Case Study-AW302

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A French multinational pharmaceutical company pays tax at 33% in France. It has a subsidiary in Ireland where the tax rate is 12,5 %. The Irish subsidiary has modern production facilities and can produce pharmaceutical which it sells to the French parent, which then handles sale of the products to the public. The price at which products are sold my MNC France is referred to as the ‘’transfer price’’.
 

a) Explain the likely impact of respective tax rates on the transfer price;
b) State which of the national governments is likely to be concerned about this and why;
c) With respect to your answer to (b) describe the commonly used methods by which taxation authorities ensure MNC’S pay tax.
d) Discuss tax implications of the transfer pricing debate from the representative of the EU, including likely future developments.
 

Case Study
 

Global Gear box Company (GGC), a U.S. taxpayer, manufactures laser guitars in its Malaysian operation (LG-Malay). LG-Malay guitars are sold to two U.S. customers, Electronic Superstores (wholly-owned subsidiary of GGC) and Walmart (unrelated party).
 

For profits remitted by dividend from LG-Malay to U.S.A., GGC is taxed in U.S.A. but a foreign tax credit is allowed by the U.S. government for taxes paid to the Malaysian government on the repatriated dividend. The tax approach is to “gross up” the dividend received in U.S.A. by the foreign (Malaysian) with holding tax and corporate tax in that country. U.S. tax is applied on the grossed up amount, but there is then a deduction for a foreign tax credit (FTC) of the lower of (a) U.S. taxes payable on the grossed up dividend (income received/(1-dividend w/h tax rate)/(1-income tax rate) and (b) foreign taxes deemed paid (by subtract ingnet dividend received from grossed up dividend).
 

For profits remitted by dividend from Electronic Superstores to its owner, GGC has 100% exemption from taxes, as is normal for parent companies which received ividends from domestic subsidiaries. (That is to say, only Electronic Super stores, not GGC, pays taxes on the income Electronic Super stores earns).
 

As a consequence of the previous two paragraphs, Electronic Superstores distributes 100% of its income to GGC as a dividend, where as the extent of LG-Malay’s dividend, if any, is dependent on tax considerations.
 
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You work in the GGC group tax and accounting department, working on the consolidation of group accounts and al soon “defence” of transfer pricing with the various tax authorities under the various recognized methods on sales from LG-Malay to Electronic Superstores. Following advice from GGC’s tax advisors, you keep a file of three transfer pricing methods acceptable to the U.S. tax authorities: using (a) comparable uncontrolled price method (b) resale price method (c) cost plus method. So far as the
 
(a) the comparable uncontrolled price method is concerned, LG-
Malay sells guitars to Walmart at a price of $150 per unit. So far as
 

(b) the resale price method is concerned, Walmart pays applicable import duties in U.S.A. of 20% on its purchases of laser guitars and places a 50% mark upon cost plus import duty, selling the minits stores at a retail price of $270 per unit. Electronic Superstores also pays import duties on its purchases from LG-Malay. Electronic Superstores sells guitars purchased from LGMalay at a retail price of $270 per unit. So far as
 

(c) the cost plus method is concerned, laser guitars are made by LG-Malay at a product cost of $100 per unit.
 

The cost to transport the guitars to the United States is $13.50 per unit and is paid by LG Malay. Other Malaysian manufacturers of laser guitars sell to customers in the USA at a mark upon total cost (product cost plus transportation) of 40%.
 

Requirement
 

1. Explain in your own words the objective of the three methods using (a) comparable uncontrolled price method (b) resale price method (c) cost plus method and explain how each works.
 
2. Determine three possible prices for sale of laser guitars from LG- Malay to Electronic Superstores that comply with U.S. tax regulations using (a) comparable uncontrolled price method (b) resale price method (c) cost plus method. Assume that none of the three methods is clearly the one which should be used and that GGC is able to justify any of the three transfer prices if required to do so by either the U.S. or Malaysian tax authorities. Which one is
likely to be chosen?
 
3. Assume that LG-Malay’s profits are not repatriated to GGC in the U.S.A. as a dividend. Determine which of the three possible transfer prices maximizes GGC’s consolidated after-tax income. Show our income statement and net after-tax cash flow for the group at each of the three possible transfer prices showing one unit sold for illustrative purposes. Guidance: in the income statement transport cost should be part of cost of goods sold; import duty should be below gross profit as an operating expense;
 
4. Assume LG-Malay’s profits no ware repatriated to GGC in the U.S.A. as a dividend. Determine which of the three possible transfer prices maximizes net after-tax cash flow to GGC. Show your calculation of income statement and net after-tax cash flow at each of the three possible transfer prices on the same basis as in (3).
 
5. Assume the same facts as in (4) except that a U.S.A.- Malaysian income tax treaty reduce withholding taxes on dividends to 10%. Determine which of the three possible transfer prices maximizes net cash flow to GGC, considering FTC as above. Show your calculation at each of the three possible transfer prices on the same basis as in 3.

 
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