International Finance
FIN456 ♦ Spring 2013
Michael Dimond
Multinational Tax Management
• The primary objective of multinational tax planning is
the minimization of the firm’s worldwide tax burden
• Tax planning for MNC operations is extremely complex but
a vital aspect of international business
• To plan effectively, MNCs must understand not only the
intricacies of their own operations worldwide, but also the
different structures and interpretations of tax liabilities
across countries
Michael Dimond
School of Business Administration
Tax Principles
• Tax morality – the MNC must decide whether to follow a
practice of full disclosure to tax authorities or to adopt the
principle of “when in Rome, do as the Romans”
• Tax neutrality – when governments levy taxes, they must
consider not only the potential revenue from the tax but
also the effect the proposed tax can have on private
economic behavior
– The ideal tax should not only raise revenue efficiently but also have
as few negative effects on economic behavior as possible
Michael Dimond
School of Business Administration
Tax Principles
• Domestic neutrality – the burden of taxation on each
currency unit of profit earned in the home country should
equal the burden of taxation on the currency equivalent profit
earned by the same firm in its foreign operations
• Foreign neutrality – the tax burden on each foreign
subsidiary should equal the tax burden on its competitors in
the same country
• Tax equity – an equitable tax that imposes the same total
burden on all taxpayers who are similarly situated and
located in the same tax jurisdiction
Michael Dimond
School of Business Administration
Corporate Tax Rates Compared
Michael Dimond
School of Business Administration
National Tax Environments
• Nations typically structure their tax systems along one of two
basic approaches
– Worldwide approach
– Territorial approach
• Both approaches are attempts to determine which firms,
foreign or domestic by incorporation, or which incomes,
foreign or domestic in origin, are subject to the taxation of
host country tax authorities
Michael Dimond
School of Business Administration
National Tax Environments
• Worldwide approach is also referred to as the residential or
national approach
– It levies taxes on the income earned by firms that are incorporated in
the host country regardless of where the income was earned
• Territorial approach is also termed the source approach
– It focuses on the income earned by firms within the legal jurisdiction of
the host country, not the country of incorporation
Michael Dimond
School of Business Administration
National Tax Environments
• Tax deferral – foreign subsidiaries of MNCs pay host country
income taxes but many parent companies defer claiming
additional income taxes on that foreign source income until it
is remitted to the parent firm
– If the worldwide approach was followed to the letter of the law, then
the tax deferral privilege would end
• Tax treaties provide a means of reducing double taxation
– They typically define whether taxes are to be imposed on income
earned in one country by the nationals of another country and if so,
how much
Michael Dimond
School of Business Administration
National Tax Environments
• Tax treaties
– Tax treaties are bilateral, with the two signatories specifying what
rates are applicable to which types of income
– Tax treaties also typically result in reduced withholding tax rates
– This is important to MNCs operating foreign subsidiaries earning
active income and individual investors earning passive income
Michael Dimond
School of Business Administration
Tax Types
• Income Tax – many governments rely on this tax as their
primary source of revenue
• Withholding Tax – passive income (dividends, royalties,
interest) earned by a resident of one country within the
jurisdiction of a second country are normally subject to a
withholding tax in the second country
– Government wishes a minimum payment for earning income within
their tax jurisdiction knowing that party won’t file a tax return in the
host country
Michael Dimond
School of Business Administration
Tax Types
• Value-Added Tax – type of national sales tax collected at
each stage of production or sale of goods in proportion to the
value added during that stage
• Other National Taxes – there are several other taxes levied
which vary in importance from country to country
– Turnover Tax – tax on purchase/sale of securities in stock market
– Property and Inheritance Tax
– Tax on Undistributed Profits
Michael Dimond
School of Business Administration
Corporate Tax Rates for Selected Countries
Michael Dimond
School of Business Administration
Example: Value-Added Tax
Michael Dimond
School of Business Administration
Foreign Tax Credits
• To prevent double taxation, many countries grant a foreign
tax credit (FTC) for income taxes paid to the host country
– FTC’s vary widely by country and are also available for withholding
taxes
– Value-added taxes are typically deducted as an expense from pre-tax
income so FTCs don’t apply
– A tax credit is a direct reduction of taxes that would otherwise be due
and payable
• It is not a deductible expense because it does not reduce the taxable
income
Michael Dimond
School of Business Administration
Foreign Tax Credits
Michael Dimond
School of Business Administration
FTC Example
United States Taxation: Grossup
Gross dividend remitted
Less withholding taxes
b. Net dividend remitted
Add back proportion of corp income tax
Add back withholding taxes paid
Grossed-up dividend for US tax purposes
Theoretical US tax liability
Foreign tax credits (FTCs)
Additional US taxes due?
Excess foreign tax credits?
c. Net dividend, after-tax
Total taxes paid on this income
Income before tax
2011
$
$
$
$
$
4,509
4,509
NI x Dividend Payout Rate
Rate given as 0.0%
891
5,400
(1,890)
(891)
(999)
-
HK Corp Income Taxes x Dividend Payout Rate
From above (Rate given as 0.0%)
3,510
1,890
5,400
$5,400 x US Corp. Tax Rate
Corp Inc Tax + Withholding Tax Paid
Theoretical US Tax Liability – FTC
FTC - Theoretical US Tax Liability
Depends on which is larger, FTC or
Theoretical US Tax Liability.
Lower limit = 0.
FTC + Additional US Tax Due
Michael Dimond
School of Business Administration
Transfer Pricing
• The pricing of goods, services, and technology transferred to
a foreign subsidiary from an affiliated company, transfer
pricing, is the first and foremost method of transferring funds
out of a foreign subsidiary
• These costs enter directly into the cost of goods sold
component of the subsidiary’s income statement
• This is a particularly sensitive problem for the MNC
• Both funds positioning and income tax effects must be taken
into consideration
Michael Dimond
School of Business Administration
Transfer Pricing
• Fund positioning
– A parent wishing to transfer funds out of a particular country can
charge higher prices on goods sold to its subsidiary in that country –
to the degree that government regulations allow
– A foreign subsidiary can be financed by the reverse technique, a
lowering of transfer prices
– Payments by a subsidiary for imports transfers funds out of the
subsidiary
– A high transfer price allows funds to be accumulated in the selling
country
Michael Dimond
School of Business Administration
Transfer Pricing
• Income tax effect
– A major consideration in setting a transfer price is the income tax
effect
– Worldwide corporate profits may be influenced by setting a transfer
prices to minimize taxable income in a country with a high income tax
rate
– This can also be done to maximize income in a country with a low
income tax rate
Michael Dimond
School of Business Administration
Transfer Pricing
• IRS regulations provide three methods to establish arm’s
length prices
– Comparable uncontrolled prices
• Regarded as the best evidence of arm’s length pricing
• Transfer price is the same as bond fide sales of the same items between
unrelated firms
– Resale prices
• Begins with the final selling price to an independent purchaser less an
appropriate markup
– Cost-plus calculations
• Begins with full cost to the seller plus a profit margin
Michael Dimond
School of Business Administration
Effect of Transfer Price on Net Income (US$ 000s)
Michael Dimond
School of Business Administration
Tax Management of Foreign-Source Income
Michael Dimond
School of Business Administration
International Offshore Financial Centers
Michael Dimond
School of Business Administration
Tax Management at Trident
• The MNC has operations in Brazil and Germany and must
manage its taxes when remitting income from these
subsidiaries
– The corporate tax rate in Germany is 40%, higher than the US rate of
35%
• Because this rate is higher, the US parent will realize excess FTCs
– The corporate tax rate in Brazil is 25%, thus the parent will not realize
FTCs
– Management would like to manage the dividend remittances to match
the credits with the deficits
Michael Dimond
School of Business Administration