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Global Money Management: the Tax Objective Different countries have different tax regimes. Table 20.3 illustrates top corporate income tax rates for countries that are members of the Organization of Economic Cooperation and Development (OECD).10 The top tax rate varies from a high near 60 percent in Germany to a low of 25 percent in Finland. The picture is much more complex than the one presented in Table 20.3. For example, in Germany and Japan, the tax rate is lower on income distributed to stockholders as dividends (36 and 35 percent, respectively), whereas in France the tax on profits distributed to stockholders is higher (42 percent). Table 20.3 OECD Corporate Income Tax Rates
Source: Organization of Economic Cooperation and Development Many nations follow the worldwide principle that they have the right to tax income earned outside their boundaries by entities based in their country.11 Thus, the US government can tax the earnings of the German subsidiary of an enterprise incorporated in the United States. Double taxation occurs when the income of a foreign subsidiary is taxed both by the host-country government and by the parent company's home government. However, double taxation is mitigated to some extent by tax credits, tax treaties, and the deferral principle. A tax credit allows an entity to reduce the taxes paid to the home government by the amount of taxes paid to the foreign government. A tax treaty between two countries is an agreement specifying what items of income will be taxed by the authorities of the country where the income is earned. For example, a tax treaty between the United States and Germany may specify that a US firm need not pay tax in Germany on any earnings from its German subsidiary that are remitted to the United States in the form of dividends. A deferral principle specifies that parent companies are not taxed on foreign source income until they actually receive a dividend. For the international business with activities in many countries, the various tax regimes and the tax treaties have important implications for how the firm should structure its internal payments system among the foreign subsidiaries and the parent company. As we will see in the next section, the firm can use transfer prices and fronting loans to minimize its global tax liability. In addition, the form in which income is remitted from a foreign subsidiary to the parent company (e.g., royalty payments versus dividend payments) can be structured to minimize the firm's global tax liability. Some firms use tax havens such as the Bahamas and Bermuda to minimize their tax liability. A tax haven is a country with an exceptionally low, or even no, income tax. International businesses avoid or defer income taxes by establishing a wholly owned, nonoperating subsidiary in the tax haven. The tax haven subsidiary owns the common stock of the operating foreign subsidiaries. This allows all transfers of funds from foreign operating subsidiaries to the parent company to be funneled through the tax haven subsidiary. The tax levied on foreign source income by a firm's home government, which might normally be paid when a dividend is declared by a foreign subsidiary, can be deferred under the deferral principle until the tax haven subsidiary pays the dividend to the parent. This dividend payment can be postponed indefinitely if foreign operations continue to grow and require new internal financing from the tax haven affiliate. For US-based enterprises, however, US regulations tax US shareholders on the firm's overseas income when it is earned, regardless of when the parent company in the United States receives it. This regulation eliminates US-based firms' ability to use tax haven subsidiaries to avoid tax liabilities in the manner just described. |
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