Here, reported dividends on the parent company's tax return will be calculated to include the amount of that tax (deemed paid) plus any applicable foreign withholding taxes. As with the royalty payment, the effect of the foreign tax credit is to limit the total tax on foreign income to the higher of the two countries' tax. A branch operation, which is seen as an extension of the parent company, is covered by the home country's full tax rate.
As shown in columns 2 and 3 of Exhibit 12-4, the maximum tax liability will always be higher than the tax rates in the host country or the source country. Accordingly, its income is immediately consolidated with that of the parent company (an option not available to the subsidiary) and fully taxed in the year earned, whether remitted to the parent company or not. Recall that in the United States, as in many other countries that adopt the worldwide principle of taxation, the income of foreign subsidiaries is not taxed to the parent company until it is repatriated as a dividend - the so-called deferral principle.
INTERNATIONAL TRANSFER PRICING: COMPLICATING VARIABLES The need for transfer pricing arises when goods or services are exchanged between organizational units of the same company. Transfer pricing in the United States evolved along with the decentralization movement that affected many American businesses during the first half of the 20th century. In the United States, Section 482 of the Internal Revenue Code gives the Internal Revenue Service authority to prevent a shift of income or deductions between related taxpayers in order to exploit differences in national tax rates.
Internal price-fixing subsidies do little to instill a competitive mindset in the minds of managers whose firms benefit from the subsidy. Superficial calculations of the effects of transfer pricing policy on individual units in a multinational system are not acceptable. First, the routine functions performed by associates – the parent company and its subsidiary – are determined at each stage of the production process using appropriate benchmarks.
It can often be useful to consider more than one method to arrive at a satisfactory approximation of the market price given the available evidence. The Internal Revenue Code provides a best methods rule that requires a taxpayer to select the best transfer pricing method based on the facts and circumstances of the case. This is true regardless of the tax jurisdiction and transfer pricing methods it may favor.
For example, taxpayers must provide such documentation within 30 days of the request in the United States and within 60 days in France. Therefore, it is not surprising that we find different transfer pricing methods in practice.23 Most of the empirical evidence on transfer pricing practices is based on surveys.
Discussion Questions
Exercises
Required: Calculate the value added tax of the jewelry manufacturer's activities if the Dutch value added tax rate is 17.5 percent. Calculate the total tax that will be paid by a company headquartered in Stockholm that earns 1,500,000 Swedish kroner (SEK) and distributes 50 percent of its earnings as a dividend to its shareholders. 6.Global Enterprises has a manufacturing affiliate in Country A that incurs costs of $600,000 for goods it sells to its sales affiliate in Country B.
Required: If Global Enterprises increases the total transfer price such that shipments from production to sales increase, what effect would this have on consolidated taxes? 7. Based on the facts reported in Exercise 6, what would be the tax effects of the transfer pricing action if corporate tax rates were 30 percent in country A and 40 percent in country B. 8. Based on the background facts from Exercises 6 and 7 , assume that the unit production cost, based on the full capacity of 10,000 units, is $60, and so is the uncontrolled selling price of the unit in country A.
There is a 10 percent withholding tax on the royalty from Country A and a 10 percent withholding tax on the dividend from Country C. Now suppose that Country B levies a corporate income tax of 40 percent on taxable income (versus 30 percent in Country A ) and a tariff of 20 percent on the declared value of the imported goods. The minimum declared value legally allowed in Country B is $100 per unit with no upper limit.
Based on the above information, formulate a transfer pricing strategy that will minimize Global Enterprise's total tax burden. 9.Lumet Corporation, a manufacturer of mobile phones, wants to invoice a sales company in Fontainebleau for an order of 10,000 units. The duty rate is 5 percent and Lumet Corporation wants to earn 6 percent on the transaction.
Required: Determine the price at which Lumet will invoice its French subsidiary for the mobile phones. Required: Based on this information, at what price will the Lund Manufacturing Company invoice its distribution subsidiary in neighboring Finland.
CASES
Bank secrecy and custodial services provided by globalized financial institutions operating abroad provide a safe cover for money laundering from political corruption, fraud, embezzlement, illicit arms trade and global drug trade.36. The study points the finger at international institutions such as the International Monetary Fund and the World Bank, multinational corporations, banks and accountants. The company paid no tax at all between 1995 and 1999.37 The accountants made this possible through tax planning that involved establishing a global network of 3,500 companies, more than 440 of which were in the Cayman Islands.
The subsequent Sarbanes-Oxley legislation in the United States is intended to act as a deterrent by making directors and shareholders more accountable for the consequences of such strategies. 2. Do you agree that accountants and accounting firms share the blame for the perpetuation of poverty in the developing world? 4. Assume that you agree that new policies are needed to improve the ability of Third World countries to raise their tax revenues.
Provide policy recommendations that will achieve this result and explain why you believe these policies are necessary. 35 The report cites data that 45 to 50 percent of intra-company transfers are misjudged in Latin America and 60 percent in Africa.