Tax and accounting aspects of global expansion.

For clients desiring to do business worldwide, a host of tax and accounting considerations await. This article presents an overview of a number of these issues, including the foreign tax credit, use of foreign sales corporations, joint ventures, passive foreign investment companies, controlled foreign corporations and branches and foreign currency and transfer-pricing issues.

American companies wishing to expand beyond U.S. markets are faced with many tax and accounting issues and decisions that differ from those confronted in a purely domestic environment. An organizational form must be selected for conducting business abroad; the tax consequences of global operations vary significantly depending on the business form selected. In addition, the accounting aspects of international operations have reporting, control and behavioral implications. This article examines several important tax and accounting dimensions for U.S. companies venturing into the global marketplace.

Tax Issues

Business considerations (e.g., market penetration and risk management) often suggest the organizational form or structure for doing business abroad. However, because each organizational form involves different tax issues, this decision should not be made without considering the tax consequences. The foreign tax credit (FTC) effect is a central issue, regardless of the organizational form selected.

Regs. Sec. 1.11-(a) taxes U.S. domestic corporations on their worldwide income. Thus, any tax paid to a foreign country results in double taxation on the same income. To mitigate this effect, Sec. 901 allows a company to claim an FTC on its U.S. tax return for income tax paid or accrued to foreign countries. However, Sec. 904(a) limits the FTC to the U.S. tax imposed on foreign income.

Example: 1: D Corp. (a U.S. multinational) has $1,000 of foreign income on which it pays $400 of foreign tax (a 40% foreign tax rate). Before considering the FTC limit, D can claim a credit on its U.S. tax return for the $400 paid. However, if the effective U.S. tax rate is 35%, D is allowed a credit of only $350 (i.e., the U.S. tax on the foreign income); the additional $50 of foreign income tax paid is an "excess credit" and indicates that both the U.S. and the foreign country are effectively taxing some portion of the foreign income. If, instead, the U.S. tax rate is 42%, D can take a full $400 FTC. D will have an "excess limit" of $20; no portion of the foreign income is subject to double taxation.

In effect, the FTC allows the company to credit foreign tax against the U.S. tax on the foreign income; no credit can be taken against the U.S. tax on the company's domestic income. Thus, companies conducting business in high-tax (low-tax) foreign countries often have excess FTCs (limits). If those companies can conduct international business so that some profits are taxed at low foreign rates, while others are taxed at high foreign rates, the hightaxed income can be averaged with the low-taxed income, minimizing double taxation and resulting in a lower overall effective tax rate. This is a major objective of international tax planning.

Exporting

Export sales generally attract no foreign tax. For a multinational corporation with excess FTCs from other international activities (e.g., a foreign sales branch in a high-tax country), an export sale is effectively taxed at only half of the normal U.S. tax rate.

Example: 2: The facts are the same as in Example 1; the U.S. tax rate is 35%. D paid $400 on $1,000 of foreign income; the FTC completely offset the U.S. tax otherwise due. D later made an export sale that generated $200 of net income. If the product sold is U.S.-manufactured and the sale occurred outside the U.S., half of the income is deemed foreign-source income for FTC purposes. D's total $1,100 of foreign income is taxed a total of $400 by the foreign country, but the FTC limit is now $385 ($1,100 x 0.35).

How much additional tax was paid on the $200 of export income? At a 35% U.S. tax rate, $70 of U.S. tax results. However, the export sale also allowed D to increase its FTC from $350 to $385. Thus, the net increase in tax from the export sale is $35 (i.e., $70 U.S. tax -- $35 FTC increase); the export sale is effectively taxed at only 17.5% ($35 net tax increase/$200 income), half the normal U.S. rate.

FSCs: When a U.S. company does not have excess FTCs, export sales can be made through a foreign sales corporation (FSC), defined in Sec. 922. Most FSCs operate as commission agents and are located in the U.S. Virgin Islands or Barbados. Although the FSC requirements appear complex, the proliferation of FSC management companies means that most U.S. exporters can establish and maintain such entities at a modest annual cost (around $10,000). A less costly and simpler alternative, the "small FSC" (defined in Sec. 922(b)), provides tax benefits to businesses with up to $5 million in annual foreign trading gross receipts, under Sec. 924(b) (2).

For most products exported, the FSC tax benefit is 15%. For example, if a U.S. company normally pays U.S. tax at a 35% rate, the use of an FSC results in an effective tax rate of only 29.75% (0.35 x 0.85) on export profits. For high-volume, low-profit items such as grain, the FSC benefit can range between 15% and 30%. The FSC tax benefit can reach as high as 65% when the U.S. company uses marginal costing techniques under Sec. 925(b)(2) to seek or maintain a foreign market.(1) Sec. 927(d)(2)(B) allows FSCs to group transactions in strategic ways or to unbundle transactions to obtain significant tax savings.(2)

Sec. 927(a) permits most products manufactured in the U.S. to qualify for the FSC tax benefit if sold for use or consumption abroad. Section 1171 of the Taxpayer Relief Act of 1997 (TRA '97) added computer software to the list of items that qualify. Notable exceptions for which no benefits are allowed under Sec. 927(a)(2) include manufacturing and marketing intangibles, primary oil and gas products and unprocessed softwood timber.

In summary, U.S. companies with excess FTCs from foreign operations (e.g., a manufacturing plant in Germany) generally should conduct their export operations without an FSC. Such export sales are effectively taxed at half the normal U.S. rate. U.S. companies without excess FTCs can use an FSC to reduce their U.S. tax bill on export sales by 15% or more.

Licensing Arrangements

Royalty income from licensing agreements with distributors and producers in other countries are subject to U.S. tax; in addition, many foreign countries impose a flat withholding tax on such income. For example, French law requires that 33 1/3% be withheld on royalties paid to nonresidents.(3) U.S. treaties generally reduce the withholding percentage, but the actual withholding sometimes varies, depending on the type of property rights licensed. Under the U.S.-France income tax treaty, copyright and film royalties (and certain broadcasting royalties) are exempt from withholding; all other royalties are subject to 5% withholding.(4)

Because both the U.S. and a foreign country often tax the same royalty income stream, an FTC is allowed on the U.S. tax return for the withholding tax; such withholding is subject to the limit discussed earlier. When royalty income is exempt from foreign withholding tax (whether due to host country law or treaty) and the U.S. recipient has excess FTCs from other international activities, they can shield the U.S. tax otherwise due on the royalty income (much as the excess FTC shielded half the U.S. tax on the export income in Example 2). Thus, royalty income from foreign licensing agreements often is taxed at very low effective rates.

Joint Ventures

A joint venture (JV) often involves two participants--a U.S. and a foreign company. Under Kegs. Sec. 301.7701-1 through -3, a JV can "check-the-box" to select whether to be treated as a partnership or corporation for U.S. tax purposes. The ability to predetermine a JV's legal form greatly facilitates international tax planning.

A partnership JV operates much as a domestic partnership with all U.S. owners. Any foreign taxes the partnership pays flows through to the owners. Thus, the U.S. participant can claim its allocable share of foreign taxes as a credit on its U.S. return. Similarly, if operating losses are incurred (particularly during the early years), an allocable share flows through to the U.S. participant and is deductible on the U.S. tax return.

A corporate JV is more complex. If the U.S. participant owns between 10% and 50% of a corporate JV, it has a significant (but non-controlling) investment (in a so-called "10/50 company").When the U.S. company owns more than 50% of the corporate JV, the JV is a controlled foreign corporation (CFC), discussed below.

Unlike a partnership JV, the U.S. company does not report its share of a corporate JV's operating profit or loss on its U.S. return. The inability to flow through losses is a disadvantage of a corporate JV, especially in the early years. On the other hand, U.S. taxation of operating profits is generally deferred until the corporate JV remits such profits.

Remittance of profits might take the form of dividends or, depending on contractual agreements, interest or royalties. The form of the remittance has several tax implications. First, interest and royalties are generally deductible in the host country against operating profits, while dividends (a distribution of earnings) are not. Second, different withholding tax rates may apply to different remittance forms. Third, dividends can be used to increase the U.S. company's FTC (discussed below).

Careful selection of the remittance form often can minimize withholding taxes. Under the host country tax system and U.S. income tax treaties (when applicable), different withholding tax rates often apply to different forms of remittances. For example, Cypriot domestic law generally requires 20% withholding on dividends, 25% on interest and 10% on royalties.(5) The U.S.-Cyprus treaty reduces the withholding rate on interest to 10% and exempts dividends and royalties from withholding.(6) Thus, in many cases, royalties are the preferred method for remitting profits from Cyprus. Not only are royalties deductible in Cyprus against the corporate JV's operating profits, but Cyprus imposes no withholding tax when royalties are paid to the U.S. participant. As noted earlier, if the U.S. company has excess FTCs, the royalties are taxed at a relatively low effective rate in the U.S.

"Deemed paid" credit: When a corporate JV pays foreign income tax, the U.S. company can claim a portion of such taxes as a Sec. 902 "deemed paid" credit on its U.S. return. In effect, the U.S. participant is treated as having paid some of the JV's foreign income tax. A deemed paid credit is allowed only when dividends are received from the JV. Generally, the percentage of foreign income tax allowed as a credit is in the same proportion as the JV's earnings and profits (E&P) received as a dividend. For example, if the JV pays 50% of its E&P as a dividend to its U.S. owner, 50% of the JV's foreign income tax is attributed to the U.S. owner.

The FTC limit applies to "deemed paid" taxes. Before the TRA '97, a separate limit (basket) applied to the dividends received from each 10/50 company. Thus, the excess FTC resulting from a 10/50 JV in a high-tax country could not be averaged against that from a 10/50 JV in a low-tax country. In effect, activity of a JV the U.S. participant did not control was discouraged, because valuable FTCs were often lost. To encourage more minority-position JV activity on the part of U.S. multinationals, TRA '97 Section 1105(b) amended Sec. 904(d)(4) to establish an overall limit for dividends from all 10/50 companies when paid from E&P accumulated in tax years beginning before 2003. For dividends paid out of E&P accumulated in tax years beginning after 2002, a special "lookthrough" rule applies, which should continue to alleviate the tax burden for minority-position JVs.

PFICs: Finally, a corporate JV is a passive foreign investment company (PFIC) under Sec. 1297(a) if either (1) 75% or more of its gross income or (2) 50% of more of its assets are passive for any tax year. Service businesses that require comparatively few business assets are particularly susceptible to PFIC status. A substantial decline in business income can also cause a corporate JV to become a PFIC. Thus, a corporate JV must monitor assets and income carefully to avoid PFIC status. If a corporate JV is a 10/50 company, however, the U.S. participant may have insufficient control over operations and investments to effectively avoid the 75% and 50% tests.

Sec. 1291 imposes a deferred interest charge on the U.S. owner of a PFIC on certain dividends received therefrom or gain realized on the disposition of PFIC stock. The interest charge retroactively precludes the present value benefits of deferring income in an offshore company.

Example 3: E Corp., a U.S. multinational, owns 50% of F Corp., a PFIC. During each of 1999 and 2000, F has $2,000 of net income. Thus, the value of E's F stock increases $1,000 each year. At the end of 2000, E sells its F stock and realizes the $2,000 gain. Under the PFIC rules, $1,000 of gain is allocated to the year of sale (2000) and taxed as ordinary income. The remaining $1,000 of gain is attributable to 1999. The highest corporate tax rate for 1999 is imposed on this $1,000, even if E is actually subject to a lower tax rate; interest must be paid on the tax deferred.

As Example 3 illustrates, PFIC status can be costly. One alternative is for the U.S. multinational to elect to treat its PFIC stock as stock in a qualified electing fund (QEF) under Sec. 1295. The effect is that the QEF is treated like a branch (discussed below). The U.S. participant's share of profits and gains from the corporate JV (or QEF) flow through to the U.S. tax return each year, even if not actually distributed. Further, such profits and gains retain their characters (e.g., capital gain is not converted to ordinary income). However, unlike in a branch, QEF losses do not flow through; thus, they are not deductible against domestic income.

Foreign Branch Operations

A foreign branch or division is not a separate entity for tax purposes. Operating profits of the branch are income on the multinational's U.S. return; operating losses are deductible against U.S. income. The ability to flow-through losses during the start-up years is an attractive feature of conducting international business through a branch. However, the deduction of losses against U.S. income can result in the recapture (or curtailment) of FTCs in subsequent years.

In most countries, branch profits of nonresident companies are taxed at the same rate as the profits of resident companies. Remittances to the U.S. home office are exempt in many countries (e.g., Luxembourg, the Netherlands).(7) In other countries (e.g., Thailand), branch profits (or actual remittances) are subject to a withholding tax similar to that applicable to dividends paid by a subsidiary to a U.S. parent.(8) Income tax treaties may reduce or eliminate such a branch profits tax, either through explicit treaty language or a nondiscrimination clause. Any foreign income taxes imposed on branch profits or withheld on remittances are taken as a credit on the U.S. multinational's tax return (subject to the limit discussed earlier).

Some foreign countries impose a heavier tax burden on branch operations than on resident companies. For example, a Brazilian branch cannot deduct expenses incurred outside the country.(9) Thus, branch operations in Brazil cannot deduct an allocable share of a head office's administrative expenses. Similarly, interest, commissions and management fees that a Turkish branch pays to a U.S. home office are not deductible in determining the Turkish income tax on the branch's profits.(10)

Wholly Owned Foreign Subsidiaries

Sec. 957(a) defines a CFC as any foreign corporation in which U.S. shareholders own more than 50% of either vote or value. Thus, a U.S. multinational's wholly owned foreign subsidiary is a CFC. TRA '97 Section 1123(a) amended Sec. 1297(e) to bar the application of the PFIC rules to U.S. shareholders of CFCs, effective for tax years beginning after 1997.

Generally, a foreign subsidiary's profits are not taxed in the U.S. until remitted and actually received as a dividend. The deferral of U.S. tax on such profits can be a substantial benefit, especially when operating in low-tax foreign countries. However, a CFC's "subpart F income" is treated as a constructive dividend to the U.S. parent under Sec. 951(a) and taxed currently, even if no dividend is actually paid (i.e.,no tax deferral is allowed).

Subpart F income: Sec. 952(a) defines subpart F income to include (1) income from insuring risks outside the CFC's country, (2) income from participating in an international boycott of a country, (3) income equal to illegal bribes and kickbacks paid to a foreign government, (4) income from countries that sponsor international terrorism and (5) foreign base company income. Sec. 954(a) defines foreign base company income to include (1) most types of passive income, (2) sales income for which neither manufacturing nor sales occur within the CFC's country, (3) many types of services income for which the services are performed outside the CFC'S country for a related party, (4) most types of shipping income (unless the shipping activity begins and ends in the CFC's country) and (5) certain types of oil-related income. Thus, a U.S. multinational that owns CFCs with any of these categories of income cannot defer the U.S. tax on such income.

When a CFC pays an actual dividend to its U.S. parent or earns subpart F income (a constructive dividend), a pro rata share of any foreign income taxes paid is attributed to the dividend recipient. For example, if the CFC pays 40% of its E&P as a dividend to its U.S. parent, the latter is deemed to have paid 40% of the foreign income taxes the CFC has paid. These foreign taxes can be claimed as a credit on the U.S. return, under Sec. 960(a)(1).

When a CFC owns foreign subsidiaries, foreign income taxes paid by second-tier subsidiaries can be attributed to the CFC's U.S. parent.

Example 4: X Corp., a U.S. multinational, owns 100% of CFC 1, which owns 100% of CFC2. CFC2 pays $500 of foreign income tax. After CFC2 pays all of its E&P to CFC1 as a dividend, CFC1 pays all of its E&P to X as a dividend. X can claim the $500 as a deemed paid credit on its U.S. return (subject to the limit previously discussed).

Before the TRA '97, deemed paid credits could be claimed only for foreign income tax paid by first-, second- and third-tier subsidiaries. For tax years beginning after Aug. 5, 1997, TRA '97 Section 1113(c)(2) amended Sec. 902(b)(2) to permit deemed paid credits to be claimed for fourth-, fifth- and sixth-tier foreign subsidiaries. Allowing credits for lower-tier subsidiaries is expected to reduce the sometimes enormous cost of international restructuring and to facilitate a U.S. multinational's acquisition of foreign subsidiaries.

Accounting Considerations

In the international setting, accounting issues are often strongly influenced by external forces not as significant in a purely domestic setting. Examples include cultural differences, foreign currencies, local laws and regulations and unfamiliar political considerations. The multinational corporation entering a new geographical area must possess or acquire expertise in these and other disciplines to avoid costly mistakes.

Foreign Currency

Statement of Financial Accounting Standards (SFAS) No. 52(11) addresses many fundamental foreign currency accounting issues; it provides guidance on accounting for transactions denominated in foreign currency and requires that they be recorded at the spot exchange rate on the transaction date. When subsequent financial statements are prepared, receivables and payables denominated in the foreign currency must be brought to the current exchange rate as of the statement date. Gains or losses attributable to these adjustments must be recognized in the current income statement. On the settlement date of the receivables or payables, any foreign exchange gain or loss must be recognized.

SFAS No. 52 also provides the standard for translating foreign currency financial statements. While it requires different translation methods in various circumstances, financial statements of most typical parent-foreign subsidiary arrangements are translated using the current rate method. Under this method, assets and liabilities are translated at the exchange rate on the balance sheet date; revenues and expenses are translated at the average exchange rate for the period. Translation gains or losses are carried directly to stockholders' equity, rather than first being reflected in income. SFAS No. 52 also prescribes significant disclosure requirements for currency transaction and translation effects.

Multinational corporations with significant exposure to foreign currency exchange risk generally develop a risk management policy. Such a policy often relies on financial instruments (e.g., currency forwards, options, futures and swaps) to manage foreign currency risk. Use of these instruments must be structured to achieve the desired accounting results. Usually, the company's goal is to achieve hedge accounting treatment, which allows gains and losses on the related underlying balances to offset those on the financial instruments. Thus, under hedge accounting treatment, the latter gains and losses are not reflected in current income.

SFAS No. 133(12) generally provides that all derivative financial instruments be recognized as assets or liabilities on a company's balance sheet and measured at fair market value (FMV). It also expands disclosure, requirements for derivatives and is effective for fiscal years beginning after June 15, 1999.

Countertrade 

Countertrade is an exchange between parties from different countries in which at least part of the consideration is not in cash. In most cases, countertrade occurs because one of the trading partners has insufficient access to hard currency. For example, a Russian purchaser of medical supplies might not be able to make payment in U.S. dollars; a U.S. seller may be unwilling to accept Russian rubies, but will accept bottles of vodka. The U.S. party, in turn, expects to sell the vodka for U.S. dollars. The simplest form of countertrade is a basic barter transaction. More sophisticated countertrade transactions are common, however, involving several partners and complex offset and compensation arrangements.

Countertrade activities raise many interesting accounting issues, including questions of revenue measurement, valuation and revenue timing. Revenue measurement often is difficult, due to the absence of a cash component for all or part of a transaction. In general, the CPA uses the value of that which is given or received (whichever is more objective) to value the transaction. This rule is often awkward to apply, because the quantities, conditions or locations of the commodities involved may preclude accurate valuation and, thus, revenue and asset measurement. The time that may elapse in transporting goods between parties and the time required to dispose of goods received in the countertrade complicate the timing of revenue recognition.

Very little specific authoritative guidance exists on accounting for countertrade. Accounting Principles Board Opinion No. 29(13) provides general guidance on accounting for noncash transactions. In addition, accounting in some specialized industries can be useful in making the appropriate accounting and reporting decisions. For example, SFAS No. 63(14) discusses how broadcasters should report barter transactions.

Evaluating Performance

Performance evaluation techniques used by management for domestic purposes are generally applicable to foreign operations; however, additional factors must be considered. For example, the multinational must decide whether to evaluate its foreign operation in local currency or U.S. dollars. Evaluating the foreign activities after financial results are translated into U.S. dollars places the responsibility for exchange rate risk on the foreign operation. If the management of the foreign operation has no authority to hedge or otherwise mitigate foreign exchange risk, this responsibility is misplaced. Changes in exchange rates can make a superb operation look like a poor performer or a slack operation appear successful when the results are viewed after translation. Conversely, evaluating the foreign operation only in its local currency may fail to reflect its effect on the multinational's overall financial results.

If clearly and carefully formulated, the multinational corporation's goals for its foreign operation should suggest the performance evaluation method. If operated as a profit or investment center intended to enhance the multinational's current financial results, management probably will evaluate performance on an after-translation basis. In this case, measures such as return-on-investment, return-on-sales, residual income or economic value added are appropriate. However, the multinational often has additional goals for its foreign operation, such as penetrating the foreign market, establishing name recognition and performing some operational task (e.g., manufacturing). In these cases, performance evaluation based solely on profitability may be inappropriate; the multinational should explore different or additional performance measures (e.g., obtaining market share, increasing efficiency, achieving volume and quality targets and reducing costs).

Transfer Pricing and Cost Allocation

Transfer pricing in international commerce is often viewed primarily as a tax issue. Absent some constraint, related entities can use transfer pricing to concentrate profits in low-tax jurisdictions, thus decreasing global income taxes. The Sec. 482 regulations contain detailed rules designed to curb abusive transfer-pricing practices. Similar to income tax-motivated policies, transfer prices are sometimes manipulated to reduce customs duties or circumvent anti-dumping provisions.

However, from the managerial accounting standpoint, transfer-pricing policies have a number of behavioral implications. For example, the transfer prices assigned to a foreign subsidiary's inputs or outputs affect its operating results. If the affiliate is given no control over the transfer prices, basing the evaluation of its performance solely on profit measures provides little motivation to improve operations or, at worst, demotivates the affiliate's management. In addition, an incentive compensation policy based on profit measures that depend on noncontrollable transfer prices can have a significant negative effect on employee motivation and morale.

Ideally, multinationals should set the transfer price of goods equal to an arm's-length FMV. However, in an international setting, such measurements are often elusive, due to unique products and markets; FMVs frequently do not exist or cannot be readily determined. Nonetheless, if a multinational's transfer-pricing policies are to be effective, they must be carefully designed to satisfy both performance evaluation criteria and the income tax regulations.

Other cost allocation issues arise, regarding management fees, interest on capital used, research and development expenses and royalties on technology use. The multinational parent must carefully decide the portion of these corporate costs to be allocated to foreign affiliates. Such allocations involve many of the same issues as transfer pricing, including domestic and foreign tax considerations, performance evaluation effects, legal implications and the possibility of local government scrutiny.

Planning and Budgeting

The budgeting process for the foreign operation is subject tO the same considerations as in the domestic case plus an additional complication--the foreign currency question. When the exchange rate fluctuates, a budget for the foreign affiliate cast in dollars may be unrealistic after its translation into the local currency. On the other hand, if the budget is prepared in the foreign currency, exchange rate changes can make dollar-denominated results appear unsatisfactory, even if the foreign currency budget is achieved.

One solution is to construct budget targets on a nonmonetary basis using factors such as unit sales volume, production levels, cost ratios or market share. This may not satisfy the multinational's profit contribution or return on investment goals; however, it does cast the budget plan in terms that are more likely to be within the foreign affiliate's control.

Internal Reporting and Control

The U.S. corporation establishing a foreign operation may find that local managers initially hold a different view of internal controls, report formats and deadlines than is encountered domestically. In some cultures, control procedures accepted in the U.S. are considered to reflect a lack of trust and, thus, are offensive. In other cases, control procedures may be viewed as unnecessary or trivial and routinely ignored. In cultures that are less time-conscious than the U.S., reporting deadlines may not be rigorously followed. Also, the form and content of financial reports may not follow parent specifications, due to differences in accounting and reporting conventions between the U.S. and the foreign country.

Solving these difficulties usually requires the multinational's patience. Sometimes, parents fail to understand and appreciate the cultural differences that exist within their foreign affiliates and, thus, create a negative work environment affecting the success of the enterprise. Employee training designed to emphasize the parent's rationale for its requirements may provide better results.

The Foreign Corrupt Practices Act of 1977 (FCPA), as amended, applies to all registrants under the Securities Exchange Act of 1934 and, thus, can affect foreign as well as domestic companies. Aside from the anti-bribery thrust, the FCPA's accounting provisions require a high standard of record-keeping and internal control. Generally, the FCPA requires the maintenance of accounting records that accurately reflect a company's transactions in reasonable detail. In addition, the company must maintain a system of internal control that provides a level of assurance similar to that described in U.S. auditing standards. FCPA violators are subject to severe criminal or civil penalties.

External and Internal Auditing

Often, the domestic corporation's own auditor can serve the foreign affiliates on a worldwide basis. However, he may be unavailable to service a particular area abroad, or the local law may preclude his practice there. In these cases, the corporation must rely on local professionals. When selecting and dealing with a foreign auditor, the multinational must consider his qualifications, as well as the auditing, reporting and ethical standards observed in the host country. To meet security regulation requirements, the local auditor should be familiar with and follow U.S. auditing standards and issue a U.S.-style report. In addition, the local auditor's views on independence, confidentiality and conflicts of interest should be consistent with those of the multinational.

Internal auditing of the foreign affiliate involves considerations not found in the domestic setting, such as language differences and possible unfamiliarity with local business practices. If U.S. internal auditors must perform their duties through interpreters, their effectiveness can be diminished. Even with the most reliable interpreter, auditors can miss the implications and nuances of responses to their inquiries. The internal auditor may receive inadequate information to reach valid audit conclusions. Similarly, when local business customs differ from those in the U.S., U.S. internal auditors may misinterpret information or be unable to recognize occurrences of audit significance. These difficulties can be overcome with specialized training, but the multinational must recognize the need and make the required resources available.

An alternative to the visiting internal auditor is the development of a local internal audit staff. This approach overcomes the language barrier and the problems created from differences in business cultures or practices. However, independence may be a concern. The multinational must ensure that the auditing staff's loyalty lies with the parent, not the foreign affiliate.

Adherence to U.S. GAAP 

Finally, the multinational must be concerned with the accounting principles followed by the foreign operation. Some countries require resident entities to keep accounting records using local accounting principles, Because the parent needs financial reports based on U.S. generally accepted accounting principles (GAAP), however, additional accounting resources must be available to provide a dual accounting system or a conversion methodology

Financial statement disclosures also can be quite different under the two systems. Some commercially available computerized accounting systems can prepare reports based on different sets of accounting principles and in different currencies.

Conclusion

Many challenges face U.S. companies entering the global marketplace. Company goals concerning risk, control and profit often suggest the form and extent of commitment abroad. These different levels of commitment have various tax implications that cannot be ignored. Finally, the accounting information and reporting needs of a multinational business present challenges to management not found in the purely domestic setting. Skills that accounting personnel find useful in managing the accounting function include technical expertise, broad knowledge of the relevant foreign business environment and cultural sensitivity.

EXECUTIVE SUMMARY

* To mitigate double taxation of foreignsource income, Secs. 901 and 904(a) allow an FTC capped by the U.S. tax imposed on such income.

* The accounting information and reporting needs of a multinational business present challenges to management not found in the purely domestic setting.

* Allowing deemed paid credits for lowertier subsidiaries is expected to reduce the sometimes enormous cost of international restructuring and facilitate a U.S. multinational's acquisition of foreign subsidiaries.

(1) For a discussion, see Jacobs and Larkins, "Marginal Costing Can Help Exporters Gain Entry into Foreign Markets," 9 J. of Int'l Tax'n 26 (November 1998).

(2) For additional information, see Larkins and Jacobs, "Grouping for FSCs Reduces Taxable Profits," 5 J. of Int'l Tax'n 159 (April 1994).

(3) See Taxation in Western Europe: International Tax and Business Guide (Deloitte Touche Tohmatsu, 1998)(hereinafter, "Western Europe"), p. 106.

(4) Convention Between the Government of the United States of America and the Government of the French Republic for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and Capital Signed at Paris on August 31, 1994, Art. 12.

(5) See Western Europe, note 3, p. 57.

(6) Convention Between the Government of the United States of America and the Government of the Republic of Cyprus for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income Signed at Nicosia on March 19, 1984, Arts. 12-14.

(7) See Western Europe, note 3, pp. 230, 260.

(8) See Taxation in the Asia-Pacific Region: International Tax and Business Guide (Deloitte Touche Tohmatsu, 1998), p. 228.

(9) See Taxation in Central and South America: International Tax and Business Guide (Deloitte Touche Tohmatsu, 1998), p. 35.

(10) See Western Europe, note 3, p. 357.

(11) Financial Accounting Standards Board (FASB), SFAS No. 52, Foreign Currency Translation (1981).

(12) FASB, SFAS No. 133, Accounting Instruments and Hedging Activities (1998).

(13) Accounting Principles Board Opinion No. 29, Accounting for Nonmonetary Transactions (1973).

(14) FASB, SFAS No. 63, Financial Reporting Broadcaster (1981). [paragraph] 8.

Ernest R. Larkins, Ph.D. E. Harold Stokes/KPMG Professor School of Accountancy Georgia State University Atlanta, GA

Ellwood F. Oakley III, J.D. Associate Professor Department of Risk Management and Insurance Georgia State University Atlanta, GA

Gary M. Winkle, DBA, CPA Professor and Interim Director School of Accountancy Georgia State University Atlanta, GA