Transcript Managing the Multinational Financial System Chapter 16

Managing the
Multinational Financial
System
Chapter 16
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MANAGING THE
MULTINATIONAL FINANCIAL
SYSTEM
I. THE VALUE OF THE MULTINATIONAL
FINANCIAL SYSTEM
A. Its ability to arbitrage in the
following areas:
1. Tax systems
2. Financial markets
3. Regulatory systems
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TAX ARBITRAGE
Tax Arbitrage is possible because we
know:
1. Wide variations exist in global
tax systems
examples: Germany, Hong
Kong
2. Firms want to reduce taxes
paid
especially the “triple-taxed” MNC
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TAX ARBITRAGE
3. Tax Factors
a. Taxes
1.)
2.)
(triple taxation):
may be levied on
corporate income
personal income
(includes dividends)
3.) subsidiary income
b. U.S. Tax System Provisions
Offset:
Foreign tax credit given
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FINANCIAL MARKET
ARBITRAGE
Financial Market Arbitrage is possible if we
1.
assume imperfect markets exist
because
a.
Formal barriers to trade exist
b.
Informal barriers also exist
c.
Imperfections in domestic
capital markets exist.
2.
The following parity conditions
may not be
in effect:
a.
interest rate parity
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REGULATORY ARBITRAGE
Regulatory Arbitrage
1.
Regulations on environmental
pollution
2.
Arises when subsidiary profits
vary due to local regulations.
Examples of local regulations:
a.
Government price controls
b.
Union wage pressures
Firms may disguise true
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INTERCOMPANY FUND-FLOW
MECHANISMS
II.
INTERCOMPANY FUND-FLOW
MECHANISMS:
the name given to the methods
used to move funds from one
subsidiary to
another.
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INTERCOMPANY FUNDFLOW
MECHANISMS
COMMONLY USED MECHANISMS:
A.
Unbundling
B.
Transfer Pricing
C.
Reinvoicing Centers
D.
Royalties
E.
Leading and Lagging
F.
Mechanism: Dividends
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UNBUNDLING
A.
Unbundling Mechanism
breaks up a total international
transfer of
funds between pairs of affiliates
into
separate components.
Example:
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TRANSFER PRICING
B.
Transfer Pricing Mechanism
1. Definition: pricing internally
traded
goods of the firm for the
purpose of
moving profits to a
more tax-friendly
nation.
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TRANSFER PRICING
2.
Uses of Transfer Pricing
a.)
b.)
c.)
Reduces taxes paid
Reduces tariffs
Avoids exchange controls
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TRANSFER PRICING:
An Example
Suppose that affiliate A produces
100,000 circuit boards for $10 apiece
and sells them to affiliate B. Affiliate
B, in turn, sells these boards for $22
apiece to an unrelated customer.
Pretax profit for the consolidated
company is $1 million regardless of
the price at which the goods are
transferred from A to B.
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TRANSFER PRICING:
An Example
Basic rules:
If tA > tB , set the transfer price and
the mark-up policy as LOW as
possible.
If tA < tB , set the transfer price and
the mark-up policy as HIGH as
possible.
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TRANSFER PRICING:
An Example
Without markup policy
A
B
A+B
Revenue
1,500
2,200 2,200
CGS
<1,000>
<1,500>
<1,000>
Gross Profits
500
700
1,200
Expenses
<100>
<100>
<200>
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TRANSFER PRICING:
An Example
HIGH MARK-UP POLICY (unit price =
$18)
A
B
A+B
Revenue
1,800
2,200 2,200
CGS
<1,000>
<1,800>
<1,000>
Gross Profits
800
400
1,200
Expenses
<100>
<100>
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TRANSFER PRICING:
An Example
In effect:
Profits are shifted from a
higher to a lower tax
jurisdiction
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REINVOICING CENTERS
C. Mechanism: Reinvoicing
Centers
1.
2.
3.
buyer
Set up in low-tax nations.
Center takes title to all goods.
Center pays seller/paid by
all within the MNC.
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REINVOICING CENTERS
d.
Advantages:
1.) Easier control on
currency
exposure
2.) Invoice currency other
than
local
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REINVOICING CENTERS
e.
Disadvantages of Reinvoicing
1.) Increased
communications
costs
*2.) Suspicion of tax evasion
by
local governments.
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FEES AND ROYALTIES
D. Mechanism: Royalties
1.
Firms have control of payment
amounts.
2. Host governments less
suspicious.
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LEADING AND LAGGING
E. Leading and Lagging
1.
2.
debt
Highly favored by MNCs
Often used instead of formal
- may be prohibited by local
government
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DIVIDENDS!
F. Mechanism: Dividends
most important method used by
MNCs to
transfer funds to parent
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Suppose Navistar’s Canadian subsidiary sells
1,500 trucks monthly to the French affiliate at a
transfer price of $27,000 per unit. Assume that
the Canadian and French marginal tax rates on
corporate income equal 45% and 50%,
respectively.
a. Suppose the transfer price can be set
at any
level between $25,000 and
$30,000. At
what transfer price will
corporate taxes paid
be minimized?
Explain.
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