Special tax regimes and the choice of organizational form: Evidence from the European Tonnage Taxes

a r t i c l e i n f o Tax systems often discriminate among the various organizational forms of doing business and may therefore affect the choice of organizational form. This paper studies how special tax regimes shape the organizational form choice. Although the full effects depend on the way that firm-level special tax regimes are designed, special regimes generally tend to favor pass-through firms over non-pass-through firms. The tonnage tax, a tax incentive for international shipping firms available in many countries worldwide, is examined to understand these effects. Employing European firm-and country-level data, the impact of the tonnage tax on organizational form choice is studied empirically. The results are consistent with the theoretical model. Shipping firms are less likely to incorporate if the tonnage tax is also available for firms that have adopted pass-through organizational forms. The taxation of a firm depends on the organizational form under which it operates. Typically, profit generated within a sole proprietor-ship or a partnership is passed through and subject to tax at the owner's level on a pro-rata basis. Corporations are subject to a separate corporate income tax and shareholders of corporations are not taxed until they receive dividends or realize capital gains by selling their shares. 1 The coexistence of these two taxation systems, each with their respective tax rates, implies that firms face different tax burdens under different organizational forms. Other things being equal, a firm owner will choose the organizational form with the lowest tax burden. A number of studies exist on tax rate differentials and how they affect the choice of organizational forms, but other aspects of the tax system have received little attention until now. This paper explores the elasticity of organizational form with respect to the relative tax advantages resulting from firm-level special tax regimes. Whether, and how, a special tax regime affects organizational form decisions depends on the amount of tax relief relative to the overall tax burden and on the availability of the tax relief for different organizational forms. Even if a special tax regime offers identical tax advantages for all firms, it may nevertheless result in a distortion due to the double taxation of corporations. The special tax regime relieves just one layer of tax. The single layer is all there is in the case of pass-through firms, but it is only a fraction of the total in the case of corporations. …