The Effect of Moving to a Territorial Tax System on Profit Repatriations: Evidence from Japan

Japan's worldwide tax system previously taxed foreign source income upon repatriation. To stimulate dividend repatriations from Japanese-owned foreign affiliates, Japan introduced a foreign dividend exemption in 2009 that exempts dividends remitted by Japanese-owned foreign affiliates to their parent firms from home taxation. This paper examines the effect of dividend exemption on profit repatriations by Japanese multinationals. We find that the response of Japanese-owned affiliates to dividend exemption is heterogeneous. Foreign affiliates with large retained earnings are more responsive to the reform and significantly increased dividend payments to their parent firms in response to the enactment of the dividend exemption system. Dividend payments by these affiliates also became more sensitive to withholding tax rates on dividends levied by host countries because Japanese multinationals can no longer claim foreign tax credits for withholding taxes on dividends under the new exemption system.