Check the (Tax) Climate When Choosing a New Facility Location
Multinational companies must carefully monitor the evolving tax benefits of each market when considering facilities expansion strategies across the globe
Michael W. Burak, US & Global Industrial Products Tax Leader, PricewaterhouseCoopers (Fall 2012)
{{RELATEDLINKS}}As multinational companies consider facilities expansion strategies across the globe, particularly in developing markets, many factors ultimately influence their location decisions. In addition to labor costs, availability of skilled workers, raw materials supply, and regional growth potential, a myriad of regulatory and political issues also come into play. Further, with many countries vying for investment capital as well as tax revenue, companies must carefully monitor the evolving tax benefits of each market

Looking at the broader picture, PwC's 2012 tax rate benchmarking study highlights tax rate trends, based on input from nearly 325 companies across six industrial product (IP) sectors - aerospace and defense, chemicals, engineering and construction, industrial manufacturing, metals, and transportation and logistics. PwC found that tax rate volatility among global IP companies began to moderate in 2011, as the economic recovery continued to take hold. The improving economic environment, as well as a reduction in reported losses, drove an increase in the average three-year tax rate to 26.3 percent at year-end, up 0.7 percent from 25.6 percent in 2010.

As companies invest to strengthen their products and competitive positions, they may be finding more opportunities to pursue tax incentives that favorably impact tax rates. This is particularly notable for U.S.-based companies, given that the United States had the second-highest tax rate among OECD (Organization for Economic Co-operation and Development) countries in 2011. However, at the time of this article's writing, the United States had the highest tax burden among the OECD nations, surpassing Japan. Additionally, as companies increasingly expand into emerging markets, more of them may benefit from the lower tax rate policies, tax incentives, and various credits these countries offer to promote investment.

The Global Tax Picture
Taking a closer look, PwC evaluated average statutory and effective tax rates (ETR) for the past three years across 11 major markets: Canada, France, Germany, India, Japan, Korea, the Netherlands, Sweden, Switzerland, the United Kingdom, and the United States. The average statutory rate for these countries in 2011 was 29.4 percent, down from an average of nearly 30 percent in 2009. There was considerable rate variation between countries. For instance, the Swiss rate, at 21.2 percent, was nearly half of the tax rates in the United States and Japan.

On the other hand, the ETR for companies in the same 11 countries actually increased 0.2 percent over 2009. The ETR was highest for companies in Japan, at 35.3 percent, and lowest for companies based in South Korea, at 11.8 percent. However, many ETRs were lower than statutory rates, driven by the impact of foreign operations and tax incentives related to research and innovation. Companies that secured tax credits and incentives as well as tax holidays, in return for direct investment in select markets, ultimately paid lower tax rates.

Underlying tax structures naturally varied as well. For instance, the United States, India, and Korea have "worldwide" tax systems, whereby corporations are required to pay taxes on profits regardless of where they are earned. The other countries have a "territorial" tax system, where tax is paid on income earned in that country, and foreign-source dividends are totally or largely exempt from tax when remitted. The vast majority of OECD countries now follow territorial tax systems.

A number of factors ultimately determine a company's tax rate. These can be both structural and recurring, resulting from overseas operations and tax incentives, or items such as losses and tax reserve adjustments that may not necessarily occur every year. The most common factor is the impact that foreign operations can have on a company's tax exposure. As companies expand into emerging markets, and these countries broaden their tax benefit programs, the impact of this item may become even more prevalent.

Next: The Power of Tax Credits and Incentives Around the World

{{RELATEDLINKS}}World Markets - The Power of Tax Credits and Incentives
Looking at various regions around the world, many countries are using incentives to attract new jobs, capital investment, and advanced technology. While many U.S. state and local governments, as well as several European Union countries, dedicate discretionary cash grants, tax credits, tax abatements, and other incentives to create jobs and stimulate economies, other regions - including Southeast Asia, Africa, and Latin America - have fewer resources to drive commerce. These regions compete for foreign investment by offering direct tax holidays, freezes, reductions, and other agreements.

In Southeast Asia, countries such as the Philippines, Indonesia, and Malaysia are seeking to support economic growth with tax incentives. For example, the Philippines is targeting foreign investment with a four- to six-year tax holiday, which can be expanded up to an additional three years. The country has a corporate income tax (CIT) of 30 percent, and only taxes foreign corporations on income earned from Philippine sources, not on worldwide income. After the tax holiday expires, certain companies operating in special economic zones/export processing zones pay only 5 percent tax on gross income earned in lieu of all national and local taxes.

Indonesia, the largest economy in the region, has a flat corporate income tax rate of 25 percent of net income. Under certain conditions, corporations may receive tax discounts of 5 percent, reducing the effective tax rate to 20 percent. To attract more foreign investors, Indonesia provides a CIT tax holiday of five to 10 years in five industrial sectors: metals, oil refining, petrochemicals, renewable energy, and telecommunication equipment. After the holiday, a company may receive a 50 percent reduction in CIT for two additional years.

The combination of a favorable tax rate and an aggressive incentives regime makes Malaysia an attractive alternative for business expansion in the region. The country has matured from a supplier of raw materials to a strong multi-industrial economy, particularly in electronics and semiconductors, and has created close to 120,000 new jobs since 2007. Malaysia's CIT is 25 percent and companies with pioneer status in industrial and commercial sectors may receive from 70 percent up to 100 percent exemption from CIT for five to 10 years. As an alternative, an investment tax credit ranging from 60 percent up to 100 percent of qualified investments for a period of five years can reduce CIT by 70 percent.

Many developing markets in Africa also offer tax holidays and other incentives. However, some question the ability of these countries to offer tax breaks at the expense of revenue needed for infrastructure development and other services for citizens. For example, Nigeria is currently seeking tax reforms to achieve a business-friendly environment. With a CIT of 30 percent, the country taxes foreign corporations on income sourced to Nigeria. To attract new investments and jobs, Nigeria offers pioneer companies in certain industries a tax holiday for five years. In addition, an investment tax credit of 10 percent of qualifying capital investments in plant and machinery is available in the year of the investment. But, opponents of tax holidays in Nigeria argue that providing billions of dollars to attract foreign investment reduces the tax base and deprives investment of resources to Nigeria's citizens.

Uganda, another country with a narrow tax base, is also seeking to attract foreign investors to expand its tax base, support infrastructure development, and increase government revenues. Uganda's CIT is 30 percent, and a tax holiday of up to 10 years is available to exporters if they export at least 80 percent of their product. Uganda also offers a 100 percent exemption for scientific research and training costs.

Morocco is another regional hub that has infrastructure and labor skills to support multinationals. The CIT in Morocco is 30 percent and 37 percent for leasing companies and credit institutions. Foreign corporations, under certain conditions, may opt for an alternative tax at a rate of 8 percent. In addition, companies located in free-trade zones (FTZs) and in specified industries spanning food processing, textiles and leather, electronics, and chemicals are exempt from CIT for the first five years and then enjoy a reduced rate of 8.75 percent for the next 20 years.

Latin America may offer the most significant tax benefits in terms of reduced CIT. Specifically, Costa Rica and Panama offer tax incentives that could potentially outweigh all other factors when deciding to locate a facility in this region. The CIT in Costa Rica is 30 percent, and only income sourced to the country is taxable. An income tax exemption is available for eight to 12 years, depending on the location in a FTZ within Costa Rica. Panama expects increased attention as a business location with the completion of the Panama Canal expansion in 2014. Additionally, real estate costs are low compared to other countries in the region. Companies are subject to a CIT of 25 percent and can receive a full tax exemption on foreign-sourced income if they locate in an FTZ. Moreover, a tax exemption for executives is available for personal income tax and contributions when a foreign entity pays the executive's salary.

These emerging markets all provide tax benefits to attract investment, foster growth, and energize their economies. When reviewing the key factors that contribute to facilities location decisions, tax considerations cannot be overlooked. The types of tax incentives offered and the terms of these programs can impact where a new facility and jobs locate. Tax holidays, exemptions, reductions, and other tax agreements can reduce the taxes companies pay for a defined period, with additional benefits potentially available after the term expires.

PwC's tax experts team with some of the world's largest organizations on tax planning, global structuring, and tax controversy. They analyze and interpret tax policy, advise corporations on intricate tax matters, and help companies comply with increasingly complex tax compliance requirements. Utilizing their knowledge and experience regarding the tax structures of both developed countries and emerging markets worldwide, they provide counsel and direct assistance to industrial products companies that wish to tap into the many tax benefits that may come with international expansion.

This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.