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

A parent plans to remit 600,000 of dividends from a subsidiary. Local tax rules impose a 5% withholding tax on dividends, but a 15% withholding tax on royalties and none on interest. The parent has a tax rate of 25% with full credit for foreign tax, while the subsidiary's rate is 20%. Which of the following statements best explains why the group might use royalties or management charges alongside dividends?

Royalties and management charges are usually tax-deductible in the paying subsidiary and can cut group tax, but they attract withholding taxes and must be arm's length, so authorities may challenge them. They neither avoid all tax nor remove currency risk.

  1. AThey are deductible in the subsidiary's profits and may reduce overall tax, though the tax authorities may challenge the amounts chargedCorrect
  2. BThey avoid all tax in both countries with no risk of challenge
  3. CThey are not deductible but lift the dividend cover ratio
  4. DThey eliminate the need to consider currency risk

Explanation

Royalties, interest and management charges are generally deductible by the payer, so can lower local tax, but must be at arm's length and may suffer withholding tax. They do not avoid tax entirely or remove currency risk.

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