3. MANAGING THE MULTINATIONAL
FINANCIAL SYSTEM
I. THE VALUE OF THE MULTINATIONAL
FINANCIAL SYSTEM
Its value lies in its ability to arbitrage in the following
areas:
1. Tax systems
2. Financial markets
3. Regulatory systems
4. TAX ARBITRAGE
Tax Arbitrage is possible because we know:
1. Wide variations exist in global
tax systems
examples: Germany vs. Honk Kong
2. Firms want to reduce taxes paid
especially the “triple-
taxed” MNC
move funds to low-tax
jurisdiction
5. TAX ARBITRAGE
3. Tax Factors (triple taxation):
a. Triple Taxes may be levied on
1.) corporate income
2.) personal income
(includes dividends)
3.) subsidiary income
b. U.S. Tax System Provision
Offset:
Foreign tax credit given on
tax already paid abroad.
6. FINANCIAL MARKET ARBITRAGE
Financial Market Arbitrage
is possible if we
1. assume imperfect markets exist
because
a. Formal barriers to trade exist
b. Informal barriers also exist
c. Imperfections in domestic
capital markets exist
2. agree parity conditions not in effect, namely
a. interest rate parity
b. International Fisher Effect
7. REGULATORY ARBITRAGE
Regulatory Arbitrage:
1. Arises when subsidiary profits vary
due to local regulations.
2. Examples of local regulations:
a. Government price controls
b. Union wage pressures:
Firms may disguise true profits
in order to gain better
negotiations advantages
10. 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 (wages, rent, utilities, etc.) by affiliate
11. 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.
12. TRANSFER PRICING
2. Uses of Transfer Pricing
a. Reduces taxes paid
b. Reduces tariffs
c. Avoids exchange controls
13. 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.
14. TRANSFER PRICING:
An Example
Basic rules: Between Affiliate A and B
If tax rateA > tax rateB , set the transfer price and the mark-up
policy as LOW as possible.
If tax rateA < tax rateB , set the transfer price and the mark-up
policy as HIGH as possible.
15. TRANSFER PRICING:
An Example
Without markup policy
A B A+B
Revenue 1,500 2,200 2,200
CGS <1,000> <1,500> <1,000>
Gross Profits 500 700 1,200
Expenses <100> <100> <200>
Income b/t 400 600 1,000
Taxes (30/50) <120> <300> <420>
Net Income 280 300 580
16. TRANSFER PRICING:
An Example
HIGH MARK-UP POLICY (unit price = $18)
A B A+B
Revenue 1,800 2,200 2,200
CGS <1,000> <1,800> <1,000>
Gross Profits 800 400 1,200
Expenses <100> <100> <200>
Income b/t 700 300 1,000
Taxes (30%/50%) <210> <150> <360>
Net Income 490 150 640
18. REINVOICING CENTERS
C. Mechanism: Reinvoicing Centers
1. Set up in low-tax nations.
2. Center takes title to all gods.
3. Center pays seller/paid by buyer
all within the MNC.
21. FEES AND ROYALTIES
D. Mechanism: Royalties
1. Firms have control of payment
amounts.
2. Host governments less suspicious
22. 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.
