MANAGING INTRACOMPANY
FUND FLOWS
THE MNC’s DISTINCT VALUE
MNCs can arbitrage
1. Financial markets
2. Tax systems
3. Regulatory systems
International Taxation
The goal to international tax management is to
increase the parent’s after-tax profits, usually by
reducing the total amount of taxes paid.
(Usually, but not always-Timing matters)
TAXES MATTER
Complicated
One must take account of:
Home country tax policy
Host country tax policy
Primarily corporate income tax
Elements of national tax policy: tax base, tax rates, treatment
of foreign taxes paid, administration
Remembering always that the host country always gets “First
Crack” at tax base within its borders
International Taxation
General principle of international taxation: There is a clear
distinction between returns to debt and returns to equity.
1. Tax deductibility of interest payments
2. Treatment of foreign exchange gains/losses
Corporate income tax is designed as a tax on the returns to
equity only
International Tax Policy
Equity returns are taxed in the host country,
then may be taxed in home country
(possibly different timing)
Host government
acts first
Home government
determines policies
vis-à-vis the host
government
Treatment of foreign income and
taxes paid
Type
Summary
Implication
Exempt from
Domestic
Firm will not be taxed on any income
earned aboard
Foreign tax rate governs taxes
paid by the firm
Full Tax Credit
Profits earned overseas are taxed at
same rate as profits earned at home;
full tax credit given for foreign taxes
paid
Home tax rate generally governs
taxes paid by the firm, except
where foreign tax rates are
higher
Deduction
Profits earned overseas are taxed at
domestic rate; deduction given for
foreign taxes paid
Foreign taxes paid reduce total
taxable income. Some double
taxation (not used much)
Double Tax
Profits earned overseas are taxed at
domestic rate; no deduction given for
foreign taxes paid
Double taxation
Example 11.1
Peripatetic Enterprises headquartered in Nide, has foreign
income from Serendip.
Foreign Income
$1000
Serendip Tax Rate
35%
Domestic Tax Rate
45%
Example of Home Policies
Exemption
Credit
Deduction
Double Tax
Foreign
Income
$1000
$1000
$1000
$1000
Foreign Taxes
Paid
$350
$350
$350
$350
Home Taxes
Paid
$0
$100
$293
$450
Net Income
$650
$550
$357
$200
Peripatetic prefers tax exempt policy. Beyond that, tax credit over
deduction, and prefers either of these over double taxation.
Timing of Taxation
Contemporaneous Taxation: home
country may choose to tax
foreign equity returns during
fiscal year in which they are
earned.
• Used mostly for foreign
branches of MNE.
• Branch is an extension of parent
company
Tax Deferral: taxation occurs at
time profits are repatriated as
dividends.
• Used for foreign subsidiaries of
MNE.
• Subsidiary is an affiliate of a
MNE that is incorporated in the
country in which it operates
• Encourages profits to be
reinvested abroad rather than
repatriated.
Summary of International Tax
Policies
• First Crack Principle: Host country sets corporate tax rates
• Home country reacts to host country’s policies by deciding treatment
of foreign income and taxes, as well as timing of taxes.
• MNEs prefer to invest where taxes are lower
• Tax laws are more complicated then the framework presented.
Subpart F: Subsidiary income taxed regardless of repatriation.
International Tax Management
MANAGING INTRACOMPANY
FUND-FLOWS
Unbundling decomposes total international
transfer of funds between pairs of affiliates
(parents, subsidiaries, branches) into separate
portions.
• Allocation of profits (branch vs. subsidiary)
Dividends
Most important method of transferring
funds to parents
Cost Allocation
A. Definition: Allocation of pooled and joint costs
to subsidiaries , can be used move profits to
more tax-friendly nations.
B. Uses of cost allocation.
1.
2.
3.
Reduce corporate taxes paid
Reduce ad valorem taxes (VATs, excises, and tariffs)
Avoid exchange controls
Transfer Pricing
A.
Definition: prices on internally-traded goods, can
be used move profits to more tax-friendly nations.
B. Uses of Transfer Pricing.
1. Reduce corporate taxes paid
2. Reduce ad valorem taxes (VATs, excises, and
tariffs)
3. Avoid exchange controls
Reinvoicing Centers
A.
B.
C.
D.
Set up in low-tax nations.
Center takes title to all goods.
Center pays seller/paid by buyer all within the
MNC.
Advantages:
1.
2.
E.
Simplifies currency exchange
Can invoice in currencies other than the local one.
Disadvantages of reinvoicing.
1.
2.
Increased communication costs
Suspicion of tax evasion by local governments.
Fees and Royalties
A. Firms have control of payment
amounts.
B. Host governments less suspicious.
Intracompany Loans
Protect against confiscation, reduces taxes, accesses
blocked funds especially when following are present:
1.
2.
3.
Credit rationing
Currency controls
Differential tax rates
Types of Inter-company Loans
1.
2.
Back-to-back loans: Often called fronting loan, channeled
through a bank and collateralized by parent deposit
Parallel loans consist of 2 related but separate loans with 4
parties in 2 nations.
Case Study
CC&S, a Multinational Company headquartered in
Chicago and traded on NY Stock Exchange.
Branches located in Japan, Canada, Ireland, Great
Britain and Germany.
The tax structure is based on worldwide tax
principle: gross foreign branch income is taxed
and a full credit is given for foreign taxes paid up
to the amount of the US tax liability.
Cost Allocation
Currently, expenses incurred at C&C Enterprise headquarters in Chicago
total $50,000, each branch is charged $10,000.
There is a proposal to allocate costs to high-tax countries in order to
achieve the largest tax deductions possible. As such:
• This decreases foreign taxes paid from $88,100 to $83,400
• US tax liability increases from $300 to $5000
• Net branch income remains unchanged, $171,600
Taxes are shifted from host countries to home country, but total taxes
remain the same. By using the credit method, home country taxes
total branch income regardless of where the income is earned or
where the taxes are paid.
International Tax Management
Principle I:
If there are no excess tax credits, cost allocation
decisions do not matter for branches. If there are
excess tax credits, show branch profits in the
lowest-tax jurisdictions by allocating costs to the
highest-tax jurisdictions, without making negative
profits.
Transfer Pricing
Pricing of internally-traded goods. Management may suggest altering the
company’s transfer prices to show profits in low-tax jurisdictions.
The Vice-President of C&C Enterprises suggests raising transfer prices from $16
to $18 for countries with high-tax jurisdictions. By increasing the transfer
prices, it:
•
•
•
Reduces total foreign taxes paid from $88,100 to $81,500
Domestic tax liability increases from $300 to $6,900
Net branch income remains unchanged, $171,600
Total net income remains unchanged because US tax liability increases while the
foreign taxes paid decreases. Transfer pricing affects what government
receives the tax revenue, but it does not affect the total taxes the corporation
pays.
International Tax Management
Principle II
If there are no excess tax credits, transfer pricing decisions do not matter
for branches. If there are excess tax credits, show branch profits in the
lowest-tax jurisdictions by following a simple rule:
If one branch is selling to a foreign branch, set the transfer price as high as
possible when T*> T without making profits negative, and as low as
possible when T*<T without making profits negative.
T=Tax rate on profits earned by the branch
T*=Tax rate on profit earned by the foreign branch.
Tariffs and Transfer Pricing
Tariffs are additional costs imposed on goods and services imported to a country.
Management can minimize import duties paid by setting transfer prices as low as
possible. Tariffs are levied on the transfer prices selected and are deductible
expenses in figuring the branches’ income taxes.
Setting low transfer prices to $14:
•
•
•
•
Can minimize the import duty paid from $64,000 to $56,000
Total foreign income taxes rise from $62,900 to $69,220
The US tax liability falls from $3,740 to $140
Net Branch Income increases $5,280 to $134,640
Because an import tariff is a deductible expense, it does not generate a US tax
credit, thus affecting net branch income.
International Tax Management
Principle III
If there are no excess tax credits, use the lowest possible transfer
price between branches in the presence of import tariffs. If there
are excess tax credits, minimize branch taxes paid in the
presence of import tariffs by comparing T* to [T + Td*(1-T*)]:
Use the high transfer price if T*>[T +Td*(1- T*)] without making
profits negative, and use the low transfer price if T*<[T +Td*(1T*)] without making profits negative.
Summary of Tax Management
Principles
Decision
No Excess Tax Credits
Excess Tax Credits
Cost Allocation
Does not matter
Allocate costs to hightax countries
Transfer Pricing
Does not matter
Show profits in low-tax
countries
Transfer Pricing with
Tariff
Low transfer price
Minimize total taxes by
comparing T* to [T
+Td*(1- T*)]
DESIGNING A GLOBAL
REMITTANCE POLICY
A. Factors:
1. Number of financial links
2. Volume of transactions
3. Ownership patterns
4. Product standardization
5. Government regulations
Information Requirements
1.
2.
3.
4.
5.
6.
7.
Subsidiary financing requirements
Sources/costs of external capital
Local investment yields
Financial channels available
Transaction volume
Relevant tax factors
Government restrictions on transfer of
funds.
Questions