The Ten Commandments of International Tax Management

International Tax Management International tax management Cost allocationTransfer pricingImport tariffs Repatriation of profits

First Commandment Where you have excess tax credits, report branch profits in the lowest-tax jurisdiction by allocating costs to highest tax-jurisdiction. Elsewhere, cost allocation does not matter (from the standpoint of tax payments).

Second Commandment Where one branch sells to another, set the transfer price as high as possible when π*>π, without making profits negative, and as low as possible when π* π, without making profits negative, and as low as possible when π*<π without making profits negative. π is the tax rate on profits earned by the first branch π* is the tax rate on profits earned by foreign branch.

Third Commandment 3a. In the absence of excess tax credits, use low transfer prices to minimize tariffs. If you have excess tax credits, minimize the sum of taxes and tariffs by comparing π* to [π + π* d ( 1-π*)] 3a. In the absence of excess tax credits, use low transfer prices to minimize tariffs. If you have excess tax credits, minimize the sum of taxes and tariffs by comparing π* to [π + π* d ( 1-π*)] 3b. Use a high transfer price if π*>[π +π* d (1-π*)], so long as profits are positive, and a low transfer price if π* [π +π* d (1-π*)], so long as profits are positive, and a low transfer price if π*<[π+ π* d (1-π*)]. π-income tax rate in exporting country π*-income tax rate in importing country (foreign tax paid on marginal profits booked in the importing country) π+ π* d (1-π*)]- total tax bill associated with marginal profits booked in the exporting country) π* d- Import duty in the importing country

Fourth Commandment  If you don’t plan to repatriate profits, profitable operations should be subsidiaries. Loss making foreign operations should always be branches so long as loses can be used to offset profits elsewhere.

Fifth Commandment  Where profits aren’t repatriated they should be reported in the lowest-tax jurisdiction by allocating cost to the highest-tax jurisdiction or by setting transfer price as high as possible when π* > π, and as low as possible when π* π, and as low as possible when π*< π, so long as profits are positive. π is the tax rate on profits earned by the first subsidiary π* is the tax rate on profits earned by foreign subsidiary

Sixth Commandment  If there is no repatriation, report subsidiary profits in the lowest-tax jurisdictions by setting transfer prices as high as possible when π* > π, and as low as possible when π* π, and as low as possible when π*< π, without making profits negative. π is the tax rate on profits earned by the first subsidiary π* is the tax rate on profits earned by foreign subsidiary

Seventh Commandment  If there is no repatriation of profits, minimize total subsidiary taxes paid in the presence of import tariffs by comparing π* to π + π d * (1- π*) by using a high transfer price if π* > π +π d * (1- π*) and a low transfer price if π* π +π d * (1- π*) and a low transfer price if π* < π + π d * (1- π*), without making profits negative.

Eighth Commandment  Repatriate profits from branches before repatriating profits from subsidiaries (there is no tax payoff to holding profits from branches abroad.

Ninth Commandment  If profits are fully repatriated and there are no excess tax credits, it generally doesn’t matter whether foreign operations are branches or subsidiaries.  Where there are excess tax credits, foreign operations should be set up as branches to avoid withholding taxes on profit repatriation, or if unprofitable, to receive immediate tax benefits.

Tenth Commandment  With partial repatriation, subsidiaries should pay dividends where the sum of the withholding tax and additional tax liability to the U.S. government is lowest. In other words, minimize excess tax credits.

Intertemporal Considerations  One-year investment horizon-focus on before-tax rates of return  Longer investment horizon- after-local-tax rates of return are relevant

Summary of Branch Tax Management Commandments Decision Firm Doesn’t Have Excess Tax Credits Firm Has Excess Tax Credits Cost allocation Does not matter Allocate cost to high-tax countries Transfer Pricing Does not matter Show profits in low- tax countries Transfer Pricing with Tariff Low transfer price Minimize total taxes