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Seeing Both the Forest and the Trees- Supervising Systemic Risk




José Viñals, IMF Financial Counsellor and Director, Monetary and Capital Markets Department
Opening Remarks at the Eleventh Annual International Seminar on Policy Challenges for the Financial Sector

It is a great pleasure to welcome all of you on behalf of the Fund at the second day of the Annual International Seminar on Policy Challenges for the Financial Sector, jointly organized by the Federal Reserve Board, the World Bank, and the International Monetary Fund. We are pleased to have with us distinguished participants from 75 countries, representing 83 supervisory agencies and central banks.
This is the eleventh edition of this seminar, and I am glad to notice that many of you are returning participants. The fact that you are again with us today shows that we have been able to draw your attention to various issues related to financial markets supervision, and that this is a useful forum for discussing high-priority items on the national and international policy agenda.
This year’s seminar is no exception: our ambitious agenda focuses on an issue that is highly relevant for all of us—systemic risk. In particular, the seminar examines the multiple facets of systemic risk, as well as the policy instruments aimed at safeguarding the stability of the financial system as a whole.
The financial crisis revealed major shortcomings in the financial sector supervisory processes. First, the supervision of individual financial institutions – the “trees” – did not have the intrusiveness and intensity necessary to recognize and address growing risks that contributed to the financial crisis. Second, we also failed to grasp the nature of this financial “ecosystem”, where distress or damage of one component may have a significant impact on the whole system, and where the total risk of the system is greater than the sum of individual risks.
Based on an examination of lessons from the crisis, we have identified at the Fund key elements of good supervision—we believe good supervision should be intrusive, skeptical, proactive, comprehensive, adaptive, and conclusive. To achieve this perfect combination, the “ability” to supervise—which requires appropriate resources, authority, organization, and constructive working relationships with other agencies—must be complemented by the “will” to act.
However, strong and effective supervision of the “trees” is a necessary, but not a sufficient condition for ensuring financial stability. Therefore, a higher level perspective on systemic risks is necessary, which would enable us to see the “forest” and improve our understanding of the intricate web of connections between financial institutions, financial markets, and the macro-economy.
This higher-level perspective is now being referred to as macroprudential policy. There is broad international consensus on the importance of developing a macroprudential framework, which became a priority on the G20 policy agenda. However, the analytical underpinnings are still in their infancy, and many challenges lie ahead of us.
Many policymakers are already grappling with this issue, both at the conceptual level and in practical terms. A recent IMF survey (December 2010) shows that authorities in many countries are exploring the appropriate institutional infrastructure for macroprudential policy; and that the use of macroprudential instruments is becoming increasingly common. Countries are also actively engaged in designing new macroprudential instruments in international fora, such as the Basel Committee for Banking Supervision.
The IMF takes a strong interest in these developments, not least because we think that effective macroprudential policy frameworks can make a strong contribution to crisis prevention in our member countries. The G-20 has asked the IMF to further develop the elements of effective macroprudential frameworks, in close collaboration with the Financial Stability Board and the Bank for International Settlements. As part of these efforts, we have recently laid out our thinking in an IMF policy paper, published in April. We are also working with our colleagues in Basel on a progress report to the G-20, due later this year.
Our recent paper on macroprudential policy is not intended to reach definitive conclusions, because we recognize that more work is needed to develop a comprehensive and coherent framework. Instead, it is a roadmap for developing the policy framework. It can, therefore, offer guidance for today’s seminar discussions.
We believe that macroprudential policy should be based on three pillars:
– governance arrangements
– policy instruments, and
– coordination with other policies.
Let me provide some highlights of our thinking in each of these areas …

1. Effective governance arrangements

Macroprudential policy involves managing a tail risk—the benefit of taking action is uncertain and only apparent in the long run, while the costs will often be highly visible immediately. This can create a bias in favor of inaction, or insufficiently forceful action, especially in the face of strong industry lobbying.
Taking away the punch bowl just as the party gets going has never been easy in any area of public policy, and macroprudential measures are certainly not an exception to this rule. It is, therefore, very important that governance arrangements strengthen policymakers’ ability and willingness to act.
This means that those who conduct macroprudential policy need to have clear mandates and rulemaking powers, so as to enhance their accountability and reduce the risk of political pressure.
In setting the mandate of macroprudential authorities, we need to be clear as to what macroprudential policy actually is; what it is meant to achieve; and what it is not designed to do.
In particular, macroprudential policy should focus on risks arising primarily within the financial system, or amplified by the financial system. It would be wrong to use it to address risks associated with macroeconomic imbalances and shocks, or inappropriate macroeconomic or structural policies—for which the first line of defense should be adjustments in macroeconomic policies.
At the same time, macroprudential policy is no substitute for robust prudential policies of the traditional kind, which primarily aim at ensuring the solidity of individual financial institutions.
Macroprudential authorities will need to have access to information and analytical capability to indentify systemic risks in a timely manner and deploy adequate instruments to contain such risks.
Because of the dynamic nature of financial systems, macroprudential policy requires continuous monitoring of a broad set of information—including on firms and activities that might be outside of the perimeter of regulation. Macroprudential policy also requires identifying systemically important financial institutions (SIFIs), markets, and instruments. Here, data gaps are an important constraint—a challenge that is being tackled at the international level through the combined efforts of the IMF, FSB, and BIS.
Further progress is also needed in refining models and forward-looking measures of systemic risk, and improved cooperation will be needed in sharing information among relevant authorities. Finally, we should also strive to complement quantitative tools with more qualitative assessments, including supervisory judgment and market intelligence.
The choice of the specific institutional arrangements for macroprudential policy needs to reflect local conditions. In Europe, for example, we have recently seen the launch of the European Systemic Risk Board and various national institutional arrangements, such as the Financial Policy Committee in the UK, and the Financial Regulation and Systemic Risk Council in France. In the US, the Financial Stability Oversight Council has been established. Moreover, the impetus for institutional reform has not been limited to those advanced countries that have been hardest hit by the crisis. A number of emerging market economies, such as Malaysia and Mexico, have made, or are in the process of making, changes to their institutional framework for financial stability.
Some key features of the institutional arrangements for macroprudential policy are already emerging.
One is that central banks should play a prominent role, given their expertise in monitoring macroeconomic and financial market developments, and their existing roles in monetary policy and payment systems. This analytical expertise can help achieve greater clarity about the benefits and costs of macroprudential policies. They also have strong institutional incentives to ensure that macroprudential policies are effective—because if they are not, central banks will have to take costly corrective measures.
In addition to the central bank, the regulatory and supervisory agencies need to be involved, most obviously when they retain operational authority over macroprudential instruments. The involvement of finance ministries has its pros and cons: the main pros are the ease of integration of fiscal policy and of discussion of legislative changes that may be required to mitigate systemic risks. The key counter-argument is the reduced degree of independence from the political process.
Questions remain regarding the decision-making process within multi-agency macroprudential councils and the best arrangements for ensuring accountability for implementing actions.
The next step in cementing the institutional setup is to equip the macroprudential authorities with …

2. A set of instruments for conducting macroprudential policy
Mirroring the complexity of systemic risk, the set of macroprudential policy tools is likely to be wide in scope. We agree today that the macroprudential tools should enhance policymakers’ ability to cope with two interrelated dimensions of systemic risk:
1) The time dimension, or cyclical dimension, which includes risks associated with swings in credit and liquidity cycles, driven by pro-cyclical forces such as leverage and herding behavior by financial institutions, non-financial firms, and households; and
2) The cross-sectional dimension, which focuses on the concentration of risk in certain financial institutions and markets that are highly interconnected within, and across, national borders.
Some key tools are currently being developed to specifically address systemic risk—such as countercyclical bank capital charges that lean against the economic cycle, or systemic capital surcharges that grow as the systemic impact of individual financial institutions increases.
There is also a broad range of tools that has already been used in some countries—mostly traditional prudential tools adjusted specifically to address the build-up of systemic risk. Some countries have sought to address risks in their real estate markets by putting limits on Loan-to-Value, Debt-to-Income, and Loan-to-Income ratios (China, Hong Kong, Poland, Serbia, Singapore, and South Korea). Others have deployed time-varying caps on credit or credit growth (aggregate or sectoral) to constrain credit during booms, and sustain it during busts (Serbia and Malaysia). Recent structural measures to address risk concentrations and interconnectedness include the “Volcker-rule”, which would create a ban on proprietary trading for systemically important U.S. banks; and proposals in the European Union to restrict short selling and limit the use of certain derivatives in the event of a serious threat to financial stability.
How should these tools be used? One key issue is whether we should use rules, discretion, or a combination of both. Rules would help overcome the bias for inaction that is likely to arise. But some form of discretion is also needed to help adjust policies to a financial sector that evolves rapidly, and where the specific sources of systemic risk are subject to change. Therefore, a combination of both approaches may eventually emerge as the sensible choice—incorporating more rules than is the case for monetary policy; but leaving scope for some discretion to adjust to a dynamically evolving financial sector.
Let me now turn to the issue of…

3. Coordination with other policies
Regardless how different policy mandates are structured, ensuring financial stability is a shared responsibility. Other policies, for which financial stability is—at most—a secondary objective, should not lose sight of the systemic consequences of their action, or inaction, and should not be a source of financial instability. An especially prominent role is played by microprudential policy and monetary policy, both of which affect the amount of risk the financial system is willing (and able) to bear. For example, the larger the buffers created by microprudential policy, the smaller the need for macroprudential policy to step in.
Macroprudential and other policies interact in complex ways that are not yet fully understood. Policy conflicts may arise. For instance, if monetary policy is loosened for a long period, macroprudential policy may want to become tighter to avoid excessive risk-taking. Or, if macroprudential policy encourages drawing down bank capital buffers in a downturn to sustain the flow of credit, microprudential policy may be inclined to keep buffers unchanged to guard against the heightened risks.
All this calls for mechanisms for coordination across policies, which should be done in a manner that fully respects the independence of policies in different areas. Coordination will be particularly important where the operational control over the macroprudential instruments may not rest with the macroprudential body itself. Moreover, we need to acknowledge that the macroprudential policy should be viewed as a complement, rather than a substitute to macroeconomic and microprudential policies.
Obviously, many questions remain unanswered in this area, and hopefully today’s discussions would help clarify some of them.
Finally, international cooperation should complement national frameworks for macroprudential policy. We live in a globalized world, and multilateral aspects of macroprudential policies have to be taken into account. The benefits of international cooperation in macroprudential policies are multifaceted.
First, cooperation in macroprudential policies can reduce the scope for international regulatory arbitrage that may otherwise undermine the effectiveness of national policies—for example, when tightening requirements on domestic banks lead to a provision of credit by foreign parent institutions.
Second, cooperation and information sharing in macroprudential policies can help address cross-border interconnectedness and mitigate the risk of cross-border distortions and spillovers and the potentially destabilizing effects of capital flows.
As we can see, much work is needed to develop the macroprudential framework, because many operational and analytical underpinnings are not yet fully understood.
But macroprudential policy is only one tool to strengthen the resilience of the financial sector and improve our capacity to prevent and manage crises. At the same time, efforts are being made to develop instruments aimed at improving the resolvability of SIFIs and enhancing the cross-border cooperation framework.
Indeed, there are efforts to develop guidelines for contingent capital and bail-in instruments. And further effort are need to develop more effective resolution tools that can preserve financial stability in an increasingly complex and interconnected global system, while allowing losses to be borne by creditors rather than taxpayers.
Finally, while supervisory colleges are an important tool, they are relatively new and continue to evolve as jurisdictions become more comfortable with the process. Colleges should lead to stronger relationships and more joint-reviews by home and host-supervisors. Here again, work is being done by standard setters to upgrade the guidance in this area; and the FSB suggests that follow-up work should be done to test the effectiveness of such colleges.
It is apparent that, despite recent progress, many issues remain unresolved, and the challenges facing policymakers are daunting. We should not be intimidated by the complexity of our task, and we should maintain the momentum for promoting courageous reforms of the financial systems. This is a journey that we have to make collectively, and today’s conference is an excellent opportunity to make further progress.
Still, as we strive to define the framework for macroprudential policy, we should not forget that this will not be a panacea for all problems in financial systems. The message that we are trying to convey at this year’s conference is that we should see both the “forest” and the “trees”.
Macroprudential policy is not meant to be a substitute for sound policies in other areas—including strong regulation of individual institutions, intrusive and vigilant prudential supervision, and sound macroeconomic policies. In order to enhance the effectiveness of financial system surveillance, we need to encourage close interaction among all policies that help maintain financial stability.
The Fund stands ready to support such efforts through its surveillance mandate and financial sector expertise. Our collaboration with the FSB and BIS will enhance our understanding of macroprudential policies.
We hope that you will use this opportunity to share your insights and experiences, so we can improve our common knowledge and understanding of macroprudential policy and its interactions with other public policies.
I wish you all productive discussions today, and I look forward to our continued dialogue in the period ahead.


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Lockdown 2.0 – Here’s how to be the best-looking person in the virtual room



Lockdown 2.0 – Here's how to be the best-looking person in the virtual room 1

By Jeff Carlson, author of The Photographer’s Guide to Luminar 4 and Take Control of Your Digital Photos

suggests “the product you’re creating is not the camera, the lens or a webcam’s clever industrial design. It’s the subject, you, which is just on e part of the entire image they see. You want that image to convey quality, not convenience.”

Technology experts at Reincubate saw an opportunity in the rise of remote-working video calls and developed the app, Camo, to improve the video quality of our webcam calls. As part of this, they consulted the digital photography expert and author, Jeff Carlson, to reveal how we can look our best online. 

It’s clear by now that COVID-19 has normalised remote working, but as part of this the importance of video calls has risen exponentially. While we’re all used to seeing the more casual sides of our colleagues (t-shirt and shorts, anyone?), poor webcam quality is slightly less forgivable.

But how can we improve how we look on video? We consulted Jeff Carlson for some top tips– here is what he had to say.

  1. Improve the picture quality of your call

The better your camera, the higher quality your webcam calls will be. Most webcams (as well as currently being hard to get hold of and expensive), are subpar. A DSLR setup will give you the best picture, but will cost $1,500+. You can also use your iPhone’s amazing camera as a webcam, using the new app from Reincubate, Camo.

Jeff’s comments “The iPhone’s camera system features dedicated coprocessors for evaluating and adjusting the image in real time. Apple has put a tremendous amount of work into its imaging software as a way to compensate for the necessarily small camera sensors. Although it all works in service of creating stills and video, you get the same benefits when using the iPhone as a webcam.”

Aidan Fitzpatrick, CEO of Reincubate explains why the team created Camo, “Earlier this year our team moved to working remotely, and in video calls everyone looked pretty bad, irrespective of whether they were on built-in Mac webcams or third-party ones. Thus began my journey to build Camo: an iPhone has one of the world’s best cameras in it, so could we make it work as a webcam? Category-leading webcams are noticeably worse than an iPhone 7. This makes sense: six weeks of Apple’s R&D spend tops Logitech’s annual gross revenue.”

  1. Place your camera at eye level

A video call will never quite be the same as a face-to-face conversation, but bringing your camera up to eye level is a good place to start. That can involve putting your laptop on a stand or pile of books, mounting a webcam to the top of your display screen, or even using a tripod to get the perfect position.

Jeff points out, “If the camera is looking down on you, you’ll appear minimized in the frame; if it’s looking up, you’re inviting people to focus on your chin, neck, or nostrils. Most important, positioning the camera off your eye level is a distraction. Look them in the eye, even if they’re miles or continents away.

Lockdown 2.0 – Here's how to be the best-looking person in the virtual room 2

Low camera placement from a MacBook

  1. Make the most of natural lighting

Be aware of the lighting in the room and move yourself to face natural lighting if you can. Positioning the camera so any natural light is behind you takes the light away from your face, which can make it harder to see and read expressions on a call.

Jeff Carlson’s top tip: “If the light from outside is too harsh, diffuse it and create softer shadows by tacking up a white sheet or a stand-alone diffuser over the window.” 

Lockdown 2.0 – Here's how to be the best-looking person in the virtual room 3Lockdown 2.0 – Here's how to be the best-looking person in the virtual room 4

Backlit against a window Facing natural light

  1. Use supplementary lighting like ring lights

The downside to natural lighting is that you’re at the mercy of the elements: if it’s too bright you’ll have the sun in your eyes, if it’s too dark you won’t be well lit.

Jeff recommends adding supplementary lighting if you’re looking to really enhance your video calls. After all, it looks like remote working will be carrying on for quite some time.

“The light can be just as easy as a household or inexpensive work light. Angle the light so it’s bouncing off a wall or the ceiling, depending on your work area, which, again, diffuses the light and makes it more flattering.

Or, for a little money, use a softbox or a shoot-through umbrella with daylight bulbs (5500K temperature), or if space is tight, LED panels. Larger lights are better for distributing illumination– don’t be afraid to get them in close to you. Placement depends on the look you’re going after; start by positioning one at a 45-degree angle in front and to the side of you, which lights most of your face while retaining nice shadow detail.” 

In some cases, a ring light may work best. LEDs are arranged in a circle, with space in the middle to put the camera’s lens and get direct illumination from the direction of the camera.

  1. Centre yourself in the frame

Make sure you’re getting the right angle and that you’re using the frame effectively.

“You should aim for people to see your head and part of your torso, not all the space between your hair and the ceiling. Leave a little space above your head so it’s not cut off, but not enough that someone’s eyes are going to drift there.”

  1. Be mindful of your backdrop

It’s not always easy to get the quiet space needed for video calls when working from home, but try as best you can to remove anything too distracting from your background.

“Get rid of clutter or anything that’s distracting or unprofessional, because you can bet that will be the second thing the viewers notice after they see you. (The Twitter account @RateMySkypeRoom is an amusing ongoing commentary on the environments people on television are connecting from.)”

A busy background as seen by a webcam

  1. Make the most of virtual backgrounds

If you’re really struggling with finding a background that looks professional, try using a virtual background.

Jeff suggests: “Some apps can identify your presence in the scene and create a live mask that enables you to use an entirely different image to cover the background. While it’s a fun feature, the quality of the masking is still rudimentary, even with a green screen background that makes this sort of keying more accurate.”

  1. Be aware of your audio settings

Our laptop webcams, cameras, and mobile phones all include microphones, but if it’s at all possible, use a separate microphone instead.

“That can be an inexpensive lavalier mic, a USB microphone, or a set of iPhone earbuds. You can also get wireless lavalier models if you’re moving around during a call, such as presenting at a whiteboard in the camera’s field of view.

The idea is to get the microphone closer to your mouth so it’s recording what you say, not other sounds or echoes in the room. If you type during meetings, mount the mic on an arm instead of resting it on the same surface as your keyboard.”

  1. Be wary of video app add-ons

Video apps like Zoom include a ‘Touch up your appearance’ option in the Video settings. This applies a skin-smoothing filter to your face, but more often than not, the end result looks artificially blurry instead of smooth.

“Zoom also includes settings for suppressing persistent and intermittent background noise, and echo cancellation. They’re all set to Auto by default, but you can choose how aggressive or not the feature is.”

  1. Be the best looking person in the virtual room

What’s important to remember about video calls at this point in time is that most people are new to what is, really, personal broadcasting. That means you can easily get an edge, just by adopting a few suggestions in this article. When your video and audio quality improves, people will take notice.

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Bringing finance into the 21st Century – How COVID and collaboration are catalysing digital transformation



Bringing finance into the 21st Century – How COVID and collaboration are catalysing digital transformation 5

By Keith Phillips, CEO of TISATech

If just six or seven months ago someone had told you that in a matter of weeks people around the world would be locked down in their homes, trying to navigate modern work systems from a prehistoric laptop, bickering with family over who’s hogging the Wi-Fi, migrating online to manage all financial services digitally, all while washing their hands every five minutes in fear of a global pandemic… You’d think they had lost their mind. But this very quickly became the reality for huge swathes of the world and we’re about to go through that all over again as the UK government has asked that those who can work from home should.

Unsurprisingly, statistics show that lockdown restrictions introduced by the UK government in March, led to a sharp increase in people adopting digital services. Banks encouraged its customers to log onto online banking, as they limited (and eventually halted) services at branches. This forced many customers online as their primary means of managing personal finances for the first time.

If anyone had doubts before, the Covid-19 pandemic proved to us the importance of well-functioning, effective digital financial services platforms, for both financial institutions and the people using them.

But with this sudden mass online migration, it’s become clear that traditional banks have struggled to keep up with servicing clients virtually. Legacy banking systems have always stilted the digitisation of financial services, but the pandemic thrust this issue into the limelight. Fintech firms, which focus intently on digital and mobile services, knew it was only a matter of time before financial institutions’ reliance was to increase at an unprecedented rate.

For years, fintechs have been called upon by traditional players to find solutions to problems borne from those clunky legacy systems, like manual completion of account changes and money transfers. Now it is the demand for these services to be online coupled with the need for financial services firms to cut costs, since Covid-19 hit the economy.

Covid-19 has catalysed the urgent need to bring digital transformation to a wider pool of financial services businesses. Customers now have even higher expectations of larger institutions, demanding that they keep up with what the younger and more nimble challengers have to offer. Industry leaders realise that they must transform their businesses as soon as possible, by streamlining and digitising operations to compete and, ultimately, improve services for their customers.

The race for digital acceleration began far before the recent pandemic – in fact, following the 2008 financial crisis is likely more accurate. Since the credit crunch, there has been a wave of new fintech firms, full of young, bright techies looking to be the next big thing. Fintechs have marketed themselves hard at big conferences and expos or by hosting ‘hackathons’, trying to prove themselves as the fastest, most innovative or the most vital to the future of the industry.

However, even during this period where accelerating innovation in online financial services and legacy systems is crucial, the conditions brought about by the pandemic have not been conducive to this much-needed transformation.

The second issue, which again was clear far before the pandemic, is that fact that no matter how nimble or clever the fintechs’ solutions are, it is still hard to implement the solutions seamlessly, as the sector is highly fragmented with banks using extremely outdated systems populated with vast amounts of data.

With the significance of the pandemic becoming more and more clear, and the need for better digital products and services becoming more crucial to financial services firms and consumers by the day, the industry has finally come together to provide a solution.

The TISAtech project was launched last month by The Investing and Saving Alliance (TISA), a membership organisation in the UK with more than 200 leading financial institutions as members. TISA asked The Disruption House, a specialist benchmarking and data analytics business, to create a clearing house platform for the industry to help it more effectively integrate new financial technology. The project aims to enhance products and services while reducing friction and ultimately lowering costs which are passed on to the customers.

With nearly 4,000 fintechs from around the world participating, it will be the world’s largest marketplace dedicated to Open Finance, Savings, and Investment.

Not only will it provide a ‘matchmaking’ service between financial institutions an fintechs, it will also host a sandbox environment. Financial institutions can pose real problems with real data and the fintechs are given the space to race to the bottom – to find the most constructive, cost-effective solution.

Yes, there are other marketplaces, but they all seem to struggle to achieve a return on investment. There is a genuine need for the ‘Trivago’ of financial technology – a one stop shop, run by an independent body, which can do more than just matchmaking. It needs to go above and beyond to encompass the sandboxing, assessments, profiling of fintechs to separate the wheat from the chaff, and provide a space for true collaboration.

The pandemic has taught us that we are more effective if we work together. We need mass support and collaboration to find solutions to problems. Businesses and industries are no different. If fintechs and financial institutions can work together, there is a real chance that we can start to lessen the economic hit for many businesses and consumers by lowering costs and streamlining better services and products. And even if it is just making it that little bit easier to manage personal finances from home when fighting with your children for the Wi-Fi, we are making a difference.

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What to Know Before You Expand Across Borders



What to Know Before You Expand Across Borders 6

By Sean King, Director of International Tax at McGuire Sponsel

The American retail giant, Target Corporation, has a market cap of $64 billion and access to seemingly limitless resources and advisors. So, when the company engaged in its first global expansion, how could anything possibly go wrong?

Less than two years after opening its first Canadian store in 2013, Target shut down all133 Canadian locations and terminated more than 17,000 Canadian employees.

Expansion of an operation to another country can create unique challenges that may impact the financial viability of the entire enterprise. If Target Corporation can colossally fail in its expansion to Canada, how might Mom ‘N’ Pop LLC fare when expanding into Switzerland, Singapore, or Australia?

Successful global expansion requires an understanding of multilayered taxes, regulatory hurdles, employment laws, and cultural nuances. Fortunately, with the right guidance, global expansion can be both possible and profitable for businesses of any size.

Permanent establishment

Any company with global ambitions must first consider whether the company’s expansion outside of the U.S. will give rise to a taxable presence in the local country. In the cross-border context, a “permanent establishment” can be created in a local country when the enterprise reaches a certain level of activity, which is problematic because it exposes the U.S. multinational to taxation in the foreign country.

Foreign entity incorporation

To avoid permanent establishment risk, many U.S. multinationals choose to operate overseas through a formal corporate subsidiary, which reduces the company’s foreign income tax exposure, though it may result in an additional level of foreign income tax on the subsidiary’s earnings. In most jurisdictions, multinationals can operate their business in the foreign country as a branch, a pass through (e.g., partnership,) or a corporation.

As a branch, the U.S. multinational does not create a subsidiary in the foreign country. It holds assets, employees, and bank accounts under its own name. With a pass through, the U.S. multinational creates a separate entity in the foreign country that is treated as a partnership under the tax law of the foreign country but not necessarily as a partnership under U.S. tax law.

U.S. multinationals can also create corporate subsidiaries in the foreign country treated as corporations under the tax law of both the foreign country and the U.S., with possibly two levels of income taxation in the foreign country plus U.S. income taxation of earnings repatriated to the U.S. as dividends.

Check-the-box planning

Under U.S. entity classification rules, certain types of entities can “check the box” to elect their classification to be taxed as a corporation with two levels of tax, a partnership with pass-through taxation, or even be disregarded for U.S. federal income tax purposes. The check the box election allows U.S. multinationals to engage in more effective global tax planning.

Toll charges, transfer pricing and treaties

When establishing a foreign corporate subsidiary, the U.S. multinational will likely need to transfer certain assets to the new entity to make it fully operational. However, in many cases, the U.S. multinational cannot perform the transfer without recognizing taxable income. In the international context, the IRS imposes certain outbound “toll charges” on the transfer of appreciated property to a foreign entity, which are usually provided for in IRC Section 367 and subject to various exceptions and nuances.

Instead, the U.S. multinational may prefer to license intellectual property to the foreign subsidiary for a fee rather than transfer the property outright. However, licensing requires the company and foreign subsidiary to adhere to transfer pricing rules, as dictated by IRC Section 482. The U.S. multinational and the foreign subsidiary must interact in an arms-length manner regarding pricing and economic terms. Furthermore, any such arrangement may attract withholding taxes when royalties are paid across a border.

Are you GILTI?

Certain U.S. multinationals opt to focus on deferring the income recognition at the U.S. level. In doing so, they simply leave overseas profits overseas and delay repatriating any of the earnings to the U.S.

Despite the general merits of this form of planning, U.S. multinationals will be subject to certain IRS anti-deferral mechanisms, commonly known as “Subpart F” and GILTI. Essentially, U.S. shareholders of certain foreign corporations are forced to recognize their pro rata share of certain types of income generated by these foreign entities at the time the income is earned instead of waiting until the foreign entity formally repatriates the income to the U.S.

The end goal

Essentially, all effective international tax planning boils down to treasury management. Effective and early tax planning can properly allow a company to better achieve its initial goal: profitability.

If global expansion is on the horizon for your company, consult a licensed professional for advice concerning your specific situation.

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How to use data to protect and power your business 13 How to use data to protect and power your business 14
Business2 days ago

How to use data to protect and power your business

By Dave Parker, Group Head of Data Governance, Arrow Global Employees need to access data to do their jobs. But...

How business leaders can find the right balance between human and bot when investing in AI 15 How business leaders can find the right balance between human and bot when investing in AI 16
Business2 days ago

How business leaders can find the right balance between human and bot when investing in AI

By Andrew White is the ANZ Country Manager of business transformation solutions provider, Signavio The digital world moves quickly. From...

Has lockdown marked the end of cash as we know it? 17 Has lockdown marked the end of cash as we know it? 18
Finance2 days ago

Has lockdown marked the end of cash as we know it?

By James Booth, VP of Payment Partnerships EMEA, PPRO Since the start of the pandemic, businesses around the world have...

Lockdown 2.0 – Here's how to be the best-looking person in the virtual room 19 Lockdown 2.0 – Here's how to be the best-looking person in the virtual room 20
Top Stories2 days ago

Lockdown 2.0 – Here’s how to be the best-looking person in the virtual room

By Jeff Carlson, author of The Photographer’s Guide to Luminar 4 and Take Control of Your Digital Photos suggests “the product you’re creating is...

Banks take note: Customers want to pay with points 24 Banks take note: Customers want to pay with points 25
Banking2 days ago

Banks take note: Customers want to pay with points

By Len Covello, Chief Technology Officer of Engage People ‘Pay with Points’ – that is, integrating the ability to pay...

Are you a fighter or a freezer? The 4 “F’s” of Surviving Danger 26 Are you a fighter or a freezer? The 4 “F’s” of Surviving Danger 27
Business2 days ago

Are you a fighter or a freezer? The 4 “F’s” of Surviving Danger

By Dr.Roger Firestien, Author of Create In a Flash. The fight, flight, freeze survival response – or FFF for short...

Why the FemTech sector might be the sustainability saviour we have been waiting for 28 Why the FemTech sector might be the sustainability saviour we have been waiting for 29
Technology2 days ago

Why the FemTech sector might be the sustainability saviour we have been waiting for

By Kristy Chong, CEO & Founder Modibodi ® Taking single use plastics out of circulation is no easy feat, but...

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