Question

Trans Atlantic Metals has two operating divisions. Its forging operation in Finland forges raw metal, cuts it, and then ships it to the United States where the company’s Gear Division uses the metal to produce finished gears. Operating expenses amount to $21.4 million in Finland and $61.4 million in the United States exclusive of the costs of any goods transferred from Finland. Revenues in the United States are $164 million.

   

If the metal were purchased from one of the company’s U.S. forging divisions, the costs would be $31.4 million. However, if it had been purchased from an independent Finnish supplier, the cost would be $41.4 million. The marginal income tax rate is 70 percent in Finland and 30 percent in the United States.

Required:

What is the company’s total tax liability to both jurisdictions for each of the two alternative transfer pricing scenarios ($31.4 million and $41.4 million)? (Enter your answers in dollars and not in millions of dollars.)

Total Tax Liability for 31.4:

Total Tax liability for 41.4:

Answer 1

Computation of Tax Liability in Case of transfer price is 31.4 million

	Finland	USA
Revenue(a)	$31,400,000	$164,000,000
Third-party costs	$21,400,000	$31,400,000
Transferred goods costs		$31,400,000
Total costs(b)	$21,400,000	$62,800,000
Taxable income(a-b)	$10,000,000	$101,200,000
Tax rate	70.00%	30.00%
Tax Liability	$7,000,000	$30,360,000
Tootal Tax Liabilty	$37,360,000

Computation of Tax Liability in Case of Transfer price is $41.4 million

	Finland	USA
Revenue(a)	$41,400,000	$164,000,000
Third Party costs	$21,400,000	$31,400,000
Transfered goods costs		$41,400,000
Total costs(b)	$21,400,000	$72,800,000
Taxable income(a+b)	$20,000,000	$91,200,000
Tax rate	70%	30%
Tax Liabilty	$14,000,000	$27,360,000
Total Tax liability	$41,360,000

The total tax liability is higher if profits are shifted to the country with the higher tax rate.