International Taxation: Debt Financing, Taxation and Transfer Pricing. By Koy Saechao. Overview. Debt financing T ax implications for equity International tax policies for host and home government Tax management principles. Debt Financing.
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By Koy Saechao
Taxes are often considered with the treatment of debt financing. Debt management is affected by:
General principle of international taxation: There is a clear distinction between returns to debt and returns to equity.
Corporate income tax is designed as a tax on the returns to equity only
Equity returns are taxed in the host country, then may be taxed in home country (possibly different timing)
vis-à-vis the host
Determine tax rates on corporate profits first
Set withholding taxes: taxes imposed on capital paid to the parent as they are taken out of the country.
“First Crack” to tax income produce within host country’s boarders
Tax policies are complicated because they establish policies relative to previously determined host country’s policies
Policies must consider two factors:
Peripatetic Enterprises headquartered in Nide, has foreign income from Serendip.
Peripatetic prefers tax exempt policy. Beyond that, tax credit over deduction, and prefers either of these over double taxation.
Contemporaneous Taxation Transfer Pricing: 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.Timing of Taxation
The goal to international tax management is to increase corporation-wide profits by reducing the total amount of taxes paid.
We want to allocate pre-tax profits to maximize after-tax profits.
General Rule: A dollar spent on generating income should be allocated to and deducted from revenue in the same country.
C&C Enterprise, a Multinational Company located in Chicago. 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.
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:
Taxes are shifted from foreign countries to domestic country, but total taxes remain the same. By using the credit method, domestic country taxes total branch income regardless of where the income is earned or where the taxes are paid.
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.
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:
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.
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 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:
Because an import tariff is a deductible expense, it does not generate a US tax credit, thus affecting net branch income.
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*(1- T*)] without making profits negative.