How do companies use different international tax rates to their advantage?

Tax is a major issue for companies today and can affect competitiveness of the company. All companies would like to lower the tax bill; this creates more shareholder value which is the overall aim of companies. Internationally, corporate tax rates vary dramatically and companies are looking to move to ‘tax havens’ in order to reduce their tax outgoings.

Well known tax havens are Ireland and Switzerland. Within Switzerland the Canton of Zug has one of the lowest corporate tax rates in the country, today around 12-25%. Many companies have offices or headquarters there including Boots, Siemens, Zstrata, Tata AG and Johnson and Johnson. Ireland has a corporate tax rate of 12.5- 25%.  These rates are significantly lower than the 28% paid in the UK and companies who operate from Switzerland or Ireland can make real savings on their tax bill.

There are 26 Cantons in Switzerland which make up the federal state and each canton has its own constitution, legislation, government and courts which is why tax rates can vary within Switzerland itself. Switzerland in general is seen as a tax haven for companies.

Some people would argue that it can be viewed as ‘un-fair’ that businesses move around to gain benefits from lower taxes. In some ways they would be right as everyone else has to pay income tax so why should companies get away with avoidance? Companies offer great benefits to the local communities they are based in. They move so that they can benefit from lower tax bills which creates more available funds for investments and growth, which achieves the long-term objective of maximising shareholder value.

Johnson and Johnson’s pharmaceutical and biotechnology sectors are primarily located within Europe, in particularly Ireland, Belgium and Switzerland. The facilities there can produce the products and they have R&D facilities. They then sell the products to relevant subsidiaries around the world. Through the method of transfer pricing they are able to retain a large amount of profits within Switzerland and Ireland where the tax rate is lower. The UK subsidiary can benefit through only paying tax once due to double taxations treaties with Ireland since 1998, Switzerland since 1977 and Belgium since 1987.

Through techniques like over invoicing, profits can accumulate in the lower tax regions. Johnson and Johnson report figures as a whole and by sector and as long as the figures remain in the correct sector it does not cause an issue to top managers or investors.

One disadvantage to having facilities in different countries is the affect currency variations have upon pricing. The Johnson and Johnson (J&J) plants in Europe all invoice out in GBP so the European based subsidiaries take the risk, rather than the UK subsidiaries purchasing the goods. The invoice is created on the day the goods leave the warehouse, so by the time payment is due, currency exchange rates can have changed dramatically especially with the current problems in the Euro Zone which is a form of transaction exposure.

Another type of currency exposure J&J have to deal with is translation exposure. This is due to all reports having to be produced in USD, as they are incorporated there and trade on the NYSE. Each subsidiary company hedges to protect against currency differences.

The savings companies’ makes in re-locating to countries with lower tax rates must more than compensate for the currency risks that occur through the currency variations. I therefore can see why people do oppose companies moving to gain tax breaks, but I can see why companies do it. They have more income which they can use for other projects or investments which could help the community in the longer term. Governments today are trying to reduce these ‘tax havens’ so companies cannot save large amounts by moving country. This may work for a while until they are able to find another area which offers low taxation rates.

(References – BBC News, Bloomberg, The Financial Times, Johnson and Johnson and Corporate Financial Management – Drury.)

How do companies raise additional finance?

There are two major ways in which companies can raise finance. These are Debt and Equity finance. There is also a third method of using the retained earnings the company already has. This is a method most companies initially try to use as retained earnings are dividends which have not been paid out to the shareholders, but retained within the business. With this form of finance the cost of finance is the expected return required by the shareholders and the cost of accessing the funds is minimum.

Equity finance involves issuing new ordinary shares, but is only a good choice if a large amount of finance is required due to the high charges involved. Through issuing new shares they are diluting the control of the business and again the cost of finance is the required return demanded by the shareholders. Regular repayments do not have to be made and dividends to shareholders are not legal requirements. Shareholders just expect to gain dividend from their investment.

Finally debt finance involves loans and debt securities. This is a cheaper method than issuing shares, but does involve regular repayments. If large amounts are required then syndicated loans are an option, due to many banks lending to spread the risk and one bank taking overall responsibility for the entire loan amount. Currently there are limits to the amount as Glencore and Xstrata are finding out, due to them both being among the biggest borrowers of syndicated loans. The two companies are merging and both have high amounts of syndicated loans which will need to be restructured to remain in these limits set out by the banks involved.

Companies sometimes offer products at a loss or below the required rate of return. They do this for many reasons such as gaining awareness of the product or to gain market share. An example of this is the Amazon Kindle Fire.

Amazon in 2011 released their Kindle Fire for $199 in the US which was $300 cheaper than the basic iPad. Through this low price Amazon were not even covering the cost of the components, never mind the technology and research that went into producing this. They were happy to sell the Fire as a loss leader in order to gain potential iPad customers and to be able to enter the tablet computer market.

When Amazon released their figures in October 2011, profit figures were down 73% due to the heavy investment in the Fire. They have had high cash reserves in the past which will have been used to fund investment for the Fire. But after the figures were released the share price fell 12% as a consequence, which shows that the shareholders expect high returns from using retained profits to finance projects and were not satisfied with the profit figure and profit warning for the Christmas period. The return on capital for the Fire will be unsatisfactory due to the loss they are making on each device. But Amazon will make very high returns on other devices such as the basic Kindle which will help overall figures.

Amazon can sell the Fire at a loss due to the requirement to purchase ‘apps’ and e-books to be able to use the Fire to its full potential. With the e-books certainly in the UK sometimes it is cheaper to buy the paperback version instead, although some are free or heavily discounted. I myself have a regular Kindle and sometimes the prices of e-books are significantly higher than the paperback on Amazon itself. If that is the case I purchase the proper book instead of the download option. But Amazon is able to charge the high prices as some consumers do not think of checking the paperback price. This is where Amazon makes a great deal of money allowing the Fire to be sold at a loss.

In the past three months, Amazon has sold 3.9 million Fire’s making them the worlds second largest tablet maker. This seems impressive but compared to Apple who sold 15.4 million iPads the figure seems quite insignificant. Will the Kindle Fire become as successful as the iPad and create the returns required by Amazon or will the next iPad which is rumoured to be smaller, mean the Fire project ultimately fails? Amazon is confident that the Fire offers something different to the iPad and I would definitely consider a Fire due to the premium price you pay for an Apple device. If the Fire can compete with the iPad then surely it will gain a different audience who do not require everything they own to be an Apple device.  Globally people do not have as much disposable income so maybe the Fire will become an alternative to the iPad for many. If demand for the Fire declines and can not compete with the iPad, then unfortunately for Amazon it could become a failed project losing them and the shareholders a lot of money.

(Sources: Corporate Financial Management – Arnold, The Financial Times, Reuters, Amazon.com, BBC news)

The Internationalisation of the stock markets and the potential of Facebook’s IPO.

Recently stock markets have become a global industry. Investors no longer only buy domestic shares from their local stock markets. Instead they can purchase shares from any stock exchange at the click of a button or a simple phone call. This is great news for the companies who are able to raise capital from a wider population and also for investors who can potentially gain higher returns through greater choice of investments.

It is only in the last 30 years that purchasing shares from international markets has started. Currently the London Stock Exchange has the highest value of foreign shares whereas New York has the highest value of domestic shares (Arnold, 2008). Recently different stock exchanges have merged to enable investors to easily trade shares from different areas. For example, the NYSE and Euronet merged together in 2007. Euronet consisted of Amsterdam, Brussels, Paris and Portugal and has created a cross border exchange which increases liquidity and encourages investments. The merger has had little impact due to the time differences of the market so far, although there are potential for merges to create opportunities and increase access to investors. 

The internationalisation of stock exchanges mainly brings benefits to investors and companies.  Investors gain through being able to invest in less riskier companies as well as searching for higher returns depending on the risk appetite of the investor. Companies benefit through access to capital and attracting more investment. The local economies also benefit through attracting foreign savings which are used to benefit them.

For example, when Facebook shares are available to buy, people in the UK will be able to invest even though they will be listed in the US. This is great news for Facebook as they will be able to gain maximum investments through the international markets. There is a risk to investors regarding Facebook shares and if they are going to be a good long term investment, which is what they require through shareholder wealth maximisation theory. Many recent articles have been discussing if Facebook shares will provide returns or if they are too hyped and if Facebook is performing as well as expected.

The one of the main problems with the listing is the shift in customer base. Previously people like me who signed up to use Facebook were the customers. Once it becomes listed in a sense we will become the product. There is already a huge amount of adverts on Facebook and this can only increase as a way for them to make money. Every time you ‘like’ something, Facebook uses this information to target adverts and the company or product are able to see who their target audience is. How long will it be before the users of Facebook no longer wish to share all this personal data and get sick of being targeted with adverts and recommendations? Personally, I feel that they already know too much about the users so, if it does continue maybe my usage of it will decrease.

When the shares finally float it could be possible that they are over valued due to the potential interest markets expect them to have. There is no doubt that currently they are the ‘fashionable’ shares to have, but are they likely to provide long term returns required by shareholders? When Google floated it did increase the share price showing that sometimes the hype is justified. LinkedIn was the ‘hot’ listing from last year and the share price doubled on day one. But today they have fallen by around a fifth of the high showing over-reaction by the market.

With the listing comes a range of new requirements and disclosures which previously Facebook have avoided and some critics feel that the growth potential may be less than anticipated. Although, there may be growth potential as the accounts from previous years are not currently available for public view, so we can not say where the revenue currently come from.

Is it possible that Facebook only works as a private company, where there are not numerous shareholders who require returns on their investments? Are the investors going to be bothered about the number of adverts placed on the site and are they even users of the site? The public offering is going to make a lot of employees at Facebook very rich quickly on paper, but are they going to be the real winners in the offering? It is something that only time will be able to tell.

It can be argued that gaining high returns on investing in stock exchanges is more luck than actual skill, due to the unpredictable nature of the industry and how events and news rapidly affects the share price. For every person who is making a gain there is someone making an equal loss. The internationalisation of stock markets has opened up the markets to new investors, and has also increased the competitiveness of the markets which has lead to the development of the finance industry. The ability for companies to gain investment from different investors around the world has lead to many companies being hugely successful. It is unknown if Facebook will join the list of successful listings or if it will become a casualty due to the nature of their business.

(Sources: BBC News, Financial Times, The Guardian, Reuters and Corporate Financial Management – Glen Arnold.)

How have Burberry managed to increase shareholder value over the past 5 years?

Shareholder wealth maximisation is gained through increasing share prices and gaining dividends. It is a long-term measure with shareholders investing and expecting gains in the future as opposed to immediately. Share price is typically the measure most commonly used to show shareholder wealth maximisation, as it takes into account the current performance of the company along with expectations of future dividends and growth opportunities.

Burberry plc on the 18th November 2008 had a share price of £1.73 which at the time was a six-year low. This low share price was caused in part by the global recession, but also from a press release stating a profit warning that they would be at the lower end of expectations. The fall in shares also happened the same day a joint venture was announced with Sanyo Shakai and Mitsui & Co in Japan to increase distribution in Japan. This joint venture in the longer term helped to increase Burberry’s presence in Japan and other Asian companies, which have lead to the increase in profits throughout the following years.

Between 2008 and 2011 they have increased shareholder value with the share price peaking on the 25^th July 2011 at around £16. The company increased the share price by over 9 times the value from 2008 creating huge amounts of shareholder value.

The way they managed to increase the price and become a major player in the luxury goods industry was by rebranding their image.  The iconic tartan pattern was created in the 1920’s as a lining for their trench coats. But by the 1970’s it started being used for casual outfits and highlighted a shift in clientele. By the 1990’s Burberry themselves started to ‘cash in’ on the demand for designer labels and prints such as the Louis Vuitton monogram. Unfortunately for Burberry the iconic tartan that symbolised their brand became one of the most copied trademarks and developed a reputation as being ‘chavvy’ which goes against the heritage of Burberry.

Through a change in strategy and new glossy advertising campaigns which stared a range of well known celebrities and models, they have changed the image of the brand, back to being a top luxury brand. Noticeable celebrities who have fronted the campaigns in magazines and billboards include Kate Moss, Emma Watson, George Craig and Eddie Redmayne. They have heavily invested in the company to produce new product lines and developed the communication used to target potential customers. There is increased use of the internet to broadcast catwalk shows live from their website, items can be purchased online and through numerous outlets and started using Facebook and Twitter.

In January 2012, Burberry reported a 21% sales increase in its third quarter boosting sales to £574million in the three months running up to the 31^st December 2011. This increase in sales has been put down to the increase in demand in Asian markets along with Burberry becoming the most popular luxury label on Facebook with 10million fans and over 700,000 followers on Twitter. Despite the results the share price is currently 20% lower than the peak of around £16 in July 2011. It is believed that the reasoning for the share price being slightly lower is due to the expectation that the demand in Asia will start to decline despite the market growing by 30% in the third quarter. The CFO has announced that there are contingency plans in place in case the Eurozone problems worsen and the demand for luxury goods decreases showing planning in their strategy for future problems.  In developed markets such as the US they are increasing their presence in department stores to help improve sales figures.

In terms of management and creative leadership they have had stability for a number of years with the creative director, Christopher Bailey joining in 2001, the Chairman, John Peace in 2002 and CEO, Angela Ahrendts in 2006. This stability has allowed Burberry to grow in terms of revenue and profit and expand into new market places and new lines.

The luxury fashion industry at the moment appears to be one of the only industries which is not ‘failing’ and going into administration. Recently many luxury brands such as Mulberry have announced profit increases whilst low end high street fashion brands such as Peacocks are experiencing difficulty. Yesterday (2^nd February) the LVMH group also reported increased profits, demonstrating growth in the luxury goods markets. There appears to be a definite switch to buying quality items that will last you a lifetime rather than cheap items that will wear out or break after only a few uses which will help the luxury goods industry continue to flourish.