 Hello, and welcome to the session. This is Professor Farhad. In this session, we would look at an introduction to international taxation. This topic is covered in international accounting course, sometime in a tax course. It's covered on the CPA exam, as well as the CACCA exam. If you haven't connected with me on LinkedIn, please do so. YouTube is where you would need to subscribe. I have 1,500 plus accounting, auditing, tax and finance lectures. Please like my lectures if you like them. Click on the like button. It helped me tremendously. Share them. Put them in playlist. If you're listening to my lectures, it means they're benefiting you. It means they might benefit other people as well. Also, I do have a website. If you wanna go more than the lectures and you would like to access additional resources, please visit my website and see the details if you are interested. StudyPal.co is an artificial intelligence study body platform that matches you with another candidate. They can the CPA or the CFA exam. They have users in many countries and in 2800 cities. So what is the big picture? What is international taxation? And why is it important? Well, let's think about the tax in general. Tax is a burden. Tax is a burden. I mean, for most companies, it's the most significant cost incurred by a business enterprise. Sometime it's bigger than cost of goods sold. Taxes, they reduce cash and they reduce profit. So it's very important that companies look at their tax bill to see if there's any way they can minimize their taxes legally by utilizing strategies. And international taxation will come into that picture. What can we do? What is, how can we reduce our taxes? Because the goal is to minimize the taxes while complying with applicable laws. Now for a mom and pop store or a mom and pop company, small companies, they might not have this window, international window that they can go through to minimize their taxes. But for multinational corporation, they can reduce their taxes on their worldwide income as long as they know the rules in different countries that would require expertise of different countries and knowledge how that earned income is taxed in a different country. So if you are making a profit in country A and you're paying 20%, if you could move to country B and only pay 10%, you might think about it, but you wanna study not only the rate, you wanna study all the other consequences of that decision. But the point is you want to see if you have an option to lower your taxes. So multinational corporations, they make a number of very important decision, which taxation is an important variable. Again, taxation is a large burden of cost and it takes into account whether you want to move or to operate in a foreign country. But usually the three most important issues when it comes to international taxation are obviously the location, where are you gonna be located? That's obviously relevant because if you are located in a certain country that the legal jurisdiction will apply to you as well as the tax jurisdiction. The legal form, what legal form of operation should take? How are you gonna operate? Under what type of legal structure, business legal structure and how are you gonna be financing your operation? Are you gonna be using stocks, bond? Are you gonna borrow money? Are you gonna put borrowing money from yourself, from your parent company? Are you gonna be borrowing money from the local banks in a foreign currency? How are you gonna finance yourself that matters as well? And we're gonna look at each one of those separately then when we talk about tax planning, we will revisit this topic. For location, that's an obvious one. We have to keep in mind that. So when you make a decision, when you make a decision, you have to look at after tax profit. So if you're gonna make a profit of $100, but you're gonna have to pay taxes of $40, what matters is the 60, the after tax profit because this $100 is irrelevant if you're gonna be paying taxes of $40. So that's why we want to look at places, at locations. We want to locate in places where that $40 is minimized, okay? So we have to keep in mind because of the effective tax rate varies across countries and sometimes within the same country, when after tax return from competing investment, locations vary. So we have to be very careful in seeing that if I operate in a certain country, my after tax return might be different. And within the same country, sometimes it's different. For example, in the US, different states will tax you differently. Some states they have no income taxes and some states they have up to 12, 15 income taxes. So the decision, whether you want to operate in Spain or Portugal could be affected by differences in the tax system. How are they gonna be taxing you? That's very important, the location. The second factor is the legal form. How are you gonna be operating in that country? You can operate either as a branch, basically the kind of satellite of the company or as a subsidiary. Once you are a subsidiary, basically you become part of that foreign country, part of their system. So some countries tax branches differently from subsidiary. So you have to find out which is the most efficient or the optimal way for me to operate in this country. Should I open just the branch or should I create a subsidiary basically becoming part of that country? Because different countries will tax that differently, okay? So the difference, the different tax treatment for branches and subsidiaries could result in one legal form being preferable to the other because of the impact on profit in cash flow. Again, each country is different, but those are the factors that you have to look at. The third factor is the method of financing. How are you gonna finance yourself? How are you gonna get capital? Is it through equity? Are you gonna issue stocks or are you gonna issue loans or bonds or debt? Are you gonna borrow money, okay? Because cash flow generated by a foreign operation can be repatriated basically, repatriated basically send back to the home country, to the parent company, make an either dividend payment or interest payment. So when you finance yourself, how are you going to repatriate that money? And that's an interesting topic. We're gonna talk a little bit more about when we discuss tax planning, okay? So also countries often impose a special withholding taxes on dividend and interest payment made to foreigners. Also we'll talk about this a little bit more in detail. So how you structure yourself will matter because when you pay interest versus dividend, it makes a difference on the withholding as well. And withholding just like the tax rate will vary from country to country and by the type of the payment. So some countries they will hold 10, 15, some none and depending on the country. The rate is different between countries and in the form of the payment. So you have two complexity to work with. Okay, when this is the case, the multinational corporation may wish to use more than one type of financing than the other because the positive impact on cash flow. So you have to determine which one is the most efficient or the most optimal way for you. And what's the most optimal way? Reduce your taxes, that's the whole point. Which method is gonna reduce your taxes more? Should you employ that? Should you employ equity? So what is the importance of international taxation? Obviously for the reasons that we mentioned. So it's very important for managers to understand to develop some sort of expertise. Now you cannot be, you know, you have to ask for help from your CPA firm, from your CPA, but you have to be familiar at least to be able to articulate yourself what the issue is so they can help you. So the managers don't have to be an expert but they have to know enough information to basically be familiar with the major issues international taxation. So if they call on an expert, they can at least explain their possession. Also we have to understand there are different type of taxes and that one type of taxes. Our corporation are subject to many different taxes including property taxes, payroll taxes, XI taxes and many more. I mean, that's, there's many taxes. You know, it's important for managers to know what these taxes are about because they, what matters is the profit after the taxes. What matters is how much money are we gonna take home after we pay the taxes. But for our purposes, we're gonna be looking at two different taxes. We're gonna be looking at corporate income taxes and withholding taxes because those usually corporate income tax is a large one and withholding also an important tax as well. So those are the two that I will focus on throughout this chapter, not the session. I'm gonna be breaking it down into several sessions. So let's talk about income taxes. So what is income taxes? Well, the government need to raise money. The government need to raise money. All government, they need to operate. So what do they do? If you operate in that country and you make a profit, you have to pay taxes on that money. Well, that's income tax for the government, okay? Now, most government impose income taxes and they have a specific rate, but rate don't, and the rate varies. So for example, in Switzerland, rate will be different than Germany. Germany will be different than France. So on and so forth. France will be different than Australia, okay? So in most countries, the rate ranges from 15 to 35 and the US used to be one of the highest rate but there's a lot of loophole in our tax system. Now they reduced it at 21, but the point is it differ, okay? Because they differ, this is an opportunity for multinational corporation because now they can decide where to locate, where to locate to minimize their taxes, okay? So we have to be very careful also, not only the national tax, sometimes there's a national tax and there's a local tax. I'll give you an example. The US is a good example. In the US, for example, if you incorporate in Delaware, you don't have no state income tax and I know my brother, he has his corporation in Delaware. He incorporated in Delaware. There is no state income tax. Well, not only my brother and many, the majority of corporations, all the big corporations, all the big corporations are incorporated in Delaware because they have no state income tax but you have to pay federal income tax. If you operate in Pennsylvania, you have to pay what's called a franchise tax, which is, they don't call it income tax, but it's basically, it's an income tax, but they call it franchise tax. The point is if you operate in Pennsylvania, you'll have to pay, I believe it's an additional 10% to your federal income tax. If you operate right across the border in Delaware, which is five miles away from Delaware where I'm sitting right now, you don't have to incorporate there, you don't have to pay state income tax. It matters if a multinational company, for example, a German company wants to operate in the US, what are they gonna incorporate? Because that matters, that matters. In some countries, local government imposes separate tax on business income in addition to the tax levied by the national government. Obviously, I just stated so. A good example is Switzerland. If you look at the Switzerland national tax rate, it's 8.5, which is, wow, this is way below the 15th, right? But you have to understand within each jurisdiction, within each, I'm not sure if they call them state in Switzerland, there is local taxes that could range between 12 to 24, which you have to add to the 8.5 to the national average. For example, a company located in Zurich can pay up to 21.15% to local and federal government together, okay? So corporate income taxes imposed an individual state in the US varies from zero, Delaware, oh, South Dakota, I guess, zero, to high as 12% in Iowa, okay? So that's why you have not only look at the state, the state rate, the country rate, you have to look to see if there's any local or state taxes. For example, this is a list of some countries. For example, Argentina, they're high as 35, and there's a lot of issues going on with the economy. They're Australia 30, let's see, select some countries, Germany 29, Greece 30, let's look at Hungary 9%, Hungary only 9%, India 30%. Now again, those are very, this is the big picture. This is the sources, KPMG corporate tax rate, January 2018, accessed on that date from their website. But basically those are the rates. Now again, the rates are very misleading in a sense that you have to see if there's any state or local taxes. For example, I can tell you the US here, where's the US? The US is 40%, which is not, it used to be 39%, not 40%, 39, the highest corporate tax rate. Now it's 21%, but that's not the only thing. You have to understand how you are taxed. For example, in the US, companies, they have a lot of loopholes that sometimes companies don't report a profit. So even whether it's zero or 40%, that doesn't matter because you have so many tax breaks that you end up not paying any taxes legally. For example, in Russia, it's 20%, but who knows what other local taxes you are responsible for. But the point is, look, it's all over the place. It's all over the rate, the rate is all over the place. Look at the global average, which is meaningless in a sense because in the US we change and those rates are constantly changing. So looking at an average is just like meaningless. It doesn't mean anything. So there's more variation in the tax structure, more, more variation. In a few countries, corporate income tax rate can vary according to the type of activity. For example, what business you are in, you are gonna be taxed differently than the other business. So for example, the rate of national tax in France is reduced to 15% on income generated from certain intellectual property, right? So they would reduce it to 15% if you are in that industry. In Malaysia, a special 5% tax rate applies to corporation involved in a qualified insurance business. You have to pay more. For example, in India, foreign companies are taxed at a 10% higher than the domestic company. So whatever the Indian rate is, if you're a foreign company, you have to pay 10% more unless you structure your business in a way to make it an Indian business, then you pay the local tax. So that's what you have to keep in mind. Because capital budgeting, what matters in capital budgeting when the company plan to undertake an investment is the after tax. How much am I gonna get after I pay my tax, okay? So obviously taxes paid to the foreign government will have a negative impact on the future cash flow and might affect the location. Of course it does. That's the whole purpose of it, okay? For example, assume a Japanese musical instrument manufacturers is deciding whether to locate a new factory in Hungary or in Switzerland. Although the national tax rate in Hungary is slightly higher, the effective rate in some part of Switzerland is much higher, okay? So Hungary, we said 9%, you know, Switzerland said 8.5, but then in Switzerland, you're gonna have to pay that additional local tax. That local tax may not be in Hungary. Also, the rate matters what the rate is, what you are paying, but what really matters, it's how you compute your taxes. How do you compute what's called your taxable income? What revenue? You're gonna include what expenses you're gonna include. Because the way you compute your taxable income will affect how much taxes you pay. Of course it does. It's what revenue is taxable. Some revenues is not taxable. For example, in the U.S., certain revenue is not taxable. You're gonna get certain deductions that are not available in other places. For example, in the U.S., we have the dividend received deduction as well as many other deductions for that matter. Also in the U.S., there are certain income that's not taxable. For example, or certain losses that are not deductible. A case in point is you have to keep in mind that you cannot live by the tax rate alone. So you cannot look at the percentage, what the rate is, and say, okay, I'm gonna base my decision on that rate. Because the way you compute your taxable income, which is your taxable revenue minus your tax expenses, might be different from country to country, although the rate might be different. Also, the way you compute this, just as the tax rate varies, the way you compute this taxable income might vary as well. For example, expenses can be deducted for tax purposes, can greatly vary from country to country. For example, in the U.S., the CEO of the company, you can pay them as much as you want to, but you can only deduct a million dollar. So if you pay the CEO five million dollar, guess what? You can only deduct one million of the five million. The remainder is not tax deductible. And there are many, many other rules and they're gonna get into them. But the point is, how you compute your taxes are important. Also in the U.S., we have LIFO, LIFO for inventory. What does LIFO stand for? LIFO stand for last and first out. What does it mean last and first out? Which means, generally speaking, prices rises, generally speaking. So as prices rises, as your input, as your cost of the goods sold rises, you're gonna be matching that prices, which is last in, last in, first out. You're gonna be matching high, higher cost to revenue. And what happened when you have higher cost? Well, your profit goes down. As your profit goes down, then your taxes go down because you pay less taxes if you have lower profit. Well, LIFO is available in the U.S. It's not available anywhere else. So although the rate might be higher in the U.S., but if you employ LIFO, if you're in the U.S. and you employ LIFO, you might be able to pay a lower effective tax rate. And last but not least, changes in the corporate income tax rate. There's always changes. So you have to understand this. How stable, not necessarily stable, but how often does a country change its tax rate? Because if you start operating there and you make an investment and now the tax rate is low, but they increase the tax rate, well, you have to take that into account. Or on the other hand, what if they reduce the tax rate, which should be in your best interest? So corporate income tax rate varies across the world. So they don't remain constant. So that's obvious, but that's something you want to be aware of. So for the most part, there had been a continuing trend to reduce the corporate tax rate. You might be saying why? Why do countries want to reduce their tax rate? You might be saying, well, that's gonna give them less revenue. Yes, it gives them less revenue, but it's a cost-benefit relationship. You have to understand, if I lower my tax rate, more companies will move into my country. And as a result, I will have overall a larger tax base. I will collect more income. And basically the US started this when they did the first, basically the first overhaul of the tax system in 1986 and they lowered their tax rate for corporate tax rate from 46 to 34%. Obviously it was raised subsequently to 35% in 1994 when Clinton was in office. Then it was lower than it was raised again. It doesn't matter. Now it's 21, which is good. But again, 21, but you have a lot of, they took some loopholes out. The UK quickly followed the US and they dropped the rate from 15 to 35. Why? Because if the US lowered the rate, you have UK companies that might think about moving to the US and operate from the US. And Canada obviously reduced it because Canada basically a direct competitor with the US to just our next door neighbor from 34 to 29. Also Spain recently lowered their tax rate from 28 to 25. Malaysia reduced it from 25 to 24, not that much. But the point is it's trending lower. It's trending lower. This followed the leader effect and be explained by the fact that countries compete against one another in attracting foreign investment. That's the point here, is they will try to attract companies by making the rate lower, okay? They want to be competing on the international stage. And what you would do, you'd say, okay, my country have a lower tax rate can operate with us. You'll bring the capital. You would hire employees. The government makes profit. You have payroll taxes. And that's the whole purpose is to make the life of your citizen better. So heaven said so. There's a lot of politics that goes into the taxes. Of course it does. I'm stating the obvious, but the point is the tax system is not logical. It's much of that's politically motivated, politically based, politically based. Okay, for example, in 2017, the US had the highest effective corporate tax rate. But again, which is federal plus state among the countries listed. But I can tell you from my own experience, I mean, I work in a medium CPA firm, not a large CPA firm. I did not work with the big four. I did not look at multinational, but that information is well known. You could look up at their income statement and see how much taxes they paid. But I can tell you in the US, I mean, you're gonna love, but what I used to work most companies, most companies either incur the loss or they break even. Why? Because we had so many credits, loophole, expenses, all legal to help those companies structure their business in a way to pay the least amount of taxes. So although it may appear it's expensive, but if you plan, if you plan properly, if you have proper tax planning, if you're making a lot of money, there's no way you can get out of paying taxes. But the point is, you could always minimize your taxes. So that 39 or 40% that you see it used to be, that's not really the effective. So I'll tell you that for sure from my own experience. But in 2017, President Trump lowered the corporate income tax rate from 35, now it's 21 starting 2018. This change was part of the Tax Cuts and Jobs Act. If you're interested in this, I have a whole course. You can go to my YouTube or to my website. I have a whole course about tax cuts and jobs acts which made most extensive change in the US tax law within three decades. So this is basically an introduction about the international taxation. We'll look at tax holidays and tax haven in the next session. If you're interested in more lectures, if you're an accounting students or a CPA student, please visit my website. I have additional resources. And if you're interested, please consider subscribing. You'll have access to additional information. For example, you can access the PowerPoint slides, so on and so forth as well as quizzes and exercises for the related lecture. Study hard, stay motivated and good luck.