Foreign Direct Investment Discuss the impact of corporate taxation on corporate decision-making, particularly investment and transfer pricing decisions

Taxation has a direct correlation to corporate profits and subsequent earnings per share. Taxes are a necessary aspect of the capital markets. In many instances, taxes are needed to maintain the overall economic system in which corporations operate in. Aspects such as national security, infrastructure, social safety nets, and other firms of government initiatives, are financed through taxes. Corporations benefit as they can now operate in a more efficient, credible, and transparent business environment. Taxes however, when excessive can discourage foreign direct investment within particular countries.

Taxes particularly for equity investors, have a profound impact on the overall attractiveness of securities. For one, investors are often taxed twice due to capital gains and dividend income. For instance, investors in equities often receive dividend payments throughout the duration of the year. These payments are often taxed as income for the individual investor. Furthermore, in the event that the investor sales securities within the company, he is also taxed for capital gains. Finally, the investor is also impacted as the company in which he invests in, is also taxed for its own income which indirectly affects the equity investor. In this instance, the equity investor is taxed twice. The first taxation occurs when corporations realize profits. The second taxation is on dividends that are given to investors throughout the year.

These taxation procedure directly impact foreign direct investment in international corporations. First, these taxation procedures discourage investment as equity investors will lose a disproportionate amount of their potential gains in taxes. To compensate for this potential lose of income, investors will demand higher rates of return. Companies must therefore, take on riskier projects to compensate for the higher rates of taxation that equity investors will incur. Further compounding these issue riskier projects, by virtue of their risk, may not obtain the returns that equity investor's demand. This could potentially drive down the price of...

offers tax credits to help mitigate the instance of double taxation. In many developed nations such as Europe and Canada income tax systems that tax residents on income, generally offer a foreign tax credit to mitigate the potential for double taxation. The credit may also be granted in those systems taxing residents on income that may have been taxed in another jurisdiction. The credit generally applies only to taxes of a nature similar to the tax being reduced by the credit. In the United States, these rules are computed through the source of income, the manner in which the income was generating, and the class of income.
A historical example of the use of tax credits is found with Bank of America. Bank of America almost tripled its stockpile of foreign tax credits to $6.2 billion in 2012. The credits sit on its books as deferred tax assets. They can be used to reduce future U.S. tax bills only after the company generates enough taxable income to exhaust $4.9 billion in U.S. deductions for losses. Outside the U.S., some of the banks businesses may have recorded gains with attached foreign tax credits and others may have had losses. When combined, they may have created a situation in which the bank received relatively little net income and was able to obtain the foreign tax credits.

As a simplified example, if the company had $100 of income in a country with a 20% tax rate, it would have a $20 foreign tax credit and would still have to pay $15 in tax to the U.S. If the profits were repatriating. If that income were combined with $90 of losses, then the company would have $10 of income to repatriate and a U.S. tax liability of $3.50. The company would still have paid $20 in taxes, creating $16.50 of excess foreign tax credits

Discuss the impact of income taxes on direct foreign investment and the desirability of equity vs. debt financing of foreign subsidiaries

In the section above, the effect of taxation on the return of equity investors was discussed. Now in regards to countries that can potentially generate high rates of return for investors, emerging markets seem particularly attractive. In many instances countries are encouraging direct investment within their…