Question

Phipps manufactures circuit boards in Division A in a country with a 30% income tax rate and transfers these circuit boards to Division B in a country with a 40% income tax. An import duty of 15% of the transfer price is paid on all imported products. The import duty is not deductible in computing taxable income. The circuit boards' full cost is $1,000 and variable cost is $700; they are sold by Division B for $1,200. The tax authorities in both countries allow firms to use either variable cost or full cost as the transfer price. Using Excel or another spreadsheet software, prepare a summary that shows a comparison of the full cost transfer pricing method and variable cost transfer pricing method. Your summary should clearly show the total taxes the company would be subject to under each method.

Answer 1

Full cost transfer pricing method
	Division A	Division B
Sales Revenues	1,000	1,200
Costs	1,000	1,000
Profit	-	200
Taxes	-	80
Import Duty Paid		150
Total Taxes paid by Company = 80+150 = $230
Variable cost transfer pricing method
	Division A	Division B
Sales Revenues	700	1,200
Costs	1,000	700
Profit	(300)	500
Taxes	(90)	200
Import Duty Paid		105
Total Taxes paid by Company = 200+105-90 = $215
Hence, variable cost transfer pricing method is better as lower overall taxes