Prof. Dr.

Martin Jacob

INTERNATIONAL TAX STRATEGY EXERCISES SPRING TERM 2014

Master of Science 2015

1ST SET OF HOMEWORK

1.

The following project is available (in ).

t CF t

0 -3,900

1 975

2 799

3 377

4 182

5 2,260.12

a) Calculate the NPV of the project before taxes. The interest rate is 5%. b) Calculate the after-tax NPV. Assume a tax rate of 42% is applied on cash flows and interest. The investment is depreciated over 5 years. In case of a negative tax base, an immediate tax refund is granted.

2.

The student Fred has 240,000 equity available and is offered the following project: t CF t (in ) 0 -240,000 1 97,000 2 86,000 3 95,000

Straight-line depreciation applies. Fred intends to establish a sole proprietorship. The marginal income tax rate is 45%. Interest income is subject to a final withholding tax of 25%. The interest rate is 6%. In t=2, Fred has to account for accounts receivables of 10,000 from the cash inflow of t=3. Please assume that after-tax cash flows are withdrawn at the end of each period and that there is an immediate full loss offset. a) Would you invest in the project in a world without taxes? b) What is the net present value after taxes (NPV)? Comment your result.

INTERNATIONAL TAX STRATEGY EXERCISES SPRING TERM 2014

Prof. Dr. Martin Jacob

c) Instead of running the business as sole proprietor, his tax advisor recommends him to invest in project P I and to run the company as a corporation. The corporate tax rate amounts to 22%. Dividends are taxed a rate of 27%. Capital decreases are allowed in every period. Please calculate the net present value after taxes (NPV) assuming that the investment is financed with new equity. Which organizational form do you prefer?

3.

An investor with equity of 4,000 is looking for the best investment alternative. The real investment cannot be financed with debt. His alternatives are as follows:

a financial investment within his company with a before-tax return of 6.5%, a private financial investment with a before-tax return of 6.0%, a real investment with following cash flows (in ):

t CF t

0 -4,000

1 1,250

2 950

3 850

4 1,340

5 800

a) What is the NPV of the real investment before taxes? Now include taxes in the decision. In case of a negative tax base, an immediate tax refund is granted.
b) Interest income from privately held financial investments is taxed at a flat tax of

25% and profits are taxed at the marginal tax rate of 45%. The investment is depreciated over 5 years. What is the NPV of the real investment after taxes?
c) Instead of applying a flat tax on interest income, assume that interest income is

taxed at the marginal tax rate of the investor (45%). Once again calculate the NPV of the real investment! Briefly discuss the impact of the flat tax on financial investments!

INTERNATIONAL TAX STRATEGY EXERCISES SPRING TERM 2014

Prof. Dr. Martin Jacob

2ND SET OF HOMEWORK 1. A taxpayer realizes total income (y) of 135,000. This amount is earned from business operations in the country of residence and a foreign country. Following alternatives are taken into account: Alternative I: 82,500 in the country of residence, 52,500 in the foreign country; Alternative II: -30,000 in the country of residence, 165,000 in the foreign country; Alternative III: 152,500 in the country of residence, -17,500 in the foreign country; A progressive tax rate is applied in the country of residence. To calculate the tax burden add up the tax payment of the different tax brackets (income y in ): - 0 9,000 25,000 55,000 95,000 140,000 180,000 < < < < < < < < y y y y y y y y 0 9,000 25,000 55,000 95,000 140,000 180,000 0% 0% 20% 30% 35% 42% 45% 48%

A flat tax of 38% on positive income is applied in the foreign country. Calculate the total tax burden provided that 1. no double taxation relief mechanisms are applied; 2. the full credit method is applied; 3. the limited credit method is applied; 4. the exemption method is applied; 5. the exemption with progression method is applied; 6. the deduction method is applied; 7. the deduction method with a full offset of foreign losses is applied.
3

INTERNATIONAL TAX STRATEGY EXERCISES SPRING TERM 2014

Prof. Dr. Martin Jacob

Summarize the total worldwide tax burden in a table with the following layout: Alternative: Applied method: 1. no double taxation relief mechanisms 2. full credit method 3. limited credit method 4. exemption method 5. exemption with progression method 6. deduction method 7. deduction method with a full offset of foreign losses I. II. III.

2.

The German Dr. Clever lives in Hamburg. He is not married and his annual income in Hamburg amounts to 32,500. In addition, he yields income of $55,000 per year from immovable property in Miami, Florida. According to the double tax convention U.S.Germany income from immovable property is only taxed in the U.S. In Germany, the exemption with progression method is applied.

Calculate the federal income tax payment in the U.S. and the income tax payment in Germany. Please ignore community, state and property taxes in the U.S. Assume an exchange rate of 1.3 $/ .

INTERNATIONAL TAX STRATEGY EXERCISES SPRING TERM 2014

Prof. Dr. Martin Jacob

3.

Stan is a passionate golf player. He spends about 9 months in Munich where is working for a consulting company. His annual salary amounts to 45,000. Over the summer is joins a tour of semi-professional golf players. He visited three countries where he won several tournaments. His income and the respective tax rate are summarized in the following table: Country Netherlands Slovakia Sweden Total income 15,000 17,500 23,500 Days spent in country 6 6 5 Income tax rate 37% 19% 51%

The double tax treaties between Germany and all other countries rule that Germany applies the exemption with progression method. a) A friend argues that his income from abroad is not taxable since he spent less than a week in each country. Is the friend right? Comment briefly. b) Please calculate Stans overall tax burden on his worldwide income. c) His tax advisor recommends him to opt for the limited credit system. This way, Stan could get a tax credit for foreign taxes paid. Briefly comment on this recommendation. Is the tax advisor right? Should Stan opt for the credit system? Personal income tax rates Germany 2014 32a (1) EStG (German Income Tax Code): Progressive tax rates Income in from to 0 8,354 8,355 13,469 13,470 52,881 52,882 250,730 > 250,731

Tax rate in 0 (974.58y + 1,400)y, y = (Income 8,354)/10,000 (228.74z + 2,397)z + 971, z = (Income 13,469)/10,000 0.42 Income 8,239 0.45 Income 15,761

INTERNATIONAL TAX STRATEGY EXERCISES SPRING TERM 2014

Prof. Dr. Martin Jacob

3RD SET OF HOMEWORK 1. Mr. Cutlery is only shareholder of the American Knife Corporation. Knife Corp. has 100% stakes in two separate permanent establishments (PE) located in Country A and in Country B. The expected profits of the three companies for the financial years 1 to 4 are presented in the following table: t PE-A PE-B 1 2 3 4 60.00

75.00 210.00 165.00 82.50 165.00 90.00

80.00 420.00 30.00 165.00

Knife Corp. 160.00

The tax rate in Country A is 50%, in Country B 30%. The U.S. Knife Corp. faces a tax rate of 35%. In year t=4, the tax rate in Country B decreases to 20%. a) Calculate the U.S. tax burden by applying the credit method for foreign taxes and taking overall limitation into account. Note: According to 904 (c) IRC not creditable FTCs can be carried back 1 year and carried forward 10 years. b) How does the U.S. tax burden change if there is only one PE in Country A in which the foreign-source income is completely generated? Explain your results!

INTERNATIONAL TAX STRATEGY EXERCISES SPRING TERM 2014

Prof. Dr. Martin Jacob

4TH SET OF HOMEWORK 1. The U.S.-based internet company NET-Co. has recently acquired a 60% share in the SYS-Corporation located in Country A. They expect the subsidiary to be very successful and to generate the following cash flows (which are equal to profits): Year 1 Profit of SYS-Corp. in Country A Tax Rate Country A Net-Co. 400,000 25% 500,000 Year 2 500,000 40% 560,000 Year 3 600,000 28% 580,000

The management of the SYS-Corp. decides to distribute all cash flows immediately at year end. The relevant corporate tax rate in Country A changes over the years. U.S. based companies are subject to 35% corporate tax. U.S. bonds are assumed to yield a return of 4%. The double tax treaty between the USA and Country A rules that dividends received by a U.S. company from a subsidiary located in Country A are subject to a 8% withholding tax. According to 904 (c) IRC not creditable foreign tax credits can be carried back 1 year and carried forward 10 years. Please assume that free cash flow is always reinvested in bonds. a) Please calculate the final value from the investment in SYS-Corp. Alternatively, NET-Co. could run its own branch in Country A. The branch is expected to generate profits of: Year 1 Profit of branch in Country A 0 Year 2 240,000 Year 3 400,000

Please calculate the final value from opening the branch. Please assume that profits are retained and distributed only in t=3 to NET-Co. There are no withholding taxes in case of redistributed branch profits. Bonds in Country A yield a return of 7%. Is it more favorable to set up an own branch in Country A?

INTERNATIONAL TAX STRATEGY EXERCISES SPRING TERM 2014

Prof. Dr. Martin Jacob

2.

You are asked to consult an entrepreneur owning a corporation with the following group structure:
U.S. Headquarter

60%

100%

75%

German Subsidiary
60%

Irish Subsidiary

Danish Subsidiary
80%

German Subsidiary

Irish Branch

Country Germany Ireland Denmark USA

Corporate Tax Rate Withholding Tax to U.S. 30%.5 12.5% 25%.5 35%.5 0% 0% 0% -

Each affiliate generates profits of 325,000. All affiliates immediately distribute all net-profits. The headquarter does not generate any profits and has no further investment opportunities in the U.S. The company plans to expand and to acquire new international affiliates in the future. The company plans to keep all existing affiliates. a) b) Identify three tax related problems of the group structure of the U.S. company. You are asked to optimize the group structure of the U.S. company. Please illustrate your tax-optimal group structure graphically. How much tax can you save with your proposed optimization scheme in the current year?