Step 4. Calculate the option price (for a call option)
2.3 Multinationals and tax planning
Multinationals are subject to tax on their profits in all the countries in which they operate. They are also subject to tax on their world-wide profits in their country of registration. As explained earlier, the tax burden is reduced by the existence of double taxation agreements between countries, and a multinational is able to set off tax paid in foreign countries against tax payable in the country of registration.
For example, a UK multinational may be liable to tax in Country X on the profits of a subsidiary in Country X. Suppose that the amount of this tax liability is the equivalent of £500,000. The UK parent company will also be liable to tax in the UK for the profits (or dividends) of the foreign subsidiary. If a double taxation agreement exists between the UK and Country X, the following tax positions might arise.
If the UK tax liability for the foreign subsidiary is more than £500,000, tax payable in the UK will be reduced by the tax payable in Country X (£500,000).
If the UK tax liability for the foreign subsidiary is less than £500,000, no tax is payable in the UK.
Tax planning to reduce a tax liability
A multinational may be able to reduce its world-wide tax liability through tax planning. One measure might be to establish a subsidiary company in a tax haven, and by channelling its profits and capital gains in other countries through the tax haven, its total tax liability might be reduced.
An example may help to illustrate this point.
Example
A UK multinational company has three wholly-owned foreign subsidiaries, in Country A, Country B and Country C. The profits of each subsidiary for the year are the equivalent of £100,000. The rate of corporate tax in the UK is 30%.
The tax rates in the other countries are set out below.
Country
Tax on profits
Withholding tax on dividends
% of after-tax profit remitted to the UK as dividends
Country A 20% 5% 90
Country B 25% - 90
Country C 40% 10% 80
Double taxation agreements exist between the UK and each of the three countries.
Required
Calculate the world-wide tax liability of the UK multinational in each of the three following circumstances:
(a) The UK government charges companies tax on the dividends remitted from foreign subsidiaries. The amount of the dividend is grossed up at the local tax rate, before deduction of any withholding tax, and UK tax is calculated on this grossed-up dividend.
(b) The UK government charges multinationals tax on the gross income of their foreign subsidiaries. A tax credit is available for all corporate taxes paid in foreign countries, including withholding tax.
(c) The multinational sets up a subsidiary in a tax haven (Country D). All income from the foreign subsidiaries would be transferred to the UK via this tax haven
company. The UK government would then treat all the foreign income as coming through a single source, the tax haven company in Country D.
Calculate the total tax payable on the foreign profits of the multinational if the tax rules are:
(i) the same as in (a) (ii) the same as in (b).
Answer (a)
Country A Country B Country C
£000 £000 £000
Taxable income 100.0 100.0 100.0
Local tax on profits (20%) 20.0 (25%) 25.0 (40%) 40.0
80.0 75.0 60.0
Dividend payment
before withholding tax (90%) 72.0 (90%) 67.5 (80%) 48.0
Withholding tax (5%) 3.6 (10%) 4.8
Dividends to UK before deducting withholding tax
72.0 67.5 48.0
Gross up for local tax (× 100/80) 90.0 (× 100/75) 90.0 (× 100/60) 80.0
UK tax liability at 30% 27.0 27.0 24.0
Foreign tax credit (see
note below) (20 + 3.6) 23.6 25.0 24.0
UK tax payable 3.4 2.0 0.0
Note: The foreign tax credit is the lower amount of tax payable in the foreign country and tax payable in the UK.
Summary £000 Tax payable in other countries (20 + 25 + 40 + 3.6 + 4.8) 93.4
Tax payable in the UK (3.4 + 2.0) 5.4 Worldwide tax liability 98.8 (b)
Country A Country B Country C
£000 £000 £000
Taxable income 100.0 100.0 100.0
Local tax on profits (20%) 20.0 (25%) 25.0 (40%) 40.0 80.0 75.0 60.0 Dividend payment before withholding
tax
(90%) 72.0 (90%) 67.5 (80%) 48.0
Withholding tax (5%) 3.6 (10%) 4.8
Income for UK tax purposes 100.0 100.0 100.0 UK tax liability at 30% 30.0 30.0 30.0 Foreign tax credit (see note above) 23.6 25.0 30.0
UK tax payable 6.4 5.0 0.0
Summary £000 Tax payable in other countries (20 + 25 + 40 + 3.6 + 4.8) 93.4
Tax payable in the UK (6.4 + 5.0) 11.4 Worldwide tax liability 104.8
Under these tax rules, more tax is payable in the UK than with the tax system in (a).
(c)
Tax system in (a)
Tax system in (b)
£000 £000
Tax payable in other countries 93.4 93.4 UK tax liability (90 + 90
+ 80)
260.0 300.0
UK tax at 30% 78.0 90.0
Foreign tax credit 78.0 90.0 Tax payable in the UK 0.0 0.0
The worldwide tax payable is just £93,400 because no tax is now payable in the UK (because a tax credit of up to £93,400 would be available). Setting up the tax haven therefore reduces the word-wide tax burden for the multinational.
Free trade and protectionism
Protectionism
Free trade
The arguments for free trade and potectionism
Common markets
Restrictions on movements of capital or currency
World Trade Organisation (WTO)
3 Free trade and protectionism
You need to be aware of the arguments for and against free trade, and for and against protectionism.