Systems of Taxation of Multinational Firms under Exchange Risk

Abstract

The great stride of multinational firms during the last two decades has raised several problems in the home countries of such firms, notably in the United States. It is argued that the most serious problems are those of substitution of foreign production for exports of goods from the home countries, the negative impacts on the balance of trade of the home countries, and the possible losses of home tax revenues. These problems led to reconsideration of the system of taxation of multinational firms. One of the popular systems of taxation of foreign source income of multinational firms is the system of foreign tax credit with deferral allowed. Deferral means that profits of foreign subsidiaries of multinational firms are not taxed by the home governments until they are repatriated to the home countries. Even if repatriated profits (in the case of foreign branches all their profits) are subject to home taxation, tax credits are given by the amounts of taxes paid to the foreign countries. The tax credit system is adopted in major countries such as Japan, Sweden, the United Kingdom, the United States, and West Germany. Another method of taxation is the deduction system, under which foreign taxes paid are deducted from foreign profits taxable by home countries. It is partially adopted, for example, in Belgium and Italy (Kopits [14, 634]). Studies of the system of taxation in the United States have recently been made by Horst [9], Hartman [7], and Bergsten, Horst and Moran [4]. However, previous studies including the above three studies do not take into account exchange risk which is inevitable to multinational firms operating in different currency areas. Another shortcoming of the above three studies is that they focus only on the international investment decisions by multinational firms, and do not take into account the practice of international trade of goods and transfer pricing, which are typical features of most U.S. based multinational firms. This paper analyzes the system of taxation from new aspects, i.e., by incorporating