Solutions Manual For

Solutions Manual For International Financial Management 10 th Edition By Cheol Eun, Bruce Resnick, Tuugi Chuluun (All Chapters 1-21, 100% Original Verified, A+ Grade) All Chapters Arranged

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CHAPTER 21 INTERNATIONAL TAX ENVIRONMENT AND TRANSFER PRICING

ANSWERS & SOLUTIONS TO END-OF-CHAPTER QUESTIONS AND PROBLEMS

QUESTIONS

1.Discuss the twin objectives of taxation. Be sure to define the key words.Answer:There are two basic objectives of taxation that are necessary to discuss to help frame our thinking about the international tax environment: tax neutrality and tax equity.Tax neutrality has its foundations in the principles of economic efficiency and equality. Tax neutrality is determined by three criteria. Capital-export neutrality is the criterion that an ideal tax should be effective in raising revenue for the government and not have any negative effects on the economic decision-making process of the taxpayer. That is, a good tax is one that is efficient in raising tax revenue for the government and does not prevent economic resources from being allocated to their most appropriate use no matter where in the world the highest rate of return can be earned. A second neutrality criterion is national neutrality. That is, regardless of where in the world taxable income is earned it is taxed in the same manner by the taxpayer’s national tax authority. In theory, national tax neutrality is a commendable objective, as it is based on the principle of equality. The third neutrality criterion is capital-import neutrality. This criterion implies that the tax burden placed on the foreign subsidiary of a MNC by the host country should be the same regardless in which country the MNC is incorporated and the same as that placed on domestic firms.Tax equity is the principle that all similarly situated taxpayers should participate in the cost of operating the government according to the same rules. This means that regardless in which country an affiliate of a MNC earns taxable income, the same tax rate and tax due date apply.

2.Compare and contrast the three basic types of taxation that governments levy within their tax jurisdiction.Answer:There are three basic types of taxation that national governments throughout the world use in generating tax revenue: income tax, withholding tax, and value-added tax. Many countries in the world obtain a significant portion of their tax revenue from imposing an income tax on personal and corporate income. An income tax is a direct tax, that is, one that is paid ©MCGRAW HILL LLC. ALL RIGHTS RESERVED. NO REPRODUCTION OR DISTRIBUTION WITHOUT THE PRIOR WRITTEN CONSENT OF MCGRAW HILL LLC 2 / 4

directly by the taxpayer on whom it is levied. The tax is levied on active income, that is, income that results from production by the firm or individual or from services that have been provided. A withholding tax is a tax levied on passive income earned by an individual or corporation of one country within the tax jurisdiction of another country. Passive income includes dividends and interest income, and income from royalties, patents or copyrights paid to the taxpayer. A withholding tax is an indirect tax, that is, a tax borne by a taxpayer that did not directly generate the income that serves as the source of the passive income. The tax is withheld from payments the corporation makes to the taxpayer and turned over to the local tax authority. A value-added tax (VAT) is an indirect national tax charged on the sales price of a service or consumption good as it moves through the various stages of production and/or service. As such, a VAT is a sales tax borne by the final consumer.

3.Discuss how double taxation on a taxpayer may result if all countries were to tax the worldwide income of their residents and the income earned within their territorial boundaries.Answer:There are two fundamental types of tax jurisdiction: the worldwide and the territorial.The worldwide method of declaring a national tax jurisdiction is to tax national residents of the country on their worldwide income no matter in which country it is earned. The territorial method of declaring a tax jurisdiction is to tax all income earned within the country by any taxpayer, domestic or foreign. Hence, regardless of the nationality of a taxpayer, if the income is earned within the territorial boundary of a country it is taxed by that country.If a MNC was a resident of a country that taxed worldwide income, the foreign-source income of its foreign affiliates would be taxed in the parent country. If the host country also taxes the income of the affiliate earned within its territorial borders, the foreign affiliate would pay taxes on the same income both in the host country and in the parent country. To avoid this “evil,” some mechanism needs to be established to prevent double taxation.

4.What methods do taxing authorities use to eliminate or mitigate the evil of double taxation?Answer:The typical approach to avoiding double taxation is for a nation not to tax foreign- source income of its national residents. An alternative method, and the one the U.S. follows on certain types of foreign-source income, is to grant to the parent firm foreign tax credits against U.S. taxes for taxes paid to foreign tax authorities.©MCGRAW HILL LLC. ALL RIGHTS RESERVED. NO REPRODUCTION OR DISTRIBUTION WITHOUT THE PRIOR WRITTEN CONSENT OF MCGRAW HILL LLC 3 / 4

5.How might a MNC use transfer pricing strategies? How do import duties affect transfer pricing policies?Answer:A MNC might use transfer pricing strategies for two basic purposes: income tax liability reduction or funds repositioning. If the tax rate in the country of the selling affiliate is less than the tax rate in the buying affiliate country, a high markup policy on sales will leave little taxable income in the buying affiliate country to be taxed at the higher rate. Even if the tax rate in the buying affiliate country is not more than that in the selling affiliate country, a high markup policy will leave less funds to be removed from the buying affiliate country. In general, import duties work in the opposite direction from income taxes. For example, a high markup policy will decrease the income taxes due in the buying affiliate country but increase the import duty due in that country. Generally, the income tax is more important in comparison to the import duty in its after-tax effect on consolidated net income.

6.What are the various means the taxing authority of a country might use to determine if a transfer price is reasonable?Answer:The U.S. and many other countries require the transfer price to be consistent with arm’s length pricing, i.e., be a price that an unrelated party would pay for the same good or service. The taxing authority can arbitrarily set the transfer price if it believes that transfer pricing schemes are being used to evade taxes or that taxable income is not being clearly reflected.There are three general methods to establish arm’s length pricing. One method is to use a comparable uncontrolled price at which the good or service would be priced between unrelated parties. A second method is the resale price approach; that is, reduce the price at which the good is resold by an amount sufficient to cover overhead costs and a reasonable profit for the selling affiliate. The third method is the cost-plus approach, where an appropriate profit is added to the cost of the manufacturing affiliate.

7.Discuss how a MNC might attempt to repatriate blocked funds from a host country.Answer:There are several methods a parent firm might use to repatriate profits from an affiliate in a host country that is blocking funds. Some of these measures should be enacted early on as a guard against future funds blockage. One is to establish a regular dividend policy that the host country becomes used to and expects. This assumes, however, the host country ©MCGRAW HILL LLC. ALL RIGHTS RESERVED. NO REPRODUCTION OR DISTRIBUTION WITHOUT THE PRIOR WRITTEN CONSENT OF MCGRAW HILL LLC

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