Managing the Multinational
Financial System
Shapiro: Chapter 16
Shapiro: Chapter 16
Problem
16.1
Multinational Financial System
“...
ability to shift funds and
accounting profits among its
various units ...
through internal financial
transfer mechanisms.”
Multinational Financial System
“
… over 38% of U. S. imports
and exports are transactions
between U. S. firms and their
foreign affiliates or parents.”
Two-way International Trade
Parent
to/from a foreign
subsidiary:
–U. S. & Japan: 80%
–U. S. & Europe: 40%
–EC & Japan: 55%
Multinational Arbitrage
Opportunities
Tax
arbitrage
Financial market arbitrage
Regulatory system arbitrage
Multinational Financial System
[Advantages]
Tax
arbitrage:
– high-tax to low-tax nations
– taxpaying to tax-loss units
Financial
market arbitrage:
– circumvent exchange controls
– earn higher risk-adjusted returns
– reduce borrowing costs
Multinational Financial System
[Advantages]
Regulatory
system arbitrage:
–disguise true profitability
–negotiating advantage
Offset credit restraint or controls
–draw on external sources of
funds
Tax Factors
(Intercompany Transfers)
Types
of taxes (host country)
– corporate income taxes
– taxes on dividends, interest, and fee
remittances
– taxes on retained earnings
Foreign
tax credit
– offsets U. S. taxes
MNC Financial Channels
Transfer
pricing
Reinvoicing Centers
Fees and royalties
Leading and lagging
Intercompany loans
Dividends
Equity vs. debt
Transfer Pricing
Reduce
taxes
Unit A sells to Unit B:
–if tA > tB, low transfer price
–if tA < tB, high transfer price
Transfer Pricing
[A sells to B]
TaxA
TaxB
Transfer
Price
ProfitA ProfitB
Transfer Pricing
[A sells to B]
TaxA
TaxB
High
Low
Transfer
Price
ProfitA ProfitB
Transfer Pricing
[A sells to B]
TaxA
TaxB
Transfer
Price
High
Low
Low
ProfitA ProfitB
Low
High
Transfer Pricing
[A sells to B]
TaxA
TaxB
Transfer
Price
High
Low
Low
Low
High
ProfitA ProfitB
Low
High
Transfer Pricing
[A sells to B]
TaxA
TaxB
Transfer
Price
High
Low
Low
Low
High
Low
High
High
High
Low
ProfitA ProfitB
Transfer Pricing Strategy
Reduce
taxes
Reduce tariffs
Avoid exchange controls
Increase profits from joint ventures
Disguise affiliate’s profitability
Fees and Royalties
[International Transfers]
Intangible
factors of production
– headquarters services
– allocated overhead
– patents and trademarks
IRC Section 482:
– “commensurate with the income
generated”
Fees and Royalties
[International Transfers]
Allocate
total fees according to
sales or assets
Leading & Lagging Payments
Accelerating
or delaying payments
Modifying credit terms
Opportunity cost of funds:
– paying unit
– receiving unit
– interest rate differentials
Leading & Lagging Payments
Advantages
over direct loans:
–no formal note of indebtedness
–less government interference
–interest free for 6 months (Sec.
482)
Leading & Lagging Payments
United States
Borrowing
Rate
3.8%
Lending
Rate
2.9%
Germany
3.6%
2.7%
Leading & Lagging Payments
United States
Borrowing
Rate
3.8%
Lending
Rate
2.9%
Germany
3.6%
2.7%
Germany
(+)
(+)
United States
(-)
(-)
Leading & Lagging Payments
United States
Borrowing
Rate
3.8%
Lending
Rate
2.9%
Germany
3.6%
2.7%
Germany
(+)
United States
(-)
(+)
2.9% - 2.7%
[+0.2%]
(-)
Leading & Lagging Payments
United States
Borrowing
Rate
3.8%
Lending
Rate
2.9%
Germany
3.6%
2.7%
Germany
(+)
United States
(-)
(+)
2.9% - 2.7%
[+0.2%]
3.8% - 2.7%
[+1.1%]
(-)
2.9% - 3.6%
[-0.7%]
3.8% - 3.6%
[+0.2%]
Intercompany Loans (1)
Transfer
of funds through making and
repaying of intercompany loans
More valuable than arm’s-length
transactions if the following exist:
– credit rationing
– currency controls
– differential tax rates
Intercompany Loans (2)
Direct
Loans
Back-to-Back Financing
Parallel Loans
Direct Loans
Straight
extension of credit
From parent to affiliate
From one affiliate to another
No intermediary involved
Back-to-Back Loans (1)
[Fronting loans; link financing]
Used
in countries with:
–high interest rates
–restricted capital markets
–currency controls
–different tax rates for loans from
a financial institution
Back-to-Back Loans (2)
Parent
deposits funds with a
bank in Country A
Bank lends funds to subsidiary
in Country B
Effectively, an intercompany
loan channeled through a bank
Back-to-Back Loans (3)
Risk
free for the bank - deposit
collateralizes the loan
Bank serves as intermediary
Bank’s compensation is the
difference between borrowing
and lending rates
Structure of a Back-to-Back Loan
Parent firm
in Country A
Subsidiary in
Country B
Structure of a Back-to-Back Loan
Parent firm
in Country A
Direct Loan
Subsidiary in
Country B
Structure of a Back-to-Back Loan
Parent firm
in Country A
Direct Loan
Deposit
Bank in
Country A
Subsidiary in
Country B
Structure of a Back-to-Back Loan
Parent firm
in Country A
Direct Loan
Deposit
Bank in
Country A
Back-to-Back Loan
Subsidiary in
Country B
Parallel Loans
Two
related but separate borrowings
Usually involves four parties
Two separate countries
Bank fees: 0.25%-0.50% of principal
Dividends
Most
important transfer mechanism
Over 50% of remittances to USA
Parent’s dividend payout ratio (D/E)
Other factors:
– tax effects
– financing requirements
– exchange controls
Equity vs. Debt?
MNCs
generally prefer loans to equity
Easier to repatriate interest and
principal than dividends and equity
Tax benefits of debt:
– interest deductible in host country
– loan repayments not taxable to
parent
Designing a Global Policy
How
much money to remit?
When to remit?
Where to transmit funds?
Which transfer method to use?
Satisfactory vs. optimal decisions
Shapiro: Problem 16-1
Navistar’s
Canadian subsidiary sells
1,500 trucks per month to a French
subsidiary at $27,000 per unit.
Canadian tax rate = 45%
French tax rate = 50%
Price between $25,000 and $30,000
Shapiro: Problem 16-1.a
a.
1,500 (27,000 - P) (.45 - .50)
P = $30,000 maximizes tax
savings
Shapiro: Problem 16-1.b
a.
French government imposes an “ad
valorem” tariff of 15% on imported
tractors
b. 1,500 (27,000 - P)[.45+.15-.50(1.15)]
= 1,500 (27,000 - P) (.025)
P = $25,000 maximizes tax savings
Shapiro: Problem 16-1
c. $27,000 X 1.05 = $28,350
1,500 (27,000 - 28,350) (.45 - .50)
= $101,250 (decline in tax)
1,500 (28,350-27,000)[.45+.15-.5(1.15)]
= $50,625