Global money management, transfer pricing, other tax issues

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Global money management, transfer pricing, other
tax issues (D/R, p.552, pp. 530-540, Head 12.1,
12.5.1-12.5.3 (p. 183, pp.190-193) Global
financial management economic risk / political
risk may have significant impacts on firms'
investment decisions, financing decisions, and
money management investment decisions Example.
Capital budgeting for an FDI project (1) Estimate
cash flows associated with the project over time
(negative cash flows, followed by positive
ones) (2) Calculate the NPV using some discount
rate (the firm's cost of capital, some other
required rate of return) NPV gt 0 ---gt accept the
project Where do political and economic risks
affect the NPV calculations above? (higher risks
imply "higher discount rate") Can you treat the
cash flows to the FDI project (in the host
country) and the parent firm equally?
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Financing Decisions Source of financing
... local (does host government like this?),
global (low cost?) Currency......................
in hard currencies (US ?), or in local currency
Any possibility of depreciation or
appreciation? Financial structure Debt ratio
..................follow Italians in Italy (high
debt)? ........ Or, follow your home country
practice (low debt) Is tax a factor? (Local
taxes for dividends versus interest expenses
home-country taxes)  
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Global Money Management TAX ISSUES---gt how to
minimize total taxes payable legally Tax rates
range 50 - 0 in different countries Where are
tax havens? -----gt E.g. www.escapeartist.com How
should you finance FDI operations ? A fronting
loan (a loan between a parent and its subsidiary
through an intermediary) may save money compared
to a direct intra-firm loan Example. A tax haven
(Bermuda) subsidiary 100 owned by the parent
firm deposit 1M in a London international bank
at 8 interest. The bank in turn lends 1M to
another foreign sub at 9 interest, in Country
Risky with a 50 tax rate.
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Sub in Risky pays 90,000 interest to the London
Bank at the net after-tax cost of 45,000 to the
Sub The Bank keeps 10,000 and pays 80,000
interest to Bermuda sub. The parent could move
additional 35,000 beyond the cost (45,000) out
of Risky. The bank "fronts" for the parent. This
is a good deal for the bank, since its profit
(10,000) is risk free (the parent's 1M as
collateral). Two advantages for the parent (1)
Country Risky has high political risk and may not
allow a direct loan payback to the parent firm,
but payback to an international bank is usually
allowed in order to maintain Risky's credit
image. (2) If the Bermuda sub made a direct loan
to the Risky Sub, Risky Government might not
allow a 50 tax deduction on the interest payment
from the sub in Risky to the Bermuda Sub, arguing
that it was really a dividend to the parent in
disguise.
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Does it matter how you repatriate your foreign
profits back to the head office? - Dividends ?
Royalties ? Consulting fees ? Or manipulating
with transfer prices? How? - Royalties and
fees often tax-deductible in the host
country. Dividends only after paying local
income taxes
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UNBUNDLING - transferring funds across borders
using different methods - these different forms
of repatriation have different tax consequences
  Global techniques for reducing transaction
cost (1)Centralized depositories of cash
holding. By combining cash holdings across
several countries the parent firm can reduce the
required cash balance (2)Bilateral /
Multilateral Netting (pp. 533-535). By netting
required foreign currency transactions among
different countries, the parent firm can save
foreign exchange fees Samsung's multilateral
netting table (1 Sub each in SK, Mexico,
UK) US (million) payment owed by Subs
in SK Mexico UK Total Net transfer Receipts S
K --- 5 4 9 1 Due to Mexico 2 --- 3 5 -1 UK
6 1 --- 7 0 Total 8 6 7 21 gtMexican Sub pays
1 million to South Korean Sub. The rest settled
by paper. (This exchange transaction costs
5,000 1M x 0.5. Savings???) (3) Managing
foreign exchange risk  
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TRANSFER PRICES (TP) The price at which goods and
services are transferred between divisions of a
company - Not limited to IB TP exists for
domestic business EXAMPLE U.S.A. LOTS OF TP
AND LOCATION CONSIDERATIONS to minimize taxes
because of different state tax rules TP BASED ON
ECONOMIC THEORY MARKET PRICE, OR ARMS-LENGTH
PRICE
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Reasons why market price may not be used for
inter-firm transfer pricing - market price may
not exist - intra-firm transactions involve
firm-specific intermediate goods which may have
no market counterparts (i.e. any price can be
charged! Highly profitable) - transfer price may
be used by the head office for manipulating
subsidiaries' (divisions') incentives - transfer
price may reflect bargaining power between a
subsidiary (JV, or 100 sub) and the head office
----gt NEGOTIATED TP - Many companies use one of
several types of t.p. arms-length price,
negotiated price, cost plus ( standard mark up)
price
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Example. No auditing of TP in Japan until
recently. Virtually all foreign/U.S. companies in
Japan manipulate their transfer prices because of
Japan's high corporate income tax rate relative
to the U.S. Rate (and due to lax government
inspection rules) GOVERNMENTS TEND TO RETALIATE
EACH OTHER U.S. IRS questioning Matsushita
Electric's transfer price policies in the
U.S. Was followed immediately the next day by a
visit by MOF to IBM Japan, asking for company
records, books