Evaluation of Subsidiary Performance in Multinational Operations
A parent company may employ several criteria to evaluate the performance of its
foreign subsidiaries. Sales growth, market share, stability in output, asset growth and
returns on investment are some of these criteria. Out of these, Return On
Investment,(ROI) is the most widely-used criteria-because the interest of the parent
company ultimately lies in the Return On its Investment. The ROI as calculated on the
basis of reported profit repatriation may however not show the true return from the
subsidiary. This is because it may be grossly-distorted, due to the following reasons.
(i) The subsidiary’s profits are taxed in the host country and repatriation of profit may
be subject to further tax. Therefore, the parent company tries to transfer the money
from the subsidiary in various other ways such as high royalty, high interest on loan,
high expert fees, etc. As a result the, profit repatriation becomes a grossly understated
figure of the true transfer. The parent company may transfer money from the
subsidiary through the mechanism of transfer prices. In order to reduce tax liability
the profits of the subsidiary are understated. For this purpose, all sales to the
subsidiary are over priced while all purchases from the subsidiary are under priced.
As a consequence, repatriated profit and ROI based on such profit are both under
stated.
Transfer prices may be manipulated in the following ways
1. When the are restrictions on repatriation, of profits, transfer price may be
manipulated transfer funds from the subsidiary.
2. When the corporate tax rate in the host-country is different from that of the
home, counter money may be transferred to the low tax country in order to
reduce over tax liability. For this purpose, profit is shown lower in the high tax
country higher, in the low tax country. In such a case, transfer price should be
beneficial to the company (whether parent or subsidiary), which operates in
the low tax country.
3. Inflation rules differ from, country to country. There is risk of devaluation of
currency, in order high inflation country. In order to avoid, the adverse effect
of devaluation of currency may be transferred from the high inflation country
through manipulation of transfer price.
4. The parent company may charge low prim from its -subsidiaries operating in
countries with high import duty in order to reduce the burden of import duty.
Thus, multinational corporations try to manipulate transfer price, to their overall
advantage. However, Governments also try to check such manipulations through
regulations. For example, in the USA, the, Government, has powers under Sec. 482 of
the Internal Revenue Service Code to determine the price independently and allocate
income between parent and foreign subsidiary so as to reflect the true income of the
two companies. Moreover, almost in every country the customs authority has its own
price list for the imported products and duties are charged on the basis of such prices.
However, transfer price may be understated in spite of such pre-cautions and
regulations.
(ii) Accounting procedures and regulations concerning profit computation tends to be
different from country to country. Reported profits may become non-comparison due
to differences in methods of inventory valuation, depreciation, vestment allowance
etc. However this issue becomes important only when comparisons between two
subsidiaries operating in different countries are made.
(iii) The parent company is interested in net repatriated profit (representing the true
net flow) rather then in gross repatriated profit. The two figures differ due to host
country tax on repatriation, withholding taxes, and home country tax on receipt of
foreign profit. In order to calculate the act repatriated profit these items must be
deducted from the gross repatriated profit.
Credit: Management Control Systems-MGU
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