Masama industry is a Japanese middle-sized company that manufactures motorcycles. Owing to competition, the company has formed Masama (U.S.) with Jack Blakely as its president, in-charge of marketing development in north and South America. A dilemma has irrupted between the management form the parent company and Jack, over the form of registration that its Brazilian operation should assume. The parent company wants it to be under Masama manufacturing Japan, so that it can benefit from the brazil-Japan treaty that recognizes Japan as a tax haven, and the withholding rate on dividends is 12.5%.
On the other hand, Jack wishes the Brazilian operation to be under Masama (U.S.) which he helped building. The U.S- Japan income tax treaty allows for a 10 % withholding on tax. Additionally, the U.S and Brazil do not have an operational treaty, and so Brazil taxes dividends of American companies at a rate of 25%. To harmonize jack’s operational goals and the cost-minimization concept of the parent company, perhaps it would be best if the company decided to register Masama (U.S.) as an independent entity in Brazil. This way, it will benefit from the tax holiday accorded to the local companies by the Brazilian government.
Masama industries, a middle-sized company that manufacture motorcycles, have identified a market for expansion in America. Through the efforts of its hands-on American president Jack Blakely, the company has established a manufacturing plant in Brazil. Japan and Brazil enjoys a tax exemption clause for their foreign investors, and this has led to the company enjoying a 15 year tax holiday. Nevertheless, the parent company is more concerned with cost minimization, while Jack has his operational goals to think about, regarding the south and North American market that he heads, and this has become a source of conflict.
What are the repercussions to operations, and specifically to Jack Blakely, should the legal form of organization for tax treaties be adopted?
Should Masama industries go ahead with their plan to adopt legal form of tax treaty, then there is a possibility that the organization chart that was proposed by Jack Blakely may not serve its purpose. This is because as per the chart, Masama US, of which Jack is the president, is mandated with the development of markets in north and South America. In this case, Brazil happens to be in South America, under therefore it falls under the jurisdiction of Masama US.
Additionally, the adoption of legal tax treaties would also be contrary to the hiring contract between Jack and his employer. Apparently, the goal of Masama industries is to make as much profit as possible, and then send it back to Japan. That is why the Chief finance officer of Masama industries, Yasuo Tagawa, would wish to have the tax problem in their Brazilian plant handled by the parent company directly, rather than by Masama US.
The goal of the company is to be able to evade an extra 10 percent taxation that would otherwise be slapped on them, since the united states and brazil have no tax treaty, and hence the reason for the withholding of tax. Thanks to globalization, there has then resulted conflict with regard to tax jurisdiction, which is exactly the case with Masama industries. On the one hand, the mother company is based in Japan, and for this reason, enjoys a tax exemption by Brazil by virtue of the treaty the two countries have signed.
On the other hand, Masama US is in-charge of the marketing and operations of the plant in Brazil, by virtue of its territory. Therefore, the company, though registered in Brazil, is technically American, and the two countries do not have a relationship with regard to exemptions of tax. The international laws do not however impose restrictions to tax collection, but rather, the whole process has its basis on the legislative process of the domestic market (World Bank, 2001). This is more of an expression of national sovereignty.
To provide any restriction, the application of tax jurisdictions by any one given state will therefore depends on the principles that govern the income sources country, and the country of residence. In the case of Masama US, the residence country is Japan, while the source country is Brazil. in case Masama industries succeeds in their bid to have their tax treaty with Brazil adopted, then on technical terms, Jack will lose his grip over the firm he has seen grow, and this will not only demoralize him, but also his team as well. Consequently, he will not be able to achieve his monetary objectives, as a result of the eroded sales.
What can be done to bring Jack’s operational goals in line with tax-cost minimization?
Clearly, there is a conflict of interest between Jack as the president of Masama (U.S.) On one hand, and Masama industries on the other hand. According to Jack, his operational goals are such that he would wish to see an increase in the distribution of sales outlets in the United States. More importantly, jack has used his connections, vision and leadership to identify and expand Masama’s market share in Brazil and Mexico for the company’s motorcycle. As such, it can be seen that Jack is more committed towards the growth and expansion of Masama in the American continent.
On the other hand, the top management at Masama Japan views the expansion proposal by Jack as one that is too expensive; in as far as taxation is concerned. For the parent company, the bottom-line is profits, and they are committed to making as much of it as possible, after taxation, and the taking home a tidy sum of profits to Japan. Already, the company has a tax holiday than spans for 15 years (Moore, 1994), and the bone of contention then is the tax that they have to pay by virtue of having been registered as Masama (U.S.). This means that they will experience an extra 10 percent tax holding, over and above what would have been the case, had the company been set as Masama manufacturing Japan (Moore,1994).
This way, the company would benefit from the tax holiday that Brazil has extended to Japan. The problem then is how to ensure than Masama Japan, on the one hand is able to minimize its cost, and thus be able to achieve its goals of profitability, and helping Jack to fulfill his goals on the other hand. Competition within a company’s market will normally necessitate a need to minimize costs (PWC, 2005). Additionally, there is also a potential for a double taxation, if a company like Masama (U.S.) continues with its registration as Masama Japan.
This poses a threat, by way of creating uncertainty with regard to the projected profits. Perhaps a model worth adopting by Masama Japan is the arm’s length pricing model. This is a model that treats the individual parts of a multinational as separate entities (Sadiq, 2004). This then means that Masama Japan would be treated as a private entity from Masama (U.S.). As such, all the operations and transactions that occur in Brazil would then technically fall under the jurisdiction of Masama (U.S.). Alternatively, the company could opt to have a fully fledged and operational branch in Brazil, but then under the mandate of Jack at the Masama offices in the United States.
As a result, both parties benefit. Jack will still continue with his plans for expansions of the vast market in Mexico and Brazil, and in the process realize his dream of increasing his earnings. On the other hand, the mother company, Masama Japan, based on its historical treaty relations with Brazil, will continue benefiting form tax exemption. Hence, the management will be in a position to minimize costs and get more profits, hence achieving its operational goal congruency.
Computing the effective tax rate for Masama case study.
Effective Tax Rate (ETR) (%) = Income Tax Expense
Income Tax Expense is the sum of payable income tax + differed taxes. It refers to the effect of income taxes on a corporation’s net income for the year, based on the measurements of GAAP (Generally Accepted Accounting Principles) rules.
Pre-tax income or earnings before taxes is the reported income prior to the deduction of income taxes.
Let the income tax expense for Masama operation in Brazil be X.
Let the pre-tax income for Masama operation in Brazil be Y.
Therefore, Effective Tax Rate (ETR) (%) = X * 100
A. Effective tax rate of the new Brazilian operation as a subsidiary of Masama U.S
When a Brazilian company is paying dividends in a non-treaty situation, Brazil taxes dividends at 25 percent. In addition, if these profits come into the United States and then go to Japan, there will be another 10 percent withholding tax under the U.S. – Japan income tax treaty. The firm would thus face a total of 35 % tax rate. Since the company has decided to pay its shareholders in the form of dividends, it means that the rule of double taxation will have to apply.
When a company has decided that it will pay dividends to its shareholders, their earnings get taxed by the government twice. First, the company has to pay taxes on earnings at the end of a financial year. Secondly, shareholders are also taxed by the government upon receiving their dividends from a company’s after-tax earnings. It therefore means that Masama (U.S.) gets to pay 22.5% more tax than if the company would have been registered under Misama Japan, in accordance with Brazil-Japan income tax treaty, that recognizes Japan as a tax haven, hence the reduced taxation.
Effective tax rate of the new Brazilian operation as a subsidiary of Masama Industries (Japan).
If dividends come directly from Brazil to Japan, under Brazil-Japan income tax treaty, the withholding rate on dividends is 12.5 percent. Under such an arrangement, there would only be a 12.5 percent withholding on tax, and Masama industry gets to send more profits home, in accordance with the desires of the company’s top management. This is because fewer jurisdictions are at play, as opposed to when taxes had to go through the US first, then to Japan.
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