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ACCA Strategic Professional · Advanced Financial Management · Dividend policy in multinationals and transfer pricing

A multinational parent wants to extract cash from a foreign subsidiary in a country with a high withholding tax on dividends but no withholding tax on royalties or management charges, and where both payments are tax-deductible for the subsidiary. Which repatriation approach is most likely to reduce the group's total tax cost?

Substituting royalties and management charges for part of the dividend is likely to cut the group tax cost, because they are deductible in the subsidiary and bear no withholding tax, whereas dividends come from taxed profit and suffer withholding tax. Arm's length pricing must still be respected.

  1. APay the whole amount as dividends to keep the structure simple
  2. BReplace part of the dividend with royalties and management charges, subject to arm's length and transfer pricing rulesCorrect
  3. CRetain all profits in the subsidiary indefinitely
  4. DPay dividends only in the parent's currency

Explanation

Royalties and management charges are deductible locally and bear no withholding tax, so shifting part of the remittance to them lowers total tax, provided they are at arm's length. Dividends are paid from taxed profits and suffer withholding tax. Paying dividends in the parent currency changes nothing about the tax.

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