufacturing, and the entire 

3
 

 

 

financial and nonfinancial sectors by ownership category.3 As in Figure 1, profitability is 

expressed relative to total receipts rather than total assets or equity because of the 

historical book value (i.e., the value at the time of acquisition) and other problems 

associated with assets reported on the corporate tax return. Newly acquired assets 

generally have a higher book value than the assets they replaced. Comparisons using 

book value measures may be misleading if either FCDCs or DCCs contain a larger share 

of corporations with newly-acquired assets, such as new corporations. In addition, the 

balance sheet also includes foreign assets and liabilities, and furthermore corporations 

apparently vary on how these are stated, e.g., sometimes the foreign assets are on a gross 

basis and sometimes on a net equity basis. Also, corporations that file consolidated tax 

returns frequently do not net out intercompany assets and liabilities. 

 The three categories of corporations displayed in Table 1 are those that are more 

than 50 percent owned by foreigners, those with 25 to 50 percent foreign ownership, and 

all other corporations (referred to as domestically controlled). The estimated lower 

profitability of FCDCs compared with DCCs is evident in all industry groupings. For 

example, in manufacturing the ratio of net income to total receipts is about one-third 

lower for FCDCs (3.3 percent) than for DCCs (4.9 percent). The ratio of net income to 

total receipts is also substantially lower for FCDCs than for DCCs in the financial and 

nonfinancial sectors. 

3

 Table 1 is based on tabulations of data from Form 1120, the corporate income tax return. They differ 

somewhat from the tabulations published by the Statistics of Income Division, which were used to 

construct Figure 1. Unlike Figure 1, Table 1 is not restricted to large corporations. Also, Table 1 defines 

FCDCs as corporations with greater than 50 percent foreign ownership, whereas Figure 1 uses 50 percent 

or more foreign ownership. 

4
 
 

Table 1 

The Ratio of Net Income to Total Receipts and Number of Corporate Tax Returns 

by Ownership Category and Sector: 2004 

All 

Industries Manufacturing All 

Nonfinancial Financial 

Ownership Category Ratio of Net Income to Total Receipts (%) 

Foreign Ownership > 50% 2.9 3.3 2.8 3.9 

Foreign Ownership 25 - 50% 3.0 4.9 2.9 6.1 

Domestically Controlled 4.3 4.9 3.8 6.6 

Number of Corporate Returns in Sample 

Foreign Ownership > 50% 10,202 2,671 8,243 1,959 

Foreign Ownership 25 - 50% 832 238 724 108 

Domestically Controlled 65,550 10,197 52,638 12,912 

Notes: These estimates are based on data from corporate income tax returns for 2004. They exclude 

REITs, RICs, Subchapter S Corporations, and branches of foreign corporations filing on 1120F. 

Number of returns is unweighted. 

This paper explores the possible sources of the apparent discrepancy between the 

net income of foreign-controlled and domestically-controlled corporations, with a special 

attention to interest expense. Several explanations for the difference in profitability are 

possible, such as start up costs, a different structure of income and assets, and the 

distortion of transfer prices in intercompany transactions. The low relative profitability 

of foreign-controlled domestic corporations has been studied in the past by Grubert, 

Goodspeed and Swensen (1993), Grubert (1997) and Blouin, Collins and Shackelford 

(2001), among others. This paper updates some of these earlier studies for recent 

developments. It also extends the analysis in Grubert, Goodspeed and Swenson (1993) 

and Grubert (1997) to include the financial sector. The emphasis is on industries in 

which foreign-controlled domestic corporations are heavily represented, such as 

manufacturing and securities dealers and investment banks. 

The study of the profitability of foreign-controlled domestic corporations in the 

United States raises the question of the appropriate “control” or comparison group for the 

analysis. The corporations in the 25 to 50 percent ownership category are a convenient 

5
 
 

 

comparison group because minority ownership would be expected to provide much fewer 

opportunities for income shifting. If they have profitability levels comparable to foreigncontrolled domestic corporations, this might indicate that all foreign corporations tend to 

invest in similar U.S. corporations irrespective of ownership levels. (The overwhelming 

share of foreign-controlled domestic corporations in the United States are the product of 

acquisitions, not ‘green field’ startups.) However, the 25-50 percent owned category 

tends to be a small group of corporations and they cannot be consistently relied on for 

any firm conclusions, particularly at the industry level. Most of the discussion below, 

therefore, is based on a comparison of foreign-controlled and domestically-controlled 

corporations. 

Some may claim that U.S. based multinational corporations (MNCs) should not 

be in the control group because they have many opportunities to shift income out of the 

United States as well. However, the group of domestic corporations with no foreign 

operations, in industries like manufacturing, may have special characteristics such as 

lower profitability and fewer intangible assets which limit their opportunities for 

investing abroad. 

Grubert (1997) found that one factor explaining a substantial part of the differing 

net profitability of FCDCs and DCCs in the nonfinancial sector is that DCCs receive a 

substantial amount of dividends, interest, and royalties from foreign affiliates. Their 

observed net income, therefore, does not accurately reflect the profitability of their 

domestic operations alone. In order to isolate some of the more important factors that 

may explain differences in profitability, a measure of operating income is calculated for 

the two groups by subtracting interest, royalties and dividends received from net income, 

6
 
 

 

and adding back interest paid, depreciation, depletion and amortization. The objective is 

to obtain a measure of income that reflects the profitability of corporations’ domestic 

operations. The denominator in the operating profits ratio, total receipts, is similar to 

domestic sales in the case of nonfinancial corporations. 

 Table 2 therefore constructs the ratio of operating income to total receipts for 

all nonfinancial corporations and for manufacturing corporations alone.4 The first row 

for each category repeats the ratio of net income to total receipts from Table 1 and shows 

the large difference in profitability between foreign-controlled domestic corporations and 

domestically-controlled corporations. The next six rows present the income and expense 

components used to convert net income to operating income, all in relation to total 

receipts, for foreign-controlled and domestic corporations. There are substantial 

differences between the two groups. DCCs pay somewhat more interest in relation to 

total receipts but this is more than offset by the much larger amount of interest income 

they receive.5

 DCCs receive substantially more dividends and royalties than FCDCs. 

FCDCs and DCCs had similar depreciation deductions, with somewhat larger DCC 

deductions in the entire nonfinancial sector, but not in the manufacturing sector by itself. 

The net result of adding and subtracting the various components is shown in the 

last row. The discrepancy in profitability between FCDCs and DCCs in the nonfinancial 

sector when net income is the profitability measure disappears. In the nonfinancial 

sector, FCDCs are slightly more profitable than DCCs in terms of operating income (6.3 

4

 The same definition of operating earnings cannot be used in the financial sector. Interest income and
 

expense and the spread they earn on them are an intrinsic part of their operations. 5

 The regressions below attempt to estimate the extent to which greater interest income creates the 

opportunity for greater borrowing.
 

7
 
Table 2 

Net Income Adjusted to Operating Income 

in the Nonfinancial and Manufacturing Sectors 

by Ownership Category: 2004 

All Nonfinancial 

Foreign 

Control 

Foreign 

Ownership 

25 - 50% 

Domestic 

Control 

Net Income / Total Receipts 2.8 2.9 3.8 

Plus:

 Interest Paid / Total Receipts 3.1 1.8 3.8

 Depreciation & Amortization / Total Receipts 4.2 3.9 4.4

 Depletion / Total Receipts 0.1 0.1 0.1 

Minus:

 Dividends Received / Total Receipts 0.5 0.5 1.2

 Interest Received / Total Receipts 2.9 0.7 4.4

 Royalties Received / Total Receipts 0.5 1.2 1.0 

Operating Income / Total Receipts 6.3 6.3 5.5 

Manufacturing 

Foreign 

Control 

Foreign 

Ownership 

25 - 50% 

Domestic 

Control 

Net Income / Total Receipts 3.3 4.9 4.9 

Plus:

 Interest Paid / Total Receipts 2.4 2.3 3.2

 Depreciation & Amortization / Total Receipts 4.3 5.0 4.0

 Depletion / Total Receipts 0.1 0.0 0.1 

Minus:

 Dividends Received / Total Receipts 0.4 0.7 2.1

 Interest Received / Total Receipts 1.3 0.8 2.4

 Royalties Received / Total Receipts 0.5 1.4 1.8 

Operating Income / Total Receipts 7.9 9.3 5.9 

Notes: Shares reported as percentages. Operating Income = Net Income + Interest Paid + 

Depreciation + Depletion - Dividends - Royalties - Interest Received. Estimates based on 

corporate income tax returns for 2004. Excludes RICs, REITs, and Subchapter S 

Corporations. 

percent for FCDCs compared with 5.5 percent for DCCs). In manufacturing, FCDCs are 

significantly more profitable than DCCs on this basis (7.9 percent for FCDCs compared 

with 5.9 percent for DCCs). An important reason for these differences is that DCCs 

receive a greater amount of dividends and royalties relative to total receipts (which are 

subtracted in computing operating income), particularly in manufacturing where DCCs 

8
 
 

have significant foreign operations. On the basis of these aggregate data, FCDCs in the 

nonfinancial sector do not seem on average to be less profitable than DCCs when their 

operating incomes are compared. However, that still leaves open the question of leverage 

and interest expense, which is the reason they are the subject of much of the analysis 

below. 

As noted later when the regression analysis is discussed, it might be claimed that 

royalties received should not be taken out of operating income because they represent the 

return to R&D and other expenses that have been deducted from taxable income. But 

even if royalties are kept in operating income, both Table 2 and the regression indicate 

that FCDC operating earnings continue to be greater than DCC earnings in relation to 

total receipts. 

The higher profitability of FCDCs compared to DCCs when operating income is 

used as the profitability measure does not mean that FCDCs are not shifting income out 

of the United States. The comparison shown in Table 2 is at an aggregate level and may 

not account for systematic differences between foreign and domestic corporations at the 

level of the firm that may affect profitability.6

 Further, the domestic corporation control 

group itself also may be shifting income out of the United States. Grubert (1997) found 

that the translation from net income to operating income only eliminated about 60 percent 

of the initial gap in the ratio of net income to receipts in manufacturing in 1993. The 

adjustment is much more significant for 2004. The possibility that DCCs are shifting 

more income abroad is suggested by Figure 1, which shows that the ratio of net income to 

receipts of U.S. corporations in manufacturing declined substantially from 1995 to 2003. 

6

The statistical analysis presented below attempts to control for other factors that may affect profitability. 

9
 
 

 

Section 163(j) is directed at taxpayers that have very high interest expense relative 

to cash flow. Whereas Table 2 provided information on average interest expense relative 

to total receipts, Table 3 presents the distribution of interest paid relative to cash flow by 

FCDCs and DCCs. The distributions are presented for all industries and separately for 

manufacturing, and the entire nonfinancial sector. A similar distribution of interest 

expense relative to cash flow in the financial sector (excluding insurance) is presented in 

Table 8 below in the separate section on financial industries. 

Table 3 presents the percent of FCDC and DCC receipts and cash flow accounted 

for by corporations in selected intervals of the ratio of interest expense to cash flow. 

Cash flow is defined similarly to “adjusted income” in section 163(j): net income (before 

net operating loss deductions) plus interest paid, depreciation, depletion and amortization. 

The ratio differs from section 163(j) in that interest income is not netted from interest 

expense in the numerator. 

Table 3 indicates that, in manufacturing and the nonfinancial sector as a whole, it 

is very difficult to identify major differences in the frequency of high interest expense. 

DCCs are somewhat more likely to have high interest expense in relation to cash flow. 

For example, in the manufacturing sector FCDCs with interest expense equal to 50 

percent or more of cash flow accounted for 10.4 percent of their receipts (6.6 percent plus 

3.8 percent) and 10.6 percent of their cash flow (7.9 percent plus 2.7 percent). In 

contrast, DCCs with interest expense equal to 50 percent or more of cash flow accounted 

for 13.7 percent of their receipts (8.8 percent plus 4.9 percent and 16.2 percent of their 

cash flow (14.0 percent plus 2.2 percent). 

10
 
 

Table 3 

Distribution of Interest Paid to Cash Flow by Percent of Total Receipts 

and Cash Flow for All Industries, Manufacturing and the Nonfinancial 

Sector: 2004 

All Industries 

Interest Paid/Cash Flow 

Total Receipts Cash Flow 

Foreign 

Control 

Domestic 

Control 

Foreign 

Control 

Domestic 

Control 

.00 ≤ ratio < .25 62.7 61.9 50.1 49.0 

.25 ≤ ratio < .50 19.1 22.4 21.5 21.1 

.50 ≤ ratio < .75 12.4 8.7 16.1 17.0 

.75 or more 5.9 7.0 12.3 13.0 

Total 100.0 100.0 100.0 100.0 

Manufacturing 

Interest Paid/Cash Flow 

Total Receipts Cash Flow 

Foreign 

Control 

Domestic 

Control 

Foreign 

Control 

Domestic 

Control 

.00 ≤ ratio < .25 69.3 61.1 62.7 62.4 

.25 ≤ ratio < .50 20.3 25.2 26.6 21.5 

.50 ≤ ratio < .75 6.6 8.8 7.9 14.0 

.75 or more 3.8 4.9 2.7 2.2 

Total 100.0 100.0 100.0 100.0 

All Nonfinancial 

Interest Paid/Cash Flow 

Total Receipts Cash Flow 

Foreign 

Control 

Domestic 

Control 

Foreign 

Control 

Domestic 

Control 

.00 ≤ ratio < .25 64.4 63.8 55.6 56.5 

.25 ≤ ratio < .50 19.4 22.7 24.1 23.1 

.50 ≤ ratio < .75 12.6 8.4 18.0 17.5 

.75 or more 3.6 5.0 2.4 2.8 

Total 100.0 100.0 100.0 100.0 

Note: These estimates are based on data from corporate income tax returns 

for 2004. They exclude REITs, RICs, Subchapter S corporations, and 

branches of foreign corporations filing on Form 1120F and corporations in 

the 25-50% ownership category. The financial sector excludes insurance 

and real estate. 

However, the comparison of FCDCs and DCCs in manufacturing with interest 

expense equal to 75 percent or more of cash flow yields a somewhat more mixed picture, 

with the result depending on whether the share of total receipts or the share of total cash 

flow is used as the criterion. Corporations with interest expense equal to 75 percent or 

11
 
more of cash flow account for 3.8 percent of FCDC receipts compared to 4.9 percent of 

DCC receipts. On the other hand, corporations with interest expense equal to 75 percent 

or more of total cash flow accounted for 2.7 percent of FCDC cash flow but only 2.2 

percent of DCC cash flow. 

In the nonfinancial sector as a whole, the comparison of FCDCs and DCCs with 

interest expense equal to 50 percent or more of cash flow also provides mixed results, 

depending on whether the share of total receipts or the share of cash flow is used as the 

criterion. The share of total receipts is 16.2 percent for FCDCs (12.6 percent plus 3.6 

percent) and 13.4 percent for DCCs (8.4 percent plus 5.0 percent). However, the share of 

total cash flow is approximately the same for both FCDCs and DCCs: 20.4 percent for 

FCDCs (18.0 plus 2.4 percent) compared to 20.3 percent for DCCs (17.5 percent plus 2.8 

percent). On the other hand, DCCs with interest expense of 75 percent or more of cash 

flow are more likely to have high interest expense than FCDCs using either total receipts 

or cash flow as the criterion. 

Most of the remaining analysis of nonfinancial corporations is based on 

regressions and probit techniques using firm level data. These statistical techniques 

control for systematic differences between the groups of corporations that might cause 

their profitability and interest expense to vary. For example, profitability might be 

affected by corporate age and comparisons may be distorted because foreign-controlled 

domestic corporations are more recently established. Profitability in relation to sales may 

be influenced by how much the corporations purchase from others. A higher reliance on 

outside components means that they need less capital per unit of final sales. Similarly, in 

analyzing the use of debt, it is important to control for the composition of the 

12
 
 

 

corporation’s assets because this could determine how much they can borrow. For 

example, they might be expected to be able to have greater leverage if they have a greater 

amount of cash and other very liquid assets instead of fixed depreciable plant and 

equipment. 

 One issue in using regressions in which the observations vary greatly in size is 

how the observations should be weighted. The ratio of net income to receipts is likely to 

exhibit much more variability (heteroskedasticity) in the case of small corporations than 

large corporations. Large observations, therefore, carry more information. One solution 

is to weight each observation in a given regression by the size of total receipts. In this 

paper, we first estimated the relation between the variance of the profit rate in a sector 

and the size of the corporations’ gross receipts. In most cases, the size variable is the log 

of total receipts, but in a few cases the inverse of total receipts proved to be a better 

specification. In all cases the variability of the profit rate fell as the corporation became 

larger. The estimated relationship between size and variance was then used to form the 

weights in the final regression.7 

While the results are generally consistent, it is necessary to distinguish between 

the questions answered by the aggregate data in Tables 1-3 and by the firm level 

regressions. The aggregate tables give an overall picture, as if all the corporations in a 

particular category were aggregated into a single firm. The regressions attempt to 

determine if there are statistically significant differences between FCDCS and DCCs 

after controlling for identifiable characteristics of each corporation. One reason why the 

answers may differ is because the aggregate data can be affected by extreme behavior by 

a limited number of firms, but they are too few and idiosyncratic to permit us to draw 

7

 The weight for an observation was the inverse of the variance for a company of its size. 

13
 
 

 

statistically reliable conclusions. For example, there may be a very large corporation that 

dominates the aggregate statistics but does not reveal enough about the “typical” 

corporation to permit general conclusions.8 

As indicated earlier, the analysis first concentrates on nonfinancial corporations 

and then examines selected financial industries, such as investment banking and 

insurance, in the next section. Because of the special nature of finance, the data analysis 

must necessarily differ. For example, interest received may be passive portfolio income 

for a manufacturing corporation, but part of operating income for a bank. 

Tables 4 and 5 present firm level regressions in which the dependent variables are 

the ratio of net income to total receipts and the ratio of operating income to total receipts 

in manufacturing and nonfinancial industries as a whole (excluding utilities), 

respectively.9 Therefore, they complement the aggregate tabulations in Tables 1 and 2. 

The regressions use the same Statistics of Income Division sample of corporate returns 

for 2004. As in the aggregate tabulations in Tables 1 and 2, the sample excludes tax 

returns filed by subchapter S corporations, Regulated Investment Corporations (RICs), 

Real Estate Investment Trusts (REITs) and branches of foreign corporations. In addition, 

corporations with assets below $50 million are excluded.10 

In Tables 4 and 5, for corporations in manufacturing and the entire nonfinancial 

sector, respectively, the first column of results relates the ratio of net income to total 

receipts to dummy variables for the two basic foreign ownership categories, greater than 

8

 In the regressions, some observations are deleted, for example, if there are no assets or sales for the 

company in the data file. 

9

 Utilities are excluded from the nonfinancial sector in the regressions because of the special features of rate 

regulated industries, such as the ability to issue a large amount of debt. 

10 The exclusion of corporations with less than $50 million in assets supplements the weighting scheme to
 

keep the conclusions from being unduly influenced by small idiosyncratic corporations. 

14
 
 

50 percent and 25 to 50 percent. They therefore parallel the net income tabulations in 

Table 1 and yield similar results on the discrepancy between FCDCs and DCCs. For 

example, Table 1 shows that in manufacturing, the profit rate of FCDCs is 1.4 percentage 

points lower than the 4.3 percent of sales earned by DCCs. The coefficient of the FCDC 

variable in the first regression on Table 4 indicates that FCDCs on average have a profit 

rate 1.4 percentage points below the rate of profits on sales earned by DCCs and that the 

sample mean is 4.3 percent. 

The second column of results in Tables 4 and 5 analyzes how much the estimated 

differential between FCDCs and DCCs in the first column, the FCDC coefficient, is 

explained by systematic differences between the corporations. The four added 

explanatory variables are two age categories, based on the date of incorporation, the ratio 

of purchases to sales and the ratio of total assets to total receipts. The age variables test 

the possibility that some of the net income discrepancy between FCDCs and DCCs is 

attributable to start-up costs by relatively immature FCDCs.11 The ratio of purchases to 

sales adjusts for the possibility that corporations that rely more on outside supplies can be 

expected to have a lower profit margin on total receipts because they need less of their 

own capital. The purpose of the fourth variable, the ratio of assets to sales, is to adjust 

for the fact that net income is expressed relative to receipts, rather than assets, which 

would be closer to a rate of return measure. As in the aggregate tabulations, total receipts 

are chosen for the denominator because of the uncertainty over what corporations put on 

the balance sheet reported on their tax return, even apart from the standard historical 

11 A recent incorporation date may indicate a recent acquisition or merger, not an actual start up. 

15
 
 

 

 

book valuation problems in asset accounts.12 Nevertheless, the ratio of total assets to 

total receipts is added as an indicator of capital intensity because of the possibility that 

the total asset data do contain some information, albeit flawed. 

Table 4 

Manufacturing, 2004 

Regressions for Net Income & Operating Income 

Independent Variables 

Dependent Variables 

Net Income / Total 

Reciepts 

Net Income / Total 

Reciepts 

Operating Income / 

Total Receipts 

Foreign Ownership > 50 percent 

-.0140** 

(4.20) 

-.0058 

(1.76) 

.0095** 

(3.02) 

Foreign Ownership 25-50 percent 

.0120 

(1.15) 

.0117 

(1.15) 

.0175 

(1.82) 

Age < 5 years 

-.0314** 

(7.24) 

-.0008 

(0.20) 

Age 5 - 15 years 

-.0146** 

(4.10) 

.0007 

(0.22) 

Purchases / Sales 

-.0773** 

(10.25) 

-.1173** 

(16.47) 

Assets / Sales 

.0009 

(0.91) 

.00003 

(0.04) 

Mean of dependent variable .0433 .0433 .0854 

Number of observations 3087 3087 3087 

Notes: 

1) Operating income is net income minus interest income, dividends and royalties, interest paid, depreciation, 

depletion, and amortization. 

2) t values are in parentheses. 

3) Companies with total assets less than $50 million are excluded from the sample. 

4) ** means significant at the 1 percent level 

The second column of results in both Tables 4 and 5 indicate that these added 

variables seem to explain a substantial portion of the initial FCDC-DCC discrepancy in 

the ratio of net income to total receipts. Indeed, the initial negative coefficients for 

FCDCs in the first column shrink by more than half in the second column. The 

12As discussed earlier, one issue is how assets in subsidiaries abroad are reported. The use of total receipts, 

which are dominated by sales in the case of nonfinancial corporations, largely abstracts from this by 

focusing only on the operations of the company in the United States. 

16
 
 

 

 

 

 

 

coefficients for the age dummies and the purchases variable have the expected negative 

signs and are statistically significant. Adding the purchases variable has a particularly 

significant impact on the FCDC coefficient. 

Nonfinancial Sector, 2004 

Regressions for Net Income & Operating Income 

Table 5 

Independent Variables

Dependent Variables 

Net Income / Total 

Reciepts 

Net Income / Total 

Reciepts 

Operating Income / 

Total Receipts 

Foreign Ownership > 50 percent 

-.0145** 

(6.21) 

-.0031 

(1.34) 

.0182** 

(5.21) 

Foreign Ownership 25-50 percent 

-.0025 

(0.32) 

-.0057 

(0.73) 

.0298** 

(2.58) 

Age < 5 years 

-.0335** 

(11.60) 

.0058 

(1.35) 

Age 5 - 15 years 

-.0164** 

(7.23) 

.0004 

(0.10) 

Purchases / Sales 

-.0620** 

(18.91) 

-.0124* 

(2.52) 

Assets / Sales 

.00003** 

(4.12) 

.000010 

(0.93) 

Mean of dependent variable .0477 .0477 .0648 

Number of observations 8185 8185 8185 

Notes: 

1) Operating income is net income minus interest income, dividends and royalties, interest paid, depreciation, 

depletion, and amortization. 

2) t values are in parentheses. 

3) Companies with total assets less than $50 million are excluded from the sample. 

4) * means significant at the 5 percent level and ** means significant at the 1 percent level. 

 The last column of results in Tables 4 and 5 substitutes the ratio of operating 

income to total receipts as the income measure. Operating income, as in Table 2, is 

defined as net income plus interest paid, depreciation, depletion and amortization and 

minus interest, royalties and dividends received. Its main purpose is to remove financial 

income such as dividends and royalties, which mainly come from foreign affiliates, so 

17
 
 

that the income measure reflects purely domestic operations. As in Table 2, the use of 

operating income as the income measure results in a positive FCDC coefficient in Tables 

4 and 5, indicating higher operating profitability by FCDCs. 

The regressions in Table 4 for net income suggested that the age of the 

corporations and their reliance on outside suppliers explained a large part of the 

profitability differential between FCDCs and DCCs. But these factors become 

insignificant when operating income is used as the profitability measure. This suggests 

that the age variables and the importance of purchased materials tend to indicate 

immature corporations that are less likely to receive dividends and royalties from their 

foreign operations. 

 It might justifiably be argued that royalties should be included in domestic 

operating income because it represents the return to domestic R&D, which is deductible 

from U.S. taxable income. However, additional regressions (not shown) indicate that 

removing dividends from net income is enough to eliminate the foreign differential in the 

regressions with the explanatory variables that are used in columns 2 and 3. Furthermore, 

the greater amount of royalties that DCCs receive from abroad probably indicates that 

they have many more U.S. developed intangibles that can be applied to domestic 

production. 

Regressions, not shown in the tables, for the separate components of operating 

income show the reasons for the difference between the net income and operating income 

comparisons. In manufacturing, the greater amount of dividends and royalties received 

by domestically-controlled corporations is particularly notable. This reflects the large 

18
 
 

 

 

amount of foreign income the domestically-controlled manufacturing corporations 

receive from their foreign operations. 

Tables 6 and 7 analyze interest expense relative to cash flow in manufacturing 

and in the entire nonfinancial sector. Interest expense is expressed in relation to cash 

flow, in part, because that is the ratio used in section 163(j). Prospective lenders would 

be expected to use the extent to which interest payments are covered by cash flow in 

judging the corporation’s creditworthiness. However, explanatory variables are added 

that provide more detail on the corporations’ assets and operations and give a clearer 

picture of the determinants of the amount they borrow. For example, if a nonfinancial 

corporation receives a great deal of interest, this might indicate that it has a substantial 

financial component and is more likely to be highly leveraged. It might also be easier to 

borrow on the basis of very liquid assets compared to fixed plant and equipment. 

Before discussing the interest expense results in Tables 6 and 7, it is appropriate 

to consider how a corporation’s interest expense might be related to these variables. The 

relationship is not entirely straightforward, because the extent to which a corporation 

incurs interest expense reflects both the credit that is available from lenders and the 

corporation’s own financial strategy as it evolves. Furthermore, stating that the optimal 

strategy is simply a matter of leveraging up until bankruptcy risks increase the after-tax 

cost of debt to the cost of equity leaves open the issue of the cost of retained earnings.13 

The role of cash on the balance sheet is a notable example of this complicated 

relationship. Lenders would be very willing to extend credit to cash laden firms but the 

presence of cash on the balance sheet is itself a reflection of the corporation’s financial 

decisions over time. The corporation may be very profitable and it may not choose to 

13See Brys and Bovenberg (2006). 

19
 
 

 

take full advantage of its borrowing power because that would require huge taxable 

dividends to shareholders. Paying off debt and accumulating liquid assets may be a 

preferred strategy. 

Table 6 provides regressions in which the dependent variable is the ratio of 

interest expense to cash flow and Table 7 presents probit analyses for the likelihood that a 

corporation with given characteristics has interest expense greater than 50 percent of cash 

flow, the section 163(j) threshold. As in Table 3, cash flow is defined as net income plus 

interest paid plus depreciation, depletion and amortization. In addition to the age and 

foreign control variables, the explanatory variables in the Table 6 regressions include: 

(1) the distribution of total assets among cash, notes and accounts receivable, government 

and tax exempt securities, inventories and depreciable capital, (2) the ratio of interest 

received to cash flow, (3) corporate size, defined as the log of total receipts, (4) loans 

from shareholders as a percent of total assets and (5) the interaction of the loans from 

shareholder variable with the identifier of foreign control.14 

The asset composition variables are included because some assets can be much 

easier to use as explicit or implicit collateral. The interest received variable is introduced 

to identify those nonfinancial corporations that have a large financial operation with 

greater opportunities for leverage. A measure of corporate size is included because larger 

corporations may be able to borrow more capital. Alternatively, large mature 

corporations may have less need for borrowing. (As suggested above, the amount of 

observed borrowing reflects both the behavior of prospective lenders and the demand for 

14 In Tables 6 and 7 corporations with 25 to 50 percent foreign ownership are included with DCCs. They 

are presumably in most cased domestically controlled and, in any case, are not in a position to shift income 

to related parties abroad. The earlier tables indicate that they are too small a group to be relied on for any 

significant conclusions. Deleting them from the sample would not make much of a difference. 

20
 
financing by the borrower.) Loans from shareholders are included because such loans 

may offer the corporation a greater opportunity for having more total debt. The 

interaction of shareholder loans with the foreign control variable indicates whether 

FCDCs in particular take advantage of shareholder borrowing to achieve greater total 

borrowing. 

The foreign control coefficients in Table 6 indicate that FCDCs in manufacturing 

and in the nonfinancial sector have smaller interest expense relative to cash flow than 

DCCs. In the nonfinancial sector as a whole, FCDCs pay almost 3 percentage points less 

of cash flow in interest than DCCs and in manufacturing the differential is more than 6 

percentage points. 

The results in Table 6 for the other explanatory variables show that recently 

incorporated corporations have a greater ratio of interest expense to cash flow. This 

might reflect leveraging up after a reincorporation associated with a merger or 

acquisition. Also, the amount of interest income relative cash flow is very strongly 

associated with greater interest expense. This could be attributable to financial 

operations that are part of the corporation identified as being principally nonfinancial. It 

could reflect liquid assets that are easier to leverage. 

Another possible explanation is the feature of the section 163(j) rules that permit 

the netting of interest received from interest expense before calculating whether any 

interest is nondeductible. Corporations with a great deal of cash on their balance sheet 

have significantly lower interest expense, presumably because the cash indicates that they 

do not have much need for debt finance. Finally, the negative coefficients for the 

21
 
 

 

 

interaction of foreign control and loans from shareholders indicate that, FCDCs are less 

likely to use these loans as an opportunity to increase total borrowing than DCCs. 

Whereas the Table 6 regressions examine the interest paid by FCDCs in 

manufacturing and the entire nonfinancial sector on average, the probit equations in 

Table 7, similar to regressions but applicable when a bifurcated frequency is studied, 

examine whether the frequency of extremely high interest expense relative to cash flow is 

greater for foreign-controlled corporations. These corporations are presumably the 

potential targets of a thin capitalization or interest stripping policy. The threshold chosen 

in Table 7 is 50 percent of cash flow, as in section 163(j) except that interest income is 

not netted from interest expense in the denominator for the purposes of calculating the 

ratio. The independent variables in Table 7 are the ones like the ratio of interest received 

to cash flow that were most significant in Table 6 or were of special interest like the 

amount of related party loans. The probit analyses in Table 7 indicate that foreign FCDCs 

in manufacturing and the entire nonfinancial sector are less likely to have interest 

expense in excess of 50 percent of cash flow than DCCs.15 (Other probits, not displayed, 

show that FCDCs are also less likely than DCCs to have interest expense greater than 75 

percent of cash flow.) The fact that FCDCs are less likely to be above the threshold may 

reflect the impact of section 163(j). The impact of the other variables is generally similar 

to Table 6. Recently incorporated corporations are more likely to have interest payments 

in excess of 50 percent of cash flow. 

15 The observations are not weighed in the probit analyses because heteroskedasticity is less of an issue for 

bifurcated 0 or 1 dependent variables. 

22
 
 

Table 6
 

Nonfinancial Sector and Manufacturing, 2004
 

The Ratio of Interest Paid to Cash Flow
 

Independent Variables Manufacturing Nonfinancial Sector 

Foreign Ownership > 50 percent 

-.0643** 

(3.03) 

-.0278** 

(2.77) 

Age < 5 years 

.2470** 

(9.04) 

.1647** 

(13.37) 

Age 5 - 15 years 

.1085** 

(4.92) 

.0772** 

(8.12) 

Depreciable Assets / Total Assets 

-.0805 

(1.33) 

-.1066** 

(4.32) 

Inventories / Total Assets 

-.0825 

(0.96) 

-.1757** 

(5.39) 

Cash / Total Assets 

-.9570** 

(10.88) 

-.6739** 

(18.18) 

Interest Income / Cash flow 

1.0407** 

(17.60) 

.3519** 

(25.12) 

Notes + Accounts Receivable / Total 

Assets 

-.2392** 

(3.17) 

-.2533** 

(10.27) 

Government Securities / Total Assets 

-.9652** 

(2.76) 

-.7874** 

(8.55) 

Purchases / Sales 

.1020* 

(2.09) 

.0850** 

(4.79) 

Loans from Shareholders / Total Assets 

.8908* 

(2.18) 

.5068** 

(3.79) 

Foreign Control X Loans from 

Shareholders / Total Assets 

-.8219 

(1.89) 

-.3194* 

(2.11) 

Size: Log of Total Receipts 

-.0133* 

(1.97) 

-.0055* 

(2.05) 

Mean of dependent variable .3132 .2859 

Number of observations 3087 8185 

Notes:
 

1) Cash flow is equal to net income plus interest paid plus depreciation, depletion, and amortization.
 

2) Weights as in Tables 4 and 5.
 

3) t values are in parentheses.
 

4) Companies with less than $50 million in assets excluded from sample. 

5) * means significant at the 5 percent level and ** means significant at the 1 percent level.
 

23
 
 

 

 

 

Table 7 

Nonfinancial Sector and Manufacturing, 2004 

Greater than 50 Percent of Cash Flow 

Probit Analysis: The Probability that a Company has Interest Paid 

Independent Variables Manufacturing Nonfinancial Sector 

Foreign Ownership > 50 percent 

-.2630** 

(3.83) 

-0954* 

(2.13) 

Age < 5 years 

.7800** 

(10.12) 

.5885** 

(12.39) 

Age 5 - 15 years 

.4319** 

(6.18) 

.3400** 

(8.42) 

Cash / Total Assets 

-4.637** 

(8.76) 

-3.301** 

(12.78) 

Interest Income / Cash Flow 

2.596** 

(15.25) 

1.008** 

(27.24) 

Purchases / Sales 

.2284 

(1.52) 

.0862 

(1.31) 

Size of Company: Log of Total Receipts 

-.0019 

(0.09) 

-.0049 

(0.42) 

Loans from Shareholders / Total Assets 

1.992 

(1.86) 

2.001** 

(4.17) 

Foreign Control X Loans from Shareholders / Total Assets 

-1.169 

(-1.02) 

-1.172* 

(-2.14) 

Mean Likelihood 0.1701 0.2004 

5) * means significant at the 5 percent level and ** means significant at the 1 percent level. 

Notes to table: 

1) t values are in parentheses. 

2) Companies with total assets less than $50 million are excluded from the sample. 

3) Observations in probits are unweighted. 

4) Cash flow is defined as in Table 6. 

Greater interest income is very significant in pushing corporations over the threshold. 

Furthermore, the coefficient of the interaction of the FCDC dummy variable with loans 

from shareholders indicates that FCDCs are less likely than DCCs to use shareholder 

loans to be able to have ‘excess’ interest expense. 

The Financial Sector 

Because the financial sector is very heterogeneous, several industries are 

examined separately: commercial banks, brokers and investment banks, stock life 

24
 
insurance, stock property and casualty insurance, and real estate. Foreign corporations in 

each of these industries vary a great deal in terms of how their profitability and leverage 

compare to their domestically-controlled counterparts. For example, commercial bank 

FCDCs had a slightly lower ratio of net income to total revenue than DCC commercial 

banks, but any discrepancy seems largely attributable to the greater amount of dividends 

that DCC banks receive. However, the profitability differential between FCDC and DCC 

securities dealers and investment banks was substantial in 2004, with net income equal to 

4.2 percent of revenues for FCDCs compared to 7.1 percent earned by DCCs, and a wide 

disparity was also notable in 2002 and 2003, the other years examined in detail. Stock 

life insurance FCDCs had profits similar to their DCC counterparts in 2004 (as well as in 

2002 and 2003). However, stock property and casualty FCDCs were much less profitable 

than DCCs in 2004, when net income was equal to1.4 percent of revenues for the former 

versus 6.4 percent for the latter. The FCDCs in property and casualty insurance also 

made large losses in 2002 when DCCs were profitable and they had meager profits 

compared to DCCs in 2003. Finally, FCDCs in real estate were much more profitable 

than comparable DCCs in each of the three years and they also had much less debt. 

In the financial sector, corporations generally have much greater leverage than in the 

nonfinancial sector. Therefore, in Table 8 which parallels Table 3 in presenting the 

distribution of the ratio of interest to cash flow for FCDCs and DCCs , a threshold ratio 

of interest expense to cash flow of 90 percent, rather than the 50 percent threshold used 

above for nonfinancial corporations, may be a more appropriate measure of high interest 

expense. The distribution of interest paid to cash flow in Table 8 shows that FCDCs do 

seem to be more likely to have very high levels of interest expense relative to cash flow, 

25
 
 

 

 

but the comparison is not completely unambiguous.16 Table 8 indicates that corporations 

with interest expense of 90 percent or more of cash flow account for 50.3 percent of total 

FCDC receipts compared to 24.3 percent of total DCC receipts, and 53.7 percent of total 

FCDC cash flow compared to 37.4 of DCC cash flow. FCDCs in finance are also much 

more likely to have interest expense greater than or equal to cash flow, measured either in 

terms of the share of total receipts or cash flow. However, a greater share of receipts and 

cash flow are above the 95 percent threshold for DCCs than for FCDCs. A significant 

share of DCC receipts and cash flow fall in the 95 to 100 percent category.17 

Table 8 

Distribution of Interest Paid Relative to Cash Flow by Percent of 

Total Receipts and Cash Flow for the Financial Sector: 2004 

Financial 

Interest Paid/Cash 

Flow 

Total Receipts Cash Flow 

Foreign 

Control 

Domestic 

Control 

Foreign 

Control 

Domestic 

Control 

.00 ≤ ratio < .25 16.7 18.5 16.7 9.5 

.25 ≤ ratio < .50 9.1 16.4 6.5 10.8 

.50 ≤ ratio < .75 5.0 15.2 5.2 14.5 

.75 or more 69.1 49.9 71.6 65.3 

i. .75 ≤ ratio < .90 18.8 25.6 17.9 27.9 

ii. .90 ≤ ratio < .95 37.9 4.8 39.1 6.1 

iii. .95 ≤ ratio < 1.0 1.4 18.0 2.5 29.7 

iv. ratio ≥ 1 11.0 1.5 12.1 1.6 

Total 100.0 100.0 100.0 100.0 

Note: These estimates are based on data from corporate income tax 

returns for 2004. They exclude REITs, RICs, Subchapter S corporations, 

and branches of foreign corporations filing on Form 1120F and 

corporations in the 25-50% ownership category. The financial sector 

excludes insurance and real estate. 

16 We exclude insurance corporations from finance for this purpose because they are likely to have a much 

different relationship between interest expense and cash flow than other financial intermediaries. 

17 Corporations in finance tend not to be constrained by 163(j) because they can net interest income from 

interest paid. Because financial intermediaries earn an interest spread, they can frequently have negative net 

interest expense. 

26 
 

 

Tables 9 and 10 examine the profitability and interest expense issues in greater 

detail using firm level regressions and probits. Table 9 provides profitability regressions 

for selected financial industries which are similar to the regressions for the nonfinancial 

sector in Tables 4 and 5. The selected financial industries are the following: (1) 

commercial banks, (2) securities dealers and investment banks, (3) stock life insurance, 

(4) stock property and casualty insurance, and (5) real estate. In each regression, the 

dependent variable is the ratio of net income (line 28 on the Form 1120) to total revenue. 

The independent variables are the two age dummy variables and the two foreign 

ownership categories, greater than 50 percent and 25 to 50 percent.18 In each case, as in 

Tables 4 and 5, the weights for the observations are based on the relationship between the 

variance of the profit ratio and the size of total receipts. 

Table 9 shows that foreign-controlled domestic commercial banks are slightly less 

profitable than domestically-controlled banks, but the differential is neither very large nor 

statistically significant. The greater amount of dividends, not displayed explicitly on the 

table, that DCCs receive seems to account for any differential. Foreign-controlled 

domestic securities dealers and investment banks seem particularly unprofitable 

compared to DCCs. Indeed, the large (in absolute value) negative coefficient indicates 

that they are barely profitable when compared to the weighted industry mean of 7.1 

percent of total receipts. (Other data, not displayed, show that foreign-controlled brokers 

and investment bankers also seem very unprofitable in terms of the ratio of net income to 

total assets.) 

18 The ratio of purchases to sales and the ratio of sales to assets used in the nonfinancial regressions in 

Table 4 and 5 are less relevant for financial corporations. 

27
 
 

 

 

 

 

Table 9 indicates that foreign-controlled domestic real estate corporations are 

much more profitable than domestically-controlled real estate corporations. (Other data, 

not displayed, show that they are also much less highly leveraged.) Foreign-controlled 

domestic life insurance corporations are very close to DCC life insurance corporations in 

terms of net income as a percent of total revenue, with only a small and statistically 

insignificant coefficient. However, the regression for FCDC property and casualty 

insurance corporations shows that they were significantly less profitable than comparable 

DCCs, with a negative coefficient greater than 50 percent of the weighted industry 

mean. 

Table 9 

Profitability Regressions for Selected Financial Industries and Real Estate, 2004 

(Dependent variable is the ratio of net income to total receipts) 

Independent Variables Commercial 

Banks 

Securities 

Dealers & 

Investment 

Banks 

Stock Life 

Insurance 

Stock P&C 

Insurance Real Estate 

Foreign Ownership > 50 percent 

-.0274 

(1.64) 

-.0664** 

(3.64) 

-.0048 

(0.47) 

-.0357** 

(2.60) 

.1235** 

(4.34) 

Foreign Ownership 25-50 percent 

-.0164 

(0.30) 

.0340 

(0.14) 

-.0597 

(0.18) 

.0710 

(1.03) 

-.0477 

(0.15) 

Age ≤ 5 years 

-.0729** 

(6.20) 

-.0076 

(0.39) 

.0908 

(1.43) 

-.1016** 

(3.31) 

.0499 

(1.30) 

Age 5 - 15 years 

-.0094 

(0.60) 

.0727** 

(2.70) 

-.0224 

(0.56) 

-.0251 

(1.46) 

.0331 

(1.17) 

Mean of dependent variable .1820 .0706 .0467 .0671 .0775 

Number of observations 731 94 272 406 446 

Notes: 

1) Companies with assets less than $50 million excluded. 

2) Observations are weighted based on the relationship between the variance of profitability and company size. 

3) t values are in parentheses. 

4) ** means significant at the 1 percent level. 

28
 
 

 

 

 

 

In order to supplement the distributions of the ratio of interest expense to cash 

flow in the financial sector shown in Table 3, Table 10 focuses on the frequency of very 

high interest expense in relation to cash flow in commercial banking and in securities 

dealing and investment banking. The threshold used is interest expense that is greater 

than 90 percent of cash flow. Thus Table 10 presents probit equations that can be used to 

calculate the probability that a bank or broker with given characteristics will pay interest 

greater than the 90 percent of cash flow threshold. The equations include explanatory 

Table 10
 

Probits: Probability that Interest Paid is Greater than 90 Percent of Cash Flow
 

Commercial Banks & Investment Banks and Securities Dealers, 2004
 

Independent Variables Commercial Banks Security Dealers and 

Investment Banks 

Foreign Ownership > 50 percent 

1.096** 

(2.59) 

1.32** 

(2.72) 

Age < 5 years 

.1949 

(0.85) 

-.0163 

(0.03) 

Age 5 - 15 years 

.1188 

(0.39) 

.3843 

(0.74) 

Cash / Total Assets 

-1.451 

(0.94) 

-.5610 

(0.27) 

Interest Income / Cash Flow 

.7321** 

(8.45) 

.7856* 

(2.05) 

Size of Company: Log of Total Receipts 

-.4800** 

(2.71) 

.2161* 

(2.32) 

U.S. Government Obligations / Total Assets 

-1.697* 

(2.03) 

1.305 

(0.45) 

Tax Exempt Securities / Total Assets 

-.0584 

-0.03 --

Number of Observations 731 94 

Mean Likelihood .0561 .2021 

Notes to table:
 

1) Companies with assets less than $50 million excluded.
 

2) t values are in parentheses.
 

3) Companies with foreign ownership between 25 and 50 percent are included in domestic controlled. 

4) -- means too few held for valid estimation.
 

5) * means sigificant at the 5 percent level and ** means significant at the 1 percent level.
 

29
 
 

 

variables such as the amount of cash and government bonds on the balance sheet in order 

to control for the possibility that some financial businesses may be able to have much 

higher levels of debt because of the nature of their assets and operations. 

Table 10 shows that FCDCs in both commercial banking and securities dealing 

and investment banking are much more likely to have interest expense greater than 90 

percent of cash flow than comparable DCCs. The differential seems particularly notable 

for securities dealers and investment banks, a sector in which a much greater percent of 

the corporations are above the threshold than in commercial banking. For example, 

translating the probit equation in Table 10 into probabilities shows that the probability 

that a domestically-controlled securities dealer or investment bank pays more than 90 

percent of cash flow in interest is less than 5 percent but more than 40 percent in the case 

of comparable foreign-controlled domestic corporations. 

Conclusions 

The analysis above indicates that in the nonfinancial sector foreign-controlled 

domestic corporations are not less profitable than their domestically-controlled 

counterparts when net income is adjusted for interest expense and investment income so 

that the income from U.S. domestic operations, before interest expense, can be more 

accurately compared. Much of the investment income that domestically-controlled 

corporations receive, particularly dividends and royalties, is from their affiliates abroad. 

FCDCs in the nonfinancial sector on the average have a lower ratio of interest expense to 

cash flow than comparable DCCs. They are also less likely to have interest expense that 

is greater than 50 percent of cash flow. 

30
 
 

 

 

Foreign-controlled domestic corporations in the financial sector and real estate 

exhibited a wide range in relative profitability. Foreign-controlled domestic real estate 

corporations are much more profitable than comparable domestically-controlled 

corporations. Foreign-controlled domestic life insurance corporations are not 

significantly different from domestically-controlled stock corporations in profitability. 

However, foreign-controlled domestic property and casualty corporations were much less 

profitable than domestically-controlled corporations in 2004. (They made very large 

losses in 2004 when DCCs were profitable and they made modest profits compared to 

DCCs in 2003.) 

Foreign-controlled domestic commercial banks were slightly less profitable than 

comparable domestically-controlled banks in 2004, although this seemed largely 

attributable to the greater amount of dividends domestic banks received. FCDC 

securities brokers and investment banks were much less profitable than comparable 

DCCs, barely profitable in 2004 as well as in 2002 and 2003. They were also much more 

likely to have extremely high levels of interest expense relative to cash flow. For 

example, the probability that a foreign-controlled domestic securities dealer or 

investment bank pays more than 90 percent of cash flow in interest is greater than 40 

percent but less than 5 percent in the case of domestically-controlled corporations. 

31
 
 

 

 

 

 

 

References 

Blouin, Jennifer, Julie Collins, and Douglas Shackelford (2001), “Does Acquisition by 

Non-U.S. Shareholders Cause U.S. Firms to Pay less Tax?” presented at the International 

Seminar on Public Economics Conference on Income Taxation and Financial Innovation, 

Berkley, December 2001. 

Brys, Bert, and Lans Bovenberg (2006), “The Life Cycle of the Firm with Debt and 

Capital Income Taxes,” CentER Discussion Paper No. 2006-91. 

Grubert, Harry, Timothy Goodspeed, and Deborah Swensen (1993), “Explaining the Low 

Taxable Income of Foreign-Controlled Corporations in the United States,” in Studies in 

International Taxation, edited by Alberto R. Giovannini, R.Glenn Hubbard, and Joel 

Slemrod, 237-70, Chicago: Chicago University Press, 1993. 

Grubert, Harry (1997), “Another Look at the Low Taxable Income of Foreign-Controlled 

Corporations in the United States,” Office of Tax Analysis Paper 74, Department of the 

Treasury, October. 

32