GLOBAL ACCOUNTING AND CONTROL: A MANAGERIAL EMPHASIS

1. GLOBAL ACCOUNTING AND CONTROL: A MANAGERIAL EMPHASIS • Sidney J. Gray, University of New South Wales • Stephen B. Salter, University of Cincinnati • Lee H. Radebaugh, Brigham Young University Slides Prepared by: Jennifer Anne Salter Gray, Salter & Radebaugh Chapter 6

2. CHAPTER SIX TAXATION AND THE MULTINATIONAL ENTERPRISE Gray, Salter & Radebaugh Chapter 6

3. INTRODUCTION • Challenges to the MNE in terms of taxation of its global operation: • Variety of taxes and types of taxable income. • Home govts. want to tax global income. • Key taxes for MNEs: • Direct taxes, e.g., corporate income taxes • Indirect taxes, e.g., Value Added Tax. Gray, Salter & Radebaugh Chapter 6

4. DIRECT TAXESCorporate Income Tax • Key questions: • what income is taxable? • what expenses are deductible? • what additional taxes will be charged when dividends are paid. • General corporate tax rates have been coming down in recent years Gray, Salter & Radebaugh Chapter 6

5. DIRECT TAXESAverage Corporate Income Tax Rates - Table 6.1 Gray, Salter & Radebaugh Chapter 6

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8. DIRECT TAXESWhat Income is Taxable? Two approaches to taxation of foreign source income: • Territorial approach, e.g., Hong Kong. Only income earned in Hong Kong should be taxed there. • Worldwide approach, e.g., U.S.. Taxes both domestic and foreign source income. Can lead to double taxation but this can be minimized through tax credits and tax treaties. Gray, Salter & Radebaugh Chapter 6

9. DIRECT TAXESDetermination of Expenses • The way expenses are treated for tax purposes, can cause differences in tax paid • Differences in treatment of income and expenses can result in differences between statutory and effective tax rates. Gray, Salter & Radebaugh Chapter 6

10. DIRECT TAXESWithholding Tax and Taxing Dividends • The income earned by a foreign subsidiary is taxable in a foreign country when cash is returned to the parent through: • dividends, • royalties • interest on intra company debt, • When cash is returned to parent withholding taxes are often deducted. Gray, Salter & Radebaugh Chapter 6

11. DIRECT TAXESWithholding Tax and Taxing Dividends There are two approaches to taxing corporate income: • Classic System: e.g., US • income is taxed when the corporation earns it and when dividends are received by the shareholders. • Integrated System: • tries to eliminate double taxation. Gray, Salter & Radebaugh Chapter 6

12. International Comparison of Effective Tax Rate of Corporate Income Taxation Gray, Salter & Radebaugh Chapter 6

13. Tax Rates Around the World Gray, Salter & Radebaugh Chapter 6

14. Tax Rates Around the World Gray, Salter & Radebaugh Chapter 6

15. Tax Rates Around the World Gray, Salter & Radebaugh Chapter 6

16. Tax Rates Around the World Gray, Salter & Radebaugh Chapter 6

17. International Comparison of Individual Income Taxes Gray, Salter & Radebaugh Chapter 6

18. International Comparison of Effective Tax Rates for a couple with two children Gray, Salter & Radebaugh Chapter 6

19. INDIRECT TAXESValue Added, Goods and Services Tax • Examples of indirect taxes: • consumption taxes (sales tax), • VAT, • excise tax, • estate tax, • gift tax, • employment tax, • user fees. • In Europe, VAT is a considerable source of revenue. • tax applied at each stage of production for the value added to the goods. • tax burden eventually falls on the consumer because companies can reclaim taxes paid. Gray, Salter & Radebaugh Chapter 6

20. INDIRECT TAXESValue Added, Goods and Services Tax- Table 6.2 Gray, Salter & Radebaugh Chapter 6

21. Value-added Tax Rate in Various Countries Gray, Salter & Radebaugh Chapter 6

22. AVOIDANCE OF DOUBLE TAXATION OF FOREIGN SOURCE INCOME Credits and Deductions: • When subsidiaries are based in a country which uses a worldwide approach to taxation, income may be taxed twice: • when earnings are realized in the foreign location • when earnings are realized in the parent country. • This is double taxation Gray, Salter & Radebaugh Chapter 6

23. AVOIDANCE OF DOUBLE TAXATION OF FOREIGN SOURCE INCOME • For income earned outside the country, most developed countries offer credits to offset the foreign tax paid • In the US, taxes paid on foreign income: • can be treated as a credit applied against tax liability • can be deducted from income to reduce taxable income. Gray, Salter & Radebaugh Chapter 6

24. AVOIDANCE OF DOUBLE TAXATION OF FOREIGN SOURCE INCOME- Table 3 Gray, Salter & Radebaugh Chapter 6

25. AVOIDANCE OF DOUBLE TAXATION OF FOREIGN SOURCE INCOME Foreign Tax Credit (FTC) Limitation • Corporation's FTC is equal to the percentage of its US tax laibility that results from its foreign source taxable income being included in its total US taxable income • Amount of FTC = US taxes before FTC times (taxable income from foreign sources/total worldwide taxable income) • Amount of FTC cannot exceed amount of foreign taxes paid during year Gray, Salter & Radebaugh Chapter 6

26. AVOIDANCE OF DOUBLE TAXATION OF FOREIGN SOURCE INCOME • Tax Treaties: • can specify that certain classes of income would not be taxable; • can reduce the rate on income and/or withholding taxes; • can specifically deal with the issue of tax credits Gray, Salter & Radebaugh Chapter 6

27. MINIMIZING GLOBAL TAXTax Havens • Is a “place where foreigners may receive income or own assets without paying high rates of tax.” • can offer low taxes or no taxes on certain classes of income Gray, Salter & Radebaugh Chapter 6

28. MINIMIZING GLOBAL TAXTax Havens • Examples of tax havens: • No Income Taxes - Bahamas, Bermuda, Cayman Islands. • Low Tax Rates - British Virgin Islands • Exempt foreign source income - Panama, Hong Kong. Gray, Salter & Radebaugh Chapter 6

29. MINIMIZING GLOBAL TAXTax Incentives There are two major types of tax incentives. • tax holidays • given by countries to attract foreign investors • export incentives • given by countries to encourage exports of goods and services Gray, Salter & Radebaugh Chapter 6

30. MINIMIZING GLOBAL TAXThe Controlled Foreign Corporation • A US corporation may choose to produce or sell in a foreign country through a branch or foreign corporation. • US parent does not have to pay US tax on income from a subsidiary until it receives a dividend. This is called deferral. Gray, Salter & Radebaugh Chapter 6

31. MINIMIZING GLOBAL TAXThe Controlled Foreign Corporation • An exception to the deferral is given if: • US shareholders hold more than 50% of a controlled foreign corporation (CFC). • A foreign company owned by US citizens is deemed to be a CFC. • Its passive income is taxable in the US, regardless of whether a dividend has been paid. Gray, Salter & Radebaugh Chapter 6

32. TAX DIMENSIONS OF EXPATRIATES • Most countries tax earnings of their residents. • The US taxes the worldwide income of its citizens. • The US does provide some relief if you have been resident outside the US for a certain uninterrupted period. Gray, Salter & Radebaugh Chapter 6

33. INTRACORPORATE TRANSFER PRICING • This is also known as transfer or internal pricing. • Refers to the pricing of goods and services bought and sold between members of a corporate family. • Includes transfers of raw materials, semi or finished goods, loans, fees, etc. Gray, Salter & Radebaugh Chapter 6

34. INTRACORPORATE TRANSFER PRICING - Example • German subsidiary of US parent company manufactures goods and sells them to its Irish subsidiary that then sells them back to the US parent company. Why? • Goods cost German subsidiary $80/unit and were sold to Irish subsidiary for $80/unit • German tax rate – 45% • German taxable income $80 – 80 = $0/unit • German income taxes $0 * 45% = $0/unit • Goods cost Irish subsidiary $80/unit and were sold to US parent company for $150/unit • Irish tax rate - 4% • Irish taxable income $150 – 80 = $70/unit • Irish income taxes $70 * 4% = $2.80/unit • Goods cost US parent company $150/unit and were sold for $150/unit • US tax rate – 35% • US parent company taxable income $150 – 150 = $0/unit • US parent company income taxes $0 * 35% = $0/unit • Total income taxes paid $2.80/unit • If German subsidiary sold goods directly to US parent company for $150/unit, German subsidiary would have had taxable income of $70 and paid income taxes of $31.50/unit ($70 * 45%) Gray, Salter & Radebaugh Chapter 6

35. TAX PLANNING IN THE INTERNATIONAL ENVIRONMENT There are several ways in which a firm can choose to service its foreign markets: • exports of goods and services; • foreign branches; • foreign subsidiaries; • location of foreign operations. Gray, Salter & Radebaugh Chapter 6

36. TAX PLANNING ……Exports • Should products be serviced from the parent country or foreign location? • What are the benefits: • Can use the Foreign Sales Corporation (FSC) which allows: • substantial tax benefits if operations are legitimate • setting up in a tax haven country to shelter income. • Be aware of withholding taxes and treaties. Gray, Salter & Radebaugh Chapter 6

37. TAX PLANNING ……Foreign Branches There are benefits to operating abroad: • Branch profits/losses not subject to deferral so beneficial during initial years which are normally loss years. • Can offset home office income for tax purposes. • Branch remittances usually not subject to withholding taxes (subsidiaries are). Gray, Salter & Radebaugh Chapter 6

38. TAX PLANNING ……Foreign Subsidiaries Major benefit is that income is usually sheltered from taxation in the home country until a dividend is remitted. Gray, Salter & Radebaugh Chapter 6

39. TAX PLANNING ……Location of Foreign Operations Influenced by three major tax factors: • Tax incentives • can materially reduce the cash outflow for an investment project • Tax rates • have competent tax and legal help in local country. • Tax treaties • can help choose location of legal operations. Gray, Salter & Radebaugh Chapter 6