Debt reallocation in multinational firms: evidence from the UK worldwide debt cap

How do multinational firms respond to reforms that limit interest deductibility? In this paper, we analyze debt reallocation of multinationals after the implementation of a worldwide debt cap in the UK in 2010. We find that multinationals affected by the cap significantly reduced the tested debt ratio, suggesting the cap is effective. Affected multinationals increased debt holdings and the fraction of subsidiaries in non-UK subsidiaries facing a high corporate tax rate, while shrank operations in low tax countries. Although the cap allowed the UK tax authority to collect more tax revenue from affected multinationals, it did not change their worldwide effective tax rate. There is also evidence that the debt cap induced non-UK headquartered multinationals to shrink their operation in the UK. Our findings provide causal evidence for tax-motivated debt reallocation within multinationals, and shed light on how multinationals can circumvent regulations via adjusting their debt policies and organizational structures.