International Finance

1. International Finance FIN456 ♦ Spring 2013Michael Dimond

2. Multinational Tax Management The primary objective of multinational tax planning is the minimization of the firm’s worldwide tax burden Tax planning for MNC operations is extremely complex but a vital aspect of international business To plan effectively, MNCs must understand not only the intricacies of their own operations worldwide, but also the different structures and interpretations of tax liabilities across countries

3. Tax Principles Tax morality – the MNC must decide whether to follow a practice of full disclosure to tax authorities or to adopt the principle of “when in Rome, do as the Romans” Tax neutrality – when governments levy taxes, they must consider not only the potential revenue from the tax but also the effect the proposed tax can have on private economic behavior The ideal tax should not only raise revenue efficiently but also have as few negative effects on economic behavior as possible

4. Tax Principles Domestic neutrality – the burden of taxation on each currency unit of profit earned in the home country should equal the burden of taxation on the currency equivalent profit earned by the same firm in its foreign operations Foreign neutrality – the tax burden on each foreign subsidiary should equal the tax burden on its competitors in the same country Tax equity – an equitable tax that imposes the same total burden on all taxpayers who are similarly situated and located in the same tax jurisdiction

5. Corporate Tax Rates Compared

6. National Tax Environments Nations typically structure their tax systems along one of two basic approaches Worldwide approach Territorial approach Both approaches are attempts to determine which firms, foreign or domestic by incorporation, or which incomes, foreign or domestic in origin, are subject to the taxation of host country tax authorities

7. National Tax Environments Worldwide approach is also referred to as the residential or national approach It levies taxes on the income earned by firms that are incorporated in the host country regardless of where the income was earned Territorial approach is also termed the source approach It focuses on the income earned by firms within the legal jurisdiction of the host country, not the country of incorporation

8. National Tax Environments Tax deferral – foreign subsidiaries of MNCs pay host country income taxes but many parent companies defer claiming additional income taxes on that foreign source income until it is remitted to the parent firm If the worldwide approach was followed to the letter of the law, then the tax deferral privilege would end Tax treaties provide a means of reducing double taxation They typically define whether taxes are to be imposed on income earned in one country by the nationals of another country and if so, how much

9. National Tax Environments Tax treaties Tax treaties are bilateral, with the two signatories specifying what rates are applicable to which types of income Tax treaties also typically result in reduced withholding tax rates This is important to MNCs operating foreign subsidiaries earning active income and individual investors earning passive income

10. Tax Types Income Tax – many governments rely on this tax as their primary source of revenue Withholding Tax – passive income (dividends, royalties, interest) earned by a resident of one country within the jurisdiction of a second country are normally subject to a withholding tax in the second country Government wishes a minimum payment for earning income within their tax jurisdiction knowing that party won’t file a tax return in the host country

11. Tax Types Value-Added Tax – type of national sales tax collected at each stage of production or sale of goods in proportion to the value added during that stage Other National Taxes – there are several other taxes levied which vary in importance from country to country Turnover Tax – tax on purchase/sale of securities in stock market Property and Inheritance Tax Tax on Undistributed Profits

12. Corporate Tax Rates for Selected Countries

13. Example: Value-Added Tax

14. Foreign Tax Credits To prevent double taxation, many countries grant a foreign tax credit (FTC) for income taxes paid to the host country FTC’s vary widely by country and are also available for withholding taxes Value-added taxes are typically deducted as an expense from pre-tax income so FTCs don’t apply A tax credit is a direct reduction of taxes that would otherwise be due and payable It is not a deductible expense because it does not reduce the taxable income

15. Foreign Tax Credits

16. FTC Example NI x Dividend Payout Rate Rate given as 0.0% HK Corp Income Taxes x Dividend Payout Rate From above (Rate given as 0.0%) $5,400 x US Corp. Tax Rate Corp Inc Tax + Withholding Tax Paid Theoretical US Tax Liability – FTC FTC - Theoretical US Tax Liability Depends on which is larger, FTC orTheoretical US Tax Liability.Lower limit = 0. FTC + Additional US Tax Due

17. Transfer Pricing The pricing of goods, services, and technology transferred to a foreign subsidiary from an affiliated company, transfer pricing, is the first and foremost method of transferring funds out of a foreign subsidiary These costs enter directly into the cost of goods sold component of the subsidiary’s income statement This is a particularly sensitive problem for the MNC Both funds positioning and income tax effects must be taken into consideration

18. Transfer Pricing Fund positioning A parent wishing to transfer funds out of a particular country can charge higher prices on goods sold to its subsidiary in that country – to the degree that government regulations allow A foreign subsidiary can be financed by the reverse technique, a lowering of transfer prices Payments by a subsidiary for imports transfers funds out of the subsidiary A high transfer price allows funds to be accumulated in the selling country

19. Transfer Pricing Income tax effect A major consideration in setting a transfer price is the income tax effect Worldwide corporate profits may be influenced by setting a transfer prices to minimize taxable income in a country with a high income tax rate This can also be done to maximize income in a country with a low income tax rate

20. Transfer Pricing IRS regulations provide three methods to establish arm’s length prices Comparable uncontrolled prices Regarded as the best evidence of arm’s length pricing Transfer price is the same as bond fide sales of the same items between unrelated firms Resale prices Begins with the final selling price to an independent purchaser less an appropriate markup Cost-plus calculations Begins with full cost to the seller plus a profit margin

21. Effect of Transfer Price on Net Income (US$ 000s)

22. Tax Management of Foreign-Source Income

23. International Offshore Financial Centers

24. Tax Management at Trident The MNC has operations in Brazil and Germany and must manage its taxes when remitting income from these subsidiaries The corporate tax rate in Germany is 40%, higher than the US rate of 35% Because this rate is higher, the US parent will realize excess FTCs The corporate tax rate in Brazil is 25%, thus the parent will not realize FTCs Management would like to manage the dividend remittances to match the credits with the deficits