Page 262 - DMGT514_MANAGEMENT_CONTROL_SYSTEMS

Unit 14: Management Control of MNC’s

Many countries have tax treaties with one another specifying the withholding tax rate applied to Notes
various types of passive income. For example, a tax treaty between the US and Germany may
specify that a US firm need not pay tax in Germany on any earnings from its German subsidiary
that are remitted to the US in the form of dividends. A deferral principle specifies that parent
companies are not taxed on foreign source income until they actually receive a dividend.
14.1.3 Value Added Tax

A Value Added Tax (VAT) is an indirect national tax levied on the value added in the production
of a good (or service) as it moves through the various stages of production. In many European
countries (especially the EU) and also Latin American countries, VAT has become a major source
of taxation on private citizens. Many economists prefer VAT in place of personal income tax. A
VAT encourages national saving, whereas income tax is a disincentive to save because the
returns from savings are taxed. Moreover, national tax authorities find that VAT is easier to
collect than an income tax because tax evasion is more difficult. Under a VAT, each stage in the
production process has an incentive to obtain documentation from the previous stage that the
VAT was paid in order to obtain the tax credit. Of course, some argue that cost of record-keeping
under VAT imposes a hardship for the small business.

Example: Value added calculations.
Consider a VAT of 15% charged on a consumption good that passes through three stages of
production. Suppose that stage I is the sale of raw materials to the manufacturer at a cost of Euro
100 per unit of production, stage II results in finished goods shipped to retailers at a price of Euro
300, stage III is the final retail sale to the final consumer at a price of Euro 380.
1. Euro 100 of value has been added in stage I resulting in VAT of Euro 15.
2. In stage II, the VAT is 15% of Euro 300 or Euro 45 with a credit of Euro 15.

3. In stage III, an additional VAT of Euro 12 is due on Euro 80 of value added by the retailer.
Since the final consumer pays a price of Euro 380, he effectively pays the total VAT of Euro 57
(Euro 15 + Euro 30 + Euro 12) which is 15 per cent of Euro 380. VAT is the equivalent of imposing
a national sales tax.

14.1.4 Worldwide Taxation

The international tax environment confronting the MNC or an international investor is the tax
jurisdiction of the respective countries where the MNC does business or in which the investor
owns financial assets.
These are two fundamental types of tax jurisdiction. The worldwide and the respective territory:
In case of the national residents of a country, national tax jurisdiction is to tax on their worldwide
income no matter in which country it is earned. An MNC firm with many foreign affiliates
would be taxed in its home country on its income earned at home and abroad. If the host
countries of the foreign affiliates of an MNC also tax the income earned within their territorial
boundaries, there will be the possibility of double taxation, unless there is a mechanism to
prevent it.

14.1.5 Territorial Taxation

The territorial or source method of defining a tax jurisdiction is to tax all income earned within
the country, by any tax payer, domestic or foreign (regardless of the nationality of the tax

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