Taxes And Multinational Corporate | Test Bank Docx Ch.15

Chapter 15 Taxes and Multinational Corporate Strategy

Notes to instructors:

Answers to non-numeric multiple choice questions are arranged alphabetically, so that answers are randomly assigned to the five outcomes.

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1. A neutral tax is one that is designed to have the least effect on gross national product.

A neutral tax does not interfere with capital flows.

2. Domestic tax neutrality attempts to put the foreign and domestic operations of domestically based multinational corporations on an even footing.

3. The objective of foreign tax neutrality is to ensure that taxes imposed on the foreign operations of domestic companies are similar to those facing local competitors in the host countries.

4. If a nation’s taxes conform to domestic tax neutrality, they also conform to foreign tax neutrality.

Cross-border differences in national tax systems make tax neutrality unachievable.

5. Bilateral tax treaties ensure some consistency in the tax treatment of foreign-source income.

6. Bilateral tax treaties ensure that both domestic and foreign tax neutrality are upheld.

If national tax rates differ, joint domestic and foreign tax neutrality cannot hold.

7. The Model Treaty of the Organization for Economic Cooperation and Development identifies target corporate income tax rates for various nations.

It is a model of a bilateral tax treaty designed to avoid double taxation of income.

8. The law of one price imposes an implicit tax on assets in low-tax jurisdictions.

9. The law of one price requires that expected before-tax rates of return on comparable-risk assets are equal across all countries.

After-tax returns matter to investors.

10. Value-added taxes are a form of implicit tax.

Value-added taxes are an explicit tax.

11. Income from a foreign branch is taxed by the U.S. government at the time the funds are repatriated to the U.S. parent corporation.

Foreign-source income from a foreign branch is taxed as it is earned.

12. Income baskets in the U.S. tax code reduce the usefulness of excess foreign tax credits.

13. Earnings from foreign corporations that are between 10 percent and 50 percent owned by a U.S. parent are called Subpart F income.

14. Since the passage of the Tax Reform Act (TRA) of 1986, the multinational corporation can ignore implicit taxes in its global site location decisions.

Implicit taxes must be considered.

15. International taxation is the overriding factor in global site location decisions.

It is but one of many factors.

16. Section 486 of the U.S. Internal Revenue Code requires transfer prices be set at par value.

Transfer prices must be set as if transactions were between unrelated parties.

Multiple Choice Select the BEST ANSWER

1. ____ tax neutrality ensures that incomes arising from foreign and from domestic operations are taxed similarly by the domestic government.

a. Domestic

b. Foreign

c. Global

d. Two or more of the above

e. none of the above

2. ____ tax neutrality ensures that taxes imposed on the foreign operations of domestic companies are similar to those facing local competitors in the host countries.

a. Domestic

b. Foreign

c. Global

d. Two or more of the above

e. none of the above

3. National tax policies influence each of the following characteristics (a through c) of the multinational corporation EXCEPT ____.

a. the organizational forms in which multinational corporations choose to operate

b. the types and locations of assets held

c. the way in which the multinational corporation finances its operations

d. Each of the above is are influenced by national tax policies.

e. National tax policy has little effect on any of the above.

4. In a(n) ____ tax system, the multinational’s worldwide income is taxed by the home country as this income is repatriated to the parent company.

a. explicit

b. implicit

c. global

d. territorial

e. worldwide

5. In a(n) ____ tax system, only domestic income is taxed by the domestic government. Foreign-source income is not taxed as long as it is earned in an active business.

a. explicit

b. implicit

c. global

d. territorial

e. worldwide

6. Implicit taxes include which of the following?

a. asset taxes

b. higher pretax required returns in countries with high tax rates

c. income taxes

d. value-added taxes

e. none of the above

7. Which of the following is not a form of explicit tax?

a. asset taxes

b. tariffs on cross-border trade

c. value-added taxes

d. withholding taxes

e. All of the above are explicit taxes.

8. Withholding taxes on distributions to nonresidents are most frequently found on which income category?

a. assets

b. capital gains

c. dividends

d. royalties

e. value-added

9. Value-added taxes are a form of ____.

a. capital gains tax

b. implicit tax

c. income tax

d. sales tax

e. tariff on cross-border trade

10. Implicit taxes arise from ____.

a. a failure to hide income from the taxing authorities

b. a nation’s labor laws

c. the law of one price

d. value additivity

e. none of the above

11. Tax rates in countries B and S are t_B = 40% and t_S = 25%, respectively. Pretax required returns in B are i_B = 25%. What should be the pretax required return in S?

a. 5%

b. 10%

c. 15%

d. 20%

e. none of the above

12. Active income earned from a foreign branch is taxed by the U.S. government ____.

a. after pooling this income with all other income sources

b. as funds are repatriated to the U.S. parent corporation

c. as it is earned in the foreign country

d. at the foreign tax rate

e. none of the above

13. Foreign branches of a U.S. corporation are treated as ____.

a. a domestic corporation

b. a controlled foreign corporation

c. a part of the parent rather than as a separate legal entity

d. slaves to the master corporation

e. none of the above

14. The United States allows a foreign tax credit against U.S. income taxes up to ____.

a. £200,000

b. £1,000,000

c. the amount of consolidated foreign-source income

d. the amount of foreign taxes paid

e. the amount of taxes paid to the U.S. government

15. The intent of the foreign tax credit is to ____.

a. avoid double taxation of foreign-source income

b. ensure national sovereignty

c. ensure that foreign multinationals pay their fair share of the tax burden

d. pay for social programs

e. none of the above

QUESTIONS 16-18 ARE BASED ON THE FOLLOWING DATA

Exhibit T15.1

Australia China

a Dividend payout ratio 100% 100%

b Foreign dividend withholding tax rate 30% 10%

c Foreign corporate income tax rate 30% 25%

16. Consider Exhibit T15.1. A U.S.-based firm has $10,000 in foreign-source income from Australia. What is the dividend paid to the U.S. parent if this is the firm’s only foreign subsidiary?

a. $2,100

b. $3,000

c. $3,600

d. $4,900

e. $5,100

17. Consider Exhibit T15.1. A U.S.-based firm has a single foreign subsidiary in Australia with $10,000 in foreign-source income. What foreign tax credit is generated by the subsidiary?

a. $2,100

b. $3,000

c. $3,600

d. $4,900

e. $5,100

18. Consider Exhibit T15.1. A U.S.-based firm earns $10,000 from Australia and $10,000 from China. The firm has no other foreign operations. What are total foreign tax credits on a consolidated basis?

a. $2,500

b. $4,000

c. $6,000

d. $8,600

e. $9,500

19. A U.S.-based corporation has $8,000 in total foreign tax credits (FTC) on a consolidated basis. The firm’s overall FTC limitation is $5,000. What is the firm’s U.S. tax liability or excess FTC?

a. $0

b. $3,000

c. $5,000

d. $8,000

e. The firm has $3,000 in excess FTCs that can be carried back or forward.

20. If a U.S. parent corporation owns more than 50 percent of a foreign corporation either in terms of market value or voting power, the foreign subsidiary is called a ____.

a. controlled foreign corporation

b. foreign affiliate

c. foreign sales branch

d. wholly owned subsidiary

e. none of the above

21. The overall FTC limitation applies to ____.

a. consolidated foreign-source income

b. consolidated global income

c. domestic as well as foreign corporations

d. passive investment income

e. none of the above

22. The usefulness of U.S. foreign tax credits (FTCs) is limited by each of (a) through (d) EXCEPT ____.

a. the allocation of income rules

b. income baskets

c. the overall FTC limitation

d. Subpart F income

e. All of the above limit the usefulness of foreign tax credits.

23. Active income includes each of the following EXCEPT ____.

a. dividends received from active subsidiaries

b. dividends received from less-than-10% owned companies

c. income from active foreign branches

d. interest received from more-than-50% owned subsidiaries

e. management fees received from active subsidiaries

24. Suppose Belgium imposes a 34 percent tax on corporate income and Japan imposes a 41 percent tax rate. Pretax returns in Belgium are 15 percent. If the law of one price holds, pretax returns in Japan are ____.

a. 12.27%

b. 16.78%

c. 22.33%

d. 32.98%

e. 36.56%

25. Pretax returns in Malaysia are 18 percent. Pretax returns on comparable assets in Nauru are 20.215 percent. Malaysia’s tax rate is 27 percent. In equilibrium, Nauru’s tax rate would be ____.

a. 20%

b. 25%

c. 30%

d. 35%

e. 40%

26. Active management of transfer prices is likely to be the most advantageous when ____.

a. assets are tangible rather than intangible

b. gross operating margins are low

c. intermediate products have no market price

d. operations are in a single tax jurisdiction

e. transactions are between unrelated parties

27. All else constant, the multinational corporation has a tax incentive to shift ____ toward low-tax jurisdictions and shift ____ toward high-tax jurisdictions.

a. expenses; expenses

b. expenses; revenues

c. revenues; expenses

d. revenues; assets

e. assets; revenues

28. Foreign operations are more likely to be set up as a foreign branch when ____.

a. bribes are a common business practice in the foreign country

b. disclosure requirements in the foreign country are high

c. earnings are expected to be negative in the early years of operations

d. the potential for litigation over foreign operations is high

e. none of the above

29. Relative to local (foreign) competition, foreign-source income is most valuable to a U.S.-based firm when ____.

a. the income is from a low-tax country and the firm has excess foreign tax credits

b. the income is from a high-tax country and the firm has excess foreign tax credits

c. the income is from a low-tax country and the firm has no excess foreign tax credits

d. the income is from a high-tax country and the firm has no excess foreign tax credits

e. none of the above

30. Relative to local (foreign) competition, foreign-source income is least valuable to a U.S.-based firm when ____.

a. the income is from a low-tax country and the firm has excess foreign tax credits

b. the income is from a high-tax country and the firm has excess foreign tax credits

c. the income is from a low-tax country and the firm has no excess foreign tax credits

d. the income is from a high-tax country and the firm has no excess foreign tax credits

e. none of the above

Problems (Many of these can be converted into ‘Multiple Choice’ questions.)

1. Suppose income from Australia imposes a 30 percent tax on corporate income. Hungary’s maximum corporate income tax rate is 19 percent. If pretax required returns in Hungary are 10 percent, what are pretax required returns on similar assets in Australia for the law of one price to hold?

2. U.S.-based Crusty Creations, Inc. sells its prepackaged pastries in Mexico and Chile. Each facility earns the equivalent of $10,000 in foreign-source income before tax. Mexico has a 30 percent corporate income tax and no dividend withholding tax. Chile has corporate income taxes of 20 percent and dividend withholding taxes of 35 percent.

a. Calculate the overall U.S. tax liability (or excess FTC) of Crusty Creations.

b. If Crusty Creations can shift operations so that pretax income is $20,000 in Mexico and zero in Chile, what is its U.S. tax liability (or excess FTC)?

c. If Crusty Creations can shift operations so that pretax income is $20,000 in Chile and zero in Mexico, what is its U.S. tax liability (or excess FTC)?

d. How feasible is a tax-driven strategy of shifting revenues toward low-tax countries in the presence of implicit taxes?

3. U.S.-based Taxus Minimus, Inc. (symbol TM) is reviewing the performance of its overseas operations in Serbia and the Cayman Islands. Each foreign subsidiary earns the equivalent of $100,000 in foreign-source income before tax. Serbian corporate income and dividend withholding tax rates are 42 percent and 5 percent, respectively. The Cayman Islands has no corporate income or withholding taxes.

a. Calculate the overall U.S. tax liability (or excess FTC) of TM.

b. If TM can shift operations so that pretax income is $200,000 in the Cayman Islands and zero in Serbia, what is its U.S. tax liability (or excess FTC)? Does this strategy reduce TM’s overall U.S. tax liability?

c. In general, how is the attractiveness of a strategy of shifting revenues toward low-tax countries affected by the presence of implicit taxes?

4. U.S.-based Unnecessary Roughness (URgh) produces rough-hewn wool shirts in Hong Kong for sale in the United States. The effective marginal tax rate is 35 percent in the United States and 17 percent in Hong Kong. URgh has excess FTCs from its other international operations, so no additional U.S. taxes are due from U.S. sales. URgh sells shirts in the U.S. for $100 and has annual sales of 10,000 shirts.

a. The production process is an intangible asset, and URgh has wide latitude in the transfer price that it can set on sales from H.K. to the U.S. UR’s cost of goods sold is $10 per shirt in H.K. Calculate the effective tax rate on URgh’s sales for transfer prices of $20 and $80 per shirt.

b. Suppose the cost of goods sold is $5 per shirt if URgh manufactures at its U.S. plant. Where should URgh produce in order to maximize after-tax profits? Conduct your analysis using both $20 and $80 transfer prices on sales from Hong Kong to the U.S. parent.

Problem Solutions

1. From equation (15.1), interest rates in Australia dollars (A$) relative to Hungarian forints (HUF) should be i^A$ = (i^HUF)(1 − t^HUF) / (1 − t^A$) = (0.10)(1 – 0.19) / (1 – 0.30) ≈ 0.1157, or about 11.6 percent. After-tax returns in both countries are i^A$ (1 − t^A$) = (0.1157)(1 – 0.30) = (i^HUF)(1 − t^HUF) ≈ (0.10)(1 – 0.19) ≈ 0.081%.

2. Part a Part b Part c

Mexico Chile Mexico Chile Mexico Chile

a Dividend payout ratio 100% 100% 100% 100% 100% 100%

b Foreign dividend withholding tax rate 0% 35% 0% 35% 0% 35%

c Foreign tax rate 30% 25% 30% 25% 30% 25%

d Foreign income before tax 10,000 10,000 20000 0 0 20,000

e Foreign income tax (dc) –3000 –2500 -6000 0 0 –5000

f After-tax foreign earnings (d – e) 7000 7500 14000 0 0 15000

g Declared as dividends (fa) 7000 7500 14000 0 0 15000

h Foreign dividend withholding tax (gb) 0 –2625 0 0 0 -5250

i Total foreign tax (e + h) –3000 –5125 –6000 0 0 –10250

j Dividend to U.S. parent (d + i) 7000 4875 14000 0 0 9750

k Gross foreign income before tax (line d) 10000 10000 20000 0 0 20000

l Tentative U.S. income tax (k35%) –3500 –3500 –7000 0 0 –7000

m Foreign tax credit (i) 3000 5125 6000 0 0 10250

n Net U.S. taxes payable [min(l + m,0)] -500 0 –1000 0 0 0

o Total taxes paid (i + n) –3500 –5125 –7000 0 0 –10250

p Net amount to U.S. parent (k – o) 6500 4875 13000 0 0 9750

q Total taxes as separate subsidiaries (Σo) (8625) (7000) (10250)

Parent’s consolidated tax statement

r Overall FTC limitation (Σk35%) 7000 7000 7000

s Total FTCs on a consolidated basis (Σi) 8125 6000 10250

t Additional U.S. taxes due [max(0, r – s)] 0 1000 0

u Excess tax credits [max(0,s – r)] 1125 0 3250

(carried back 1 year or forward 10 years)

d. Implicit taxes will make it difficult to generate the same pretax returns in Hong Kong as can be generated in Belgium.

3. Part a Part b

Cayman Islands Serbia Cayman Islands Serbia

a Dividend payout ratio 100% 100% 100% 100%

b Foreign dividend withholding tax rate 0% 5% 0% 5%

c Foreign tax rate 0% 42% 0% 42%

d Foreign income before tax 100,000 100,000 200,000 0

e Foreign income tax (dc) 0 –42000 0 0

f After-tax foreign earnings (d – e) 100,000 58000 200,000 0

g Declared as dividends (fa) 100,000 58000 200,000 0

h Foreign dividend withholding tax (gb) 0 –2900 0 0

i Total foreign tax (e + h) 0 –44900 0 0

j Dividend to U.S. parent (d + i) 100,000 55100 200,000 0

k Gross foreign income before tax (d) 100,000 100000 200,000 0

l Tentative U.S. income tax (–k35%) –35,000 –35000 –70,000 0

m Foreign tax credit (i) 0 44900 0 0

n Net U.S. taxes payable [min(l + m,0)] –35,000 0 –70,000 0

o Total taxes paid –35,000 –44900 –70,000 0

p Net amount to U.S. parent 65,000 55100 130,000 0

q Total tax as separate subs (o) ($79,900) ($70,000)

Parent’s consolidated tax statement

r Overall FTC limitation (k35%) 70,000 70,000

s Total FTCs on a consolidated basis (i) 44,900 0

t Additional U.S. taxes due [max(0, r – s)] 25,100 70,000

u Excess tax credits [max(0, s – r)] 0 0

(carried back 1 year or forward 10 years)

Because TM has not yet reached its FTC limitation, its overall tax liability remains £70,000.

c. The law of one price requires that equivalent assets sell for the same price. Low explicit taxes result in low pretax required returns. Thus, in equilibrium, it may be difficult to generate £200,000 in taxable income merely by shifting sales from Serbia to the Bahamas. As other producers try this same approach, consumer prices will fall in the Bahamas. (Indeed, they probably already have.) This, in turn, leads to lower pretax profits from operations in the Bahamas than from similar operations in Serbia. In equilibrium, after-tax returns on similar-risk investments will be equal.

4. a. Low transfer price ($20/shirt) High transfer price ($80/shirt)

H.K. U.S. Consolidated H.K. U.S. Consolidated

Tax rate 17% 35% 17% 35%

Revenue 200,000 1,000,000 1,000,000 800,000 1,000,000 1,000,000

COGS 100,000 200,000 100,000 100,000 800,000 100,000

Taxable income 100,000 800,000 900,000 700,000 200,000 900,000

Taxes 17,000 280,000 297,000 119,000 70,000 189,000

Net income 83,000 515,000 603,000 581,000 130,000 711,000

Effective tax rate 33.0% 21.0%

b. If produced in the U.S., URgh’s U.S. tax liability would be: (Revenue – Expenses)(Tax rate) = ($1,000,000 – $50,000)(0.35) = $332,500. After-tax earnings and cash flow are then $617,500. Based only on tax considerations, URgh will pay less in taxes and have more after-tax cash flow if it produces in Hong Kong and uses the higher transfer price. However, at the lower $20 transfer price, URgh would be better off producing in the United States.