F4: Taxation and Reporting in The Multinational Firm

Question 1

What are the instruments of corporate tax planning?

Answer 1

1: Transfer Pricing
2: Intercompany financing
3: Royalties, license fees, management fees or dividends

Question 2

What is the residence principle of international taxation?

Answer 2

All residents of the country are taxed on their worldwide income
For an example if I as a person am a resident of Denmark this would mean that I pay Danish taxes on all my income no matter where in the world I receive the income

Question 3

What is the source principle of international taxation?

Answer 3

All income earned inside the country is taxable in this country (residents & non-residents)
So my normal income is taxed in Denmark, but if I own an apartment in Spain then the rental income from this apartment will be taxed in Spain

Question 4

How does double taxation occur?

Answer 4

If all countries could agree on either the residence or source principle there would be no risk of double taxation
But it’s unrealistic because either developed countries would lose income taxes from multinationals (source principle), or developing countries would lose income taxes from multinationals operating in their countries (residence principle)

Question 5

What does most countries do to avoid double taxation?

Answer 5

1: Application of residence principle to residents
2: Application of source principle to non-residents
3: Allow for tax credits or tax exemption for residents’ income generated abroad
4: Negotiate bilateral double tax treaties to clarify which country has the right to tax which kind of income

Question 6

What are the two methods to avoid double taxation?

Answer 6

1: Tax credit method = taxes paid abroad under source principle are credited against home country tax liability
2: Tax exclusion method = income taxed abroad under source principle is excluded from taxation in home country

Question 7

What are the advantages of branches?

Answer 7

1: Losses in branch can be used in home country tax calculation
2: Transfer of branch assets to/from the home entity are not sales, because it is the same entity
3: Easier to move money to main entity (because it is the legal owner)
4: Branches can later be incorporated into subsidiaries if business is well

Question 8

What are the disadvantages of branches?

Answer 8

1: Branches are taxed immediately
2: Full liability for MNC actions
3: Cost and income has to be booked separately from main entity anyways

Question 9

Explain transfer pricing

Answer 9

The overall goal of corporate tax planning is to move income from high tax branches/subsidiaries to low-tax branches/subsidiaries in order to reduce overall tax expense
Transfer pricing is the practice of setting prices for sales from one entity to another. Tax authorities require “arm’s length pricing” meaning market prices
There are 2 primary methods of transfer pricing: 1) cost plus (add a markup to production costs) and 2) comparable uncontrolled price (=market price based on independent market transactions)
Transfer pricing has the highest effect on high margin items

Question 10

Instrument of corporate tax planning: explain intercompany financing

Answer 10

Granting of loan from low-tax country to high-tax country can be tax-beneficial (but beware of withholding taxes). By doing this the entity in the high-tax country has to pay interest to the entity in the low-tax country and by doing so the taxable income in the high-tax country will decrease and the taxable income in the low-tax country will increase
The interest rate does however have to be at arm’s length

Question 11

Instrument of corporate tax planning: explain royalties/license fees

Answer 11

Having intellectual property in low-tax country and invoicing royalties / license fees / management fees to high-tax countries can be tax-beneficial
But most countries also charge withholding taxes

Question 12

Explain withholding taxes

Answer 12

Whenever money leaves the country based on something that’s subject to withholding taxes, i.e. royalties and dividends, then the country will keep a portion of the amount as withholding tax
These withholding taxes can most often be deducted from corporate tax of charging country [credit method]

Question 13

Instrument of corporate tax planning: explain dividends

Answer 13

Dividends are the only way to transfer significant distribution potential to owners of the parent entity
Many host countries charge withholding taxes for dividends leaving the country [more tax expense]
Dividends are income for the receiving company. Dividend income from majority owned entities are in most cases exempt from corporate taxation [exclusion method]

Question 14

Why is IFRS necessary?

Answer 14

Provide relevant and comparable information to international investors, lenders, and other creditors
The main point is to have relevant and comparable information to increase transparency
Help participants in the various capital markets of the world & other users make economic decisions about providing resources to an entity

Question 15

What are consolidated financial statements?

Answer 15

Consolidated financial statements are financial statements 1) of a group of companies 2) under the control of a parent 3) presented as those of a single entity
It has to be a group of entities that are under the control of one parent and if that’s the case one has to act, with regard to consolidated financial statements, as if those several entities is only one single entity for the purpose of compiling the consolidated financials

Question 16

Explain the concept of control

Answer 16

A firm controls an entity if it has rights to variable returns from the entity
A firm controls an entity if it has the ability to affect its returns through management appointments.
Control exists when the parent owns more than half the voting rights of an entity

Question 17

Explain line-by-line consolidation

Answer 17

You have to collect from every company in the group the income statement and balance – you need all assets, liabilities, expenses and revenues. Make sure it is accounted for using the same accounting policies for all group companies and then sum up line-by-line all assets, liabilities, expenses and revenue. As soon you have control you have to sum up everything – 100%
Elimination of the parent’s investment in subsidiaries and its portion of their equity
Elimination in full of intra-group balances, transactions and unrealized profits and losses

Question 18

Explain at-equity consolidation

Answer 18

You include on single line in the balance sheet and one single line in the income statement that represents your share of the company
Subsequent adjustment for proportionate change of equity of the associate or joint venture

Question 19

Explain goodwill

Answer 19

Goodwill is the amount of money a firm pays above the fair value of the assets of a company
Goodwill has to be impairment tested each year. The impairment test is based on the expected future income of the part of the group for which this goodwill is relevant
Goodwill impairment is an expense and has to be booked on the profit/loss statement
It’s often the case that there’s been a loss for a company due to the fact that some part of the corporation is having a bad time and in addition this corporation has goodwill that has to be impaired in addition to the weak operating income

Question 20

Which of the following statements about indicators for the type of consolidation are correct according to International Financial Reporting Standards (IFRS)?

Answer 20

The correct answers are (b), (d) and (e)