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Dynamics of Multinational Companies

Mayur Korivi

ESSAY
In this world nothing can be said to be certain, except death and taxes,
(Benjamin Franklin), yet many Multi-National Enterprises (MNEs) appear not
to be paying their fair share of the latter. Evaluate the arguments regarding the
share of taxes paid by MNEs and assess the impact that national governments
and supranational bodies have had on ways to increase the amount of tax that
MNEs pay.
Introduction:
The fundamental issue at hand is that MNEs operate across international boundaries.
There are various forms of organizational structures such as holding companies,
subsidiary companies, affiliates, Joint Ventures, branches etc. The biggest challenge
for tax authorities is that businesses are international but the authority of countries to
tax is national. By concept, it is to be understood that the term international tax is
incorrect. The correct understanding is taxation of international business transactions.
In recent times, countries have come together to fight against the problem of MNEs
not paying their fair share of taxes. The UN and the OECD (Organization for
Economic Co-operation and Development) model are the generally accepted although
there are many other frameworks, which the countries may depend upon.
Transfer pricing refers to the selling price at which one branch or affiliate of an MNE
sells a product to another branch or affiliate of an MNE along with sharing the profits.
This artificial routing of transactions through low tax jurisdictions known as tax
havens is a major technique of tax avoidance. Such shifting of activities to a tax haven
country is called Base Erosion and Profit shifting (BEPS). Off late, tax havens have
also come under the international scanner to investigate cases of terror finance and
narcotics finance. There could arise disputes between companies and tax authorities
regarding the honesty of the transfer pricing transactions. In India, there is a
mechanism by the tax authorities called Advanced Pricing Agreements (APA), which
is like a pre approval for the proposed transactions. This mechanism is to avoid
disputes and undue hardships for genuine transactions. Overpricing or under-pricing
can be compared with similar transactions between unrelated parties for reference,
which is known as Arms Length Pricing (ALP). Implementation of Double Tax
Avoidance Agreement (DTAA) between countries removes the difficulty in trade and
investment. This is done through bilateral treaties and trade agreements.
Since a company is uncertain about its ability to sustain transfer pricing, it often faces
the challenge of being in an uncertain tax position, which has a direct impact on the
companys tax provision. This in turn, indirectly affects the companys ability to
realize its deferred tax assets. Also, transfer pricing could have a material impact on
the companys financial statements.
Taxation is an important source of revenue for each country in order to manage their
economies. It is natural for companies to organise their affairs in such a manner that
the ultimate tax impact is minimal leaving more profit in the hands of the owners

(shareholders). According to Brian J. Arnold (2007), different countries have different


tax rates ranging from 55% to 0, causing harmful tax competition. This gives rise to
tax arbitrage, i.e., shifting of business transactions from high tax to low tax
jurisdictions. Taxation policies and rates have also evolved over the years. On the one
hand, taxation related disputes between countries could subject MNES to double
taxation and undue hardship. This may harm trade and investment relationship
between countries. At the same time, harmful tax competition especially from tax
havens should be curbed so that countries can collect their fair share of taxes.
Aggressive tax planning by MNEs causes Base Erosion and Profit Shifting (BEPS). It
is known that countries need tax collections to reduce their fiscal deficit.
Apart from MNEs, which pay huge dividends but not taxes due to BEPS, another
group of entities who do not pay taxes, are large banks and financial entities. They
trade in financial assets particularly in derivatives in huge volumes as compared to
retail investors. In order to bring these large banks and financial entities to pay taxes,
France and other entities in the EU introduced a Financial Transaction Tax (FTT) on
Derivatives. It is hoped that such taxes help in reducing distortions in asset pricing,
and also enable countries to raise their tax collections from financial entities.
Initially in the 1960 and 70s many of the imperial countries powers like UK, France,
Spain, Portugal had withdrawn from their colonies some of which were economically
poor countries, these countries were not expected to compete economically with their
colonizers. However, many of these former colonies, with zero or no income tax rates
became tax havens. This is because, in order to facilitate general trade and
investments, there were bilateral agreements between two countries called Double Tax
Avoidance Treaties (DTAT). However, it was not foreseen that tax havens would be
used by MNEs for routing financial transactions. This became the main tool for
BEPS. At the supranational body level, tax haven countries have been requested to
review their tax policies.
According to D.P Mittal, (2012), the fiscal deficits of USA, EU countries and Japan
are already under strain and can be aggravated due to falling tax revenues. For this
reason, various groups of countries such as G7, G20, OECD, FATF (Financial Action
Task Force) etc., have made BEPS their focus of attention. Notably, four of the more
profitable companies in the world pay very high dividends and comparatively low
taxes. These are Apple, Amazon, Google and Starbucks. In an elaborate structure of
their affiliates that include tax havens, they engage in BEPS and avoid considerable
amounts of taxes. Notably, these companies have received tax notices from the
European authorities.
In all these four companies, the introduction of e-commerce has made it extremely
difficulty for tax authorities to determine the source and destinations of transactions
especially in a borderless world of business.

The purpose of OECD (Organization for Economic Co-operation and Development)


is to promote policies that will improve the economic and social well being of the
people in the EU. According to its website, OECD has successfully persuaded

countries to complete the Mutual Agreement Procedure (MAP) which enables


exchange of information and will provide with a tangible measure to resolve disputes.
The purpose of FATF (Financial Action Task Force), is to set standards and promote
effective implementation of legal, regulatory and operational measures to combat
against money laundering, terrorist financing and other threats with respect to the
integrity of the global financial system. According to its website, the organization
brought together, anti-money laundering and anti-corruption experts for the first time,
in Japan to exchange views on combating corruption and money laundering across the
world.

Conclusion and Recommendations


Implementation of Double Tax avoidance between countries is for removal of
difficulty in trade and investment. This is done through of bilateral treaties and trade
agreements. However, these were exploited by large MNEs and financial entities
through the exploitative use of tax havens. Growing fiscal deficits of countries as well
as anti social and terrorist activities all over the world have bought tax havens under
the scanner. At the board level also, MNEs have been sensitized against aggressive tax
policies and advised to pay their fair share of taxes. In the long run, one could
envisage a convergence of tax rates, that is, tax havens raise their tax rates and other
countries reduce their tax rates to reduce the phenomenon of tax arbitrage. Also in the
long run, it is hoped that source and residence countries are chosen based on genuine
business considerations rather than mere tax consideration.
India has DTATs with over 70 countries in order to facilitate trade. According to the
Finance Minister of India, India is in the process of reducing its effective tax rate to
around 22% by rationalizing its tax rates and laws. This is fairly comparable to the tax
rates of some of the tax havens, which have a rate of 10-15%. India is also a part of
the G20 negotiations and FATF for a review of the activities taking place through tax
havens. Thus, India is also at the forefront of international tax reform, in order to
bring in a balance between trade facilitation and tax collection. The author
recommends a combination of measures which may control the problem of MNEs not
paying their fair share of taxes:
The government must engage with business and industry and sensitize them against
aggressive tax planning and tax avoidance and also reward and recognize good
corporate citizens. The government needs to enhance business transparency, improve
the ease of doing business and reduce corporate tax rates and remove tax anomalies in
a phased manner.
The Indian tax authorities need to engage with tax authorities in other countries to
streamline Double Tax Avoidance Agreement (DTAA) and Tax Information Exchange
Agreement (TIEA). India has also obtained the cooperation of the Swiss authorities
who have agreed to relax their banking secrecy laws to increase transparency.
The government needs to continue its engagement with other supranational bodies
such as UN, OECD, G20, FATF, etc., for a convergence of international practices and
for international cooperation to check tax avoidance.

REFERENCES
International Tax Primer 2007
by Brian J. Arnold and Michael J. McIntyre
Indian Double Taxation Agreements & Tax Laws- 2014
by D.P. Mittal, 2014
Principles of International Tax Planning- May 2015
by Rohit Gupta, 2015 Edition
Guide To Transfer Pricing With Transfer Pricing Auditby Taxmann, 2015
Law and Practice Relating to General Anti Avoidance Rules (GAAR)-2012
By D.P. Mittal, 2012 Edition
Basic International Taxation (Vol I)By Roy Rohatgi

Case Study Report


A Multi National Enterprise (MNE) in an organisation which has its operations along
with its assets in one or more countries apart from its home country.
Foreign Direct Investment is an investment of a business wherein an investor of a
foreign country has control over the investment in the company which has been
purchased. (World Bank, 2016)
According to the International Monetary Fund, FDI (Foreign Direct Investment)
refers to an investment made to acquire lasting or long term interest in enterprises
operating outside of the economy of the investor.
According to UNCTAD website, a business strategy where a domestic firm expands
its operations to a foreign country via merger/acquisition or expansion of an existing
foreign facility. Using outward FDI is a natural phenomenon for firms to gain better
business opportunities in foreign countries when the domestic markets become too
saturated.
Evaluate the benefits to the home economy from outward FDI
Japan is geographically a small country and the domestic market for goods and
services is limited. However, Japan has made large and rapid strides in technology,
making it one the leading industrialised nation in Asia and 3 rd in the world according
to reports by BBC (2015). It is obvious that the production capacity of Japan cannot
be justified by servicing its domestic markets alone. For this reason, Japan, like many
other South Asian countries which form the Tiger Economy became export oriented.
In order to keep up the technological and economic momentum, these economies
followed the philosophy of export or perish. This philosophy was aided by a cheap
manufacturing domestic base and a relatively weaker currency as compared to U.S
and Europe. Over the years, standard of living in industrialised Japan began to
increase. With this, the cheap labour cost advantage began to diminish. A stronger Yen
also made exports less competitive in comparison to China and other South East
Asian Tiger economies. Japanese companies have a huge technological base, low cost
funds from the home banking system and large domestic savings.
Japan was an imperial power at the time of the Second World War with a strong sense
of Nationalism. With the defeat of Japan in the WW2, the Japanese were seeking

ways to restore their national pride. From an economic perspective, Japanese societies
can be divided in three centres of power Government
Bankers
Businessmen
Japan was not known as a manufacturing power until the 1960s. Sony Corporation
was the first Japanese Corporation which made the Japanese believe that their
products could achieve global standards. Make in Japan became a symbol of quality
in the 1960s mainly on the achievements of Sony. Japanese business is all about
conglomerates, i.e. large business groups. Every large Japanese company would be
supported by a number of smaller ancillary units. This helps in dividing the
investment risk for large manufacturing operations. For example, all the
conglomerates associated with Sony Television are not manufactured by Sony itself.
Barring a few critical components, most of it is produced by small ancillary units.
Strict Cost control and Quality control is maintained at all stages. Other successful
companies include Mitsubishi, Toshiba, National Panasonic. Famous automobile
companies include Toyota Honda, Suzuki, Nissan, Kawasaki etc. The country also
excels in shipping, ship building and seafood.

Government

Business

Banks

(Sourcefieldwork)

These three elements of the Japanese economy work closely together. The focus of
Government activities revolve around the Ministry for Industry and Technology
(MITI). MITI maintains a close coordination with businesses and also encourages the
Banks to lend to businesses at low interest rates. These factors have greatly helped
Japan in making huge investments in order to capture global markets.

With respect to the Spillover theory, the economic conditions for trading partners does
in fact, matter significantly growth. The countrys economic growth is positively
influenced by both, growth rate and relative income of trading partners. Countries
benefit relatively more if their trading partners grow faster than they themselves and
are more profitable. The estimated impact of growth spillovers is relatively large. It
has been even larger for open economies, implying that international spillover effects
may increase as globalization continues. The importance of growth spillovers has
increased with the expansion of world trade. The results also suggests that both rich
and poor countries benefit from trading with fast growing trading partners. In
addition, countries that trade with relatively rich countries in one decade tend to
continue to trade with them in the next decade. The same applies for relatively poor
countries.
With respect to Japanese MNEs, most obvious channel is trade linkages: a rise in the
growth of the trading partners leads to an increase in their demand for imports, which
then contributes directly to an increase in the net exports of Japan.
The Japanese industry mainly practices Applied Research as compared to Americans
and Europeans who follow the concept of Basic Research. In other words, the
Japanese concentrate quickly on converting research into products. The basic
inventions for various products such as TV, cars, medical equipment, consumer
durables etc. has been done by the Americans and Europeans. Since the Japanese
could afford to invest large amounts and with a relatively small market, they had to
look for global markets to invest in. Thus, the Japanese economy became export
oriented. In this manner, most Japanese companies are
Also, the positive implications of trade for economic growth are not limited to
countries similar to the Japanese economy only, since countries can benefit from
technology transfers and other efficiency gains associated with international trade.
Coe and Helpman, (1995). Japanese MNEs avail of their home grown advantage of
technology and capital with low labour and manufacturing costs in other countries in
Asia which have their bases outside Japan. Some of the popular destinations for
outward investment are China, Myanmar, Thailand, India, Sri Lanka etc.
The Eclectic paradigm theory by Dunning (1974,1981) in economics, is also known
as the OLI framework. It is an improvement over transaction cost approaches by
including location and ownership as well as transaction cost variables. The idea
behind this theory is to merge several isolated theories related to international
economic, in one approach. Three basic forms of international activities of companies
can be distinguished: Export, FDI and Licensing. There are three advantages to this
theory, namely:
Ownership advantage- (trademark, production technique, entrepreneurial skills,
returns to scale). These refer to the competitive advantages of the firm seeking to
engage in Foreign Direct Investment.
Locational advantages- (existence of raw materials, low wages, special taxes or
tariffs). These refer to the alternative countries or regions, for undertaking the value
added activities of MNEs.
Internalisation advantages- (advantages by own production rather than producing
through a partnership arrangement such as licensing or a joint venture). Here, the
forms may organise the creation and exploit their core competencies.

Since FDI is a foreign investment, it involves a Japanese MNE, which acquires assets
in a foreign country. It also acquires control of those assets. Thus, the Japanese
company could buy or build a production facility there which it owns. The company
may start producing some parts of its product in the foreign country instead of
producing it at home. Since The foreign business costs, which include currency risks
and the cost of adjusting to cultural differences is higher in the foreign market, there
have to be compensating net gains apart from the foreign business costs to justify
investing in a foreign market instead of the domestic market. If a Japanese company
has ownership advantage, for example, appropriate products or information about
import permissions, it can do a listening. It is less cost intensive as compared to other
forms of internalisation. Furthermore, the MNE can invest in more capital overseas.
This can be achieved in the form of an export subsidiary. According to Dunning, it is
considered that locational advantages are necessary for FDI. An example of this is
Japanese factories which are either bought or are constructed abroad.
Large Japanese conglomerates are powerfully organised. They have also developed
their own Quality Control Systems such as the Kaizen and Kanban etc. The Japanese
industry expanded rapidly from 1960 to 1990 capturing most global markets.
However, with a fall in global exports since 1990 a rise in Japanese labour costs,
exports from Japan became more expensive and less competitive due to a stronger
Yen. Moreover, Japan imports a lot of basic raw materials such as steel, petrol, coal,
chemicals etc. After 1990, Japanese MNCs began to set up production centres all over
the world, especially close to the markets which manufactured the final products. For
example, Japanese automobile manufacturers set up production units in USA, Canada,
India, Thailand and Sri Lanka. The capital investment and technology would be
supplied by Japanese MNCs. Land and other resources would be sourced locally
under the close supervision of the Japanese Management. Japanese investments in
India have grown over the last several decades. Within Japan rising labour costs make
manufacturing a less competitive activity and therefore, unattractive as an investment.
However Japanese banks have a large amount of low cost funds. Therefore, it makes
sense for Japanese MNEs to borrow money from Japanese banks to set up factories in
other countries in Asia.
According to the author, this theory is the most complete theory up to now, with
respect to the explanation of internalisation process. It focuses on several steps of
internalisation process that each company must comply to in order to successfully
invest abroad. All the steps are necessary beginning with microeconomic factors
(internal) and ending with macroeconomic factors (external) of the company.
Modes of entry
MNEs practise various modes of entry that enable them to enter new markets in
various countries across the world and lead the organization towards globalization,
this is all in line with their strategic planning and future prospects, along with
alliances in international markets and establishing themselves by setting up
manufacturing facilities and marketing units with their ownership and control; which
benefits the Japanese companies.
Mergers and acquisitions is the merging of two or more companies by offering one
company, shares or other financial assets .

The first successful product was Maruti Suzuki India limited- MSIL. Started in
Gurgaon, MSIL revolutionised the four wheeler market in India. Ballabhgarh and
Faridabad became hubs ancillary units and spare parts. The top management of MSIL
had Japanese officers from Suzuki. In the last few years MILSs operations have been
expanded to Sanand in Gujarat. MSIL produces cars, not only for sale in India, but
also for export to Europe and other countries. In a recent development, cars produced
by MSIL India, will also be exported to Japan on account of cost efficiency. Within
Japan rising labour costs make manufacturing a less competitive activity and
therefore, unattractive as an investment. However Japanese banks have a large amount
of low cost funds. Therefore, it makes sense for Japanese MNEs to borrow money
from Japanese banks to set up factories in other countries in Asia.
A joint venture is an alliance between two or more parties to undertake a specific
economic project together within a limited time frame.
A major government to government initiative between Japan and India is the famous
DMIC (Delhi Mumbai Industrial Corporation) project. This comprises of an industrial
stretch covering the states of Haryana, UP, Rajasthan, MP, Gujarat and Maharashtra.
22 cities have been identified in this industrial belt. An entire network of roads and
railways, waterways, ports, bridges, industrial infrastructure, factories, power plants
and related activities are a part of the DMIC project

Conclusion
Various Japanese projects in India has the support of the Japanese India Business
Council (JIBC), Overseas Development Agency (ODA) and various Japanese
financial institutions. Mr. Shinz Abe, the Prime Minister of Japan, visited India in
2011-13 and since then Japan has created a US$33.8 billion dollars for investment in
Indian factories. One of the showcase projects is the bullet train project between
Ahmadabad and Mumbai involving an investment of 98 Million rupees. Japan has
also signed a civil nuclear technology deal with India.
These recent activities reflect the serious intent of the Indo- Jap relationships.
Japanese MNCs in India will definitely benefit from this supportive initiative. In order
to facilitate trade and investment between Japan and India, the two countries have
signed a DTAT (Double Tax Agreement Treaty) which was finalised as a part of the
Japanese PRIME Ministers trade delegation with respect to 2015.

In this manner, Japans technical knowhow and low cost finances have been used by
Japanese MNEs to set up manufacturing centres in South East Asia. Notably, South
Asia has a large population, large markets, along with a low cost and a skilled
workforce and land in comparison to Japan. This explains the framework for a typical
Japanese MNC strategy. As a matter of management culture, the top management of
every branch or affiliate of an MNC, even in an overseas country will be dominated
by the Japanese.

References:
Coe, David, and Elhanan Helpman, 1995, "International R&D Spillovers," European
Economic Review, Vol. 39 (May), pp. 85987.
, 2005a, "How Much Do Trading Partners Matter for Economic
Growth?" IMF Staff Papers, Vol. 52 (April), pp. 2440.
Dunning, John (1979). "Toward an Eclectic Theory of International Production:
Some Empirical Tests".Journal of International Business Studies
Gray, H. Peter (2003). "Extending the Eclectic Paradigm in International Business:
Essays in Honor of John Dunning"; Edward Elgar Publishing.
Twomey, Michael J. (2000). A Century of Foreign Investment in the Third
World (Book). Routledge. p. 8

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