The impact of currency values on commercial operations is a familiar topic for the international accountant. Much of the attraction of currency markets stems from its synthesis of all aspects of the world economy distilled into a single, digestible value. The significance of relative currency values rests primarily on their relationship to world markets and their interaction with international trade, investment, and monetary practices. A given exchange rate, when viewed in isolation, may at first appear to be little more than an abstraction. Yet, it exercises a significant influence on commercial relations as a pricing mechanism affecting every international transaction. The impact of exchange rate fluctuations on domestic aggregates can also affect the course of economic activity to the point that a sense of urgency is reached when dealing with volatile markets. As long as currencies remain the medium of exchange for commercial transactions, market fluctuations of relative currency values will continue to attract the attention of the investor, the banker, the speculator, and the policy maker alike. This paper will examine the tax planning logic for H&M, a large multinational retail clothing corporation based in Sweden with a significant presence in the United States.
Operating in multiple currencies have a significant impact on H&M's tax liability. Currencies are exposed to exchange rate fluctuations to the extent that they are used to conduct transactions with external markets. The greater the proportion of currency exchanges to total monetary transactions for a given market, the greater the exposure to changes in exchange rates. Commercial operations conducting international trade are exposed to exchange rate fluctuations in proportion to their total volume of transactions (Lymer and Hasseldine, 2002). As the magnitude of currency transactions increases relative to aggregate transactions, a business unit realizes greater exposure to exchange rate fluctuations. The transactions approach to exchange exposure has gained prominence in recent years. A lingering preoccupation with currency translation for the measurement of operating performance, however, has tended to divert attention away from productive commercial activity towards disingenuous, while flashy, hedging techniques. The clever money manager can still generate significant cash gains from currency hedging without increasing the productive output of a business unit. By defining exposure as the proportion of currency transactions to total transactions, greater management attention can be aimed at operating units with a high degree of exposed risk to exchange rate changes (Johnson and Scholes, 2002).
Evaluating operations performance on a global scale demands a shift in perspective towards techniques based on multilateral transactions analysis. An enterprise operating in a single market with single currency transactions can easily be evaluated in the operations currency, while one which is engaged in many markets and multiple currencies requires more extensive analysis. Common financial accounting practices require financial positions to be translated at current exchange rates from the operations currency into the reference currency. Despite the need to consolidate financial results on a consistent basis, direct translation at current exchange rates continues to obscure actual operating results when the relative currency values fluctuate from period to period (Morrison, 2002). As a result of these exchange rate fluctuations, and the extent of their volatility, comparisons over a number of periods become completely invalid from the perspective of the reference currency. A recurring theme throughout the deliberation of multicurrency financial accounting is that a commercial operation should be evaluated from the perspective of the economy in which the unit is located, as measured by the operations currency; this is the fundamental argument for establishing current rate translation accounting over historical rate translation methods. Resolving this dichotomy can be an extensive process so long as the need remains to translate the operating results of a corporation for consolidation into a single currency of reference (Lymer and Hasseldine, 2002).
In analyzing whether H&M should utilize a separate transactions accounting method or a profit and loss accounting method is a critical matter. Most large businesses and all governments must operate in at least two currencies to finance their activities. Dual currency accounting formalizes this dependence on multiple currencies by keeping financial records in two currencies. A profit and loss method uses a chart of accounts to manage transactions in multiple currencies. This system is superior as every transaction is labeled with a currency code on the last digit. This allows the system to categorize every transaction by the currency it uses and report debits and credits to accounts without the need of a currency exchange transaction.
Profit and loss accounting solves the problem of producing balance sheets with multiple currency accounts by creating as many monthly profit and loss statements as currencies used by the business or bank operating the multi-currency accounting system. In dual currency accounting this is reduced to only two currencies. Banks and business only need to calculate the exchange position of income less expense for each currency to revalue the foreign exchange in their local currency. One of the choices businesses using dual currency accounting must make is to convert the value of a transaction into the parallel currency in real-time or to do so at a specific date. The task of evaluating performance in multiple currencies extends beyond contemporary financial accounting practices. One approach is to separate the evaluation of operating results from their consolidation. A multi-tier evaluation process then evolves as operations in an external market develop through a cycle from capital investment to normal commercial operations. Ongoing business operations are evaluated in the operations currency, consolidated enterprises from the reference currency, while the return on capital investment is measured in the investment currency (Morrison, 2002).
Historically, H&M's most important distribution channel are owned stores, complemented by online shopping and catalogues (Annual Report, 2011). In examining the feasibility of liquidating H&M's American presence it is critical to keep in mind the corporation's global position. In September 2006, H&M began its expansion in Middle East in cooperation with franchise Alshaya. Operations through franchising are considered an exception from the expansion strategy of the H&M and were chosen because in the Middle East it is not possible to operate wholly-owned subsidiaries. H&M expanded through organic growth, and it financed new market entries with own cash reserves. In 2007 the company managed more then 1,500 stores in 28 countries. Its development is not only fast but also profitable -- during the last five years sales including VAT has increased by 73% and profit after tax by 139%. H&M aims at increasing the number of stores by 10-15% a year, and to increase sales at the existing stores (Annual Report, 2011). Until the 1980's the company mostly bought products from its agents in Asian countries and then re-sold them in its stores. In 1987, the company striving to improve its positioning employed a new design director to build a designers team. The new idea was to design and produce items that customers were demanding in the stores. Today, the headquarters in Sweden employ around 100 internal designers and cooperate with around 50 pattern designers and 100 buyers. Together, they create the company's collections, considering the three basic factors: fashion, quality and price (Annual Report, 2011).
As demand for its product has increased, the company decided to expand sales and distribution into Europe, South and Central America, and China. But the company's dispersed manufacturing and sales operations soon brought tax issues to the forefront. For companies doing business abroad, tax implications can include the timing of U.S. income tax, value added tax (VAT), and transfer pricing, among others. For European sales, the manufacturer had established a complicated distribution network involving as many as 40 companies. Working with local advisors who lacked international experience, the manufacturer ultimately chose methods of distribution that proved highly inefficient from a tax perspective. Moreover, the company's initial strategy to sell its products directly into China created a similarly inefficient tax structure. And in addition to tax issues, the company's method of establishing itself in multiple countries had complicated the financing of its various operations (Thruonyi, 2003).
In analyzing the company's flow of transactions it is not difficult to identify its undue complexity. With different pieces in the U.S., China, and Europe, it is too hard to manage. To optimize tax efficiency, H&M should be advised to establish new operational and legal structures in multiple locations. Much of the streamlining revolved around a newly established, centralized hub in Hong Kong -- a single location from which raw materials could be ordered and manufacturing subcontracted from mainland China, while finished goods could be distributed to all of the company's markets: China, the U.S., and over a dozen European countries. In addition to helping guide a new program of tax efficiencies, H&M should also be helped to seek and secure local financing for its newly established and revamped operations outside the U.S. This will require support for navigating local tax compliance and audit needs for the Hong Kong and China operations. With these new tax efficiencies and necessary overseas financing arraged, H&M will be better positioned to expand its global and…