Taxes and Ownership Structure: Corporations, Partnerships and Royalty Trusts

Abstract

This paper investigates the effect of taxes on the equilibrium ownership structure of productive assets. Ownership structure includes the traditional choice between debt and equity financing, but also the larger choice between corporate and partnership forms. A key feature of these alternative forms is that corporations are subject to taxation at both the corporate and investor levels, whereas partnerships are not. At the same time, depreciation and interest tax shields are taken at the corporate tax rate for corporate assets and at investors' tax rates for partnership assets. We find that assets endowed with excess non-interest tax deductions are best held in partnership form by high tax bracket investors. Assets whose allowed deductions are low enough to generate a net tax liability in corporate formare best held as partnerships by low tax bracket investors. All other assets are held in the corporate sector and are financed in a manner consistent with Miller's(1977) capital structure equilibrium.We argue that our analysis illuminates the tax aspects of such transactionsas mergers and sales or spin-offs of corporate assets to partnerships and royalty trusts. We also show that our results afford a simple characterization of the lease or buy decision.