Post on 31-Dec-2015
Multinational Financial System
“... ability to shift funds and accounting profits among its various units ...
through internal financial transfer mechanisms.”
Multinational Financial System
“ … over 38% of U. S. imports and exports are transactions between U. S. firms and their foreign affiliates or parents.”
Two-way International Trade
Parent to/from a foreign Parent to/from a foreign subsidiarysubsidiary::–U. S. & Japan: 80%U. S. & Japan: 80%
–U. S. & Europe: 40%U. S. & Europe: 40%
–EC & Japan: 55%EC & Japan: 55%
Multinational Arbitrage Opportunities
Tax arbitrageTax arbitrage Financial market arbitrageFinancial market arbitrage Regulatory system arbitrageRegulatory system arbitrage
Multinational Financial System[Advantages]
Tax arbitrage:– high-tax to low-tax nations
– taxpaying to tax-loss units Financial market arbitrage:
– circumvent exchange controls
– earn higher risk-adjusted returns
– reduce borrowing costs
Multinational Financial System[Advantages]
Regulatory system arbitrage:
–disguise true profitability
–negotiating advantage Offset credit restraint or controls
–draw on external sources of funds
Tax Factors(Intercompany Transfers)
Types of taxes (host country)– corporate income taxes– taxes on dividends, interest, and fee
remittances– taxes on retained earnings
Foreign tax credit– offsets U. S. taxes
MNC Financial Channels
Transfer pricing Reinvoicing Centers Fees and royalties Leading and lagging Intercompany loans Dividends Equity vs. debt
Transfer Pricing
Reduce taxes Unit A sells to Unit B:
–if tA > tB, low transfer price
–if tA < tB, high transfer price
Transfer Pricing[A sells to B]
TaxA TaxB Transfer Price
ProfitA ProfitB
High Low Low Low High
Low High
Transfer Pricing[A sells to B]
TaxA TaxB Transfer Price
ProfitA ProfitB
High Low Low Low High
Low High High High Low
Transfer Pricing Strategy
Reduce taxes Reduce tariffs Avoid exchange controls Increase profits from joint ventures Disguise affiliate’s profitability
Fees and Royalties[International Transfers]
Intangible factors of production
– headquarters services
– allocated overhead
– patents and trademarks IRC Section 482:
– “commensurate with the income” generated
Leading & Lagging Payments
Accelerating or delaying payments Modifying credit terms Opportunity cost of funds:
– paying unit
– receiving unit
– interest rate differentials
Leading & Lagging Payments
Advantages over direct loans:Advantages over direct loans:–no formal note of indebtednessno formal note of indebtedness
–less government interferenceless government interference
–interest free for 6 months (Sec. interest free for 6 months (Sec. 482)482)
Leading & Lagging Payments Borrowing
Rate Lending
Rate
United States 3.8% 2.9%
Germany 3.6% 2.7%
Germany
(+) (-)
(+)
United States (-)
Leading & Lagging Payments Borrowing
Rate Lending
Rate
United States 3.8% 2.9%
Germany 3.6% 2.7%
Germany
(+) (-)
(+) 2.9% - 2.7% [+0.2%]
United States (-)
Leading & Lagging Payments Borrowing
Rate Lending
Rate
United States 3.8% 2.9%
Germany 3.6% 2.7%
Germany
(+) (-)
(+) 2.9% - 2.7% [+0.2%]
2.9% - 3.6% [-0.7%]
United States (-) 3.8% - 2.7% [+1.1%]
3.8% - 3.6% [+0.2%]
Intercompany Loans (1)
Transfer of funds through making and repaying of intercompany loans
More valuable than arm’s-length transactions if the following exist:
– credit rationing
– currency controls
– differential tax rates
Direct Loans
Straight extension of credit From parent to affiliate From one affiliate to another No intermediary involved
Back-to-Back Loans (1)[Fronting loans; link financing] Used in countries with:
–high interest rates
–restricted capital markets
–currency controls
–different tax rates for loans from a financial institution
Back-to-Back Loans (2)
Parent deposits funds with a bank in Country A
Bank lends funds to subsidiary in Country B
Effectively, an intercompany loan channeled through a bank
Back-to-Back Loans (3)
Risk free for the bank - deposit collateralizes the loan
Bank serves as intermediary Bank’s compensation is the
difference between borrowing and lending rates
Parent firmParent firmin Country Ain Country A
Subsidiary inSubsidiary inCountry BCountry B
Structure of a Back-to-Back LoanStructure of a Back-to-Back Loan
Parent firmParent firmin Country Ain Country A
Subsidiary inSubsidiary inCountry BCountry BDirect Loan
Structure of a Back-to-Back LoanStructure of a Back-to-Back Loan
Parent firmParent firmin Country Ain Country A
Bank in Bank in Country ACountry A
Subsidiary inSubsidiary inCountry BCountry BDirect Loan
Deposit
Structure of a Back-to-Back LoanStructure of a Back-to-Back Loan
Parent firmin Country A
Bank in Country A
Subsidiary inCountry BDirect Loan
Back-to-Back Loan
Deposit
Structure of a Back-to-Back LoanStructure of a Back-to-Back Loan
Parallel Loans
Two related but separate borrowings Usually involves four parties Two separate countries Bank fees: 0.25%-0.50% of principal
Dividends Most important transfer mechanism Over 50% of remittances to USA Parent’s dividend payout ratio (D/E) Other factors:
– tax effects
– financing requirements
– exchange controls
Equity vs. Debt?
MNCs generally prefer loans to equity Easier to repatriate interest and principal
than dividends and equity Tax benefits of debt:
– interest deductible in host country
– loan repayments not taxable to parent
Designing a Global Policy
How much money to remit? When to remit? Where to transmit funds? Which transfer method to use? Satisfactory vs. optimal decisions
Shapiro: Problem 16-1
a. 1,500 (27,000 - P) (.45 - .50)
P = $30,000 maximizes tax savings
b. 1,500 (27,000 - P)[.45+.15-.50(1.15)]
= 1,500 (27,000 - P) (.025)
P = $25,000 maximizes tax savings