Moving Money Across Borders: Attaining Efficiencies and Reducing Taxes

Pursuing the objectives of utilizing the firm's cash resources most efficiently and minimizing the firm's global tax liability requires the firm to be able to transfer funds from one location to another around the globe. International businesses use a number of techniques to transfer liquid funds across borders. These include dividend remittances, royalty payments and fees, transfer prices, and fronting loans. Some firms rely on more than one of these techniques to transfer funds across borders--a practice known as unbundling. By using a mix of techniques to transfer liquid funds from a foreign subsidiary to the parent company, unbundling allows an international business to recover funds from its foreign subsidiaries without piquing host-country sensitivities with large "dividend drains."

A firm's ability to select a particular policy is severely limited when a foreign subsidiary is part-owned either by a local joint venture partner or by local stockholders. Serving the legitimate demands of the local co-owners of a foreign subsidiary may limit the firm's ability to impose the kind of dividend policy, royalty payment schedule, or transfer pricing policy that would be optimal for the parent company.

Dividend Remittances

Payment of dividends is probably the most common method by which firms transfer funds from foreign subsidiaries to the parent company. The dividend policy typically varies with each subsidiary depending on such factors as tax regulations, foreign exchange risk, the age of the subsidiary, and the extent of local equity participation. For example, the higher the rate of tax levied on dividends by the host-country government, the less attractive this option becomes relative to other options for transferring liquid funds. With regard to foreign exchange risk, firms sometimes require foreign subsidiaries based in "high-risk" countries to speed up the transfer of funds to the parent through accelerated dividend payments. This moves corporate funds out of a country whose currency is expected to depreciate significantly. The age of a foreign subsidiary influences dividend policy in that older subsidiaries tend to remit a higher proportion of their earnings in dividends to the parent, presumably because a subsidiary has fewer capital investment needs as it matures. Local equity participation is a factor because local co-owners' demands for dividends must be recognized.

Royalty Payments and Fees

Royalties represent the remuneration paid to the owners of technology, patents, or trade names for the use of that technology or the right to manufacture and/or sell products under those patents or trade names. It is common for a parent company to charge its foreign subsidiaries royalties for the technology, patents, or trade names it has transferred to them. Royalties may be levied as a fixed monetary amount per unit of the product the subsidiary sells or as a percentage of a subsidiary's gross revenues.

A fee is compensation for professional services or expertise supplied to a foreign subsidiary by the parent company or another subsidiary. Fees are sometimes differentiated into "management fees" for general expertise and advice and "technical assistance fees" for guidance in technical matters. Fees are usually levied as fixed charges for the particular services provided.

Royalties and fees have certain tax advantages over dividends, particularly when the corporate tax rate is higher in the host country than in the parent's home country. Royalties and fees are often tax deductible locally (because they are viewed as an expense), so arranging for payment in royalties and fees will reduce the foreign subsidiary's tax liability. If the foreign subsidiary compensates the parent company by dividend payments, local income taxes must be paid before the dividend distribution, and withholding taxes must be paid on the dividend itself. Although the parent can often take a tax credit for the local withholding and income taxes it has paid, part of the benefit can be lost if the subsidiary's combined tax rate is higher than the parent's.