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Managing the

Multinational Financial
System

MANAGING THE MULTINATIONAL


FINANCIAL SYSTEM
I. THE VALUE OF THE MULTINATIONAL
FINANCIAL SYSTEM
A. Its ability to arbitrage in the following
areas:
1.
Tax systems
2.
Financial markets
3.
Regulatory systems

TAX ARBITRAGE
Tax Arbitrage is possible because we know:
1. Wide variations exist in global
tax systems
examples:
2. Firms want to reduce taxes paid
especially the triple-taxed MNC
move funds to low-tax jurisdiction

TAX ARBITRAGE
3. Tax Factors (triple taxation):
a. Taxes may be levied on
1.) corporate income
2.) personal income
(includes dividends)
3.) subsidiary income
b. U.S. Tax System Provisions
Offset:
Foreign tax credit given on
tax already paid abroad.

FINANCIAL MARKET ARBITRAGE


Financial Market Arbitrage
is possible if we
1. assume imperfect markets exist because
a. Formal barriers to trade exist
b. Informal also exist
c. Imperfections in domestic
capital markets exist.
2. agree parity conditions not in effect
a. interest rate parity
b. International Fisher Effect

REGULATORY ARBITRAGE
Regulatory Arbitrage
1. Arises when subsidiary profits vary
to local regulations.
2. Examples of local regulations:
a. Government price controls

due

b. Union wage pressures


Firms may disguise true profits in order to gain
better
negotiations advantages

INTERCOMPANY FUND-FLOW
MECHANISMS
II. INTERCOMPANY FUND-FLOW
MECHANISMS:
the name given to the methods used to
move funds from one subsidiary to another.

INTERCOMPANY FUND-FLOW
MECHANISMS
COMMONLY USED MECHANISMS:
A.
B.

Unbundling
Transfer Pricing

C.

Reinvoicing Centers

D.
E.

Royalties
Leading and Lagging

F.

Mechanism: Dividends

UNBUNDLING
A.

Unbundling Mechanism
breaks up a total international transfer of
funds between pairs of affiliates into
separate components.
Example:
Headquarters breaks down charges for
corporate overhead by affiliate.

TRANSFER PRICING
B.

Transfer Pricing Mechanism


1.

Definition: pricing internally traded


goods of the firm for the purpose of
moving profits to a more tax-friendly
nation.

TRANSFER PRICING
2.

Uses of Transfer Pricing


a.)

Reduces taxes paid

b.)
c.)

Reduces tariffs
Avoids exchange controls

TRANSFER PRICING:
An Example
Suppose that affiliate A produces 100,000
circuit boards for $10 apiece and sells them to
affiliate B. Affiliate B, in turn, sells these
boards for $22 apiece to an unrelated
customer. Pretax profit for the consolidated
company is $1 million regardless of the price
at which the goods are transferred for A to B.

TRANSFER PRICING:
An Example
Basic rules:
If tA > tB , set the transfer price and the mark-up
policy as LOW as possible.
If tA < tB , set the transfer price and the mark-up
policy as HIGH as possible.

TRANSFER PRICING:
An Example
Without markup policy
A B
A+B
Revenue
1,500
CGS
<1,000>
Gross Profits
500
Expenses
<100>
Income b/t
400
Taxes (30/50) <120>
Net Income
280

2,200
2,200
<1,500> <1,000>
700
1,200
<100>
<200>
600
1,000
<300>
<420>
300
580

TRANSFER PRICING:
An Example

HIGH MARK-UP POLICY (unit price = $18)


A B

A+B

Revenue
1,800
CGS
<1,000>
Gross Profits
800
Expenses
<100>
Income b/t
700
Taxes (30/50) <210>
Net Income
490

2,200
2,200
<1,800> <1,000>
400
1,200
<100>
<200>
300
1,000
<150>
<360>
150
640

TRANSFER PRICING:
An Example
In effect:
Profits are shifted from a higher to a lower tax
jurisdiction

REINVOICING CENTERS
C. Mechanism: Reinvoicing Centers
1.

Set up in low-tax nations.

2.
3.

Center takes title to all gods.


Center pays seller/paid by buyer
all within the MNC.

REINVOICING CENTERS
d.

Advantages:
1.)
2.)

Easier control on currency


exposure
Invoice currency other than
local

REINVOICING CENTERS
e. Disadvantages of Reinvoicing
1.)

Increased communications

2.)

costs
Suspicion of tax evasion by
local governments.

FEES AND ROYALTIES

D. Mechanism: Royalties
1.
2.

Firms have control of payment


amounts.
Host governments less suspicious.

LEADING AND LAGGING


E. Leading and Lagging
1.

Highly favored by MNCs

2.

Often used instead of formal debt


- may be prohibited by local
government

3.

Less chance of local government


suspicion.

DIVIDENDS!
F. Mechanism: Dividends
most important method used by MNCs to
transfer funds to parent