1. Global money management, transfer pricing, other tax issues (D/R, p.552, pp. 530-540, Head §12.1, 12.5.1-12.5.3 (p. 183, pp.190-193) Global financial management: economic risk / political risk may have significant impacts on firms' investment decisions, financing decisions, and money management investment decisions Example. Capital budgeting for an FDI project (1) Estimate cash flows associated with the project over time (negative cash flows, followed by positive ones) (2) Calculate the NPV using some discount rate (the firm's cost of capital, some other required rate of return) NPV > 0 ---> accept the project Where do political and economic risks affect the NPV calculations above? (higher risks imply "higher discount rate") Can you treat the cash flows to the FDI project (in the host country) and the parent firm equally?

2. Financing Decisions Source of financing... local (does host government like this?), global (low cost?) Currency......................in hard currencies (US $?), or in local currency Any possibility of depreciation or appreciation? Financial structure: Debt ratio..................follow Italians in Italy (high debt)?........ Or, follow your home country practice (low debt) Is tax a factor? (Local taxes for dividends versus interest expenses; home- country taxes)

3. Global Money Management TAX ISSUES---> how to minimize total taxes payable legally Tax rates range: 50% - 0% in different countries Where are tax havens? -----> E.g. www.escapeartist.comwww.escapeartist.com How should you finance FDI operations ? A fronting loan (a loan between a parent and its subsidiary through an intermediary) may save money compared to a direct intra-firm loan Example. A tax haven (Bermuda) subsidiary 100% owned by the parent firm deposit $1M in a London international bank at 8% interest. The bank in turn lends $1M to another foreign sub at 9% interest, in Country Risky with a 50% tax rate. **************

4. Sub in Risky pays $90,000 interest to the London Bank at the net after-tax cost of $45,000 to the Sub The Bank keeps $10,000 and pays $80,000 interest to Bermuda sub. The parent could move additional $35,000 beyond the cost ($45,000) out of Risky. The bank "fronts" for the parent. This is a good deal for the bank, since its profit ($10,000) is risk free (the parent's $1M as collateral). Two advantages for the parent: (1) Country Risky has high political risk and may not allow a direct loan payback to the parent firm, but payback to an international bank is usually allowed in order to maintain Risky's credit image. (2) If the Bermuda sub made a direct loan to the Risky Sub, Risky Government might not allow a 50% tax deduction on the interest payment from the sub in Risky to the Bermuda Sub, arguing that it was really a dividend to the parent in disguise.

5. Does it matter how you repatriate your foreign profits back to the head office? - Dividends ? Royalties ? Consulting fees ? Or manipulating with transfer prices? How? - Royalties and fees often tax-deductible in the host country. Dividends only after paying local income taxes

6. UNBUNDLING: - transferring funds across borders using different methods - these different forms of repatriation have different tax consequences Global techniques for reducing transaction cost (1)Centralized depositories of cash holding. By combining cash holdings across several countries the parent firm can reduce the required cash balance (2)Bilateral / Multilateral Netting (pp. 533-535). By netting required foreign currency transactions among different countries, the parent firm can save foreign exchange fees Samsung's multilateral netting table (1 Sub each in SK, Mexico, UK) $US (million) payment owed by Subs in: SKMexicoUKTotalNet transfer $ReceiptsSK ---549+1 Due to:Mexico2---35-1 UK61---70 Total86721 ***>Mexican Sub pays $1 million to South Korean Sub. The rest settled by paper. (This exchange transaction costs $5,000 = $1M x 0.5%. Savings???) (3) Managing foreign exchange risk

7. TRANSFER PRICES (TP) The price at which goods and services are transferred between divisions of a company - Not limited to IB; TP exists for domestic business EXAMPLE U.S.A. LOTS OF TP AND LOCATION CONSIDERATIONS to minimize taxes because of different state tax rules TP BASED ON ECONOMIC THEORY = MARKET PRICE, OR ARMS-LENGTH PRICE

8. Reasons why market price may not be used for inter-firm transfer pricing: - market price may not exist - intra-firm transactions involve firm-specific intermediate goods which may have no market counterparts (i.e. any price can be charged! Highly profitable) - transfer price may be used by the head office for manipulating subsidiaries' (divisions') incentives - transfer price may reflect bargaining power between a subsidiary (JV, or 100 sub) and the head office ----> NEGOTIATED TP - Many companies use one of several types of t.p. arms-length price, negotiated price, cost plus (+ standard mark up) price

9. Example. No auditing of TP in Japan until recently. Virtually all foreign/U.S. companies in Japan manipulate their transfer prices because of Japan's high corporate income tax rate relative to the U.S. Rate (and due to lax government inspection rules) GOVERNMENTS TEND TO RETALIATE EACH OTHER U.S. IRS questioning Matsushita Electric's transfer price policies in the U.S. Was followed immediately the next day by a visit by MOF to IBM Japan, asking for company records, books