CHAPTER 15
MULTINATIONAL TAX MANAGEMENT
1. Primary Objective. What is the primary objective of multinational tax planning?
The primary objective of multinational tax planning is to pay the lowest global effective tax
rate.
2. Tax Morality.
a. Discuss “tax morality” in regard to tax evasion and avoidance.
b. What are the implications of MNEs’ decisions to invest in low-tax nations? How can
MNEs weigh their cost-cutting decisions against their corporate social responsibilities?
b. Most emerging market economies try to optimize their investment climate. One of the
most important policies to attract foreign and cross-border investments is to lower
corporate taxes. This motivates MNEs to invest in countries with low tax levels.
However, while there is no problem associated with moving operations to low tax
jurisdictions, a number of economic and moral problems can arise. Host emerging
countries have interlocking public interests and tax policies; attracting foreign
investments may imply lowering or cutting corporate taxes and passing less stringent tax
law compliance, which will result in higher tax evasion, less tax revenue, and lower
3. Tax Neutrality. Does the tendency of nations to move toward territorial taxation lead to tax
neutrality at the global level?
A neutral tax system strives to have investment and individual choices and decisions based
on their economic merits and not solely for tax reasons. However, policymakers distort
neutrality to serve specific goals like raising revenue for the fiscal budget. Thus, it is
important to examine whether the adopted tax system approximates or departs from
neutrality. One way to increase tax revenue is to adopt a specific tax system, namely the
worldwide system. The worldwide approach levies taxes on income of domestically
headquartered companies (and individuals), including income earned abroad. This system
4. Approaches to Taxing MNEs. Different countries adopt diverse approaches to taxing
income generated by MNEs. What are the main advantages of each of these tax approaches?
Explain how these approaches impact the competitiveness of MNEs.
When taxing the income of a multinational corporation, the home country can follow either
the worldwide approach or the territorial approach. Under the territorial approach (also
known as the source approach), the home country only taxes the income earned within its
5. Direct versus Indirect Taxes. Do direct or indirect taxes place more burdens on the poor?
Direct taxes, such as income and corporate taxes, are levied and collected directly from a
specific group of people or organizations. Indirect taxes are collected from consumers or
organizations other than the person or entity that would normally be responsible for the taxes.
6. VAT vs. Income Tax. Explain the importance of income tax over VAT in emerging
economies.
Value-added tax is a type of a consumer tax over goods and services. Its structure differs
from sales taxes in that it taxes the increased value added to a commodity or service at each
stage in the process of production. As such, it avoids double counting, and thus is usually
7. Value-Added Tax. Answer the following questions:
a. Compare sales tax to value-added tax.
a. Sales taxes or value-added taxes (VAT) are indirect consumption taxes paid by
consumers on the purchasing price of the final good or service. While the sales tax is
collected indirectly by the seller from the customers and remitted (usually monthly or
quarterly) to the tax revenue authorities, the seller calculates the VAT at various levels of
production whenever value is added and then deducts any taxes that may have arisen
during the chain of production. The accounting is more complex for VAT. The main
advantage of these taxes is that they increase the tax base, as consumers cannot evade
them. Their collection costs are minimal for the government. From the viewpoint of
consumers, they are collected in small portions, placing fewer burdens than if collected as
one large lump sum. The main disadvantage is that these taxes lead to price distortions
that may result in lower sales volumes.
8. Withholding Tax. What is a withholding tax and why do governments impose them?
Withholding taxes are a minimum tax payment due government prior to remittance, in this
case, outside the country. The reason for the institution of withholding taxes is that
governments recognize that most international investors will not file a tax return in each
9. Tax Treaty. What is usually included within a tax treaty?
Tax treaties normally define whether taxes are to be imposed on income earned in one
country by the nationals of another, and if so, how. Tax treaties are bilateral, with the two
signatories specifying what rates are applicable to which types of income between
themselves alone.
10. Active and Passive Income Tax. Are portfolio earnings taxed as active or passive income?
Contrary to active income, which is earned as a result of the active participation of an
individual (such as wages and salaries), passive income is earned from a rental property,
silent/limited partnership, or any other enterprise in which the person is not actively
involved. Portfolio income refers to income earned on holding or trading financial
instruments, such income from dividends, coupon payments, interest, or capital gains. Each
11. Tax Types. Taxes are classified based on whether they are applied directly to income, called
direct taxes, or to some other measurable performance characteristic of the firm, called
indirect taxes. Identify each of the following as a “direct tax,” an “indirect tax,” or something
else:
a. Corporate income tax paid by a Japanese subsidiary on its operating income
b. Royalties paid to Saudi Arabia for oil extracted and shipped to world markets
c. Interest received by a U.S. parent on bank deposits held in London
12. Foreign Tax Credit. What is a foreign tax credit? Why do countries give credit for taxes
paid on foreign source income?
To prevent double taxation of the same income, most countries grant a foreign tax credit for
income taxes paid to the host country. Countries differ on how they calculate the foreign tax
credit and what kinds of limitations they place on the total amount claimed. Normally foreign
tax credits are also available for withholding taxes paid to other countries on dividends,
royalties, interest, and other income remitted to the parent. The value-added tax and other
13. Earnings Stripping. What is earnings stripping, and what are some examples of how
multinational firms pursue it?
A multinational firm may allocate debt differently across its various foreign subsidiaries to
reduce tax liabilities in high tax environments. Units in high tax environments may be
14. Controlled Foreign Corporation. What is a controlled foreign corporation and what is its
significance in global tax management?
A controlled foreign corporation (CFC) is any foreign corporation in which U.S.
shareholders, including corporate parents, own more than 50% of the combined voting power
15. Transfer Pricing. What is a transfer price and can a government regulate it? What
difficulties and motives does a parent multinational firm face in setting transfer prices?
A transfer price is the amount paid by one unit of a company (domestic or international) for
goods or services purchased from another unit of the same firm. As such, a transfer price is
needed for every intrafirm transaction. Where buyer and seller are in different tax
jurisdictions (i.e., countries), governments are concerned with the possibility that transfer
16. Fund Positioning. What is fund positioning?
Fund positioning is the use of prices or transactions of different kinds to move taxable profits
out of high tax environments and into low tax environments. A parent firm wishing to
transfer funds out of a particular country can charge higher prices on goods sold to its
17. Income Tax Effect. What is the income tax effect, and how may a multinational firm alter
transfer prices as a result of the income tax effect?
A major consideration in setting a transfer price is the income tax effect. Worldwide
corporate profits may be influenced by setting transfer prices to minimize taxable income in a
18. Correct Pricing. What is meant by “correct” or proper transfer pricing? How can local
national authorities impose “correct” transfer pricing on MNEs? What is the main requisite
for the implementation of proper transfer pricing?
Theoretically speaking, a proper or correct transfer price is one that matches either what the
seller would charge an independent arm’s-length buyer, or what the buyer would pay an
independent arm’s-length seller. Since transfer prices are used to shift income to countries
with lower tax rates, they become a major concern to countries that have lost due tax
19. Cross-Crediting. Define cross-crediting and explain why it may or may not be consistent
with a worldwide tax regime.
Cross-crediting is the ability to cross-credit foreign tax credits with foreign tax deficits in the
same period. If a U.S. multinational remits profits from two different countries, one in a
20. Purposes of Transfer Pricing. In addition to calculating and setting the tax liabilities of
firms, what other purposes may transfer prices serve?
When MNEs transfer products and services across international borders, transfer prices are
important for the calculation of income taxes and for the settlement of other domestic and
global regulatory issues. Assuming that no mispricing is used, transfer pricing serves
additional purposes for the firm. First, transfer prices are necessary to calculate profits for
each jurisdiction and/or division. Not only does this affect divisional performance evaluation,
21. Measuring Managerial Performance. What role does transfer pricing have within
multinational companies when measuring management performance? How can transfer
pricing practices within a firm conflict with performance measurement?
When a firm is organized with decentralized profit centers, transfer pricing between centers
can disrupt evaluation of managerial performance. Transfer prices which are set high or low
for various tax management purposes also alter the profitability of the unit performance for
22. Tax Avoidance and Havens. One example of tax avoidance is when firms park their funds
in tax havens. While considered legal, do you think that tax avoidance is entirely ethical?
Unlike tax evasion, tax avoidance merely exploits loopholes in the law to minimise tax bills.
For example, MNEs can artificially transfer funds to a tax haven or move funds into a non-
taxable trust fund in order to avoid paying taxes. This is more like bending the rules, rather
23. Corporate Inversion. What is a corporate inversion, and why do many U.S. corporations
want to pursue it although it is highly criticized by public and private parties alike?
Corporate inversion is the changing of a company’s country of incorporation. It’s purpose is
to reduce its effective global tax liabilities by reincorporating in a lower-tax jurisdiction,
typically a country using a territorial tax regime. Although the company’s operations may be
completely unchanged, and its corporate headquarters remaining in the original country of
24. Digital Commerce. How is cross-border digital commerce challenging the traditional ways
in which multinational companies are taxed?
Digital commerce has challenged the traditional definition of where a taxable transaction
takes place. A traditional manufacturing activity is physically defined, and where the
production and value creation process takes place, specifically by country and therefore
25. Tax Competitiveness. What does it mean for a country—or its government—to compete for
business on the basis of taxation?
As global competitiveness has increased over time, the ability of business and its capital to
move across borders has heightened government awareness that a country’s tax structure and
rates may make a country more or less attractive for investment. The result has been a