4. Corporate Tax and transfer pricing

As a business management student, I believe that many businesses emphasise that expense is the most important factor they will consider with, such as spending more time and focus on how to reduce cost in all areas of their business, because all industries are very competitive and all businesses try to cut costs to get a competitive advantage in order to survive and maintain their position in the market. From last decade, many companies are seeking a strategic way to minimise their taxation, and there are many multinational enterprises that strategically avoid taxation legally, this will be explained further in later sections.

Few days ago, I attended a finance lecture and heard about a case study, a company based UK called Shire, the company wanted to pay less tax and used a method to minimise tax strategically, the company would usually need to pay corporation tax in UK of 28%, and Shire knew that the tax in Ireland is less than UK by 15.5%, the tax in Ireland is 12.5%. Therefore, Shire management team decided to allocate an office in Ireland and gather their monthly board meetings in Ireland. Through this action, Shire show that they have followed through legally and have also helped the company save lots of expenses. From this case, it reminds me that many foreign enterprises register offices in Hong Kong, it is because they know Hong Kong corporate tax rate is lower than their home countries, and thus they are using this method to minimise their tax expenses.

There is also a common method to minimise tax expense through transfer pricing. Take, for example, a enterprise based in Europe and manufactures products in Asia (e.g. Malaysia) and ships the products back to Europe to sell. Through using transfer pricing the enterprise can gain more profit as Asian countries has lower taxation, compare to European countries. The enterprise could make use of higher transfer prices, from Asian manufacture to Europe retailer division. As a result, Europe division will report high cost and low profit and Asian manufacture division will report higher profit, and thus the company could minimise their tax expense and generate more profit. However, as transfer pricing is very common, and now many countries now set a law to control transfer pricing, such as China's tax authorities are now focusing inspection and execution  of rules to prevent companies who are using transfer pricing to avoid tax liabilities, a news reported that China retrieved $398milion tax after investigations of using transfer pricing on 178 companies.

Moreover, a famous company Apple inc. is one of a company that keeps their taxes expense low by stashing cash offshore. The strategy that Apple used is to set up subsidiaries and subsidiaries of subsidiaries in countries with low corporate taxes and transfer funds between them in order to minimise its liabilities. As a result,  this makes Apple that pay less tax compare to  35 % rate in U.S.

Also, Google CEO announced that they are proud of avoiding tax, saving 1.5 billion euro by transferring 7.6 billion euro in revenues to a Bermudian tax-haven.  This makes me very struggle with a question. Do a company need to think of their ethical behaviour? Or just play a rule of the game, and maximise shareholder wealth  and company profit?

3 - Raising capital

Raising equity capital is essential to all companies, and I think it is a good opportunity to all companies, it is due to the benefit of increasing fund to business and thus they could have more opportunities to explore and develop new project and make more profits. However, how a company make sure that they could consider both raising equity capital and earn more profits? Therefore they need to look at cost of finance and decide which project to go with. There is no debate that lower cost of finance with higher rate of return is the best choice to company. If cost of finance is higher than rate of return means the company may lose their profit in achieving the project. Nevertheless, if a company has a strategic long term plan, they may adopt to lose first few years and they believe that they could earn back their profits few years later. Take, for example, Amazon was only selling books online, and the company started to sell other multi-product line, it was not successful as their main competitor eBay has the most market share of the industry. After few years, Amazon was going well and now Amazon becomes the largest online retailer.

There are a number of methods to raising capital, the most common method is to through equity. Companies need to issue ordinary shares to public, and they are available to raise their capital. Through this method companies could gain advantages, which are no obligation to pay dividends and the capital does not have to be repaid. As company does not have duty to pay dividends, if the company is doing worse in a year and therefore the company does not have a problem of finding fund to pay dividends, and issuing ordinary shares are not same as debt, the company does not need to repay it. However, if companies want to using equity to raise capital, they need to list on stock market first, which means it would be a high cost to companies, and companies also need to issue shares mean that they will loss of control and thus it may deal some problems in the future such as external equity provider may want to appoint other directors rather than internal management team.

Another common method of raising capital is to through debt finance, such as bonds and bank loan. debt finance is long term contract. This sort of financing is different to equity finance, debt finance has to be repaid. The advantages of using bonds are interest expense lowers the effective tax rate for issuers, and companies are unlikely to loss control compare to the use of equity finance.

1 - Shareholder Value

HMV announced the appointment of insolvency administrator in January 2013 and has attempted  to find a buyer to sell its business. The reason why HMV wants to sell its business to another person is because the business went declined in last few years, there are huge amount of unpaid debt and the company's shares are suspended. many Customers are able to choose where they could buy their music and video products, such as using iTunes and Amazon online sites as technology is becoming more advance and customers are adapting to changes. As technology gets improve, piracy has become another big problem, there are many illegal downloads and thus customers are not purchasing in stores.
 
HMV now has more than 230 stores in the UK and other countries and recruiting more than 4,000 employees in the UK, if HMV go bankrupt, it would cause 4,000 employees lost their job and also damage shareholder wealth. This is not a first time that HMV seeks for a buyer. In 2005, private equity firm, Permira offered £847 million bid approach, however HMV rejected it as HMV said the offer was still undervalued. Currently, it is now estimated that the value of HMV is £4.7 million from London Stock Market of closing price of 1.1 penny. If HMV accepted the bid of £847 million, it would maximise its business and shareholders wealth.
 
Since 2005, HMV tried to survive however due to the advance technology HMV has gained no competitive advantages to others, more and more customers can use other methods to buy musical and video products. HMV now faces a market shock that may force managers to focus purely on short-term issues to ensure the continuance of the business. However, since 2005, suffering shareholders may have already recognized this and diversify their investments in other business. Therefore, if HMV goes bankrupt shareholders may be disappointed but they still have other companies’ shares to fall back on.
 
The strategy HMV’s used has not been identified clearly and has therefore damaged its business and shareholders. HMV should have been aware to the changes in the market and they did not make any strategic move for their business. As a result, many convenience stores such as iTunes, has been taken lot of customers from HMV. This may be relate to HMV’s management team and links to managerialisim. As the company is seeking to survive, they have only paid attention on short term benefits which is to survive and not has not much focus on long term strategy. For example, HMV has offered many promotion in past few years, and can consider that HMV is not earning much profit as there are also maintenance expenditures. Therefore, shareholders are not gaining anthing.
 
Recently, there is an organisation (Hilco) which wants to acquire HMV, Hilco is a retail of restructuring group and private equity veteran and Hilco also owned HMV in Canada. From this purchase HMV may survive longer, however HMV will have difficulty to gain profit even if they succeed in getting back in the market, and shareholder’s trust will also be difficult to gain back.
 
To sum up, from 2005 survival to 2013, HMV cannot maintain the company’s profit and cannot maximise shareholders wealth, it  has also damaged the public's view on HMV which cannot fulfill shareholders wealth and also the value of the company has been damaged.