Managing the
Multinational Financial
System
International Finance
Dr. A. DeMaskey
Learning Objectives
 What are the principal transfer mechanisms
that MNCs use to move funds among their
various affiliates?
 What are the three arbitrage opportunities
available to MNCs that stem from their ability
to shift liquidity internally?
 What are the costs, benefits, and constraints
associated with each transfer mechanism?
 How can the MNC benefit from its internal
financial transfer system?
The Multinational Corporate Financial
System
 The MNC can control the mode and timing of
internal financial transfers and thereby
maximize global profits.

Mode of Transfer
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Transfer pricing
Timing Flexibility

Leading and lagging
The Value of the Multinational
Financial System
 The ability to transfer funds and to reallocate
profits internally presents MNCs with three
different types of arbitrage opportunities:
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Tax arbitrage
Financial market arbitrage
Regulatory system arbitrage
Constraints on Positioning of
Funds
 Political constraint
 Differential tax rates
 Transaction costs
 Liquidity requirements
Intercompany Fund-Flow
Mechanisms
 Unbundling
 Tax planning
 Transfer pricing
 Leading and lagging
Unbundling of Fund Transfers
 Breaking up total intracorporate transfer of funds into
separate flows which correspond to the nature of
payment.
 Financial Payments


Dividend remittance
Interest and principal repayment
 Operational Payments
 License and royalty fees
 Management and technical assistance fees
 Overhead charges
 Transfer prices
Intercompany Loans
 Intercompany loans are valuable to MNCs if
credit rationing, exchange controls, or
differences in national tax rates exist.
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Direct Loans
Back-to-Back Loans
Parallel Loans
Equity versus Debt
 MNCs can realize several advantages from
investing funds overseas in the form of loans
rather than equity.

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Repatriation of Funds
Tax Benefits
Equity Investment
Tax Factor
 Total tax payments on internal funds transfers
depend on the tax regulations of both the
host and the recipient nations.
 Types of taxes

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Corporate income tax
Dividend withholding tax
 If Td > Tf, parent companies must pay an
incremental tax cost on remitted dividends
and other payments.
 Foreign tax credit
Tax Planning (1)
 Suppose an affiliate earns $1 million before taxes in
Spain. It pays Spanish tax of $0.52 million and
remits the remaining $0.48 million as a dividend to its
U.S. parent.
 Under current U.S. tax law, the U.S. tax owed on the
dividend is calculated as:
Tax Planning (2)
 Suppose the Spanish government imposes a
dividend withholding tax of 10%. What is the
effective tax rate on the Spanish affiliate’s before-tax
profits from the standpoint of its U.S. parent?
 Under current U.S. tax law, the parent firm’s U.S. tax
owed on the dividend is calculated as:
Transfer Pricing
 The most important uses of transfer pricing
include:
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Reducing taxes
Reducing tariffs
Avoiding exchange controls
Increasing profits from a joint venture
Disguising profitability
Tax Effects
 MNCs can minimize taxes by using transfer
prices to shift profits from the high-tax to the
low-tax nation.
 Set the transfer price as low as possible if
 Set the transfer price as high as possible if
Transfer Pricing: Tax Effect
 Suppose Navistar’s Canadian subsidiary sells 1,500 trucks
monthly to the French affiliate at a transfer price of $27,000 per
unit.
 The Canadian and French tax rates on corporate income equal
45% and 50%, respectively.
 The transfer price can be set at any level between $25,000 and
$30,000.
 At what transfer price will corporate taxes paid be minimized?
Tariffs
 Ad-valorem import duty
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Levied on the invoice price of the imported
goods.
Raising the transfer price will thus increase the
import duty.
In general, the higher the ad-valorem tariff
relative to the income tax differential, the more
desirable it is to set a low transfer price.
Transfer Pricing: Tariff Effect
 Suppose the French government imposes an ad-valorem tariff of
15% on imported trucks.
 How would this affect the optimal transfer pricing strategy,
assuming that the ad-valorem tariff is paid by the French affiliate
and is tax deductible?
Constraints on Transfer Pricing
 The transfer pricing mechanism is
constrained by:
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Tax regulations in the parent and host
countries
Working relationships with authorities in host
countries
Interest and goals of local joint venture partner
Tax Provisions
 Section 482 of the U.S. IRS code
 Arm’s length transaction
 Methods of determining transfer prices:
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Comparable uncontrolled price
Resale price
Cost-plus price
Others
Reinvoicing Center
 Reinvoicing centers, located in tax havens,
take title to goods and services used in
intracorporate transactions.
 The physical flow of goods from purchasing
units to receiving units is not changed.
 Basic purpose:
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Disguising profitability
Avoiding government regulations
Coordinating transfer pricing policy
Leading and Lagging
 Leading and lagging of interaffiliate payments
is a common method of shifting liquidity from
one unit to another.
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The value of leading and lagging is
determined by the opportunity cost of funds to
both the paying and receiving units.
There is no formal debt obligation and no
interest is charged up six months.
Government regulations on intercompany
credit terms are tight and can change quickly.
Leading and Lagging: Illustration
 A U.S. parent owes its British affiliate $5 million.
 The timing of this payment can be changed by up to 90
days in either direction.
 The U.S. lending and borrowing rates are 3.2% and
4.0%, respectively.
 The U.K. lending and borrowing rates are 3.0% and
3.6%, respectively.
 If the U.S. parent is borrowing funds and the British
affiliate has excess funds, should the parent speed
up or slow down its payment to the U.K.?
 What is the net effect of the optimal payment
activities in terms of changing the units’ borrowing
costs and/or interest income?