Global sourcing decisions for a multinational firm with foreign tax credit planning

Abstract

Various countries’ tax laws adopt certain forms of a so-called worldwide tax system which levy taxes on their countries’ multinational firms’ global incomes at home country tax rates. To avoid double taxation, they permit tax cross-crediting, i.e., a global firm can use excess foreign tax credits (the portion of foreign tax payments that exceed its home country tax liabilities) generated from a subsidiary (located in a high-tax country) to offset the tax obligations from another subsidiary (located in a low-tax country). This article studies a multinational firm’s global sourcing decisions at two subsidiaries located in low- and high-tax countries, respectively, with an objective of maximizing its expected worldwide after-tax profit. We characterize the optimal sourcing decisions under various decentralized and centralized after-tax profit-maximizing performance measures. We show that the global firm can devise an easily implementable incentive scheme to optimally coordinate the decentralized sourcing decisions made at the two subsidiaries. We also demonstrate that decentralized policies with after-tax performance measures are more advantageous than the traditional pretax policies when the “tax effects”, i.e., the impacts of certain features of the tax laws (such as tax cross-crediting) on supply chain decisions, are significant.