FINC 6013 International Business Finance
Lecture 12: Multinational Tax Management
Lecturer: Andrew Grant
Introduction
› How are taxes applied across the world?
- Basics of intercountry tax treaties
› Transfer Pricing
- The setting of the price for goods and services sold between controlled (or related) legal entities within an enterprise
› The Use of Tax Haven Subsidiaries and international offshore financial centres - Part of the overall tax minimization strategy
2
Tax Principles
› Tax Morality
- The Multinational Corporation faces not only a morass of foreign taxes but also an ethical question
- In many countries, taxpayers – corporate or individual – do not voluntarily comply with the tax laws
- Smaller domestic firms and individuals are the chief violators
- This means that MNCs must either decide to disclose earnings to the local tax office, or follow the trend set by other domestic taxpayers by not choosing to pay tax. - Given the local prominence of most foreign subsidiaries, and the political sensitivity of their position, most MNCs choose the full disclosure (tax-paying) option
- However, some firms believe they will lose their competitive advantage if their domestic competitors are not paying taxes whilst they are
- Tax penalties that may be assessed against foreign subsidiaries in the case of noncompliance are likely to be harsher than those applied to domestic firms
- Thus MNCs need to work out how to respond to tax penalties that appear puntive or discriminatory 3
Tax Principles
› Tax Neutrality
- When a government decides to levy a tax it must consider not only the potential revenue from the tax, or how efficiently it can be collected, but also the effect the proposed tax can have on economic behaviour
- For example, the U.S. Government’s policy on taxation of foreign source income does not have as its sole objective, the raising of revenue
- Its other objectives include
- Neutralising tax incentives that might favour (or disfavour) U.S. Private investment in other developed countries
- Provide an incentive for U.S. Private investment in developing countries
- Improving the U.S. Balance of payments by removing the advantages of artificial tax havens and encouraging repatriation of funds
- Raising Revenue
- The ideal tax should not only raise revenue efficiently, but also have as few negative effects on economic behaviour as possible
4
Tax Principles
› Tax Neutrality
- Some theorists argue that the ideal tax should be completely neutral in its effect on private decisions and completely equitable among taxpayers
- However, other theorists argue that national policy objectives such as balance of payments or investment in developing countries should be encouraged through an active tax incentives policy
- Most tax systems compromise between these viewpoints
- Neutrality could also be thought of as:
- Domestic Neutrality: The burden of taxation for each dollar of profit earned in the home country by an MNC be equal to the burden of taxation on each currency-equivalent of profit earned by the same firm in its foreign operations
- Foreign Neutrality: The tax burden on each foreign subsidiary of the firm is equal to the tax burden on its competitors in the same country
This definition is preferred by MNCs because it focuses on an apples/apples comparison among competing firms.
5
Tax Principles
› Tax Equity
- In theory, an equitable tax is one that imposes the same total tax burden on all taxpayers who are similarly situated and located in the same tax jurisdiction
- In the case of foreign investment income, the U.S. Treasury argues that since the
United States uses the nationality principle to claim tax jurisdiction, U.S.-owned foreign subsidiaries are in the same jurisdiction as U.S. domestic subsidiaries
- Therefore a dollar earned in foreign operations should be taxed at the same rate and paid at the same time as a dollar earned in domestic operations
