Question

Phipps manufactures circuit boards in Division A, a country with a 30% income tax rate, and transfers them to Division B, 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.

Part 1: Analyze the effect of both full-cost and variable-cost transfer pricing methods on Phipps’ cash flows using a spreadsheet program such as Excel.

Part 2: Make your recommendation as to how the organization should proceed, being sure to justify your recommendation with examples form this week’s resources, and/or additional research. Complete this aspect of the Assignment by using a word processing program such as Word.

Answer 1

Part 1

	Full Cost	Variable Cost
Low Tax Country
Transfer Price	$       1,000.00	$           700.00
Less: Cost	$     (1,000.00)	$     (1,000.00)
Taxable Income	$                    -	$         (300.00)
Tax @ 30%	$                    -	$           (90.00)	a
High Tax Country
Sales Price	$       1,200.00	$       1,200.00
Less: Transfer Price	$     (1,000.00)	$         (700.00)
Taxable Income	$           200.00	$           500.00
Tax @ 40%	$             80.00	$           200.00
Import Duty @ 15%	$           150.00	$           105.00
Taxes in Higher Country	$           230.00	$           305.00	b
Total Taxes	$           230.00	$           215.00	a+b

Part 2

Company should follow variable tax method as it leads to lower tax outflows and higher income.