Consideration of taxation regulations

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Impact of taxation on financial strategy

Tax regulations are an important factor to consider in setting financial strategy

As part of maximising shareholder wealth, companies can take advantage of tax relief schemes, and have subsidiaries in countries with lower tax rates. 

Tax liabilities are an important factor in cashflow forecasts.

Domestic tax considerations

  • Payment of taxes

    The deadlines for payment of taxes needs to be factored into cashflow forecasts to ensure the entity has enough cash to meet the deadlines and avoid penalties. 

    This will have an effect on a company's working capital management.

  • Tax relief incentives

    Companies can reduce their tax bill by taking advantages of tax relief schemes. 

    For example capital allowances (ie tax allowable depreciation) on purchases of equipment are deductible from a company's taxable profits.

    Tax relief is also available for interest payments on debt finance, but not equity finance. This will be a factor in a company's financing decisions.

International tax considerations

Multinational companies will have the following tax considerations in setting financial strategy.

  • Tax regime and dividend payments

    Tax considerations are thought to be the primary reason for the dividend policies inside a multinational firm. 

    For example, the parent company may reduce its overall tax liability by receiving larger amounts of dividends from subsidiaries in countries where undistributed earnings would otherwise be taxed.

  • Tax havens

    Tax havens are countries with lenient tax rules or relatively low tax rates, which are often designed to attract foreign investment.

Multinational companies may choose to exploit these tax regimes through transfer pricing or switching production from one country to another.

Taxation issues

If a company makes investments abroad it will be liable to income tax in the home country on the profits made, the taxable amount being before the deduction of any foreign taxes. The profits may be any of the following.

  • Profits of an overseas branch or agency

  • Income from foreign securities, for example debentures in overseas companies

  • Dividends from overseas subsidiaries

  • Gains made on disposals of foreign assets

In many instances, a company will be potentially subject to overseas taxes as well as to local income tax on the same profits.

However, this can be reduced by double taxation relief (DTR).

Double taxation relief (DTR)

A DOUBLE TAXATION AGREEMENT is an agreement between two countries intended to avoid the double taxation of income which would otherwise be subject to taxation in both.

Typical provisions of double taxation agreements based on the OECD Model Agreement are as follows.

  • DTR is given to taxpayers in their country of residence by way of a credit for tax suffered in the country where income arises. 

    This may be in the form of relief for withholding tax only or, given a holding of specified size in a foreign company, for the underlying tax on the profits out of which dividends are paid.

  • Total exemption from tax is given in the country where income arises in the hands of, for example:
    i) Visiting diplomats
    ii) Teachers on exchange programmes

  • Preferential rates of withholding tax are applied to, for example, payments of rent, interest and dividends. The usual rate is frequently replaced by 15% or less.

  • There are exchange of information clauses so that tax evaders can be chased internationally.

  • There are rules to determine a person's residence and to prevent dual residence (tie-breaker clauses).

  • There are clauses which render certain profits taxable in only one rather than both of the contracting states.

  • There is a non-discrimination clause so that a country does not tax foreigners more heavily than its own nationals.

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