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Taxation of International Transactions

Introduction

Multinational corporations (MNC) are perceived to entail business enterprises that have their operations in several different countries. These enterprises are headquartered in their parent or home countries and run their operations in several other countries. MNCs are hailed for their immense contribution towards economic globalization. The distinctive character of this phenomenon is the increase in number of nations taking part in the world economic integration. This level of integration is attainable via three key channels: international capital movements, international exchange of knowledge and technology, and most importantly, through international trade (Kleinert, 2004). Foreign Direct Investments (FDI) has further encouraged the growth of MNCs and the world economy. A good example of an MNC is the Japanese owned Toyota Corporation. This MNC is wholly owned by the Japanese and it is headquartered in Tokyo, Japan, with subsidiaries in the United States and other countries.

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In the US, Toyota is one of the biggest car sellers in the economy. The USA subsidiary, Toyota Motor Sales Inc. was founded in 1957 in Hollywood. This subsidiary has witnessed steady growth in market share and has diversified its operations by going into motor manufacturing. In 1991, Toyota won the title for the most sold passenger cars. By the close of the year 2000, Toyota’s Lexus edged out Mercedes Benz as America’s most preferred luxury brand. Today, Toyota is one of the largest manufacturer and distributor of motor vehicles in Japan, the USA, and Europe and beyond.

Impacts of Multiple currencies

The multiple-currency is one of the major problems affecting most MNCs. This may lead to collection of sales revenue in one currency, assets reported in another, and profits measured in a different currency. To remedy this situation, the Financial Accounting Standards Board (FASB) of the US came up with a statement (FASB statement no. 52) that addresses foreign currency translations. According to this statement, the operations, assets, and liabilities of a foreign trading entity must be reported using the functional currency of the foreign enterprise in question. The foreign currency on the statement refers to the currency of the primary economic environment where the firm operates. All multinational corporations, regardless of ownership, are required by law to pay taxes on the profits they make as a result of their operations in the United States. The Internal Revenue Service (IRS), an agency charged with the collection of taxes, encounters problems when it comes to ascertaining the value of the multinational firm that they should tax (Eden, 1998).This problem is occasioned by the fact that the MNCs evade paying tax by shifting their deductible expenses in the USA.

Toyota Corporation subsidiaries’ accounts are reported in the currencies of their primary economic environments. In other words, each subsidiary’s financial statements are presented using the host country’s currency of trade, which may include the US dollar, the euro, the Australian dollar, the British pound, and the Canadian dollar. The accounts of the parent corporation, however, are made up in Yen, meaning that in the case of consolidated financial statements, all subsidiaries’ financial statements have to be converted to Japanese Yen at the prevailing foreign exchange rate, a scenario that may yield exchange gain or loss depending on the strength of each currency under consideration. Fluctuations in the exchange rates especially of the Yen against the subsidiaries’ currencies present a special challenge especially when it comes to drawing up of consolidated financial statements. These fluctuations expose Toyota to transaction and translation risks, and in the long run, the MNC’s operations suffer adversely. Corporation tax as an expense is deductible at the host country. The MNC declares and pays tax in the sum of its profits that it accrues in the host country. This expense is deducted by the relevant tax authority and in the functional currency prevailing; for instance, Toyota motors sales inc. (USA) pays its corporation tax in US dollars. Supposing there is a disparity in the currency exchange rates that puts the parent corporation at a weaker stand, then, it is beneficial to the parent of the MNC that tax is deducted in the host country’s currency. The multiple currency scenarios affect the operations of the MNC especially in host countries whose currencies suffer rampant hyperinflationary trends (Eden, 1998).

Separate Transaction accounting method

The dollar approximate separate accounting transactions method (DASTM) was proposed by the Tax Executives Institute (TEI) as a remedial measure in countries with hyperinflationary currencies. TEI comprises of corporate tax executives drawn from MNCs in North America. TEI proposes a translation method for evaluating DASTM loss or gain that is similar to that used for United State’s GAAP purposes. This translation in effect eliminates timing distortions occasioned by the current method. This is achieved by matching the recognition time of the DASTM loss or gain to the recognition of income or expenditure of a MNC’s Income statement (Eden, 1998).Conforming DASTM to the GAAP translation will ease the compliance burden on the MNC they can rely on the same financial statement for reporting purposes. These proposals are also aimed at reducing the compliance burden further. DASTM allows the MNCs to translate their monetary assets and liabilities at the period end exchange rate. Being that Toyota operates in the USA and the reporting currency (dollar) suffers from periodic hyperinflation, I would strongly advise the MNC to adopt the proposed DASTM regulation (Eden, 1998).

Tax plan on Liquidation of an operation

Tax planning is aimed at ensuring the liquidating MNC pays the least amount of tax. An effective tax plan can be reached at by reducing income, taking advantage of tax credits, and increasing the MNC’s tax deductions. The Adjusted gross income (AGI) is an important component in determining of the MNC’s taxes. I would advice that Toyota opens up a subsidiary in a tax haven country such as Puerto Rico and aggressively shift income from liquidation to this affiliate. This would ensure that they benefit from the tax exemption that companies hosted in Puerto Rico are enjoying. Further, the MNC can also assign the assets from the liquidating company to the Puerto Rico subsidiary. In this case, they will effectively be sure that they will not be taxed when liquidating the assets. This would be an important strategy that will not only see the MNCs cutting down on their tax burden, but also an improvement in their profitability and performance.

According to the Internal revenue Code section 334(a), the market fair value of a property received in a complete liquidation will be the basis of the property currently with the distribute. However, this code does not expressly apply to or exempt foreign corporations that are undergoing liquidation. In case of a foreign corporation, the transactions would be non-taxable, unless the company undergoing liquidation has assets that belong to the host country, in which case, the treatment would be different.

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Management of outbound and non-outbound transfers

The FASB issued an interpretation (interpretation No. 48). This interpretation relates to Accounting for Uncertainty in Income taxes. It interprets FASB statement number 109, which clarifies that accounting for uncertainty in income tax, must be recognized in the MNC’s financial statement. Outbound transfers by MNCs outside the USA taxing jurisdiction gives rise to both the exemption system and the credit system (Ault, 1997). From the exemption system’s point of view, the appreciation in the value of an asset transferred to a foreign branch whose income warrants an exemption will be exempted from tax by the host country. Similarly, if dividends from an asset that resulted from a direct investment are tax exempt, the asset itself will also not be taxed (Ault, 1997). From the point of view of a credit system, the taxing jurisdiction will reserve their claim on an asset regardless its transfer to a foreign branch. The existence of credit confers a primary tax claim to the country of source. In the event that the credit rates are similar, the overall effect will be similar to that of an exempt system.

Ordinarily, outbound transfers are supposed to be taxed by the country in the taxing jurisdiction. Outbound transfers may include royalty payments, head office charges, and dividends. On the other hand, inbound charges may include transfer of capital equipments and intermediary parts. The best way to manage the outbound transfers will be by sending these proceeds to the subsidiary located in the tax haven. Inbound transfers can also be managed by ensuring that the MNC trades only with firms that have favorable tax environments and the MNC should also capitalize on every tax incentive and credit extended to it by the host country.

Conclusion

The relevance of multinational companies in the world economy cannot be over emphasized. Further, we cannot afford to take lightly the issue of tax havens and how it impacts on the taxation of international transactions. We should appreciate that conflicts might arise from conflicting policies. Most established or developed economies have stringent measures that aim at eliminating tax havens. Such strict regulations are however retrogressive. The policies fail in their attempt to bar MNCs from utilizing the tax haven simply because they are ambiguous and have not provided clarity as regards the issue of tax havens. Until such a time that clear-cut tax laws will be instituted, the MNCs will continue to thrive by taking advantage of the tax haven. The IRS should therefore move with speed to institute stringent measures that will not only widen the tax net but also seal the loopholes that are within. This action will go a long way to trap the MNCs and the Local Corporations that made tax evasion their habit. I believe that for the sake of economic prosperity of the host country, the host government should provide incentives that will ease the tax burden on the MNCs and offer incentives such as tax credits that will encourage them to be tax compliant. Finally, we must appreciate that globalization is an ongoing process. These we should face boldly and forge ahead to create a world economy that is beneficial both to the host and parent countries.

References

Ault, H. J. (1997). Comparative income taxation: A structural analysis. The Hague: Kluwer law international.

Eden, L. (1998). Taxing multinationals: Transfer pricing and corporate income taxation in North America. Toronto: University of Toronto Press.

Kleinert, J. (2004). The role of multinational enterprises in globalization. Berlin: Springer.

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