Usually, one of the most important variables in multinational operations is taxation. Perhaps no
environmental variable, with the possible exception of foreign exchange, has such a pervasive
influence on all aspects of multinational operations as taxation: (1) the choice of location in the
investment decision, (2) the form of the new enterprise, (3) the method of finance, and (4) the
method of transfer pricing.
International taxation is complicated because tax laws differ among countries and are con-
stantly changing. Hence, it is not accidental that international taxation still remains somewhat
of a mystery for many international executives. For example, multinational financial managers
need to understand the following:
1Shareholders of foreign and domestic corporations are subject to different rules.
2Accounting for foreign taxes on foreign operations is not identical to that on domestic
operations.
3Bilateral tax treaties and foreign tax credits exist to avoid double taxation of income.
4Many countries offer a number of tax incentives to attract foreign capital and know-how.
5Tax savings realized in low-tax countries may be offset by taxes on undistributed earnings.
There are many such added complexities because governments have failed to come to any general
agreement on tax policies. Each country has its own tax philosophies, tax incentives, transfer
pricing policies, and the like. Multinational financial managers must sort them out in order to
maximize profitability and cash flow. To attain this end, they must acquaint themselves with the
ov erall tax environment.
Types of taxes
MNCs face a variety of direct and indirect taxes. Direct taxes include corporate income taxes
and capital gains taxes. Indirect taxesinclude value-added taxes, tariffs, and withholding taxes.
In addition to these direct and indirect taxes, MNCs may have to pay property taxes, payroll
taxes, stamp and registration taxes, taxes on registrations of agreements of various types, sales and
excise taxes (excluding value-added taxes), and taxes on undistributed earnings.
INCOME AND CAPITAL GAINS As with individual income taxes, corporate income taxes are an
important source of revenue for many countries. Because most developing countries have low
per capita income, individual income taxes or sales taxes are not very appropriate. Thus, devel-
oping countries obtain a larger share of government revenues from corporate income taxes than
industrial countries.
Gains and losses on sales of capital assets are called capital gains and losses . Capital assets
are those assets that are not primarily for resale and not acquired in the ordinary course of busi-
ness. These assets include stocks and bonds. If capital assets are held longer than a specified period
of time, gains on sales of these assets may be subject to preferential tax treatment:
• Value-added taxes are a special type of sales tax. Sales taxes are those taxes assessed at one or
more stages in the production process. In Canada, sales taxes are levied when production is
complete; in England, when products are wholesaled; in the USA, when products are retailed;
and in some European countries, at all stages in the production cycle. Many European coun-
tries have adopted the value-added tax as the major source of revenue to avoid the com-
pounding effect of sales taxes. For example, if a car dealer purchased a car for $10,000 from
a car manufacturing company and then sold it for $15,000, the value added would be $5,000
and the tax would be levied on this $5,000 increment.
• Tariffsare simply taxes assessed on imported goods, which parallel excise and other indirect
taxes paid by domestic producers of similar goods. They may be imposed for purposes of
re venue or protection. When tariffs are employed to increase revenues, they are usually
modest. However, when tariffs are used to protect domestic companies from foreign com-
petition, they are typically high. Although protective tariffs do not eliminate the importation
of foreign products completely, they clearly put foreign sellers at a comparative disadvantage.
In this instance, consumers must pay more for foreign goods, which in turn would reduce
their consumption of imported commodities.
• Withholding taxes are those taxes imposed by host governments on dividend and interest
payments to foreign investors and debt holders. These taxes are collected before receipt of
the income. In other words, they are usually withheld at the source by the paying corpora-
tion. For example, a 20 percent withholding tax on $10,000 interest payments to foreigners
means that the tax proceeds of $2,000 are deducted from the interest payment made to the
lender and collected by the borrower on behalf of the government. Hence, the purchaser of
the bonds would receive only $8,000, or 80 percent of the $10,000 interest payment. With-
holding taxes are generally modified by bilateral tax treaties, because they frequently restrict
the international movement of long-term investment capital.
Tax morality
The issue at stake is the conflict between economics (profits) and ethics (corporate morality).
Some business executives think that profits are one thing and corporate morality is another; thus,
they conclude that they have to make a choice. It is well known that in many countries both
corporate and individual taxpayers are not completely honest with their tax authorities. MNCs
must decide whether to comply with the tax laws voluntarily. Although most MNCs comply
fully with the tax laws, some companies feel that they should evade taxes to the same extent as
their competitors in order to protect their competitive position. Ethical standards vary greatly
among people, companies, and societies because business ethics are partly a function of cultural
patterns and historical development. Therefore, there is obviously no universally accepted answer
to the problem.
Host governments also have a similar moral problem. Two basic tax principles are that taxes
should be equitable and neutral. In other words, taxes should be fair to everyone, and they should
not affect decisions in the economic system. Nevertheless, many countries have imposed some
arbitrary tax penalties on MNCs for presumed violations of local tax laws. Many developing
countries have various tax incentive programs for private foreign investments. These tax incen-
tive programs abandon the principle of an economically neutral system. Under a neutral tax
system, if we want the most efficient economic system, supply and demand should be left alone
to determine prices and economic activity.
Tax burdens
Because different countries have varying statutory rates of income tax, differences in overall tax
burdens are another natural feature of international business operations. The corporate tax rate
ranges from zero in such tax-haven countries as the Bahamas to 60 percent in such countries as
Libya.
Differences in definitions of taxable corporate income create greater disparities than dif-ferences in nominal corporate tax rates. Thus, differential tax rates tell us only part of the
story. In one country, taxable income may be computed on a cash basis, while in another
country it may be determined on an accrual basis. Investment allowances and credits, reserves,
the timing of depreciation deductions, and asset valuations vary greatly from country to country.
Some countries provide companies with full credit for taxes on the income paid in other
countries.
Tax systems also affect relative tax burdens internationally. In general, there are three classes
of systems: single tax, double tax, and partial double tax. Under the single tax system, income is
taxed only once. If corporations pay no taxes, their stockholders pay taxes on dividends. Under
the double tax system, corporations pay taxes on profits at a given rate and dividends are then
taxed as income to stockholders at their personal income tax rates. Under the partial double tax
system, taxes are levied on corporate income, but dividends are taxed at a lower rate than other
forms of personal income, or distributed corporate earnings are taxed at a lower rate than undis-tributed earnings (retained earnings).
CARRYBACKS AND CARRYFORWARDS An operating loss is the excess of deductible expenses over
gross income. Operating losses can often be carried back or forward to offset earnings in other
years. Tax provisions for carrybacks and carryforwards vary among countries. Most countries do
not permit operating losses to be carried back. However, virtually all countries allow companies
to carry their losses forward for a limited number of years.
US companies may carry their excess foreign tax credit back 3 years and carry it forward 15
years to offset US tax on foreign-source income. The choice depends largely upon whether a
company has had foreign-source income in the 2 years immediately prior to the excess foreign
tax credit. If this is the case, the company must carry the excess foreign tax credit back in order
to expedite the refund of tax payment.
The purpose of this provision is to allow corporations to average their operating results, which
fluctuate widely from year to year. However, some profitable MNCs have used the carryback and
carryforward feature as a means of reducing their taxable income by merging with other firms
that have considerable operating losses or excess foreign tax credits.
environmental variable, with the possible exception of foreign exchange, has such a pervasive
influence on all aspects of multinational operations as taxation: (1) the choice of location in the
investment decision, (2) the form of the new enterprise, (3) the method of finance, and (4) the
method of transfer pricing.
International taxation is complicated because tax laws differ among countries and are con-
stantly changing. Hence, it is not accidental that international taxation still remains somewhat
of a mystery for many international executives. For example, multinational financial managers
need to understand the following:
1Shareholders of foreign and domestic corporations are subject to different rules.
2Accounting for foreign taxes on foreign operations is not identical to that on domestic
operations.
3Bilateral tax treaties and foreign tax credits exist to avoid double taxation of income.
4Many countries offer a number of tax incentives to attract foreign capital and know-how.
5Tax savings realized in low-tax countries may be offset by taxes on undistributed earnings.
There are many such added complexities because governments have failed to come to any general
agreement on tax policies. Each country has its own tax philosophies, tax incentives, transfer
pricing policies, and the like. Multinational financial managers must sort them out in order to
maximize profitability and cash flow. To attain this end, they must acquaint themselves with the
ov erall tax environment.
Types of taxes
MNCs face a variety of direct and indirect taxes. Direct taxes include corporate income taxes
and capital gains taxes. Indirect taxesinclude value-added taxes, tariffs, and withholding taxes.
In addition to these direct and indirect taxes, MNCs may have to pay property taxes, payroll
taxes, stamp and registration taxes, taxes on registrations of agreements of various types, sales and
excise taxes (excluding value-added taxes), and taxes on undistributed earnings.
INCOME AND CAPITAL GAINS As with individual income taxes, corporate income taxes are an
important source of revenue for many countries. Because most developing countries have low
per capita income, individual income taxes or sales taxes are not very appropriate. Thus, devel-
oping countries obtain a larger share of government revenues from corporate income taxes than
industrial countries.
Gains and losses on sales of capital assets are called capital gains and losses . Capital assets
are those assets that are not primarily for resale and not acquired in the ordinary course of busi-
ness. These assets include stocks and bonds. If capital assets are held longer than a specified period
of time, gains on sales of these assets may be subject to preferential tax treatment:
• Value-added taxes are a special type of sales tax. Sales taxes are those taxes assessed at one or
more stages in the production process. In Canada, sales taxes are levied when production is
complete; in England, when products are wholesaled; in the USA, when products are retailed;
and in some European countries, at all stages in the production cycle. Many European coun-
tries have adopted the value-added tax as the major source of revenue to avoid the com-
pounding effect of sales taxes. For example, if a car dealer purchased a car for $10,000 from
a car manufacturing company and then sold it for $15,000, the value added would be $5,000
and the tax would be levied on this $5,000 increment.
• Tariffsare simply taxes assessed on imported goods, which parallel excise and other indirect
taxes paid by domestic producers of similar goods. They may be imposed for purposes of
re venue or protection. When tariffs are employed to increase revenues, they are usually
modest. However, when tariffs are used to protect domestic companies from foreign com-
petition, they are typically high. Although protective tariffs do not eliminate the importation
of foreign products completely, they clearly put foreign sellers at a comparative disadvantage.
In this instance, consumers must pay more for foreign goods, which in turn would reduce
their consumption of imported commodities.
• Withholding taxes are those taxes imposed by host governments on dividend and interest
payments to foreign investors and debt holders. These taxes are collected before receipt of
the income. In other words, they are usually withheld at the source by the paying corpora-
tion. For example, a 20 percent withholding tax on $10,000 interest payments to foreigners
means that the tax proceeds of $2,000 are deducted from the interest payment made to the
lender and collected by the borrower on behalf of the government. Hence, the purchaser of
the bonds would receive only $8,000, or 80 percent of the $10,000 interest payment. With-
holding taxes are generally modified by bilateral tax treaties, because they frequently restrict
the international movement of long-term investment capital.
Tax morality
The issue at stake is the conflict between economics (profits) and ethics (corporate morality).
Some business executives think that profits are one thing and corporate morality is another; thus,
they conclude that they have to make a choice. It is well known that in many countries both
corporate and individual taxpayers are not completely honest with their tax authorities. MNCs
must decide whether to comply with the tax laws voluntarily. Although most MNCs comply
fully with the tax laws, some companies feel that they should evade taxes to the same extent as
their competitors in order to protect their competitive position. Ethical standards vary greatly
among people, companies, and societies because business ethics are partly a function of cultural
patterns and historical development. Therefore, there is obviously no universally accepted answer
to the problem.
Host governments also have a similar moral problem. Two basic tax principles are that taxes
should be equitable and neutral. In other words, taxes should be fair to everyone, and they should
not affect decisions in the economic system. Nevertheless, many countries have imposed some
arbitrary tax penalties on MNCs for presumed violations of local tax laws. Many developing
countries have various tax incentive programs for private foreign investments. These tax incen-
tive programs abandon the principle of an economically neutral system. Under a neutral tax
system, if we want the most efficient economic system, supply and demand should be left alone
to determine prices and economic activity.
Tax burdens
Because different countries have varying statutory rates of income tax, differences in overall tax
burdens are another natural feature of international business operations. The corporate tax rate
ranges from zero in such tax-haven countries as the Bahamas to 60 percent in such countries as
Libya.
Differences in definitions of taxable corporate income create greater disparities than dif-ferences in nominal corporate tax rates. Thus, differential tax rates tell us only part of the
story. In one country, taxable income may be computed on a cash basis, while in another
country it may be determined on an accrual basis. Investment allowances and credits, reserves,
the timing of depreciation deductions, and asset valuations vary greatly from country to country.
Some countries provide companies with full credit for taxes on the income paid in other
countries.
Tax systems also affect relative tax burdens internationally. In general, there are three classes
of systems: single tax, double tax, and partial double tax. Under the single tax system, income is
taxed only once. If corporations pay no taxes, their stockholders pay taxes on dividends. Under
the double tax system, corporations pay taxes on profits at a given rate and dividends are then
taxed as income to stockholders at their personal income tax rates. Under the partial double tax
system, taxes are levied on corporate income, but dividends are taxed at a lower rate than other
forms of personal income, or distributed corporate earnings are taxed at a lower rate than undis-tributed earnings (retained earnings).
CARRYBACKS AND CARRYFORWARDS An operating loss is the excess of deductible expenses over
gross income. Operating losses can often be carried back or forward to offset earnings in other
years. Tax provisions for carrybacks and carryforwards vary among countries. Most countries do
not permit operating losses to be carried back. However, virtually all countries allow companies
to carry their losses forward for a limited number of years.
US companies may carry their excess foreign tax credit back 3 years and carry it forward 15
years to offset US tax on foreign-source income. The choice depends largely upon whether a
company has had foreign-source income in the 2 years immediately prior to the excess foreign
tax credit. If this is the case, the company must carry the excess foreign tax credit back in order
to expedite the refund of tax payment.
The purpose of this provision is to allow corporations to average their operating results, which
fluctuate widely from year to year. However, some profitable MNCs have used the carryback and
carryforward feature as a means of reducing their taxable income by merging with other firms
that have considerable operating losses or excess foreign tax credits.
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