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A. Alternative 2: Transfer pricing analysis 1. G...

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A. Alternative 2: Transfer pricing analysis 1. Global Enterprises has a manufacturing affiliate in Country A that incurs costs of $300,000 for goods that it sells to its sales affiliates in Country B. The sales affiliate resells these goods to final consumers for $850,000. Both affiliates incur operating expense of $50,000 each. Countries A and B levy a corporate income tax of 35 percent on taxable. Required: If Global Enterprises raises the aggregate transfer price such that shipments from its manufacturing to its sales affiliate increase from $500,000 to $600,000, what effect would this on consolidated taxes? Country A Country B Global Sales $500,000.00 $850,000.00 $850,000.00 Cost of Sales $300,000.00 $500,000.00 $300,000.00 Gross Margin $200,000.00 $350,000.00 $550,000.00 Operating Expenses $50,000.00 $50,000.00 $100,000.00 Pretax income $150,000.00 $300,000.00 $450,000.00 Income Tax (35%) $52,500.00 $105,000.00 $157,500.00 Net Income $97,500.00 $195,000.00 $292,500.00 Country A Country B Global Sales $600,000.00 $850,000.00 $850,000.00 Cost of Sales $300,000.00 $600,000.00 $300,000.00 Gross Margin $300,000.00 $250,000.00 $550,000.00 Operating Expenses $50,000.00 $50,000.00 $100,000.00 Pretax income $250,000.00 $200,000.00 $450,000.00 Income Tax (35%) $87,500.00 $70,000.00 $157,500.00 Net Income $162,500.00 $130,000.00 $292,500.00 In both cases, consolidated taxes are $157,500. There is no effect on consolidated taxes because the tax rate in Country A and Country B are both 35%. 2. Using the facts states in Exercise 1 above, what would be the tax effects of the transfer pricing action if corporate income tax rates were 30% in Country A and 40% in Country B? Country A Country B Global Sales $500,000.00 $850,000.00 $850,000.00 Cost of Sales $300,000.00 $500,000.00 $300,000.00 Gross Margin $200,000.00 $350,000.00 $550,000.00 Operating Expenses $50,000.00 $50,000.00 $100,000.00 Pretax income $150,000.00 $300,000.00 $450,000.00 Income Tax (30%/40%) $45,000.00 $120,000.00 $165,000.00 Net Income $105,000.00 $180,000.00 $285,000.00 Country A Country B Global Sales $600,000.00 $850,000.00 $850,000.00 Cost of Sales $300,000.00 $600,000.00 $300,000.00 Gross Margin $300,000.00 $250,000.00 $550,000.00 Operating Expenses $50,000.00 $50,000.00 $100,000.00 Pretax income $250,000.00 $200,000.00 $450,000.00 Income Tax (30%/40%) $75,000.00 $80,000.00 $155,000.00 Net Income $175,000.00 $120,000.00 $295,000.00 Seeing as the tax rates are different in Countries A and B, if Global Enterprises raises the aggregate transfer price such that shipments from its manufacturing to its sales affiliate increase from $500,000 to $600,000, consolidated taxes would decrease from $165,000 to $155,000, reducing the total tax liability by $10,000. 3. Drawing on the background facts in Exercise 1 and 2 above, assume that the manufacturing cost per unit, based on operations at full capacity of 10,000 units, is $30 and that the uncontrolled selling price of the unit in Country A is $60. Costs to transport the goods to the distribution affiliate in Country B are $8 per unit and a reasonable profit margin on such cross-border sales in 20% of cost. Now suppose that country B levies a corporate income tax of 40% on taxable income (vs. 30% in Country A) and a tariff of 20% on the declared value of the imported goods. The minimum declared value legally allowed in Country B is $50 per unit with no upper limit. Import duties are deductible for income tax purposes in Country B. Required: a. Based on the foregoing information, formulate a transfer pricing strategy that would minimize Global Enterprise?s overall tax burden. b. What issues does your pricing decision raise?

 

Paper#6446 | Written in 18-Jul-2015

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