Chapter 8 Taxes and Multinational Corporate Strategy
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Transcript of Chapter 8 Taxes and Multinational Corporate Strategy
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 8-1
Chapter 8Chapter 8Taxes and Multinational Corporate StrategyTaxes and Multinational Corporate Strategy
8.1 The Objectives of National Tax Systems
8.2 Types of Taxation
8.3 Taxation of Foreign-Source Income in the United States
8.4 Taxes and the Location of Foreign Operations
8.5 Taxes and Organizational Form
8.6 Taxes and Cross-Border Investment Activity
8.7 Summary
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 8-2
The income tax...The income tax...
The income tax has made more liars out of the American people than golf has.
Will Rogers
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 8-3
The objectives of tax neutralityThe objectives of tax neutrality
Domestic tax neutrality - incomes arising from foreign and from domestic operations are taxed similarly by the domestic government.
Foreign tax neutrality - taxes imposed on the foreign operations of domestic companies are the same as those facing local competitors in the host countries.
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 8-4
Violations of tax neutralityViolations of tax neutrality
Different tax rates are often assessed on income from:
different tax jurisdictions
different organizational forms
different asset classes
different financing instruments
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 8-5
Forms of taxationForms of taxation
Explicit taxes– income taxes
– withholding taxes on dividends, interest and royalties
– sales and value-added taxes
– property and asset taxes
– tariffs on cross-border trade
Implicit taxes– The law of one price revisited: “Equivalent assets sell
for the same after-tax expected return”
– Tax arbitrage ensures this condition in the long run, but not necessarily in the short run
– Countries with low tax rates often have low before-tax required returns as well
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 8-6
Taxes on foreign-source incomeTaxes on foreign-source income
There are two basic types of taxation systems:
A worldwide tax system taxes foreign-source income as it is repatriated to the parent company.
A territorial tax system levies a tax only on domestic income. Taxes on foreign-source income are only paid in the country in which they are earned.
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 8-7
U.S. taxation of foreign source incomeU.S. taxation of foreign source income
In the United States:
income from foreign subsidiaries is taxed as it is repatriated to the parent
income from foreign branches is taxed as it is earned
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 8-8
The organizational formThe organizational formof foreign operationsof foreign operations
The foreign operations of manufacturing firms are usually conducted through foreign subsidiaries
» Incorporation in the host country limits the parent’s liability
» Incorporation avoids host country disclosure requirements on the parent corporation’s worldwide operations
» Foreign branches can be used for start-up operations that are initially expected to lose money
Foreign branches are used by financial institutions» Foreign branches are tax disadvantaged if the foreign branch is
in a low-tax country
» FTC limitations can be less binding for foreign branches than for foreign subsidiaries
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 8-9
Foreign tax credits & FTC limitationsForeign tax credits & FTC limitationsin the United Statesin the United States
Tax statements as single subsidiaries
Swit. Italy German
a Dividend payout ratio 100% 100% 100%
b Foreign dividend withholding tax rate 5% 5% 5%
c Foreign tax rate 28% 36% 50%
d Foreign income before tax 1000 1000 1000
e Foreign income tax (-d*c) (280) (360) (500)
f After-tax foreign earnings (d-e) 720 640 500
g Declared as dividends (f*a) 720 640 500
h Foreign dividend withholding tax (-g*b) (36) (32) (25)
i Total foreign tax (e+h) (316) (392) (525)
j Dividend to U.S. parent (d-i) 684 608 475
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 8-10
Foreign tax credits & FTC limitationsForeign tax credits & FTC limitationsin the United Statesin the United States
Tax statements as single subsidiaries (continued)
Swit. Italy German
k Gross foreign income before tax (line d) 1000 1000 1000
l Tentative U.S. income tax (k*35%) (350) (350) (350)
m Foreign tax credit (i) 316 392 525
n Net U.S. taxes payable [min(l+m,0)] (34) 0 0
o Total taxes paid (350) (392) (525)
p Net amount to U.S. parent 650 608 475
q Total taxes as separate subsidiaries (o) ($1,267)
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 8-11
Foreign tax credits & FTC limitationsForeign tax credits & FTC limitationsin the United Statesin the United States
Parent’s consolidated tax statement
r Overall FTC limitation (k*35%) $1,050
s Total FTCs on a consolidated basis (-i) $1,233
t Additional U.S. taxes due [max(0, r-s)] $0
u Excess tax credits [max(0,s-r)] $183
(carried back 2 years or forward 5 years)
Overall FTC limitation
= (Total foreign-source income)(U.S. tax rate)
when the U.S. tax rate is a constant fraction of worldwideincome
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 8-12
Additional FTC limitationsAdditional FTC limitations
Income baskets– Active income
– Passive income
– Other (e.g. income from foreign sales corporations)
Subpart F income– Foreign holding company income
– Foreign base company sales income
– Foreign base company service income
Allocation of income and expense– Allocation of interest expense
– Allocation of research and development expenses
– Other expenses
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 8-13
Effect of shifting sales to low-tax countriesEffect of shifting sales to low-tax countries
Tax statements as single subsidiaries - original allocation
Swit. Italy German
a Dividend payout ratio 100% 100% 100%
b Foreign dividend withholding tax rate 5% 5% 5%
c Foreign tax rate 28% 36% 50%
d Foreign income before tax 1000 1000 1000
e Foreign income tax (-d*c) (280) (360) (500)
f After-tax foreign earnings (d-e) 720 640 500
g Declared as dividends (f*a) 720 640 500
h Foreign dividend withholding tax (-g*b) (36) (32) (25)
i Total foreign tax (e+h) (316) (392) (525)
j Dividend to U.S. parent (d-i) 684 608 475
Total foreign taxes as single subsidiaries = $1,233
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 8-14
Effect of shifting sales to low-tax countriesEffect of shifting sales to low-tax countries
Tax statements as single subsidiaries - after sales shift
Swit. Italy German
a Dividend payout ratio 100% 100% 100%
b Foreign dividend withholding tax rate 5% 5% 5%
c Foreign tax rate 28% 36% 50%
d Foreign income before tax 2000 1000 0
e Foreign income tax (-d*c) (560) (360) (0)
f After-tax foreign earnings (d-e) 1440 640 0
g Declared as dividends (f*a) 1440 640 0
h Foreign dividend withholding tax (-g*b) (72) (32) (0)
i Total foreign tax (e+h) (632) (392) (0)
j Dividend to U.S. parent (d-i) 1368 608 0
Total foreign taxes as single subsidiaries = $1,024
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 8-15
Effect of shifting sales to low-tax countriesEffect of shifting sales to low-tax countries
Tax statements as single subsidiaries (continued)
Swit. Italy German
k Gross foreign income before tax (line d) 1000 1000 1000
l Tentative U.S. income tax (k*35%) (350) (350) (350)
m Foreign tax credit (i) 316 392 525
n Net U.S. taxes payable [min(l+m,0)] (34) 0 0
o Total taxes paid (350) (392) (525)
p Net amount to U.S. parent 650 608 475
q Total taxes as separate subsidiaries (o) ($1,267)
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 8-16
Effect of shifting sales to low-tax countriesEffect of shifting sales to low-tax countries
Tax statements as single subsidiaries (continued)
Swit. Italy German
k Gross foreign income before tax (line d) 2000 1000 0
l Tentative U.S. income tax (k*35%) (700) (350) (0)
m Foreign tax credit (i) 632 392 0
n Net U.S. taxes payable [min(l+m,0)] (68) 0 0
o Total taxes paid (700) (392) (0)
p Net amount to U.S. parent 1300 608 0
q Total taxes as separate subsidiaries (o) ($1,092)
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 8-17
Effect of shifting sales to low-tax countriesEffect of shifting sales to low-tax countries
Parent’s consolidated tax statement
Original sales Shifted sales
r Overall FTC limitation (k*35%) $1,050 $1,050
s Total FTCs on a consolidated basis (-i) $1,233 $1,024
t Additional U.S. taxes due [max(0, r-s)] $0 $26
u Excess tax credits [max(0,s-r)] $183 $0
(carried back 2 years or forward 5 years)
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 8-18
Off-shore finance subsidiariesOff-shore finance subsidiaries
The Tax Reform Act of 1986 removed the tax advantages of tax-haven affiliates
Many MNCs retain off-shore finance subsidiaries as reinvoicing centers. The location of a captive finance subsidiaries should have:
» Developed infrastructure including banking, transportation, and communication facilities
» Stable and convertible currency with access to the international currency and Eurocurrency markets
» Low income tax and withholding tax rates
» Low political risk
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 8-19
Transfer pricing and tax planningTransfer pricing and tax planning
Transfer price
Low High
Arg. Hungary Both Arg. Hungary Both
Tax rate 30% 40% 38% 30% 40% 32%
Revenue $5,000 $10,000 $10,000 $8,000 $10,000 $10,000
Cost of goods sold 3,000 5,000 3,000 3,000 8,000 3,000
Other expenses 1,000 1,000 2,000 1,000 1,000 2,000
Taxable income 1,000 4,000 5,000 4,000 1,000 5,000
Total taxes paid 300 1,600 1,900 1,200 400 1,600
Net income 700 2,400 3,100 2,800 600 3,400
Effective tax rate 38% 32%
on foreign operations