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Chapter 8 Taxes and Multinational Corporate Strategy

Chapter 8 Taxes 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

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Chapter 8 Taxes and Multinational Corporate Strategy

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  1. Chapter 8Taxes 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

  2. The income tax... The income tax has made more liars out of the American people than golf has. Will Rogers

  3. The 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.

  4. Violations of tax neutrality Different tax rates are often assessed on income from: different tax jurisdictions different organizational forms different asset classes different financing instruments

  5. Forms 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

  6. Taxes 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.

  7. U.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

  8. The organizational formof 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

  9. Foreign tax credits & FTC limitationsin the United States

  10. Foreign tax credits & FTC limitationsin the United States

  11. Foreign tax credits & FTC limitationsin the United States

  12. Additional 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

  13. Effect of shifting sales to low-tax countries

  14. Effect of shifting sales to low-tax countries

  15. Effect of shifting sales to low-tax countries

  16. Effect of shifting sales to low-tax countries

  17. Effect of shifting sales to low-tax countries

  18. Off-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

  19. Transfer 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

  20. FTCs and foreign investment

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