Issues Concerned With Developing Oversea Operations Finance Essay - Free Essay Example

Sample details Pages: 10 Words: 2887 Downloads: 1 Date added: 2017/06/26 Category Finance Essay Type Argumentative essay Did you like this example? The report summarises the issues arising when KW DT Ltd is trying to establish its operations in an overseas destination. The report briefly describes the issues for chosen Location Singapore. The advantages of choosing Singapore as a location are covered. Don’t waste time! Our writers will create an original "Issues Concerned With Developing Oversea Operations Finance Essay" essay for you Create order The issues covered include the differences in the accounting standards across countries. The accounting differences will include the estimation and consideration of various risks such as translation and transaction exposure. Also issues of taxation and transfer pricing need to be addressed. In addition, for starting a new branch, it is of utmost importance that the cultural differences be patched up. For this it becomes imperative to understand the cultural differences first. The aspect has been briefly touched upon. Objective To understand the accounting and other issues which will arise and which must be considered when developing an overseas operation in locations selected amongst Singapore, Taiwan and South Korea. Introduction KW DT Ltd, until now has been operating from Australia. It has been invoicing primarily in Australian Dollars and hence it has not been exposed much to the risks of fluctuations in the exchange rates. However, when it is considering establishing itself in other countries, it will have to face several issues. These will include the accounting issues such as differences in standards and procedures, the risks due to currency fluctuations and the taxation issues. In addition, KW DT Ltd will also have to consider the legal procedures for setting up a unit in a foreign destination where the legal procedures will be different from Australia. Lastly, due to differences in culture, the people management has to be handled tactically. Prudence lies in an understanding of these issues so that appropriate measures can be taken. Location Chosen Singapore is ranked 1st in the world in the ease of doing business by the World Bank. The report describes the issues and concerns if KW DT ltd decides to set up a branch in Singapore (World Bank Site). On the same parameters, Australia ranks 9. Advantages of Setting up a branch in Singapore For KW DT Ltd, setting up a branch in foreign country should basically provide three most important benefits. Succinctly stated these would be Strong Foothold in International Markets Cost advantage Tax benefits Singapore provides advantage in all the three aspects Foothold in International Markets Singapore is strategically located. It has access to most international markets. It is an integral part of the ASEAN (Association of South East Asian Nations). Hence enjoys trade relations with several markets both inter region and intra region. In addition the maritime routes enable Singapore an important destination. Setting up a branch in Singapore will definitely help KW DT ltd expand rapidly. Cost Advantage Singapore has efficient, hardworking labour available at relatively low cost. Hence the prospect of setting up a branch seems more lucrative. Tax Advantages The tax regime in Singapore is highly conducive for the corporate. The Income taxes as well as the corporate tax are low compared to several other nations. The tax rates shall be detailed further down the report. Although there are several benefits in setting up a branch in Singapore, there are also several issues and risks that need to be addressed. Some of the important ones include Accounting Differences Accounting standards differ across different countries. The differences occur due to following of accounting standards established by the supreme authority of the country. Singapore has modelled its accounting standards to match the IFRS. Whereas, the accounting standard followed in Australia happens to follow Australian Accounting Standards. Currency Exposure (Bennett, 2006) Until the firm was invoicing in Australian dollars, it was not facing currency risk. However, now that the branch is being set up in Singapore and its earnings will be in Singapore dollars, it will face currency risk. Currency exposure will include Foreign currency terms denominated in the balance sheet Actual, physical purchases and sales of goods and services which have yet to be involved Contracted purchases and sales such as long term contracts to purchase capital equipment and Uncontracted foreign currency denominated receipts and payments which will materialize if forecasted trading activity is realized. The exposure can take the form of translation, transaction or economic exposure. Translation exposure When the assets and liabilities in the balance sheet are converted to the foreign currency, their value is changed. This results in gain or loss. For instance if Singapore branch is reporting its asset in its local currency, when the balance sheet is translated into Australian dollars at the prevalent exchange rate, the balance sheet values change. Exchange rate movements from one balance sheet date to the next produce a period-to-period difference in the value of the Singapore Branchs balance sheet. Year Net Assets Exchange Rate 1 SGD= Australian Dollar Equivalent 1 SGD 20400000 AUD 0.77 $15708000 2 SGD 20400000 AUD 0.80 $16320000 3 SGD 20400000 AUD 0.75 $15300000 From the table, although the net asset value remains the same in Singapore dollars, the Australian dollar Equivalent changes because of the fluctuations in exchange rate. This brings a risk to KW DT Ltd. The company might need to undertake hedging depending on its acc ounting policies. Translation exposure affects the book values however; it doesnt affect the cash flows. Hence the company might assume its stand on hedging from no hedging to complete hedging. Transaction Exposure If the exchange rate changes during the course of a deal, this affects the cash flows to the company. This particular risk is termed as the Transaction exposure. For example if the branch set up in Singapore still sources its components from U.S on 30 days payment terms, the transaction is billed in dollars as follows Price to Singapore branch USD 1000000 Exchange Rate at order date 1SGD = 0.76 USD Expected cost in SGD = 1315789.4 SGD However, the SGD-USD exchange rates fluctuate to become 1SGD = 0.75 USD The cost in SGD becomes 1333333.3 USD Thus we see in addition to considering AUD- USD exchange rate, the company also has to consider SGD USD exchange rate. In order to avoid this loss, the company will have to undertake hedging. The company can use derivatives such as future contracts or currency options in order to cover its exposure. By entering into future contracts, the company can fix the exchange rates at which it will exchange SGD for USDs and hence be certain of the costs that it will have to incur to source its components at a future date. The issue is in reporting the exposures while preparing the Annual reports for KW DT ltd. Reporting the Differences The exposures mentioned above introduce changes in the book values and the profit and loss statement for the company. Hence accounting standards provide provision for the same. While KW DT ltd is preparing its consolidated books, it will have to keep in mind the provisions and mandate in the Australian Standards for accounting. The accounting standards applicable of interest include the AASB 121 (the Effects of Changes in Foreign Exchange Rates) and AASB 139 (Financial Instruments: Recognition and Measurement). AASB 121 (Aus1) This standard specifies the accounting procedures and standards to be followed. Foreign operations translate balances into functional currency: The exchange rate prevailing on the date of transaction is used for conversion from domestic to foreign currency. Closing rate is used to convert the monetary items on Balance Sheet. For items reported at historical cost, the exchange rate on the date of transaction is used. The differences, gains and losses are recognised under equity as ultimately these values affect the equity component. Foreign operations transactions When the foreign currency is reported in the domestic currency, the following have to be effected Closing period exchange rate is used for conversion purposes in case of monetary items. For non monetary items, the conversion is carried out using the exchange rate on the date when revaluation is being carried out. The differences in the values of transaction arising out of currency translation are recognised as income and expenses in the profit and loss account. In addition to considering the above points, it is also essential that disclosures should also comply with the standards specified under AASB 121. These include Profit and loss arising out of the currency translations The differences recognised under equity have to be reconciled and disclosed The reason for the change in currency in case the reporting currency and the currency of transaction are not the same. AASB 139 (Aus2) This standard specifies the accounting procedures and standards to be followed in case of using hedging instruments. Hedged Items The standard recognises a hedged item as one of the following. It can be an asset, a liability, a commitment of the firm, an investment in a foreign entity or a probable future transaction. Hedge Accounting The hedging could be carried out to ensure consistent cash flows, to maintain the value of assets or to protect form the risks of an investment. For Cash flow hedges, the change in the value of the instrument is recognised under equity in the balance sheet. To maintain the fair value of assets, the change in the value of the instrument is recognised in the profit and loss account. The accounting for net investment hedge is carried out in a similar manne to the accounting of the Cash flow hedge. Taxation The tax regimes in both the countries differ. Singapore has progressive taxation policy which makes it friendly for companies and investors. Double taxation has been done away with I Singapore. The dividends are exempt from taxation and the final tax is one paid on the taxable income. In addition, Capital gains are also not taxed. This makes the gain in sale of assets more profitable. Summary of Taxes (Solution, 2010) Tax Rate: 8.5% for taxable income till S$ 300,000 per annum Flat rate of 17% beyond that Capital Tax gain: Capital gains are not taxed Dividend Tax Gain: It is not a part of taxable income Tax Basis: All resident and foreign entities are considered at par in Singapore. However, the local laws allow resident companies to avail special benefits and rebates Taxable Income: Includes income from any trade, profession or vocation. Also included are gains in these professions. Singapore Taxation (TaxLaw) Singapore has tax treaty with Australia. Hence Australia applies taxes on Singapore companies according to the terms negotiated in the treaty. According to the treaty the resident country is mandated to remove double taxation on income from the foreign country. Hence essentially the burden of taxation is being shared by the countries. The tax relief is called Double Taxation relief DTR. In Singapore the claim is made while filing the annual income tax return. Ap propriate disclosures have to be made. There are three different methods by which tax exemption can be obtained by a foreign entity in Singapore. These can be stated as follows Reduced tax rate Under this form of relief, interest, dividends, royalties and profits from international shipping and air transport are taxed at a lower rate. Relief by deduction In case the foreign company has taxed the income in its country, the income is not taxed again in Singapore. This exemption helps Singapore attract investments. The regulations require companies to disclose the headline tax rates in their countries and corresponding benefits are provided in terms of tax relief in Singapore. Tax sparing credit Tax sparing credits are another means of providing tax relief to encourage investments in Singapore. Singapore has entered into tax treaties with countries such that Singapore will provide tax credits on royalties earned by Australia in Singapore. Hence the taxpaying company will have to pay lesser tax in Australia by the credits that it has been provided. The benefit to the companies is in availing these credits. KW DT Ltd can look forward for this benefit while setting up its base in Singapore. Withholding tax A part of remittances of entities operating out of Singapore to their parent companies in foreign countries is retained and is called as the withholding tax. Withholding tax on management fees, technical fees and service fees, the withholding tax is applicable at 17%. Also all the withholding taxes have to be paid by the 15th of the month as required by the mandate. Terms of Taxation in Australia In Australia, since 2004, income earned by an Australian Resident Corporation (AUSCO) through a foreign branch is exempted from paying corporate income tax. Hence income from Singapore branch of KW DT Ltd shall not be taxed. (PricewaterhouseCoopers, 2008). Similarly, capital gains and capital losses realized by AUSCO as part of their business operations are not included in the taxable income while calculating the applicable corporate income tax. In addition a provision entitles the companies to offset their income using foreign losses. This law is in place since July 2008. Transfer Pricing Firms that have branches and international dealings in other nations might resort to practises like paying lesser taxes than compared to counter parts in Australia. This is done by manipulating the prices such that country where income tax is lower is likely to receive higher income to save taxes. This is called as shifting of profits. The transfer pricing laws in Australia aim to remove such incidences. To counter this, arms length pricing is employed. Hence, KW DT ltd. will be subjected to reviews and audit in order to ascertain that transfer pricing and international profit shifting is not taking place in related party transactions. The Arms Length price is used as a benchmark to determine if the transfer pricing is being followed. The principle compares related party transactions and transactions between independent bodies. In order to discourage transfer pricing, Schedule 25A is mandatory for companies to fill in while filing returns. Hence all companies that have internati onal dealings are required to fill in this form. (Government, 2005) The current Schedule 25A imposes obligations to disclose information about related party international dealings, including The nature and amount of certain categories of transactions Details of interest-free loans Receipts or payments of non-monetary consideration Details of arms length methodologies used The level of documentation held to support the selection and application of the most appropriate arms length methodologies, and Details of disposals of any interest in a capital asset Appropriate disclosures help minimize the risk. In case of violations, the firm is subjected to penalties and price adjustments. Hence to avoid such situations, KW DT Ltd will have to ensure compliance with Transfer pricing policies. Political Issues It is the political environment that determines the laws in a country. Singapore has a stable democratic political system. Hence the laws are favourable for business. The laws lay emphasis on efficiency and help businessmen flourish in Singapore. In addition the relationships between Australia and Singapore have always been cordial. SAFTA agreement signed in 2003 is a reiteration of the fact that both the countries have strategic outlook in promoting cordial relationships (Department of Foreign Affairs, Australia). Hence, business is facilitated in Singapore for KW DT Ltd. Legal Issues While registering a branch in Singapore, the laws of the land have to be given due importance. Legal Status Singapore laws do not differentiate between a Singapore Branch Office from the foreign entity and the head office situated in another country outside Singapore. Any legal action against a Singapore Branch is also applicable to the head office. This has to be borne in mind by KWDT Ltd. Most of the foreign companies prefer to register as a subsidiary company in Singapore rather than declaring their office as their branch. (10Tu). In addition, the approval on the name of the entity has to be sought from the Accounting and Corporate Regulatory Authority (ACRA). Another consideration for establishing Singapore branch is that the branch must have two employees who should necessarily be the residents of Singapore. The employees should be on payrolls accepting the services and serving the company. They are called to be acting as agents for the company. Cultural issues Jeffrey Braithwaite et al. ( (Jeffrey Braithwaite, 2007) describe the differences in culture in Singapore and Australia. They mention that Singapore is a high power distance and low Individualism culture whereas Australia is low power distance and high individualism culture. Singapore is characterized by employees fearing their superiors and considering co employees as threat. Managers are less considerate, typical of high power cultures. Also consistent with the high individualism cultures, Singapore work culture is described to demonstrate calculative involvement with the work organizations and the lack of concept of organization taking care of employees. Australian employees on the other hand are more involved with their organizations and expect their organizations to look after them. Also the distance between those in power and those who arent is not so evident. In addition, Australians are more casual compared to Singaporeans and hence might appear brash to the local Singaporeans who tend to be more formal and conservative in their interaction. Hence when KW DT Ltd is considering a new office in Singapore, it has to be sensitive to these issues while dealing with people and formulating its HR policies. Conclusion Having identified the issues, it is imperative that KW DT Ltd takes appropriate measures to counter these issues. For instance to ensure that currency exposure doesnt affect the cash flows, hedging would be an option. Similarly, compliance with legal requirements should be ensured to avoid penalties and lastly, people management has to be effective in order to avoid employees resentment. The basic issues that need to be addressed have been listed down for KW DT Ltd to establish its operations in Singapore.