Multinational Financial Management

Alan Shapiro
10th Edition
John Wiley & Sons, Inc.

PowerPoints by
Joseph F. Greco, Ph.D.
California State University, Fullerton

1
 CHAPTER 20

Managing the Multinational

Financial System
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
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
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.
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
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

INTERCOMPANY FUND-FLOW
MECHANISMS

II. INTERCOMPANY FUND-FLOWMECHANISMS:

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

A. Unbundling
B. Transfer Pricing
C. Reinvoicing Centers
D. Royalties
E. 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 (wages, rent, utilities, etc.) 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.Reduces tariffs
c.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: 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.
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
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
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.Center takes title to all gods.
3.Center pays seller/paid by buyer
all within the MNC.
REINVOICING CENTERS
4. Advantages:
a.Easier control on currency exposure
b.Invoice currency other than local
REINVOICING CENTERS
5. Disadvantages of Reinvoicing
a.Increased communications
costs
b.Suspicion of tax evasion by
local governments.
FEES AND ROYALTIES

D. Mechanism: Royalties
1.Firms have control of payment amounts.
2.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
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