GLOBAL ACCOUNTING AND CONTROL: A MANAGERIAL EMPHASIS Sidney J. Gray, University of New South Wales Stephen B. Salter, University of Cincinnati Lee H. Radebaugh, Brigham Young University Gray, Salter & Radebaugh Chapter 6

TAXATION AND THE MULTINATIONAL ENTERPRISE CHAPTER SIX TAXATION AND THE MULTINATIONAL ENTERPRISE Gray, Salter & Radebaugh Chapter 6

Gray, Salter & Radebaugh Chapter 6 INTRODUCTION Challenges to the MNE in terms of taxation of its global operation: Variety of taxes and types of taxable income. Home govts. want to tax global income. Key taxes for MNEs: Direct taxes, e.g., corporate income taxes Indirect taxes, e.g., Value Added Tax. Gray, Salter & Radebaugh Chapter 6

DIRECT TAXES KPMG Corporate Tax Rate Survey Statutory Corporate Tax Rates All 86 Countries 1993-2006 Gray, Salter & Radebaugh Chapter 6

Statutory Corporate Tax Rates by Global Region 2006 DIRECT TAXES Statutory Corporate Tax Rates by Global Region 2006 Gray, Salter & Radebaugh Chapter 6

Statutory Corporate Tax Rates EU 1993-2006 DIRECT TAXES Statutory Corporate Tax Rates EU 1993-2006 Gray, Salter & Radebaugh Chapter 6

Average Corporate Tax Rates EU 2000-2006 DIRECT TAXES Average Corporate Tax Rates EU 2000-2006 Country 2000 2001 2002 2003 2004 2005 2006 Austria 34 25 Belgium 40.17 33.99 Cyprus 28 15 10 Czech Republic 31 26 24 Denmark 32 30 Estonia 23 Finland 29 France 36.66 35.33 34.33 33.83 33.33 Germany 51.6 38.36 39.58 38.29 38.31 38.34 Greece 40 37.5 35 Hungary 18 16 Ireland 20 12.5 Italy 41.25 40.25 38.25 37.25 Gray, Salter & Radebaugh Chapter 6

Statutory Corporate Tax Rates EU 2000-2006 DIRECT TAXES Statutory Corporate Tax Rates EU 2000-2006 Country 2000 2001 2002 2003 2004 2005 2006 Latvia 15 Lithuania Luxembourg 37.45 30.38 29.63 Malta 35 Netherlands 34.5 31.5 29.6 Poland 30 28 27 19 Portugal 37.4 35.2 33 27.5 Slovak Republic 29 25 Slovenia Spain Sweden United Kingdom Average Tax Rate 33.9 32.0 30.9 29.7 28.3 26.1 25.8 Number of countries 18 20 Gray, Salter & Radebaugh Chapter 6

Statutory Corporate Tax Rates Comparison OECD 2000-2006 DIRECT TAXES Statutory Corporate Tax Rates Comparison OECD 2000-2006 Country 2000 2001 2002 2003 2004 2005 2006 Australia 36 34 30 Austria 25 Belgium 40.17 33.99 Canada 44.6 42.1 38.6 36.6 36.1 Czech Republic 31 28 26 24 Denmark 32 Finland 29 France 36.66 35.33 34.33 33.83 33.33 Germany 51.6 38.36 39.58 38.29 38.31 38.34 Greece 40 37.5 35 Hungary 18 16 Iceland Ireland 20 12.5 Italy 41.25 40.25 38.25 37.25 Gray, Salter & Radebaugh Chapter 6

Statutory Corporate Tax Rates Comparison OECD 2000-2006 DIRECT TAXES Statutory Corporate Tax Rates Comparison OECD 2000-2006 Country 2000 2001 2002 2003 2004 2005 2006 Japan 42 40.69 Korea, Republic of 30.8 29.7 27.5 Luxembourg 37.45 30.38 29.63 Mexico 35 34 33 30 29 Netherlands 34.5 31.5 29.6 New Zealand Norway 28 Poland 27 19 Portugal 37.4 35.2 Slovak Republic 25 Spain Sweden Switzerland 25.1 24.7 24.5 24.1 21.3 Turkey Gray, Salter & Radebaugh Chapter 6

Statutory Corporate Tax Rates Comparison OECD 2000-2006 DIRECT TAXES Statutory Corporate Tax Rates Comparison OECD 2000-2006 Country 2000 2001 2002 2003 2004 2005 2006 United Kingdom 30 United States 40 34 Average Tax Rate 34.1 32.8 31.4 30.6 29.5 28.8 28.5 Number of Countries 29 Gray, Salter & Radebaugh Chapter 6

Statutory Corporate Tax Rates Comparison G7 1993-2006 DIRECT TAXES Statutory Corporate Tax Rates Comparison G7 1993-2006 Gray, Salter & Radebaugh Chapter 6

Statutory Corporate Tax Rates Comparison by Global Region DIRECT TAXES Statutory Corporate Tax Rates Comparison by Global Region Gray, Salter & Radebaugh Chapter 6

Direct Taxes Decline in Statutory Corporate Tax Rates 1993-2006 Consistent and dramatic reduction worldwide in corporate tax rates over last 14 years Reductions began in UK in mid-1980s when government of Margaret Thatcher lowered corporate tax rate from 52% to 35% between 1982 and 1986 forcing other countries to follow suit. In past 14 years, average corporate tax rates of countries in KPMG Survey declined 28.7% dropping from an average of 38% to 27.1%. Worldwide competition between trading blocs such as ASPAC nations, Group of 7, OECD, and EU has had impact on corporate tax rates Gray, Salter & Radebaugh Chapter 6

Direct Taxes Decline in Statutory Corporate Tax Rates 1993-2006 Has been clear impact on EU tax rates from 10 new countries that joined EU in 2004. In 1993, when EU comprised 15 nations, average corporate tax rate was 38%. By 2006, when EU comprised 25 nations, rates dropped 12.2 percentage points to 25.8%, a decline of 32%. With average corporate tax of 18.4%, Eastern European states that joined EU in 2004 have among lowest tax rates in Europe. Among major nations in EU, Germany slashed its corporate tax rates from 59.7% in 1993 to 38.3% in 2001, a decline of nearly 36%. The German government recently decided to reduce its corporate tax rate from 38.34% to about 29% beginning January 1, 2008. With reduction, Germany will move from highest tax rate to a rate that is in line with other countries in Western Europe Gray, Salter & Radebaugh Chapter 6

Corporate Statutory Tax Rates Around the World Country STR Algeria 25% Argentina 35% Australia 30% Austria Azerbaijan 24% Bangladesh 40% Belarus Belgium 33.99% Bosnia & Herzegovina Brazil 34% British Virgin Islands 0% Bulgaria 10% Cameroon 38.5% Canada 36.1% Gray, Salter & Radebaugh Chapter 6

Corporate Statutory Tax Rates Around the World Country STR Chile 17% China 25% Colombia 35% Croatia 20% Cuba 30% Cyprus 10% Czech Republic 24% Denmark Egypt 40% El Salvador Estonia 22% Finland 26% France 33 1/3% Germany Gray, Salter & Radebaugh Chapter 6

Corporate Statutory Tax Rates Around the World Country STR Georgia 20% Greece 22/29% Guatemala 31% Guyana 35-45% Hong Kong 17.50% Hungary 16% Iceland 18% India 30-40% Indonesia 10%-30% Ireland 12.50% Israel Italy 37.25% Japan 30% Jordan 15/25/35% Gray, Salter & Radebaugh Chapter 6

Corporate Statutory Tax Rates Around the World Country STR Latvia 15% Lebanon 15/4-21% Lithuania Luxembourg 29.63% Macedonia 12% Malaysia 27% Malta 35% Mauritius Mexico 28% Monaco 33.33% Montenegro 9% Morocco Netherlands 20-25.5 New Zealand 33% Gray, Salter & Radebaugh Chapter 6

Corporate Statutory Tax Rates Around the World Country STR Nigeria 30% Norway 0%/28% Pakistan 35% Panama Peru 27% Philippines Poland 19% Portugal 27.50% Romania 16% Russia 24% Saudi Arabia 20% Senegal 33% Serbia 10% Singapore 18% Gray, Salter & Radebaugh Chapter 6

Corporate Statutory Tax Rates Around the World Country STR Slovakia 19% Slovenia 25% South Africa 29% South Korea 13/25% Spain 35% Sweden 28% Switzerland 13-25% Syria 10-45% Taiwan Thailand 30% Tunisia Turkey 20% Ukraine United Arab Emirates 0% Gray, Salter & Radebaugh Chapter 6

Corporate Statutory Tax Rates Around the World Country STR United Kingdom 28% United States 15-35% Uruguay 25% Uzbekistan 18% Venezuela 15/22/34% Vietnam Zambia 35% Average 27% Developing Countries 29% Developed Countries Gray, Salter & Radebaugh Chapter 6

DIRECT TAXES Corporate Income Tax Key questions: what income is taxable? what expenses are deductible? what additional taxes will be charged when dividends are paid. Gray, Salter & Radebaugh Chapter 6

DIRECT TAXES What Income is Taxable? Two approaches to taxation of foreign source income: Territorial approach, e.g., Hong Kong. Only income earned in Hong Kong should be taxed there. Worldwide approach, e.g., U.S.. Taxes both domestic and foreign source income. Can lead to double taxation but this can be minimized through tax credits and tax treaties. Gray, Salter & Radebaugh Chapter 6

DIRECT TAXES Determination of Expenses The way expenses are treated for tax purposes, can cause differences in tax paid Gray, Salter & Radebaugh Chapter 6

DIRECT TAXES Withholding Tax and Taxing Dividends The income earned by a foreign subsidiary is taxable in a foreign country when cash is returned to the parent through: dividends, royalties interest on intra company debt, When cash is returned to parent withholding taxes are often deducted. Gray, Salter & Radebaugh Chapter 6

DIRECT TAXES Withholding Tax and Taxing Dividends There are two approaches to taxing corporate income: Classic System: e.g., US income is taxed when the corporation earns it and when dividends are received by the shareholders. Integrated System: tries to eliminate double taxation. Gray, Salter & Radebaugh Chapter 6

DIRECT TAXES Statutory vs. Effective Tax Rate Differences in treatment of income and expenses can result in differences between statutory tax rates and effective tax rates. Gray, Salter & Radebaugh Chapter 6

DIRECT TAXES Statutory vs. Effective Tax Rate Statutory Total Taxes Paid Tax = --------------------------------------- Rate Taxable Income based on Tax Laws Effective Total Taxes Paid Tax = -------------------------------- Rate Net Income before Taxes based on Accounting Rules Gray, Salter & Radebaugh Chapter 6

Gray, Salter & Radebaugh Chapter 6 Statutory Tax Rates (STR) vs Effective Tax Rates (ETR) EU Member States (1990-1996) Weighted Average Country STR ETR Difference Austria 36.02% 19.72% 16.30% Belgium 40.28% 21.64% 18.64% Denmark 14.82% 21.20% Finland 34.02% 25.28% 8.74% France 34.70% 28.45% 6.25% Germany 50.05% 33.61% 16.44% Greece 32.53% 19.79% 12.74% Ireland 21.94% 13.78% 8.16% Italy 50.48% 30.66% 19.82% Luxembourg 39.40% 35.81% 3.59% Netherlands 35.00% 26.84% Portugal 39.29% 16.89% 22.40% Spain 35.30% 22.90% 12.40% Sweden 28.54% 27.01% 1.53% UK 33.35% 25.98% 7.37% Gray, Salter & Radebaugh Chapter 6

Corporate Effective Tax Rates Around the World - 2005 Statutory Effective Tax Rate Country Tax Rate Average Marginal Australia 30% 26% 24% Austria 25% 22% 20% Belgium 34% Canada 36% 28% Finland 21% 17% France Germany 38% 32% 29% Greece Ireland 13% 11% 10% Italy 37% 19% Japan 40% Netherlands Norway Gray, Salter & Radebaugh Chapter 6

Corporate Effective Tax Rates Around the World - 2005 Statutory Effective Tax Rate Country Tax Rate Average Marginal Portugal 28% 20% 15% Spain 35% 26% 21% Sweden 16% Switzerland 34% 25% United Kingdom 30% 24% United States 39% 29% Gray, Salter & Radebaugh Chapter 6

AVOIDANCE OF DOUBLE TAXATION OF FOREIGN SOURCE INCOME Credits and Deductions: When subsidiaries are based in a country which uses a worldwide approach to taxation, income may be taxed twice: when earnings are realized in the foreign location when earnings are realized in the parent country. This is double taxation Gray, Salter & Radebaugh Chapter 6

AVOIDANCE OF DOUBLE TAXATION OF FOREIGN SOURCE INCOME For income earned outside the country, most developed countries offer credits to offset the foreign tax paid In the US, taxes paid on foreign income: can be treated as a credit applied against tax liability can be deducted from income to reduce taxable income. Gray, Salter & Radebaugh Chapter 6

AVOIDANCE OF DOUBLE TAXATION OF FOREIGN SOURCE INCOME - Table 3 Deduction Credit Income earned by foreign corp. $100.00 Foreign tax @ 30% 30.00 Net income after foreign taxes $70.00 US Tax @ 35% on $100 35.00 US Tax @ 35% on $70 24.50 US Tax @ 35% on $100 less $30 5.00 Net income after US taxes $35.00 $45.50 $65.00 Effective tax rate 65% 54.5% 35% Gray, Salter & Radebaugh Chapter 6

AVOIDANCE OF DOUBLE TAXATION OF FOREIGN SOURCE INCOME Foreign Tax Credit (FTC) Limitation Corporation's FTC is equal to the percentage of its US tax laibility that results from its foreign source taxable income being included in its total US taxable income Amount of FTC = US taxes before FTC times (taxable income from foreign sources/total worldwide taxable income) Amount of FTC cannot exceed amount of foreign taxes paid during year Gray, Salter & Radebaugh Chapter 6

AVOIDANCE OF DOUBLE TAXATION OF FOREIGN SOURCE INCOME Tax Treaties: can specify that certain classes of income would not be taxable; can reduce the rate on income and/or withholding taxes; can specifically deal with the issue of tax credits Gray, Salter & Radebaugh Chapter 6

MINIMIZING GLOBAL TAX Tax Havens Is a “place where foreigners may receive income or own assets without paying high rates of tax.” can offer low taxes or no taxes on certain classes of income Gray, Salter & Radebaugh Chapter 6

MINIMIZING GLOBAL TAX Tax Havens Examples of tax havens: No Income Taxes - Bahamas, Bermuda, Cayman Islands. Low Tax Rates - British Virgin Islands Exempt foreign source income - Panama, Hong Kong. Gray, Salter & Radebaugh Chapter 6

MINIMIZING GLOBAL TAX Tax Incentives There are two major types of tax incentives. tax holidays given by countries to attract foreign investors export incentives given by countries to encourage exports of goods and services Gray, Salter & Radebaugh Chapter 6

INDIRECT TAXES Value Added, Goods and Services Tax Examples of indirect taxes: consumption taxes (sales tax), VAT, excise tax, estate tax, gift tax, employment tax, user fees. In Europe, VAT is a considerable source of revenue. tax applied at each stage of production for the value added to the goods. tax burden eventually falls on the consumer because companies can reclaim taxes paid. Gray, Salter & Radebaugh Chapter 6

INDIRECT TAXES Value Added, Goods and Services Tax - Table 6.2 Calculation Manufacturer Wholesaler Retailer Consumer Net cost of goods £10.00 £14.00 £23.50 Markup £4.00 £6.00 Net selling price £20.00 VAT @ 17.5% £1.75 £2.45 £3.50 Gross selling price £11.75 £16.45 Accounting for VAT: Total VAT paid £7.70 VAT recoverable £0.00 £4.20 Net VAT paid £0.70 £1.05 Gray, Salter & Radebaugh Chapter 6

Indirect Tax Rates Around the World Country VAT/GST Algeria 21% Argentina Australia 10% GST Austria 20% GST Azerbaijan 18% Bangladesh 15% Belarus Belgium Bosnia & Herzegovina 17% Brazil 17-25% British Virgin Islands 0% Bulgaria 20% Cameroon 18.7% Canada 6% GST + Provincial Sales Tax Gray, Salter & Radebaugh Chapter 6

Indirect Tax Rates Around the World Country VAT/GST Chile 19% China 17% Colombia 16% Croatia 22% Cuba N/A Cyprus 15% Czech Republic 19%/5%/0% Denmark 25% Egypt El Salvador 13% Estonia 18% Finland France 2.1%/5.5%/19.6% Germany 7%/19% Gray, Salter & Radebaugh Chapter 6

Indirect Tax Rates Around the World Country VAT/GST Georgia 18% Greece 19% Guatemala 12% Guyana 16% Hong Kong N/A Hungary 20% Iceland 7%/24.5% India 12.50% Indonesia 10% Ireland 21% Israel 15.50% Italy Japan 5% consumption Jordan 13% GST Gray, Salter & Radebaugh Chapter 6

Indirect Tax Rates Around the World Country VAT/GST Latvia 18% Lebanon 10% Lithuania Luxembourg 15% Macedonia Malaysia 5-10% Service/Sales Tax Malta Mauritius Mexico Monaco 19.60% Montenegro 7%/17% Morocco 14%/20% Netherlands 19%/6% New Zealand 12.5% GST Gray, Salter & Radebaugh Chapter 6

Indirect Tax Rates Around the World Country VAT/GST Nigeria 5% Norway 13% (food)/25% Pakistan 15% Panama Peru 19% Philippines 12% Poland 7%//22% Portugal 21% Romania Russia 18% Saudi Arabia N/A Senegal 20% Serbia Singapore 7% GST Gray, Salter & Radebaugh Chapter 6

Indirect Tax Rates Around the World Country VAT/ GST Slovakia 19% Slovenia 20% South Africa 14% South Korea 10% Spain 16% Sweden 12%/6%/25% Switzerland 7.6% Syria N/A Taiwan 5% Thailand 7% Tunisia 12-18% Turkey 18% Ukraine United Arab Emirates 0% Gray, Salter & Radebaugh Chapter 6

Indirect Tax Rates Around the World Country VAT/GST United Kingdom 0/5/17.5% United States 0-9.75% in state & local sales tax typically around 8.5%, but up to 16.75% including other taxes Uruguay 22% Uzbekistan 20% Venezuela 11% Vietnam 10% Zambia 17.5% Average 15% Developing Countries 17% Developed Countries Gray, Salter & Radebaugh Chapter 6

TAX DIMENSIONS OF EXPATRIATES Most countries tax earnings of their residents. The US taxes the worldwide income of its citizens. The US does provide some relief if you have been resident outside the US for a certain uninterrupted period. Gray, Salter & Radebaugh Chapter 6

International Comparison of Individual Income Taxes Gray, Salter & Radebaugh Chapter 6

Individual Statutory Tax Rates Around the World Country Individual Tax Rate Algeria 0-40% Argentina 9-35% Australia 0-45% Austria 21-50% Azerbaijan 0-35% Bangladesh N/A Belarus 9-30% Belgium 25-50% Bosnia & Herzegovina 5% Brazil 0-15-27.5% British Virgin Islands 8% Bulgaria 10-24% Cameroon 10-35% Canada 15-29% federal Gray, Salter & Radebaugh Chapter 6

Individual Statutory Tax Rates Around the World Country Individual Tax Rate Chile 0-40% China 5-45% Colombia 0-35% Croatia 15-45% Cuba 10-50% Cyprus 20-30% Czech Republic 12-32% Denmark 38-59% Egypt 20-40% El Salvador 0-25% Estonia 22% Finland 25-53% France 5.5-40% Germany 15-42% Gray, Salter & Radebaugh Chapter 6

Individual Statutory Tax Rates Around the World Country Individual Tax Rate Georgia 12% Greece 0-40% Guatemala 15-31% Guyana 33.3% Hong Kong 0-16% Hungary 18-36% Iceland 0%/35% India 0-30% Indonesia 5-35% Ireland 20-41% Israel 10-49% Italy 23-45% Japan 15-50% Jordan 5-30% Gray, Salter & Radebaugh Chapter 6

Individual Statutory Tax Rates Around the World Country Individual Tax Rate Latvia 25% Lebanon 2-20% Lithuania 10-35% Luxembourg 6-38.95% Macedonia 12% Malaysia 0-27% Malta 15-35% Mauritius 15% Mexico 3-29% Monaco 0% Montenegro Morocco 0-41.5% Netherlands 34.15-52% New Zealand 0-39% Gray, Salter & Radebaugh Chapter 6

Individual Statutory Tax Rates Around the World Country Individual Tax Rate Nigeria 5/10/15/20/25% Norway 28-54.3% Pakistan 7.5-35% Panama 0-30% Peru 15-30% Philippines 5-32% Poland 19-40% Portugal 10.5-42% Romania 16% Russia 13% Saudi Arabia 0% Senegal 0-50% Serbia 10-14% Singapore 0-20% Gray, Salter & Radebaugh Chapter 6

Individual Statutory Tax Rates Around the World Country Individual Tax Rate Slovakia 19% Slovenia 16-41% South Africa 18-40% South Korea 0-36% Spain 15-45% Sweden 0-55% Switzerland 0-45.5% Syria 5-15% Taiwan 6-40% Thailand 5-37% Tunisia 0-35% Turkey 15-35% Ukraine 15% United Arab Emirates 0% Gray, Salter & Radebaugh Chapter 6

Individual Statutory Tax Rates Around the World Country Individual Tax Rate United Kingdom 0-40% United States 0-35% plus 0-9.3% state income tax Uruguay 0-25% Uzbekistan 13-30% Venezuela 6-34% Vietnam Zambia 10-30% Average 34% Developing Countries 41% Developed Countries 31% Gray, Salter & Radebaugh Chapter 6

INTRACORPORATE TRANSFER PRICING This is also known as transfer or internal pricing. Refers to the pricing of goods and services bought and sold between members of a corporate family. Includes transfers of raw materials, semi or finished goods, loans, fees, etc. Gray, Salter & Radebaugh Chapter 6

INTRACORPORATE TRANSFER PRICING - Example German subsidiary of US parent company manufactures goods and sells them to its Irish subsidiary that then sells them back to the US parent company. Why? Goods cost German subsidiary $80/unit and were sold to Irish subsidiary for $80/unit German tax rate – 45% German taxable income $80 – 80 = $0/unit German income taxes $0 * 45% = $0/unit Goods cost Irish subsidiary $80/unit and were sold to US parent company for $150/unit Irish tax rate - 4% Irish taxable income $150 – 80 = $70/unit Irish income taxes $70 * 4% = $2.80/unit Goods cost US parent company $150/unit and were sold for $150/unit US tax rate – 35% US parent company taxable income $150 – 150 = $0/unit US parent company income taxes $0 * 35% = $0/unit Total income taxes paid $2.80/unit If German subsidiary sold goods directly to US parent company for $150/unit, German subsidiary would have had taxable income of $70 and paid income taxes of $31.50/unit ($70 * 45%) Gray, Salter & Radebaugh Chapter 6

TAX PLANNING IN THE INTERNATIONAL ENVIRONMENT There are several ways in which a firm can choose to service its foreign markets: exports of goods and services; foreign branches; foreign subsidiaries; location of foreign operations. Gray, Salter & Radebaugh Chapter 6

TAX PLANNING …… Exports Should products be serviced from the parent country or foreign location? What are the benefits: Can use the Foreign Sales Corporation (FSC) which allows: substantial tax benefits if operations are legitimate setting up in a tax haven country to shelter income. Be aware of withholding taxes and treaties. Gray, Salter & Radebaugh Chapter 6

TAX PLANNING …… Foreign Branches There are benefits to operating abroad: Branch profits/losses not subject to deferral so beneficial during initial years which are normally loss years. Can offset home office income for tax purposes. Branch remittances usually not subject to withholding taxes (subsidiaries are). Gray, Salter & Radebaugh Chapter 6

TAX PLANNING …… Foreign Subsidiaries Major benefit is that income is usually sheltered from taxation in the home country until a dividend is remitted. Gray, Salter & Radebaugh Chapter 6

TAX PLANNING …… Location of Foreign Operations Influenced by three major tax factors: Tax incentives can materially reduce the cash outflow for an investment project Tax rates have competent tax and legal help in local country. Tax treaties can help choose location of legal operations. Gray, Salter & Radebaugh Chapter 6