Establishment of foreign manufacturing plant

"The sales of high quality optical lenses are now nearing productive capacity and because of the exceptionally heavy tooling costs involved in increasing the capacity and the limited market available for sales, Mr Holmes decides to concentrate more on building up the low quality, high volume magnifying glasses for the mass consumer market. The impediment to export sales has been the relatively high cost per unit of domestic overheads, but additionally, the high raw material costs prevent Polycon Lens Company from pricing its export sales at a level to achieve a sufficient volume to warrant the investment necessary in plant and personnel costs. With the cash generated from the sale of high quality optical lenses, Mr Holmes decides to establish a manufacturing plant abroad; first to enable the group to purchase the particular plastics involved in manufacture at a lower price than those available on the home market. Secondly to keep transport costs of such raw material to a minimum, thirdly to achieve lower labour production costs, and fourthly to take advantage of tax concessions where available."

In the same way as setting up a foreign sales organisation, a foreign manufacturing plant may be established as a branch of Polycon Lens Company in Country D, or a subsidiary company. The non-tax considerations may be more relevant than the tax considerations, but both must be considered.

It is important to fully utilise any local tax concessions given to manufacturing companies, such as depreciation allowances, investment grants and incentives, regional development grants, tax holidays, and low tax rates all are concessions which enable the Polycon Manufacturing Company to keep its direct tax liabilities low, and to retain its accumulated profits for further investment overseas. If a branch is established rather than a company, these concessions, including low tax rates or tax holidays, may not be given under local law. It is therefore important that Country A has entered into a double tax treaty with Country D that has a non-discrimination clause, which extends to non-residents the same treatment of income and expenditure for tax purposes as would apply to domestic companies.

On the assumption that Country A's tax system does not follow a territorial or exemption approach but taxes worldwide profits with credit relief given for foreign taxes incurred, it is important that any local concessions are preserved when dividends are repatriated from Polycon Manufacturing Company to Polycon Lens Company. If the concessions take the form of a tax holiday, for example, then such relief should be extended to Polycon Lens Company through a relevant double tax treaty, which prevents Country A from subjecting the profits underlying the dividend to corporate tax under the tax sparing provisions.

Where such concessions are granted or low tax rates apply, Mr Holmes will be tempted to ensure that prices charged from Polycon Manufacturing Company to Polycon Lens Company are as high as possible. As in Section 3 above, the taxable profits of Polycon Lens Company may be adjusted if the tax administration of Country A feels that the prices are not those that would be obtained in an arms-Iength situation.

Date: 2015-01-29; view: 893