sou · GMB3136d2 · 1999-01-01 00:00:00 — - Förväntade (prognostiserade) - Förväntade (prognostiserade) transaktioner bortom ett år - Vinsthemtagningar från utländska - Förväntade (prognostiserade) - Förväntade (prognostiserade) transaktioner bortom ett år Inget svar: 3 st Inte tillämpbart: 5 st Hur ofta använder valutaderivat för att säkra - Vinsthemtagningar från utländska - Förväntade (prognostiserade) - Förväntade (prognostiserade) transaktioner bortom ett år - Vinsthemtagningar från utländska - Förväntade (prognostiserade) - Förväntade (prognostiserade) transaktioner bortom ett år - Vinsthemtagningar från utländska - Förväntade (prognostiserade) - Förväntade (prognostiserade) transaktioner bortom ett år Inget svar: 1 st Inte tillämpbart: 2 st Hur ofta använder valutaderivat för att säkra - Vinsthemtagningar från utländska - Förväntade (prognostiserade) - Förväntade (prognostiserade) transaktioner bortom ett år - Vinsthemtagningar från utländska - Förväntade (prognostiserade) - Förväntade (prognostiserade) transaktioner bortom ett år - Vinsthemtagningar från utländska - Förväntade (prognostiserade) - Förväntade (prognostiserade) transaktioner bortom ett år Inget svar: 2 st Inte tillämpbart: 1 st DE MEST OMSATTA FÖRETAGEN PÅ FONDBÖRS Hur ofta använder valutaderivat för att säkra - Vinsthemtagningar från utländska - Förväntade (prognostiserade) - Förväntade (prognostiserade) transaktioner bortom ett år - Vinsthemtagningar från utländska - Förväntade (prognostiserade) - Förväntade (prognostiserade) transaktioner bortom ett år - Vinsthemtagningar från utländska - Förväntade (prognostiserade) - Förväntade (prognostiserade) transaktioner bortom ett år Inget svar: 0 st Inte tillämpbart: 0 st Hur ofta använder valutaderivat för att säkra - Vinsthemtagningar från utländska - Förväntade (prognostiserade) - Förväntade (prognostiserade) transaktioner bortom ett år - Förväntade (prognostiserade) - Förväntade (prognostiserade) transaktioner bortom ett år - Vinsthemtagningar från utländska - Förväntade (prognostiserade) - Förväntade (prognostiserade) transaktioner bortom ett år Inget svar: 6 st Inte tillämpbart: 8 st Sidbrytningarna i detta avsnitt överensstämmer inte med den tryckta upplagan The implications of permitting domestically owned firms to have their accounting in foreign currency (euro) within a taxation system that is based on domestic currency (SEK) by Hovick Shahnazarian* In this paper, we analyze the implication of permitting firms operating in (and who today have their books in the home currency, SEK) to have their accounting in foreign currency, euro, within a taxation system that still will be based in the home currency, SEK. We present a conversion method which we believe can work within such an environment. Moreover, we also show how the non-arbitrage conditions (which gives the value of the firm) is affected by the different exchange rates. By a pair wise comparison between different long term financial sources, we show that the initial choice at the between different financial sources can indeed be altered because of the conversion method. We also derive the shape of the firms balance sheet in steady state. Finally, we also provide the total cost of capital in steady state. The Swedish government decided to set up a special commission, with the task to consider whether firms operating in (and who today have their books in the home currency, SEK) should be permitted to have their accounting in the foreign currency, euro.1 In the guidelines to the commission, the government pointed out that such system should be investigated within a taxation system that still will be based in the home currency, SEK. In this context, two observations are of importance. Firstly, apply a uniform reporting convention which means that the tax balance sheet of the firm must coincide with the one drawn * The author thanks , , and for valuable suggestions and comments. 1 The initial investigation carried out by the commission was published in SOU (1997:181). The main conclusion presented was that the investigation believe that there are a strong need for a legislation that permit firms to have their books in other currencies than SEK. up for the shareholders. , and Hasset (1994) pointed out that the tax effect of such reporting convention are different compared to a separate reporting system. The uniform reporting in combination with the wish to tax firms in the home currency, while firms have their accounting in foreign currency, has many interesting economic implications. Secondly, has decided not to join Monetary Union (EMU), as a full member, at the first stage. Instead, has decided to have a floating exchange rate system. This means that the exchange rate (SEK/euro) will float during the accounting period. This creates problems for the taxation of the firmsincome and also the return shareholders receive from their ownership. The problems concerns the conversion method. The commission should present a feasible conversion method that can work within an environment described above. The report of the investigation will be published in October, 1998. The purpose of this paper is to deliver an economic analysis of the issues mentioned above. This is done by the help of a dynamic economic model where the growth of a representative firm is described by several differential equations that identify how different variables in the balance sheet change over time. To be able to do this, we use the information in the three basic financial statements: the balance sheet, the income statements, and the statements of changes in financial conditions.3 Secondly, we identify different financial and accounting constraints that constrain the behavior of the firm. Using the differential equations in describing the information in the three basic statements and different constraints on the behavior, we introduce a dynamic optimization model based on (1987), Kanniainen & (1995), and Shahnazarian (1996). The objective of the firm in this model is to maximize the present value of net cash flows subject to specified financial and accounting constraints.4 One of the contributions in this 2Kanniainen & (1995) pointed out that with a uniform reporting convention the tax balance sheet of the firm must coincide with the one drawn up for the shareholders. A description of the two different accounting regimes that govern reporting practice in most developed countries and the tax effects of these reporting conventions can be found in , (1994) and Kanniainen & (1995). 3This follows closely the work of Shahnazarian and (1998). 4The impact of taxation on corporate financial policy and the cost of capital has been examined in the literature very carefully. (1967), Poterba & Summers (1985), King (1975), (1981a), (1982b), and (1990) are examples of such studies. The importance of distinguishing the short-term effects from the long- paper is to identify how the value of the firm is affected by the conversion method. This is done by examining the implication of the conversion method5 on the non-arbitrage condition. Finally, we use the solution of the dynamic optimization model to examine the effects of the conversion method on the financial and investment behavior. The financial behavior is examined following the method presented in (1987). The paper is organized as follows. Section 1.1, presents firms three financial statements in euro, while section 1.2 presents the same statements in SEK. In section 1.2, we also present a method for converting foreign currency denominated statements into home currency. The constraints on the financial decisions are listed in section 1.3. Section 1.4 contain an expression of the value of the firm and the dynamic optimization problem. We close section 1.4 by presenting the optimality conditions. The theoretical impact of taxation, in combination to conversion method, on the financial behavior is examined in Chapter 2. The effects on the cost of capital are studied in Chapter 3. 1 The theoretical model In the theoretical model of this paper we use the information contained in the three basic financial statements: the balance sheet, the income statement, and the statement of changes in financial conditions (the sources and uses of funds statement). Following Shahnazarian and (1998), we formalize these three financial statements in section 1.1. In section 1.2, we present the method that is proposed to convert the three financial statements in euro to SEK. Section 1.3 defines the constraints on the financial decisions. In section 1.4, we set up the dynamic optimization problem and conclude the optimality conditions. term has been pointed out in much of the literature. Examples include Summers (1981), (1982), Hayashi (1982), Auerbach (1983) and Osterberg (1989). For more references, the reader is to the references in this paper. 5 It is important to mention that there are two different conversions that have to be made. Firstly, the balance sheet and the income statement are converted at the corporate level. Secondly, we also convert dividends, capital gains, interest incomes and new shares issued in euro into SEK. It is important to distinguish between these two conversions, since in the derived formulae often only one of the two is present. In this paper, we have chosen to explicitly declare when and whether the conversion at the corporate level has any implications. However, most of the implications derived in this paper are the results of the conversions of capital incomes. 1.1Firmsthree financial statements in euro 1.1.1The balance sheet in euro The balance sheet presents the firms assets, liabilities, and equity as of a given date, at the moment when the books are closed. Assets represent the firms investments, and liabilities and owners equity indicate how these investments were financed. The assets are divided into two major components: Current assets and fixed assets. The liability and shareholders equity side of the balance sheet shows what the firm owe their lenders, business partners, the tax authorities and their stock owners. This side is divided into four major components: current liabilities, long-term liabilities, untaxed reserves6, and shareholders equity. We define the accountable value of assets as K e = CAe + M e where CAe is the current assets. Fixed assets7 are assumed to consists of machinery and equipment ( M e ). The liabilities include their current liabilities ( CLe ), their long term liabilities ( LLe ), their untaxed reserves ( ASDe ) and their equity capital ( ECe ). Thus Be , the total liabilities are defined as Be = CLe + LLe + ASDe + ECe where ASDe contains the accumulated supplementary depreciation (in excess of plan). The equity ( ECe ) is defined as follows ECe = RE e + URE e = SCe + RRe + FRe + OURE e where restricted equity ( RE e ) includes share capital ( SCe ) and restricted reserves ( RRe ) while unrestricted equity (URE e ) includes free reserves ( FRe ) and other unrestricted equity ( OURE e ). 6Allocations made only for tax purposes should (in ) be reported as untaxed reserves in the balance sheet. 7which are booked at the original costs less the depreciation and revaluation. unrestricted equity includes profit or loss brought forward ( e ) and profit or loss for the financial year ( NBI e ). Table 1.1 concludes the definitions in equation (1.1)-(1.3) and set up the closing balance sheet in euro for an incorporated firm. Table 1.1: The closing balance sheet in euro for a firm In the balance sheet the value of the firms assets must be equal to the firms liabilities, so that CAe + M e = SCe + RRe + FRe + OURE e +ASDe + LLe + CLe 1.1.2The income statement in euro Let us define earnings before taxes ( EBT e ) as EBT e = f ( M e , L) - W e L - OCe - dM e - iLLe - (dT Ce - dM e ) where f ( M e , L) is the operating revenue while W e L - OCe are the operating expenses (which includes the cost for raw materials and consumables and other external charges ( OCe )8, and the firms cost for variable factor (W e L )). f ( M e , L) e > 0 , f e < 0 and < 0 . dM e depreciation of machinery and equipment. iLLe is the financial expenses which includes the firms interest costs on long-term liabilities. By adding net allocations (to the accumulated supplementary depreciation) to the economic depreciation, we get the depreciation according to the tax law. Supplementary depreciation [in excess of plan] is the difference between depreciation according to the books (depreciation according to Swedish tax laws or depreciation for income tax) and depreciation according to plan. In our case the supplementary depreciation in excess of plan is where Ce is the taxable residual value of machinery and equipments. According to the tax rules, the firm must pay their taxes in home However, we let the firm first calculate the taxes in euro. Then, we convert the calculated income tax in euro to SEK (see further section 1.2.2). The firm pays taxes based on its earnings TAe = t[ f ( M e , L) - W e L - OCe - dM e - iLLe where t is the corporate tax rate. NBI e can thus be derived as NBI e = EBT e - TAe = (1 - t) EBT e Net business income increases other unrestricted equity ( OURE e ). However, other unrestricted equity also decreases because the firm pays out dividends which are attributable to net business income, and also allocates some of the unrestricted equity into RRe , and FRe . 8 In this paper, we will assume that other costs are fixed. However, one could assume that these costs are dependent of the production level in the firm. This will only make the mathematical level more complicated but will not affect the major conclusions in this paper. change of other unrestricted equity ( OURE e )- the change from the opening balance to closing balance- can be written as OURE e = NBI e - De - rr e - fr e where the change in RRe and FRe are defined as follows FR = fr e 1.1.2.1The calculation of the tax residual value of machinery and equipments In this paper we will only model the main rule for tax depreciation of machinery and equipment. To be able to explain the implication of the main rule for depreciation according to Swedish tax legislation-the declining balance method (at 30 per cent)- we need to define the taxable residual value of machinery and equipment and also the equation of motion for such assets. The taxable residual value of these assets can be calculated by the following equation The equation of motion for the taxable residual value of machinery and equipment is Equation (1.13) states that the change of the firms taxable residual value of machinery and equipment equals the firms investment minus depreciation for income tax during that period. The declining balance method allows a maximum deduction of dT = of the remaining taxable residual value, dT Ce . The allowed tax depreciation rate is assumed to be higher than the economic depreciation rate. 1.1.2.2 The balance sheet and its dynamic characteristic The state variables of this model are LLe , CAe , CLe , SCe , RRe , FRe , OURE e , ASDe and M e . In what follows we will specify equations of motions that hold for these state variables. The long term liabilities increases by new borrowing and decreases by repayments of the loan. By defining lle as the net change in long-term liabilities, we can write the equation of motion for long term liabilities as The net change of current assets and current liabilities are defined as below The net change of share capital includes both new issues of shares, stock dividends and stock splits.9 SC e = N e 9 In addition to cash dividends, companies may pay stock dividends or split their stock. A stock dividend is the payment of additional shares of stock to common stockholders. So for example, when a company declare a 25 per cent stock dividend, it means that for every four shares owned, a stockholder on the record date will receive an additional share. A stock split is a proportionate increase in the number of common shares. For example, if a company split its stock three for one, it means that the stockholders receive three shares for each one held on the record date. Although there is no real financial difference between stock dividends and stock splits- stockholders simply receive more paper- both the typical motives behind them and their accounting treatment differ. The technical distinction between the two is that a stock dividend appears as a transfer of retained earnings to the capital stock account, whereas a stock split is shown as a reduction in the value of each share. The change of a firms machinery and equipment equals the investment in new machinery and equipment minus the economic depreciation of machinery and equipment M e = I e - dM e 1.1.5The statement of changes in financial position in euro The financial statement that is closest to reporting cash flow is formally referred to as the statement of changes in financial position. In this paper, a sources and uses statements are based on the working capital concept of funds.10 Working capital equals current assets minus current liabilities. Financial analysts often prepare a source and uses of working capital statement as an indication of a firms liquidity: The more working capital a firm can provide, the more liquid the firm is considered to be. This statement is similar to a cash flow statement. In order to prepare a source and uses of working capital statement, we must (1)determine the change in each non-working capital item on the balance sheet during the period and the effect that change has on the cash position. (2)examine the income statement to identify the effects on cash of operations, as well as the division of income between retained earnings and dividends. These items are then consolidated on the sources and uses statement. Sources of working capital include increases in non-current liabilities (via, for instance, new borrowing), decreases in non-current assets (such as plant and equipment) and increases in net worth (because of additions to retained earnings or the sale of additional shares of stock). Uses of working capital include decreases in non-current liabilities (such as the repayment of a loan), increase in non-current assets (including investments in fixed assets) and decreases in net worth (by paying dividends and/or having an operation loss). Following the procedure mentioned above, we can define the change (increases/decreases) in working capital (WCe = CAe - CLe ) as 10 However, it is also possible to base a sources and uses statement on cash statements. is the net change in share capital and M e is the net change in machinery and equipment.11 Another way of deriving equation (1.19) is to realize that changes in the asset side of the balance sheet must equal the changes on the liability side of the balance sheet. Thus, we can use condition (1.19) to see whether our system of difference equations (see section 1.3- 1.4) fulfill the necessary condition. 1.2The balance sheet and the income statements in SEK 1.2.1The balance sheet in SEK Firms assets and liabilities in Table 1.1 are denominated in foreign currency (euro). For taxation purposes these have to be converted into the home currency (SEK). There are four principal methods for converting foreign currency denominated statements into home currency. i)The Current/non-current method: Each current asset or liability is converted at the current exchange rate, non-current assets or liabilities are converted at the historical exchange rates. ii)The Monetary/non.monetary method converts monetary balance sheet items (such as cash, short- and long-term liabilities) at the current exchange rate and non-monetary items (such as machinary and equipments) at the historical exchange rate. iii)The temporal method is a refinement of the monetary/non-monetary method. The difference is that if inventories are shown in balance sheets at current market values they may be converted using the current exchange rate. iv)The current rate method: All balance sheet items are converted using the current exchange rate (the exchange rate at the balance sheet date). The first three methods mentioned above necessitate the knowledge of the historical exchange rates. This creates problems for a firm that today has its accounting in SEK. It does not have any information about the historical exchange rates. However, this is a problem during the 11 The equation of motions for these variables are defined in section 1.1.4. transition stage and can be solved by provisional regulations. For example, accounting in SEK can be converted to euro at the transition dates exchange rate. A natural transition day is of-course the last day of an accounting year. Moreover, after the transition period the firm will keep its books in euro. The government could demand that the firm, for conversion purposes, register the exchange rate at the time of the transaction. This will probably force the firm to have its accounting in both euro and SEK. The commission considered this to be very costly for the firm. From a taxation point of view, the first three methods will probably be most efficient. Most of the deductions (for example deductions for depreciation and interest costs) are based on historical values and this demands the knowledge of the historical exchange rates. On the other hand, one should be aware that a complicated conversion system by definition leads to misunderstandings and gives incentives for ignorance. At the long run, a complicated conversion system (which initially is regarded to be efficient) can have a negative effect for the taxation of a firm and its shareholders. The simplicity argument mentioned above has been considered to be very important by the commission. The current rate method satisfies the simplicity condition best. As mentioned, this method is the most suitable during the transition period. According to the current rate method all balance sheet items are converted using the exchange rate at the end of the accounting year, at (which we henceforth will call the balance day), accept the net business income which will be converted with the average exchange rate for the financial year (a ). exchange rate is used to convert NBI e because it is a approximation of the exchange rates during the period. As we mentioned earlier, the most efficient way to guarantee governments tax income is to demand that the firm register different exchange rates for different transactions. The average exchange rate for the financial year may dampen some of the externalities that may occur because government, for simplicity, let the firm use a more standardized method of conversion. This conversion method creates inequality between the asset- and the liability side of the balance sheet. We balance the difference by using a new untaxed variable, Conversion differences- CDt , at the liability side of the balance sheet as CD = (a Table 1.2 concludes the closing balance sheet converted to SEK. Table 1.2: The closing balance sheet in euro for a firm at (OUREte- 1 - Dte - rrte - frte ) + a NBIte The conversion differences is equal to the difference between the average exchange rate and the exchange rate at the balance sheet day multiplied by the net business income. 1.2.2The income statements in SEK and the calculation of the tax liability As we mentioned in section 1.2.1, we will use the average exchange rate for the financial year to convert the income statement in euro to SEK. Let us now define earnings before taxes in SEK ( EBT ) as below EBT = a [ f ( M e , L) - W e L - OCe - dM e - iLLe - (dT Ce - dM e )] The firm pays tax based on its earnings before taxes in SEK. Using (1.7), we convert the tax payments in SEK as follows TA = at[ f ( M e , L) - W e L - OCe - dM e - iLLe - (dT Ce - dM e )] Net business in SEK, NBI , can thus be derived as NBI = EBT - TA = (1 - t) EBT e = a 1.3The Constraints on the Financial Decisions