Ownership criterion: some argue that ownership is a key criterion. A firm becomes multinational only when the headquarter or parent company is effectively owned by nationals of two or more countries. For example, Shell and Unilever, controlled by British and Dutch interests, are good examples. However, by ownership test, very few multinationals are multinational. The ownership of most MNCs are uninational. (see videotape concerning the Smith-Corona versus Brothers case) Depending on the case, each is considered an American multinational company in one case, and each is considered a foreign multinational in another case. Thus, ownership does not really matter.
Nationality mix of headquarter managers: An international company is multinational if the managers of the parent company are nationals of several countries. Usually, managers of the headquarters are nationals of the home country. This may be a transitional phenomenon. Very few companies pass this test currently.
Business Strategy: global profit maximization
According to Howard Perlmutter (1969)*:
Multinational companies may pursue policies that are home country-oriented.
or host country-oriented or world-oriented. Perlmutter uses such terms as ethnocentric, polycentric and geocentric.However, "ethnocentric" is misleading because it focuses on race or ethnicity, especially when the home country itself is populated by many different races, whereas "polycentric" loses its meaning when the MNCs operate only in one or two foreign countries.
According to Franklin Root (1994), an MNC is a parent company that
*Howard V. Perlmutter, "The Tortuous Evolution of the Multinational Corporation," Columbia Journal of World Business, 1969, pp. 9-18.
There is a limit to foreign sales (tariffs, NTBs)
The licensee may transfer industrial secrets to another independent firm, thereby creating a rival.
The company becomes a multinational enterprise when it begins to plan, organize and coordinate production, marketing, R&D, financing, and staffing. For each of these operations, the firm must find the best location.
US Multinational Corporations Exxon, GM, Ford, etc.
GM purchased Monarch (GM Canada) and Opel (GM Germany). It did not buy Toyota, Datsun (Nissan) and Volkswagen. They later became competitors.
Cheap foreign labor. Labor costs tend to differ among nations. MNCs can hold down costs by locating part of all their productive facilities abroad. (Maquildoras)
MES is the minimum rate of output at which Average Cost (AC) is minimized. If minimum efficient scale (MES) is not achieved, then export.
If foreign demand exceeds the minimum efficient scale, then FDI.
Figure 1. Minimum efficient scale and FDI.
A view from the mountain top. Many multinational companies are housed in tall
buildings in Hong Kong.
Differences among national income tax systems affect the decisions of managers of MNCs, regarding the location of subsidiaries, financing, and the transfer prices (the prices of products and assets transferred between various units of MNCs)
Multiple Tax Jurisdictions creates two problems, overlapping and underlapping jurisdictions. When overlapping occurs, two or more governments claim tax jurisdictions over the same income of an MNC. The overlapping may result in double taxation.
Conversely, when underlapping occurs, an MNC falls between tax jurisdictions and escape taxation. Underlapping encourages tax avoidance.
National governments may choose a territorial jurisdiction or national tax jurisdiction or both.
Territorial Tax Jurisdiction: The government taxes business income that is earned on the national territory.
National Tax Jurisdiction: Both domestic and foreign source income of national companies are subject to income tax. US government taxes both domestic and foreign source incomes of US MNCs.
Remark: Most governments that exercise NTJ also claim a Territorial Tax Jurisdiction. This creates the problem of double taxation.
However, to avoid double taxation, the US government gives credit to MNEs headquartered in the US for the amount of tax paid to foreign governments.
2. Foreign Trade and Investment Act of 1972 (Burke-Hartke Bill) was defeated.
According to this plan, foreign taxes would be treated as business expenses. For example,
Pretax profit = $1,000
MNC's profit after foreign tax = 1,000 - 300 = 700
If foreign tax is treated as business expense, then
MNC's tax to IRS = 700 x 46% = 322.
Total taxes = 300 + 322 = 622
US taxes = 1000 x 46% = 460
but foreign tax credit = 300
Net tax to IRS = 460 - 300 = 160.
Total taxes = 300 + 160 = 460.
tp = tax rate in the parent country
th = tax rate in the host country
If tp > th, then underprice its exports to the subsidiary in the host country, and overprice its imports from the subsidiary. => lower tax.
Purpose: manipulate prices between the headquarter and the subsidiaries so that profits are highest in the low tax country.
Example: Figure 2. Choosing transfer prices to minimize tax
Total tax = $150
Thus, a multinational company's overall tax could be paid at the minimum of all tax rates of the countries in which it operates.
Abuses in pricing across national borders are illegal (if they can be proved). MNCs are required to set prices at "arms length" (set prices as if they are unrelated).
IRS argued that Toyota Inc. of Japan had systematically overcharged its US subsidiary for years on most of trucks, automobiles and parts sold to the US.
Because of abuses in transfer pricing, taxable profits were shifted to Japan. Toyota recently agreed to pay $1 billion to IRS.
Assume both countries have the same corporate tax rates = 40%
US Canada Pretax profits 10% 12% Tax 4% 4.8% Net to investors 6% 7.2% Total Gains from domestic investment = 10% (= 4% + 6%) because tax revenues can be used for public purposes.Total Gains from foreign investment = 7.2% (because US government gets nothing). The tax revenue which could have been used to build US highways would be used by Canadian government to build their highways.