International Tax Management Aaron Hasenkamp April 9, 2006 Aaron Hasenkamp April 9, 2006

Discussion of  Branch versus Subsidiary status.  Intertemporal Considerations.  Mathematics of how profits change as the transfer price changes.  Branch versus Subsidiary status.  Intertemporal Considerations.  Mathematics of how profits change as the transfer price changes.

Branch versus Subsidiary status.  Main difference is the timing of taxation.  The establishment of foreign branches centralizes finances and taxes are paid when earned.  The establishment of foreign subsidiaries decentralizes finances and taxes are paid only when profits are repatriated.  Main difference is the timing of taxation.  The establishment of foreign branches centralizes finances and taxes are paid when earned.  The establishment of foreign subsidiaries decentralizes finances and taxes are paid only when profits are repatriated.

What is the tax difference between a branch and a subsidiary? Consider the text’s example of C&C Enterprises, a manufacturer of ski paraphernalia and sporting goods. There is only a home office in Chicago and no domestic profit or loss. What is important however is their overseas interactions and they desire to know what the most profitable configuration may be…

Branch versus subsidiary status without repatriation. Principle IV: If there is no repatriation of profits, establish profitable operations as subsidiaries. If a foreign operation posts losses rather than profits, it is advisable to set up as a branch if the losses can be used to offset profits elsewhere, but to set it up as a subsidiary if this is not the case

Allocation of Subsidiary Profits Without Repatriation.  To increase subsidiary profits, headquarter overhead costs are allocated to high tax countries:  Canada $15,000--> $5,000  Britain $50,000--> $55,000  Ireland $20,000--> $10,000  Germany $65,000--> $90,000  Japan $30,000--> $20,000  Total expenses $180,000=$180,000  To increase subsidiary profits, headquarter overhead costs are allocated to high tax countries:  Canada $15,000--> $5,000  Britain $50,000--> $55,000  Ireland $20,000--> $10,000  Germany $65,000--> $90,000  Japan $30,000--> $20,000  Total expenses $180,000=$180,000

Allocation of Subsidiary Profits Without Repatriation. Principle V: If there is no Repatriation, show subsidiary profits in the lowest-tax jurisdictions by allocating costs to the highest-tax jurisdictions, without making profits negative.

Allocation of Subsidiary Profits Without Repatriation.  It is also possible to increase profits in low-tax jurisdictions by altering the transfer price.  The transfer price is changed from $16 to $18 in the low tax  It is also possible to increase profits in low-tax jurisdictions by altering the transfer price.  The transfer price is changed from $16 to $18 in the low tax

Allocation of Subsidiary Profits Without Repatriation. Principle VI: If there is no repatriation, show subsidiary profits in the lowest-tax jurisdiction by following a simple rule: If one subsidiary is selling to a foreign subsidiary, set the transfer price as high as possible when T*>T and as low as possible when T*<T, without making profits negative. If there is no repatriation, show subsidiary profits in the lowest-tax jurisdiction by following a simple rule: If one subsidiary is selling to a foreign subsidiary, set the transfer price as high as possible when T*>T and as low as possible when T*<T, without making profits negative.

Allocation of Subsidiary Profits Without Repatriation.  Britain and Germany have decided to impose a 20% import duty on the transfer price.  What does that mean for C&C’s profitability?  How does C&C recover?  Britain and Germany have decided to impose a 20% import duty on the transfer price.  What does that mean for C&C’s profitability?  How does C&C recover?

Allocation of Subsidiary Profits Without Repatriation. Principle VII: If there is no Repatriation of profits, minimize total subsidiary taxes paid in the presence of import tariffs by comparing T* to T+T*d(1-T*): Use the high transfer price if T*> T+T*d(1-T*), and use the low price if the opposite occurs, without making profits negative. If there is no Repatriation of profits, minimize total subsidiary taxes paid in the presence of import tariffs by comparing T* to T+T*d(1-T*): Use the high transfer price if T*> T+T*d(1-T*), and use the low price if the opposite occurs, without making profits negative.

Profit Repatriation Through Dividends  What happens when repatriation becomes necessary?  What is the cheapest way for C&C to move its money to the U.S.?  What happens when repatriation becomes necessary?  What is the cheapest way for C&C to move its money to the U.S.?

Profit Repatriation Through Dividends. Principle VIII: Repatriate profits from branches first because this action is without tax consequences.

Profit Repatriation Through Dividends. Principle IX: If there is full repatriation of profits, and there are no excess tax credits, the decision between establishing a branch of subsidiary generally does not matter. If there is full repatriation of profits, and there are excess tax credits, establish branches to generally avoid the withdrawing taxes on profit repatriation. As before, establish unprofitable operations as branches to receive immediate tax benefits.

Profit Repatriation through dividends  Should C&C need to repatriate only a portion of the money, what is the best course of action?  Which subsidiaries should it tap first?  Should C&C need to repatriate only a portion of the money, what is the best course of action?  Which subsidiaries should it tap first?

Profit Repatriation Through Dividends. Principle X: If there is partial repatriation from subsidiaries, pay dividends from subsidiaries where the sum of the withholding tax and the additional tax liability to the U.S. Government is the lowest. If there are several opportunities with the same marginal cash outflows, repatriate from countries which would result in the least excess tax credits.

Does Principle IV Conflict with Principles VIII and IX?  IV implies that firms should have a clear preference for subsidiaries if no repatriation is to occur.  VIII and IX imply that a firm should have a preference for branch status if substantial repatriation is to occur.  What is best for partial repatriation?  IV implies that firms should have a clear preference for subsidiaries if no repatriation is to occur.  VIII and IX imply that a firm should have a preference for branch status if substantial repatriation is to occur.  What is best for partial repatriation?

Profit Repatriation Through Dividends. Principle XI: If there is partial repatriation from foreign operations, compare the advantage of tax deferral associated with a subsidiary against the withholding taxes incurred upon repatriation from the subsidiary in deciding whether to establish a subsidiary or a branch.

Conclusion  The establishment of a branch or subsidiary is dependant on the specific needs of the firm, becoming significantly more complicated if repatriation is necessary.  Furthermore, should an investment be slated to continue beyond a single period issues such as the percentage of funds available for reinvestment in foreign countries and local rate of return become increasingly important.  The establishment of a branch or subsidiary is dependant on the specific needs of the firm, becoming significantly more complicated if repatriation is necessary.  Furthermore, should an investment be slated to continue beyond a single period issues such as the percentage of funds available for reinvestment in foreign countries and local rate of return become increasingly important.

Questions?