Managing the Multinational
Financial System
International Financial Management
Dr. A. DeMaskey
Learning Objectives
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How do MNCs reposition their profits, cash flows,
and capital within their multinational structures so as
to maximize profitability, minimize global tax liability
and optimize their use of capital?
What are the fundamental methods for setting
transfer prices between units of MNCs?
What role do royalties and license fees play in the
repositioning strategies employed by MNCs?
How are dividend remittances determined?
What is the role of leads and lags and reinvoicing
centers to reposition funds and profits?
The Multinational Corporate Financial
System
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The MNC can control the mode and timing of
internal financial transfers and thereby
maximize global profits.
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Mode of Transfer
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Transfer pricing
Timing Flexibility
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Leading and lagging
The Value of the Multinational
Financial System
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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
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Political Constraint
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Differential Tax Rates
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Transaction Costs
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Liquidity Requirements
Intercompany Fund-Flow
Mechanisms
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Unbundling Fund Transfers
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Transfer Pricing
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Payment of Fees
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Dividend Remittances
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Leading and lagging
Unbundling of Fund Transfers
Foreign Subsidiary’s Income Statement
Sales
Cost of goods sold
Gross profit
General & administrative expenses
License fees
Royalties
Management fees
Operating profit (EBITDA)
Payment to Parent Company
Payments to parent
for goods or services
Payments for technology,
trademarks, copyrights,
management or other
shared services
Depreciation & amortization
Earnings before interest & taxes (EBIT)
Foreign exchange gains (losses)
Interest expenses
Earnings before tax (EBT)
Corporate income tax
Net income (NI)
Dividends
Retained earnings
Before-Tax
in the
Host Country
Payments of interest
to parent for intrafirm debt
Distribution of
dividends to parent
After-Tax
in the
Host Country
Transfer Pricing
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The pricing of goods and services transferred to a
foreign subsidiary from an affiliated company is
transfer pricing.
The most important uses of transfer pricing include:
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Reducing taxes
Reducing tariffs
Reducing exchange rate risk
Positioning of funds in locations to achieve various
corporate objectives
Disguising profitability
Fund Positioning Effect
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A parent wishing to reposition funds out of or
into a particular country can charge higher or
lower prices on goods sold among
subsidiaries.
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This will affect the income statement of the
subsidiary and effectively raise or lower taxes.
Note that the selling subsidiary will also have an
opposite effect on its income statement.
Tax Effects
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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
TA > TB.
Set the transfer price as high as possible if
TA < TB.
Transfer Pricing: Tax Effect
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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
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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
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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
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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
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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
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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
License and Royalty Fees and
Overhead Charges
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License fees
Royalty fees
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Management fees for general advice and
expertise.
Technical assistance fees for guidance on
technical matters.
License fees for use of patented products or
processes.
Overhead charges
International Dividend Remittances
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Dividend payout policies have changed over
the years and now incorporate several
variables in determining the payout strategy.
These variables are:
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Tax implications
Political risk
Foreign exchange risk
Leading and Lagging
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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
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A U.S. parent owes its British affiliate $5 million.
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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?