Solutions Manual to accompany International

Corporate Finance 9780073530666

To download the complete and accurate content document, go to:

https://testbankbell.com/download/solutions-manual-to-accompany-international-corp
orate-finance-9780073530666/
Solutions Manual to accompany International Corporate Finance 9780073530666

14. Clover Machines Case: Minimizing Global Taxes

1. Construct plausible scenarios in which Clover faces higher Indian taxes than U.S. taxes.
Why are the data on taxes presented in the text not uniformly relevant to all corporations?

According to data from the year 2008 reported in the chapter, U.S. corporations such as
Clover face a 40% tax rate in India along with withholding taxes on dividends and
royalties of 15% and 10% respectively. This appears somewhat contradictory to the
statement in the case that the Indian corporate tax is moderately high. Further, as
discussed in the text, MNCs face other taxes such as real estate taxes, city taxes and
customs duties in foreign countries. Since exposure to these other taxes depends on
specific methods of operations (location, sourcing of local components, importations of
supplies, etc.), each firm may face a unique tax scenario.

2. Discuss the trade-off between tax savings and transaction costs. What is your
recommendation for Clover?

Taxes can be lowered by expending resources (that is, transaction costs) toward
minimization activities. At the margin, an extra dollar of resources used to “minimize
taxes” would equal a dollar of tax savings. This is the familiar “marginal cost = marginal
revenue” argument found in economics texts. If there are uncertainties (and
opportunities) related to the use of tax minimization methods such as transfer pricing,
Clover may be justified in spending more efforts and resources to save taxes. In the
Indian context, based on the facts presented in the case, it might appear that Clover is
justified in spending significant resources toward tax minimization.

3. Should Clover’s ex ante objective be minimization of taxes or minimization of tax-related

hassles? In answering this question, refer to facts pertinent to the Indian situation
presented in the case.

As a general proposition and consistent with the answer to the previous question, firms
must seek to minimize the sum of taxes and transaction costs. Tax related “hassles” such
as those presented in the Indian context may be counted as part of transaction costs. For
example, it appears that all transactions exceeding USD 3.75 million are automatically
audited. This imposes organizational costs on the firm as it responds to tax authorities.
Further, given the uncertainty of transfer pricing regulations, even when a firm makes a
good faith effort to follow rules, it may become subject to penalties. Clover must quantify
these costs and expected penalties as it develops a tax strategy.

4. Based on your general understanding of taxes comment on the following: “Clover needs
to minimize taxes by selecting appropriate countries for its operations, selecting the right
organizational structure (subsidiary or JV) in addition to selecting the right transfer

Visit TestBankBell.com to get complete for all chapters

 prices.”

The choice of subsidiary or JV will influence the form in which the parent receives cash
flows. Royalty and license fees are often tax deductible for foreign subsidiaries. Further,
as noted in the answer to question (1), the withholding tax rate on royalty is lower than
the rate for dividends. Therefore, in cases where the foreign income tax rate is higher
than the rate in the country of the parent, an MNC can minimize taxes by increasing
royalty and license fees.

5. Using information from the IRS’s Web site or other sources (e.g.,
http://www.irs.gov/irm/part4/ch46s03.html#d0e562342) briefly summarize how the IRS
would evaluate the sourcing of components from Clover’s affiliate in India. Comment on
the comparison between controlled and uncontrolled transactions.

Transfer pricing is governed by title 26 section 482 of US code (see

http://www.law.cornell.edu/uscode/html/uscode26/usc_sec_26_00000482----000-.html)
which is as follows: “In any case of two or more organizations, trades, or businesses
(whether or not incorporated, whether or not organized in the United States, and whether
or not affiliated) owned or controlled directly or indirectly by the same interests, the
Secretary may distribute, apportion, or allocate gross income, deductions, credits, or
allowances between or among such organizations, trades, or businesses, if he determines
that such distribution, apportionment, or allocation is necessary in order to prevent
evasion of taxes or clearly to reflect the income of any of such organizations, trades, or
businesses. In the case of any transfer (or license) of intangible property (within the
meaning of section 936 (h)(3)(B)), the income with respect to such transfer or license
shall be commensurate with the income attributable to the intangible.” As a practical
matter, the manner in which the IRS enforces this code is what is important for
businesses. This enforcement evolves over time and information about recent cases are
found in www.irs.gov.

The IRS website actually makes public guidance provided to IRS international examiners
(IE) concerning transfer pricing cases. A key step in evaluating a controlled transaction—
one orchestrated by the MNC—is to identify an uncontrolled or market transaction.
Prices in the controlled and uncontrolled transactions are compared. Adjustments are
made for differences. The IE exercises judgment to determine whether there are
significant differences and whether a penalty should be assessed.

A key issue for Clover is the nature of components sourced from the Indian affiliate. If
these components are similar to other products openly sold in markets, Clover is
constrained in its selection of the transfer price. The more unique the components, the
greater the discretion in setting the transfer price. However, this discretion is moderated
Solutions Manual to accompany International Corporate Finance 9780073530666

by factors such as ones discussed in the IRS document. For example, IE conduct an
economic analysis (e.g., calculate rates of return) to determine whether the affiliates and
the MNC generate normal returns from their operations. Substantial deviations from
industry averages may signify a transfer pricing problem.

Visit TestBankBell.com to get complete for all chapters