Info

are used? tax free?

tax deductible?

Belgium

Belgium

Denmark Finland

Only i! the value has clearly and permanently risen Usually done only with respect to real estate assets

Ye s

Yes, if there is permanent increase in value

Market prices, as No: revaluation reservesare Yes estimated by taxable at the corporate tax authorized experts rate. They are accounted for as "exceptional profits"

Market value No Yes

France

Germany Italy

Japan

Netherlands Portugal

Spain

Sweden

Switzerland United Kingdom

United States IAS

Yes, since 1984, under certain Market value conditions

Only according to government decree (most recent in 1983, 1990, and 1991;

No, except that land can he Market value revalued if special permission granted by government

(March 31, 1998 to March 31,

2001)

Yes, every year

Using government 1991 revaluation was price indices subject to a 16% tax

Only according to government decree [usually every two years)

Only according to government decree (most recent in 1983) Yes, if there is permanent Increase In value No

Occasionally {land and buildings)

Replacement cost Yes or market value

Using government Yes price indices

Using government Yes price indices Market value Yes

Market value

Up-to-date fair Not applicable value

Not applicable

Yes, partially (60K of additional depreciation)

Yes Yes

Partially, according to tas rules

Not applicable

Source: McKinscy research; iiilorinatiou from 1998.

The most appropriate way to take revaluation into account is to annually adjust NOPLAT and invested capital to reflect the annual increase of market values. In countries where revaluation is done over longer periods, the revaluation reserve should be spread over the period in question. In any case, when calculating free cash flow, capital spending should be determined as the increase in net fixed assets plus depreciation, less the increase in the revaluation reserve. Otherwise, investments would be overstated.

Deferred Taxation

Deferred taxes arise from differences between a company's published financial statements and its tax accounts. In Germany, Switzerland, and Italy, deferred taxes normally do not arise in the accounts of individual companies because financial statements are the same as tax accounts. However, deferred taxes may arise in consolidated accounts. In other countries, deferred taxes could be substantial because of items such as asset revaluation and accelerated depreciation.

To calculate NOPLAT, invested capital, and ROIC, income taxes should be stated on a cash basis. For NOPLAT, the increase in deferred taxes (as a balance sheet item) should be subtracted from the amount of taxes on the income statement to calculate taxes on earnings before interest and taxes (EBIT). For invested capital, deferred taxes should be treated as an equity item as described in Chapter 9.

Consolidation

As summarized in Exhibit 18.7, most countries require consolidation of accounts when a subsidiary is more than 50 percent owned, or when there is a controlling interest. In some cases, these consolidation principles were adopted only recently; consequently, historical accounts may not be entirely comparable. The footnotes to a company's accounts should be reviewed to ensure comparability across companies and time.

Foreign Currency Translation

The translation of the accounts for foreign subsidiaries into the parent company's currency for consolidation purposes follows either the current or temporal method.

The current method translates foreign-currency balance sheet items into the parent currency at the end-of-period exchange rate, except for equity accounts. Equity is converted at historical rates, for example, at the exchange rate on the day of a share issue. The income statement is translated at an average rate for the period. An equity account called translation adjustment is credited or debited with the amount necessary to balance the balance sheet.

Exhibit 18.7 Consolidation

Country When do subsidiaries have to be consoltdated?

Belgium When ownership exceeds 50%

Denmark When voting rights exceed 50%

Finland When ownership exceeds 50% or controlling interest France When ownership exceeds 50%, or 40% for two consecutive years, or one parent designated more than half of the directors, or parent has a control on subsidiary through special contracts or clauses Germany When ownership exceeds 50% or the subsidiary is managed by the parent company

Italy When ownership exceeds 50%or controlling! interest {before 1994 only for listed companies] Japan When ownership exceeds 50% or the subsidiary is effectively Controlled by the pa rent

Netherlands "Group companies": companies in which the parent executes the rights associated with a controlling interest

Norway When ownership exceeds 50%

Portugal When voting rights exceed 50%

Spain When ownership exceeds 50% or control majority of board seats

Sweden When ownership exceeds 50%

Switzerland When voting rights exceed 50%

United Kingdom When voting rights exceed 50% or controlling interest

United States When voting rights exceed 50% or effective management control IAS When voting rights exceed 50% or controlling interest

Consolidation method for affiliates and joint ventures

Equity method for affiliates (>2CJ%), proportional consolidation for joint ventures

Equity method for affiliates, proportional consolidation for joint ventures

Equity method for affiliates, proportional consolidation for joint ventures

Equity method for affiliates (>20%). proportions!

consolidation for joint ventures

Equity method for affiliates (>10%), proportional consolidation for joint ventures is possible but rare

Equity method for affiliates (>1IM), proportional consolidation for joint ventures is possible but rare

Equity method for affiliates (>20%) or when parent has substantial influence over management

Equity method or proportional consolidation for non-"group companies" (A minority interest can be a group company in the case of special voting rights)

Equity method for affiliates, proportional consolidation for joint ventures Equity method for affiliates (>20%), proportional consolidation for joint ventures Is possible but rare Equity method for affiliates, proportional consolidation for joint ventures is possible but rare

Equity method and proportional consolidation car be found for hoth affiliates and joint ventures Equity method for affiliates (>20%), proportional consolidation for joint ventures is possible but rare

Equity method is common, proportional consolidation is only allowed lor unincorporated joint ventures Equity method is common

Equity method for associates (>20%), proportional consolidation for joint ventures

Source: MtKirtsev rcsearcli; intomiatton [rom IMS.

Under the temporal method, assets carried at cost, such as fixed assets and inventory, are translated at historical exchange rates (the rate that applied when the asset was acquired). Other assets, and most liabilities, are translated at end-of-period exchange rates. Any gain or loss related to the translation of assets or liabilities at end-of-period rates is shown as an exchange gain or loss on the income statement. In the income statement, all items are translated at the rate in effect on the date of the transaction.

In European countries, the current method is more common. When the current method is used, we recommend that the change in the equity account for foreign translation be treated as an operating cash flow since in most cases it corrects operating assets or liabilities. This should be assessed

Exhibit 18.8 Valuation of a Japanese Electronics Company, 1992

Exhibit 18.8 Valuation of a Japanese Electronics Company, 1992

on a case-by-case basis. When the temporal method is used, no adjustments are necessary. Nonoperating Assets

In some countries, nonoperating assets can be significant. Exhibit 18.8 shows the disguised valuation of a Japanese electronics company. Less than half of the total value is the operations of the business. The remainder is shares of other companies and excess real estate investments. Japanese companies customarily own minority interests in the common stock of their business partners (customers and suppliers). These securities are rarely traded and remain on the books at their historical purchase price, often a small fraction of the current worth. Their current market value should be captured in your valuation.

Real estate is another example of a nonoperating asset whose book value is often far below the market value. Estimate the market value and add it to the valuation as a nonoperating asset if the real estate is being held for eventual resale. If the real estate is used by the company's operations, however, the market value is irrelevant for valuation purposes because it cannot be sold without being replaced or rented.

Taxation

Taxation systems vary widely and are constantly changing. In Europe, corporate statutory tax rates run from as low as 12 percent in Switzerland to 53 percent in Italy. Effective tax rates may differ from statutory rates because of the way taxable income is calculated. We can't do justice to this subject, but many guides are available summarizing tax rules across countries. We will highlight one conceptual issue that particularly affects company valuation: how to deal with corporate and personal tax integration.

Many European countries have integrated corporate and personal tax systems to eliminate some or all of the double taxation on dividends to shareholders. Where mechanisms to reduce double taxation are present, they may affect companies' value.

Some countries use a dividend imputation system that provides a tax credit to shareholders for some or all of the corporate taxes already paid by the company. Dividend imputation effectively increases cash flow to shareholders by decreasing the amount of taxes received by the government. This cash flow may take the form of a reduction of tax owed or of a tax refund, depending on the overall tax liability of the shareholder. An example is given in Exhibit 18.9, which shows the calculation of tax credits under a dividend imputation system and the resulting differences in net cash flows to investors. Different countries' approaches to the double taxation issue are detailed in Exhibit 18.10.

Dividend imputation has two implications for value. First, because of the higher prepersonal-tax cash flows to shareholders, a company fiscally based in a country using a dividend imputation mechanism should be valued more highly than an identical company fiscally based in a country with double taxation of dividends. Second, in a dividend imputation system, what dividend policy a company chooses will have an impact on the overall

Exhibit 18.9 How Dividend Imputation Works

Billion Lire

Double taxation

Dividend imputation

Corporate tax rale

37%

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