1. Managing the Multinational Financial System
Shapiro: Chapter 16

2. Shapiro: Chapter 16
Problem 16.1

3. Multinational Financial System
“... ability to shift funds and accounting profits among its various units ...
through internal financial transfer mechanisms.”

4. Multinational Financial System
“ … over 38% of U. S. imports and exports are transactions between U. S. firms and their foreign affiliates or parents.”

5. Two-way International Trade
Parent to/from a foreign subsidiary:
U. S. & Japan: 80%
U. S. & Europe: 40%
EC & Japan: 55%

6. Multinational Arbitrage Opportunities
Tax arbitrage
Financial market arbitrage
Regulatory system arbitrage

7. Multinational Financial System [Advantages]
Tax arbitrage:
high-tax to low-tax nations
taxpaying to tax-loss units
Financial market arbitrage:
circumvent exchange controls
earn higher risk-adjusted returns
reduce borrowing costs

8. Multinational Financial System [Advantages]
Regulatory system arbitrage:
disguise true profitability
negotiating advantage
Offset credit restraint or controls
draw on external sources of funds

9. Tax Factors (Intercompany Transfers)
Types of taxes (host country)
corporate income taxes
taxes on dividends, interest, and fee remittances
taxes on retained earnings
Foreign tax credit
offsets U. S. taxes

10. MNC Financial Channels
Transfer pricing
Reinvoicing Centers
Fees and royalties
Leading and lagging
Intercompany loans
Dividends
Equity vs. debt

11. Transfer Pricing
Reduce taxes
Unit A sells to Unit B:
if tA > tB, low transfer price
if tA < tB, high transfer price

12. Transfer Pricing [A sells to B]

13. Transfer Pricing [A sells to B]

14. Transfer Pricing [A sells to B]

15. Transfer Pricing [A sells to B]

16. Transfer Pricing [A sells to B]

17. Transfer Pricing Strategy
Reduce taxes
Reduce tariffs
Avoid exchange controls
Increase profits from joint ventures
Disguise affiliate’s profitability

18. Fees and Royalties [International Transfers]
Intangible factors of production
headquarters services
allocated overhead
patents and trademarks
IRC Section 482:
“commensurate with the income” generated

19. Fees and Royalties [International Transfers]
Allocate total fees according to sales or assets

20. Leading & Lagging Payments
Accelerating or delaying payments
Modifying credit terms
Opportunity cost of funds:
paying unit
receiving unit
interest rate differentials

21. Leading & Lagging Payments
Advantages over direct loans:
no formal note of indebtedness
less government interference
interest free for 6 months (Sec. 482)

22. Leading & Lagging Payments

23. Leading & Lagging Payments

24. Leading & Lagging Payments

25. Leading & Lagging Payments

26. Intercompany Loans (1)
Transfer of funds through making and repaying of intercompany loans
More valuable than arm’s-length transactions if the following exist:
credit rationing
currency controls
differential tax rates

27. Intercompany Loans (2)
Direct Loans
Back-to-Back Financing
Parallel Loans

28. Direct Loans Straight extension of credit From parent to affiliate
From one affiliate to another
No intermediary involved

29. Back-to-Back Loans (1) [Fronting loans; link financing]
Used in countries with:
high interest rates
restricted capital markets
currency controls
different tax rates for loans from a financial institution

30. Back-to-Back Loans (2)
Parent deposits funds with a bank in Country A
Bank lends funds to subsidiary in Country B
Effectively, an intercompany loan channeled through a bank

31. Back-to-Back Loans (3)
Risk free for the bank - deposit collateralizes the loan
Bank serves as intermediary
Bank’s compensation is the difference between borrowing and lending rates

32. Structure of a Back-to-Back Loan
Parent firm
in Country A
Subsidiary in
Country B

33. Structure of a Back-to-Back Loan
Parent firm
in Country A
Subsidiary in
Country B
Direct Loan

34. Structure of a Back-to-Back Loan
Parent firm
in Country A
Subsidiary in
Country B
Direct Loan
Deposit
Bank in
Country A

35. Structure of a Back-to-Back Loan
Parent firm
in Country A
Subsidiary in
Country B
Direct Loan
Deposit
Back-to-Back Loan
Bank in
Country A

36. Structure of a Back-to-Back Loan
Parent firm
in Country A
Subsidiary in
Country B
Direct Loan
Deposit
Back-to-Back Loan
Bank in
Country A

37. Parallel Loans Two related but separate borrowings
Usually involves four parties
Two separate countries
Bank fees: 0.25%-0.50% of principal

39. Dividends Most important transfer mechanism
Over 50% of remittances to USA
Parent’s dividend payout ratio (D/E)
Other factors:
tax effects
financing requirements
exchange controls

40. Equity vs. Debt? MNCs generally prefer loans to equity
Easier to repatriate interest and principal than dividends and equity
Tax benefits of debt:
interest deductible in host country
loan repayments not taxable to parent

41. Designing a Global Policy
How much money to remit?
When to remit?
Where to transmit funds?
Which transfer method to use?
Satisfactory vs. optimal decisions

42. Shapiro: Problem 16-1 a. 1,500 (27,000 - P) (.45 - .50)
P = $30,000 maximizes tax savings
b. 1,500 (27,000 - P)[ (1.15)]
= 1,500 (27,000 - P) (.025)
P = $25,000 maximizes tax savings

43. Shapiro: Problem 16-1 c. $27,000 X 1.05 = $28,350
1,500 (27, ,350) ( )
= $101,250 (decline in tax)
1,500 (28,350-27,000)[ (1.15)]
= $50,625