Task: Please review the attached PowerPoint presentation, and afterward, generate your own PowerPoint presentation. TYPES OF TAXATION Three basic types of taxation that national governments throughout the world use in generating revenue: 1. Income tax 2. Withholding tax 3. Value-added tax Other taxation: Excise tax, property tax, estate tax GLOBAL FINANCIAL MANAGEMENT 2 INCOME TAX Many countries in the world obtain a significant portion of their tax revenue from imposing an income tax on personal and corporate income An income tax is a direct tax, that is, one that is paid directly by the taxpayer on whom it is levied An income tax is levied on active income, resulting from production by the firm or individual or from services that have been provided National tax rates vary from a low of 0 percent to 40 percent or more in some countries GLOBAL FINANCIAL MANAGEMENT 3 EXHIBIT 21.1 CORPORATE PERCENTAGE INCOME TAX RATES FROM CERTAIN COUNTRIES GLOBAL FINANCIAL MANAGEMENT 4 WITHHOLDING TAX Withholding tax is generally levied on passive income earned by an individual / corporation of one country within the tax jurisdiction of another country Indirect tax that is borne by a taxpayer who did not directly generate the income Withheld from payments the corporation makes to the taxpayer and turned over to local tax authority Many countries have tax treaties with one another specifying the withholding tax rate applied to various types of passive income Withholding tax rates imposed through tax treaties are bilateral, negotiated between two countries GLOBAL FINANCIAL MANAGEMENT 5 VALUE-ADDED TAX A value-added tax (VAT) is an indirect national tax levied on the value added in the production of a good (or service) as it moves through the various stages of production Several ways to implement a VAT, but subtraction method is frequently followed In many European countries (especially the EU) and Latin American countries, VAT has become a major source of taxation on private citizens GLOBAL FINANCIAL MANAGEMENT 6 EXHIBIT 21.3 VALUE-ADDED TAX CALCULATION GLOBAL FINANCIAL MANAGEMENT 7 VALUE-ADDED TAX (CONTINUED) Advantages of VAT: Discourages unnecessary consumption Fosters national saving Easier to collect than income tax because tax evasion is more difficult Problem with VAT: Not all countries impose the same VAT tax rate, and consumers who reside in a high-VAT country can purchase goods less expensively by simply shopping across the border in a lower-VAT country GLOBAL FINANCIAL MANAGEMENT 8 TAXATION Federal taxation Provincial taxation Unemployment premiums Canada Pension Plan Other OECD countries: https://www.cnbc.com/2017/08/07/canadians-may-pay-more-taxes-thanamericans-but-theres-a-catch.html GLOBAL FINANCIAL MANAGEMENT 9 NATIONAL TAX ENVIRONMENTS International tax environment confronting an MNC or an international investor is a function of the tax jurisdictions established by the individual countries in which the MNC does business or in which the investor owns financial assets Two fundamental types of tax jurisdiction: 1. Worldwide taxation 2. Territorial taxation Unless prevented, double taxation would result if all nations were to follow both methods simultaneously GLOBAL FINANCIAL MANAGEMENT 10 WORLDWIDE AND TERRITORIAL TAXATION The worldwide or residential method of declaring a national tax jurisdiction is to tax national residents of the country on their worldwide income no matter in which country it is earned National tax authority is declaring its tax jurisdiction over people and businesses The territorial or source method of declaring a tax jurisdiction is to tax all income earned within the country by any taxpayer, domestic or foreign National tax authority is declaring its tax jurisdiction over transactions conducted within its borders GLOBAL FINANCIAL MANAGEMENT 11 FOREIGN TAX CREDITS Approaches to avoiding double taxation: A nation could choose not to tax foreign-source income of its national residents Alternatively, a nation could grant to the parent firm foreign tax credits, a credit given to the parent firm against taxes due in the host country based on the taxes paid to foreign tax authorities on foreign-source income Used frequently by the United States In a given tax year, an overall limitation applies to foreign tax credits May be direct or indirect GLOBAL FINANCIAL MANAGEMENT 12 ORGANIZATIONAL STRUCTURES: BRANCH AND SUBSIDIARY INCOME 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. Active or passive foreign-source income earned by the branch is consolidated with the domestic-source income of the parent for determining the U.S. tax liability A foreign subsidiary is an affiliate organization of the MNC that is independently incorporated in the foreign country, and one in which the U.S. MNC owns at least 10% of the voting equity GLOBAL FINANCIAL MANAGEMENT 13 ORGANIZATIONAL STRUCTURES: TAX HAVENS A tax haven country is one that has a low corporate income tax rate and low withholding tax rates on passive income E.g., Bahrain, Bermuda, Cayman Islands, Channel Islands (Guernsey and Jersey), and the Isle of Man Once useful as locations for an MNC to establish a wholly owned paper foreign subsidiary, that in turn would own the operating foreign subsidiaries of the MNC GLOBAL FINANCIAL MANAGEMENT 14 ORGANIZATIONAL STRUCTURES: TAX HAVENS (CONTINUED) Benefit of a tax haven subsidiary for U.S. MNCs has been greatly reduced by two factors: Present corporate income tax rate in the U.S. is not especially high in comparison to most nontax haven countries, thus eliminating the need for deferral Rules governing controlled foreign corporations have effectively eliminated the ability to defer passive income in a tax haven foreign subsidiary GLOBAL FINANCIAL MANAGEMENT 15 PANAMA PAPERS https://www.cbc.ca/news/world/mossack-fonseca-panamapapers-new-leak-1.4714187 https://www.cbc.ca/news/business/cra-tax-gap-foreignholdings-1.4726983 GLOBAL FINANCIAL MANAGEMENT 16 ORGANIZATIONAL STRUCTURES: CONTROLLED FOREIGN CORPORATION Tax Reform Act of 1986 created a new type of foreign subsidiary called a controlled foreign corporation Purpose of reform was to prevent the tax deferral of certain income in tax haven countries Controlled foreign corporation (CFC) is a foreign subsidiary that has more than 50% of its voting equity owned by U.S. shareholders GLOBAL FINANCIAL MANAGEMENT 17 TRANSFER PRICING AND RELATED ISSUES Price assigned, for bookkeeping purposes, to the receiving division within a business for the cost of transferring goods and services from another division is the transfer price Difficult to decide on transfer prices within domestic firms, but especially so for MNCs due to the following: Exchange restrictions on the part of the host country where the receiving affiliate is located Difference in income tax rates between the two countries Import duties and quotas imposed by the host country GLOBAL FINANCIAL MANAGEMENT 18 TRANSFER PRICING AND RELATED ISSUES: MISCELLANEOUS FACTORS Transfer pricing strategies may be beneficial when host country restricts amount of foreign exchange that can be used for importing specific goods Lower transfer price allows a greater quantity of the good to be imported under a quota restriction Transfer prices also influence how divisions of an MNC are perceived locally High markup policy leaves little net income to show on the affiliates books, while low markup policy makes it appear, at least superficially, as if affiliates, rather than the parent firm, are contributing a larger portion to consolidated earnings GLOBAL FINANCIAL MANAGEMENT 19 ISSUES: MISCELLANEOUS FACTORS (CONTINUED) Transfer pricing strategies also influence international capital expenditure analysis Very low (high) markup policy makes the adjusted present value (APV) of a subsidiarys capital expenditure appear more (less) attractive As such, to obtain a meaningful analysis, armslength pricing should be used in the APV analysis to determine after-tax operating income, regardless of the actual transfer price employed GLOBAL FINANCIAL MANAGEMENT 20 BLOCKED FUNDS A country may find itself short of foreign currency reserves, and thus impose exchange restrictions on its own currency, limiting its conversion into other currencies so as not to further reduce scarce foreign currency reserves When a country enforces exchange controls, remittance of profits from subsidiary firm to foreign parent is blocked GLOBAL FINANCIAL MANAGEMENT 21 BLOCKED FUNDS (CONTINUED) Methods for moving blocked funds: Transfer pricing strategies and unbundling services Leading and lagging of payments Export creation, which involves using the blocked funds of a subsidiary in the country in which they are blocked to pay for exports that can be used to benefit the parent firm or other affiliates Direct negotiation GLOBAL FINANCIAL MANAGEMENT 22