Income and capital gains tax: MNCs face a variety of direct and indirect taxes. The direct taxes are income and capital gains tax. Income tax is the tax levied on income either of an individual or of a corporate. Corporate income tax is a source of revenue to the state. Most of the developing’ countries have low per-capita income, therefore individual income taxes do not contribute enough funds to- revenues of the state. Higher taxes on individuals are not desirable because of low disposable income, therefore, the governments try to generate larger revenue from the corporate income taxes. In developed countries, in addition to large corporate income, per capita income is also very high, therefore income tax generate large revenues even at the small rate of taxation.
Capital gains and losses occur due to local sale of capital assets especially due to sale of real estate stocks and bonds. If these assets are held for a longer period, these are likely to generate larger income and, therefore, attract preferential tax treatment.
Sales Tax: Sales tax may be levied ad-volrem (on the value) or on value addition (VAT) during a process of production. The sales tax in different 3 countries, is levied at different stages of sales process. In England, the sales tax is levied when the goods are wholesaled, in US it is applied when it is retailed. In Germany, it is levied at all stages of production cycle. Value added tax is the tax levied on the value added during a process of production. In Europe; most of the countries have started following value added tax system.
Excise and Tariffs: Excise is the tax on the production of finished goods. This tax can be ad. volrem (i.e. value based) or unit tax (unit of production based). Tariffs are levied on imported goods that parallel excise and other indirect taxes paid by domestic producers of similar goods. This tax may be levied to generate revenue or to protect domestic industry against foreign competition. Modest tariff represents revenue collections of the state but exorbitant tariffs indicate protective intentions of the government authorities. Although protective tariffs do not eliminate the import of foreign products completely, but these put the foreign product at a comparative disadvantage. In this case, consumers have to pay more for the imported goods.
Withholding taxes: These taxes are imposed by the host governments on dividend and interest payments to foreign investors and debt holders. These taxes are collected before receipt of income. These taxes are withheld at the source by the paying corporation that is why these taxes are called withholding taxes.
Princeples of taxation in MNCs
Taxes are levied and charged based on some principles. These are as follows:
There always exists a conflict between economic profits and corporate ethics (morality). Some companies feel that the corporate ethics is one, and economic profit is another, therefore, they have to make a choice between these two. It is also well known that both the corporate and the individual are not completely honest with the tax authorities. The MNCs have to decide to what an extent the company should be honest in complying with the tax laws. Some companies feel that they must evade taxes to the same extent as their competitors to protect their competitive position. Ethical standards in a nation depend on business practices, cultural history and historical development of the nation. Since these aspects differ from nation to nation, therefore, the ethical codes will differ from country to country. Host countries also have the same problem, therefore tax authorities try to adhere to two principles of international taxation: neutrality and equity.
Many developing countries, offer tax incentives for private foreign investments. These tax incentives abandon the principle of an economically neutral system.
Countries usually claim the right to tax income either on a global basis or on territorial basis. Global claims assume that countries have the right to tax companies and all their subsidiaries. The firms may be domiciled, incorporated or otherwise headquartered with in their borders. Under this philosophy, the firms will be facing double taxation. Firstly, the income is taxed at the subsidiary level and there after at the parent level.
Unitary taxation is a special type of taxation designed to tax world wide income of a company and is based on global perspective of taxation. This type of taxation is prevalent in the state of California USA. State of California in US use unitary tax system and assesses multinational companies on a proportion of their world wide profits. The tax assessment is based on a formula that requires world wide combined reporting (WWCR), which calculates taxes for multinational firms on the basis of local sales, pay roll and property as proportion of multinationals world wide total income.
The second perspective is based on the principle of national sovereignty. Under this principle, the countries claim the right to tax income earned within their own territory. The territorial claims are very popular among multinational corporations. Some countries would like to tax total income of their multinational while the others believe that the income generated within the territorial limits be taxed. The countries like Hong Kong, Switzerland and many Latin American companies do not tax the income of their companies earned overseas.
The tax systems are based on two types of concepts: (a) tax neutrality, and (b) tax equity. Tax neutrality means that the decisions regarding investments are not affected by tax laws, i.e. the taxes are neutral in their effect on decision making process. Tax equity means that equal sacrifices are made by the community in bearing the tax burden.
A tax will be neutral if it does not influence any aspect of borrowing and investment decision. The justification of the tax neutrality is the efficient use of capital. The economic welfare of nations would increase if the capital is free to move from one country to another in search of higher rates of return. In this way, the capital is used efficiently. If the tax system distorts the after tax profitability between two investments, then the gross world product would be less, had this distortion not taken place. Total neutrality has two components: (i) domestic neutrality, and (ii) foreign neutrality.
This means that the citizen investing in the domestic market and foreign markets are treated equally. In this case, the marginal tax burden on the domestic returns is equal to the marginal tax burden on the income earned overseas. This form of neutrality involves uniformity at two levels: (1) uniformity in both the applicable tax rate and the determination of taxable income, and (2) equalisation of all taxes on profit whether earned domestically or overseas.
Lack of uniformity arises because of different rules and regulations governing depreciation, allocation of expenses and determining revenue. In other words, differences in accounting methods and government policies distort uniformity in determining the taxable income. Because of these policies, different level of profitability is possible for same level of cash flows. Capital expenditure is granted concession in taxation while other expenditure are not treated in the same fashion. Thus in some cases, equal tax rates would not result into equal tax burdens.
Foreign tax neutrality means that the subsidiaries of domestic companies and foreign subsidiaries operating in the domestic economy face same level of taxation. The subsidiaries of domestic companies face competition from two types of organisations in the foreign markets: (1) the domestic companies, and (2) subsidiaries of non-US origin. If a country modifies its tax system to benefit its own companies then other countries would be forced to look at their tax system and change according to new competing system. In this, the subsidiary will be taxed only in the country of its operation.
So far as taxation policy is concerned, the major countries like US, Germany, Japan, Sweden and Great Britain follow a mixed policy of domestic and foreign neutrality. France, Canada and Netherlands exempt foreign subsidiary or branch earning.
The tax equity principle states that all taxpayers in similar situations be subject to the same tax rules. According to this principle, all corporations be taxed on income regardless of the fact where it is earned. This type of taxation neutralise the tax consideration in a decision on a foreign versus domestic location.
Reasons for differing tax structure among countries
Taxation differs in various countries because of the following reasons:
1. statutory tax rates vary across countries, from high tax countries to tax heaven;
2. differences in the definitions of taxable corporate income;
3. varying interpretation of how to achieve tax neutrality;
4. treatment of tax deferral privilege;
5. method of granting credit for foreign income taxes paid to host country;
6. concession gained in bilateral tax treaties;
7. treatment of inter-company transactions; and
8. tax systems such as single tax, double, and partial double tax system.