Capital Structure of Foreign Subsidiaries – Tax & Risk Factors

Let's say TCS creates a subsidiary in USA under the name 'TCS America'. How should TCS America get money?

1. Equity: TCS India buys shares of TCS America.
2. Parent Loan: TCS India lends to TCS America.
3. Local Loan: TCS America borrows from Citibank US.

1. Comparing Options

A. Parent Loan (Inter-company Loan)

• Pros: Interest stays within the family (TCS America pays TCS India).
• Cons: Withholding Tax applies on interest leaving USA.

B. Parent Equity

• Pros: No fixed obligation.
• Cons: Dividends are not tax-deductible in USA. (Interest IS deductible).

C. Local Loan (External)

• Pros: Reduces political risk (If US Govt seizes assets, they seize the Bank's problem too).
• Pros: No Exchange Risk (Assets in USD, Loan in USD).

2. Diagram: Financing Decision Tree

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3. Exam Notes: Writing the Answer

Question: "Discuss the trade-offs in financing a foreign subsidiary." (10 Marks)

Answering Strategy:

1. Structure: Compare Internal Sources (Parent funds) vs External Sources (Local Banks).
2. Key Factor 1: Tax. (Debt is better in high-tax zones).
3. Key Factor 2: Forex Risk. (Local borrowing matches currency of revenue and debt).

Summary

• Golden Rule: Match the liability currency with the asset currency. It is safer for TCS America to borrow in Dollars than in Rupees.
• Tax: Always check where the "Interest Deduction" is more valuable.

Quiz Time! 🎯

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