INTERNATIONAL
FINANCIAL
MANAGEMENT
EUN / RESNICK
Second Edition
20Chapter TwentyInternational Tax Environment
Chapter Objective:
This chapter provides a brief introduction to the
international tax environment.
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-1
Chapter Outline
? The Objectives of Taxation
? Types of Taxation
? The National Tax Environments
? Organizational Structures for Reducing Tax
Liabilities
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-2
The Objectives of Taxation
? The twin objectives of taxation are:
1,Tax Neutrality
2,Tax Equity
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-3
Tax Neutrality
A tax scheme is tax neutral if it meets three criteria:
?1,Capital Export Neutrality,the tax scheme does
not incentivise citizens move their money abroad.
?2,National Neutrality,taxable income is taxed in
the same manner by the taxpayer’s national tax
authorities regardless of where in the world it is earned.
?3,Capital Import Neutrality,the tax burden on a
MNC subsidiary should be the same regardless of where
in the world the MNC in incorporated.
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-4
Tax Equity
? Tax Equity,regardless of the country in which an
affiliate of a MNC earns taxable income,the same
tax rate and tax due date should apply.
? The principal of tax equity is difficult to apply; the
organizational form of the MNC can affect the
timing of the tax liability.
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-5
Types of Taxation
? Income Tax
? Withholding Tax
? Value-Added Tax
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-6
Income Tax
? An income tax is a tax on personal and corporate
income.
? Many countries in the world obtain a significant
portion of their tax revenue from income taxes.
? An income tax is a direct tax,that is one that is
paid directly by the taxpayer upon whom it is
levied.
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-7
Income Tax Rates in
Selected Countries
0
5
10
15
20
25
30
35
40
45
A
u
s
t
r
a
l i
a
B
a
h
a
m
a
s
B
e
l g
i u
m
B
r
a
z
i l
C
h
i n
a
Fr
a
n
c
e
G
e
r
m
a
n
y
I r
e
l a
n
d
J
a
p
a
n
M
e
x
i c
o
U
n
i t
e
d
S
t
a
t
e
s
R
a
t
e
I n c o m e T a x R a t e
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-8
Withholding Tax
? Withholding taxes are withheld from the payments
a corporation makes to the taxpayer,
? The taxes are levied on passive income earned by
an individual or corporation of one country within
the tax jurisdiction of another country.
? Passive income includes dividends and interest
income,income from royalties,patents,or
copyrights.
? A withholding tax is an indirect tax.
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-9
U.S,Tax Treaty Withholding Rates
Selected Countries
0
5
10
15
20
25
30
35
A
u
s
t
r
a
l i
a
B
e
r
m
u
d
a
B
e
l g
i u
m
B
r
a
z
i l
C
h
i n
a
Fr
a
n
c
e
G
e
r
m
a
n
y
I r
e
l a
n
d
J
a
p
a
n
M
e
x
i c
o
R
a
t
e
D i v i d e n d s
I n t e r e s t
R o y a l t i e s
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-10
Value-Added Tax
? A value-added tax is an indirect national tax
levied on the value added in production of a good
or service.
? In many European and Latin American countries
the VAT has become a major source of taxation
on private citizens.
? Many economists prefer a VAT to an income tax
because the incentive effects of the two taxes
differ sharply.
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-11
Value-Added Tax
? An income tax has the incentive effects of
discouraging work.
? A VAT has the incentive effect of discouraging
consumption (thereby encouraging saving).
? VATs are easier to administer as well,While
taxpayers have an incentive to hide their income,
producers have an incentive to make sure that
their upstream suppliers in the production process
declare the value added (and pay the tax!).
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-12
Value-Added Tax Calculation
In this example,the tax rate is 15 percent,Suppose that stage
one is the sale of raw materials to the manufacturer; stage
two is the sale of finished goods to a retailer; stage three is
the sale of inventory from the retailer to the consumer.
380
Production
Stage
Selling
Price
Value
Added
Incremental
VAT
1
2
3
Total
VAT
= 100?.15
= 200?.15
= 80?.15
= 380?.15
15
30
12
57
100
200
80
100
300
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-13
Other Types of Taxation
? A wealth tax is a tax levied not on income but on
the wealth of a taxpayer,Property taxes are an
example.
? A poll tax is a tax on your existence,It is so called
because it was collected from those who wished to
vote.
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-14
The National Tax Environments
? Worldwide Taxation
? Territorial Taxation
? Foreign Tax Credits
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-15
Worldwide Taxation
? Tax national residents of the country on their
worldwide income no matter in which country it
was earned.
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-16
Territorial Taxation
? Territorial taxation tax residents based upon where
the taxable event occurred.
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-17
Foreign Tax Credits
? Allows taxpayers to recover somewhat from
double taxation.
? Direct foreign tax credits are computed for direct
taxes paid on active foreign-source income of a
foreign branch of a U.S,MNC or on withholding
taxes withheld from passive income.
? Indirect foreign tax credits are for income taxes
deemed paid by the subsidiary.
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-18
Organizational Structures for
Reducing Tax Liabilities
? Branch & Subsidiary Income
? Payments to and from Foreign Affiliates
? Tax Havens
? Controlled Foreign Corporation
? Foreign Sales Corporation
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-19
Branch & Subsidiary Income
? An overseas affiliate of a U.S,MNC can be
organized as a branch or a subsidiary.
? A foreign branch is not an independently
incorporated firm separate from the parent.
? Branch income passes directly through to the parent’s
income statements.
? A foreign subsidiary is an affiliate organization of
the MNC that is independently incorporated.
? Income may not be taxed in the U.S,until it is
repatriated,under certain circumstances.
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-20
Payments to and from
Foreign Affiliates
? Having foreign affiliates offers transfer price tax
arbitrage strategies.
? The transfer price is the accounting value assigned
to a good or service as it is transferred from one
affiliate to another.
? If one country has high taxes,don’t recognize
income there—have those affiliates pay high
transfer prices,If one country has low taxes,
recognize income there—have those affiliates pay
low transfer prices.
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-21
Tax Havens
? Tax havens are countries with low corporate
income tax rates and low withholding tax rates on
passive income.
? Tax havens were once useful as locations for a
MNC to establish a shell company.
? The Tax Reform Act of 1986 greatly diminished
the need for and ability of U.S,corporations to
profit from the use of tax havens.
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-22
Controlled Foreign Corporation
? The Tax Reform Act of 1986 created a new type
of foreign subsidiary,the controlled foreign
corporation.
? A controlled foreign corporation is a foreign
subsidiary that has over half of its voting stock
held by U.S,shareholders—even if these
shareholders are unaffiliated.
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-23
Controlled Foreign Corporation
? The undistributed income of a minority foreign
subsidiary of a U.S,MNC is tax deferred until it is
remitted via a dividend.
? This is not the case with a controlled foreign
corporation—the tax treatment is much less
favorable.
? The result is that foreign tax credits are unlikely to
be completely used.
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-24
Foreign Sales Corporation
? A foreign sales corporation is a foreign corporation
established as an affiliate of a U.S,corporation for the
purpose of buying from a U.S,corporation property for use
or resale abroad,They can be used to lower taxes paid by
the U.S,MNC in two ways.
? A portion of the total foreign trade income of a FSC is exempt
from U.S,taxation (the remaining portion is fully taxable).
? The second benefit is that the transfer price between the FSC and
the U.S,MNC does not have to be an,arms length” price,Transfer
pricing can be used to shift income between the FSC and the U.S,
MNC
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-25
End Chapter Twenty
FINANCIAL
MANAGEMENT
EUN / RESNICK
Second Edition
20Chapter TwentyInternational Tax Environment
Chapter Objective:
This chapter provides a brief introduction to the
international tax environment.
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-1
Chapter Outline
? The Objectives of Taxation
? Types of Taxation
? The National Tax Environments
? Organizational Structures for Reducing Tax
Liabilities
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-2
The Objectives of Taxation
? The twin objectives of taxation are:
1,Tax Neutrality
2,Tax Equity
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-3
Tax Neutrality
A tax scheme is tax neutral if it meets three criteria:
?1,Capital Export Neutrality,the tax scheme does
not incentivise citizens move their money abroad.
?2,National Neutrality,taxable income is taxed in
the same manner by the taxpayer’s national tax
authorities regardless of where in the world it is earned.
?3,Capital Import Neutrality,the tax burden on a
MNC subsidiary should be the same regardless of where
in the world the MNC in incorporated.
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-4
Tax Equity
? Tax Equity,regardless of the country in which an
affiliate of a MNC earns taxable income,the same
tax rate and tax due date should apply.
? The principal of tax equity is difficult to apply; the
organizational form of the MNC can affect the
timing of the tax liability.
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-5
Types of Taxation
? Income Tax
? Withholding Tax
? Value-Added Tax
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-6
Income Tax
? An income tax is a tax on personal and corporate
income.
? Many countries in the world obtain a significant
portion of their tax revenue from income taxes.
? An income tax is a direct tax,that is one that is
paid directly by the taxpayer upon whom it is
levied.
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-7
Income Tax Rates in
Selected Countries
0
5
10
15
20
25
30
35
40
45
A
u
s
t
r
a
l i
a
B
a
h
a
m
a
s
B
e
l g
i u
m
B
r
a
z
i l
C
h
i n
a
Fr
a
n
c
e
G
e
r
m
a
n
y
I r
e
l a
n
d
J
a
p
a
n
M
e
x
i c
o
U
n
i t
e
d
S
t
a
t
e
s
R
a
t
e
I n c o m e T a x R a t e
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-8
Withholding Tax
? Withholding taxes are withheld from the payments
a corporation makes to the taxpayer,
? The taxes are levied on passive income earned by
an individual or corporation of one country within
the tax jurisdiction of another country.
? Passive income includes dividends and interest
income,income from royalties,patents,or
copyrights.
? A withholding tax is an indirect tax.
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-9
U.S,Tax Treaty Withholding Rates
Selected Countries
0
5
10
15
20
25
30
35
A
u
s
t
r
a
l i
a
B
e
r
m
u
d
a
B
e
l g
i u
m
B
r
a
z
i l
C
h
i n
a
Fr
a
n
c
e
G
e
r
m
a
n
y
I r
e
l a
n
d
J
a
p
a
n
M
e
x
i c
o
R
a
t
e
D i v i d e n d s
I n t e r e s t
R o y a l t i e s
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-10
Value-Added Tax
? A value-added tax is an indirect national tax
levied on the value added in production of a good
or service.
? In many European and Latin American countries
the VAT has become a major source of taxation
on private citizens.
? Many economists prefer a VAT to an income tax
because the incentive effects of the two taxes
differ sharply.
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-11
Value-Added Tax
? An income tax has the incentive effects of
discouraging work.
? A VAT has the incentive effect of discouraging
consumption (thereby encouraging saving).
? VATs are easier to administer as well,While
taxpayers have an incentive to hide their income,
producers have an incentive to make sure that
their upstream suppliers in the production process
declare the value added (and pay the tax!).
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-12
Value-Added Tax Calculation
In this example,the tax rate is 15 percent,Suppose that stage
one is the sale of raw materials to the manufacturer; stage
two is the sale of finished goods to a retailer; stage three is
the sale of inventory from the retailer to the consumer.
380
Production
Stage
Selling
Price
Value
Added
Incremental
VAT
1
2
3
Total
VAT
= 100?.15
= 200?.15
= 80?.15
= 380?.15
15
30
12
57
100
200
80
100
300
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-13
Other Types of Taxation
? A wealth tax is a tax levied not on income but on
the wealth of a taxpayer,Property taxes are an
example.
? A poll tax is a tax on your existence,It is so called
because it was collected from those who wished to
vote.
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-14
The National Tax Environments
? Worldwide Taxation
? Territorial Taxation
? Foreign Tax Credits
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-15
Worldwide Taxation
? Tax national residents of the country on their
worldwide income no matter in which country it
was earned.
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-16
Territorial Taxation
? Territorial taxation tax residents based upon where
the taxable event occurred.
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-17
Foreign Tax Credits
? Allows taxpayers to recover somewhat from
double taxation.
? Direct foreign tax credits are computed for direct
taxes paid on active foreign-source income of a
foreign branch of a U.S,MNC or on withholding
taxes withheld from passive income.
? Indirect foreign tax credits are for income taxes
deemed paid by the subsidiary.
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-18
Organizational Structures for
Reducing Tax Liabilities
? Branch & Subsidiary Income
? Payments to and from Foreign Affiliates
? Tax Havens
? Controlled Foreign Corporation
? Foreign Sales Corporation
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-19
Branch & Subsidiary Income
? An overseas affiliate of a U.S,MNC can be
organized as a branch or a subsidiary.
? A foreign branch is not an independently
incorporated firm separate from the parent.
? Branch income passes directly through to the parent’s
income statements.
? A foreign subsidiary is an affiliate organization of
the MNC that is independently incorporated.
? Income may not be taxed in the U.S,until it is
repatriated,under certain circumstances.
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-20
Payments to and from
Foreign Affiliates
? Having foreign affiliates offers transfer price tax
arbitrage strategies.
? The transfer price is the accounting value assigned
to a good or service as it is transferred from one
affiliate to another.
? If one country has high taxes,don’t recognize
income there—have those affiliates pay high
transfer prices,If one country has low taxes,
recognize income there—have those affiliates pay
low transfer prices.
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-21
Tax Havens
? Tax havens are countries with low corporate
income tax rates and low withholding tax rates on
passive income.
? Tax havens were once useful as locations for a
MNC to establish a shell company.
? The Tax Reform Act of 1986 greatly diminished
the need for and ability of U.S,corporations to
profit from the use of tax havens.
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-22
Controlled Foreign Corporation
? The Tax Reform Act of 1986 created a new type
of foreign subsidiary,the controlled foreign
corporation.
? A controlled foreign corporation is a foreign
subsidiary that has over half of its voting stock
held by U.S,shareholders—even if these
shareholders are unaffiliated.
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-23
Controlled Foreign Corporation
? The undistributed income of a minority foreign
subsidiary of a U.S,MNC is tax deferred until it is
remitted via a dividend.
? This is not the case with a controlled foreign
corporation—the tax treatment is much less
favorable.
? The result is that foreign tax credits are unlikely to
be completely used.
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-24
Foreign Sales Corporation
? A foreign sales corporation is a foreign corporation
established as an affiliate of a U.S,corporation for the
purpose of buying from a U.S,corporation property for use
or resale abroad,They can be used to lower taxes paid by
the U.S,MNC in two ways.
? A portion of the total foreign trade income of a FSC is exempt
from U.S,taxation (the remaining portion is fully taxable).
? The second benefit is that the transfer price between the FSC and
the U.S,MNC does not have to be an,arms length” price,Transfer
pricing can be used to shift income between the FSC and the U.S,
MNC
McGraw-Hill/Irwin Copyright ? 2001 by The McGraw-Hill Companies,Inc,All rights
reserved,
20-25
End Chapter Twenty
