Question

Part 1 Tax arbitrage

Products, Inc., Singapore (PI Asia) and Products, Inc. US (PI North America) are part of an affiliated group of companies, all of which have common ownership. These affiliates do business in Singapore and the US, respectively, and have regular transactions with each other. On such transaction involves assemblies that PI Asia produces and sells to PI North America. PI Asia purchases materials and labor from unrelated third parties for S$1000, incurs additional expenses of S$1000 and sells the partially completed assemblies that it produces to PI North America. PI North America incurs additional expenses of $500 to finish production and sells the completed product to unrelated customers for $2500.  

The average exchange rate is USDSGD 1.2500. Assume the corporate income tax rate in Singapore is 17%, and in the US, 25% (combined state and federal).

Transfer pricing

1a. What price should PI Asia charge to minimize the total tax liability for the affiliated group of companies?

b. What is the general rule about the transfer price that minimizing taxes when a company from a low tax jurisdiction sells a product to a related company in a high tax jurisdiction?

Answer 1

1a) the given information:

	PI ASIA(SINGAPORE)	PI US(NORTH AMERICA)
SALE PRICE	?	$2500
LESS COST:
MATERIAL AND LABOUR	SGD 1000	$0
ADDITIONAL EXPENSES	SGD 1000	$ 500
TRANSFER PRICE FROM PI ASIA (EXCHANGE RATE 1$=$1.25 SGD)		?
TAX RATE	17%	25%

NOW BEFORE WE FIX A PRICE LETS ANSWER THE b. Part FIRST THE GENERAL RULE ABOUT TRANSFER PRICE IN RELATION TO TAXES:

Basic thumb rule: WHEN "A" TRANSFERS TO "B" & t_A, t_B : marginal tax rates respectively.

                                    If t_A > t_B set as low transfer price as possible.

                                    If t_A < t_B set as high tranfer prices as possible.

HERE WE CAN SEE THAT TAX RATE OF PI ASIA (17%) < PI US (25%)

SO USING THE GENERAL RULE TO MINIMIZE TAXES , WE HAVE TO SET THE TRANSFER PRICE AS HIGH AS POSSIBLE.

NOW,

PI ASIA :HAS EXPENSES OF SGD 2,000 AND TAX RATE OF 17%

PI USA : HAS SALES REVENUE = $2,500 ADDITIONAL COST = $500 ,WITHOUT TAKING THE TRANSFER PRICE ITS PROFIT IS $2,000 AND TAX RATE OF 25%

NOW WE HAVE TO SET A TRANSFER PRICE AS HIGH AS POSSIBLE

NOW AS A GROUP YOU WOULD WANT TO PAY TAX @17% RATHER THAN 25%

SO THINK OF A SITUTATION WHERE THERE WOULD BE ZERO PROFITS OF PI US, AND YOU WOULD'NT HAVE TO PAY TAXES, THAT WOULD BE POSSIBLE ONLY WHEN YOUR TRANSFER PRICE IS $2,000

EXCHANGE RATE 1$=1.25 SGD FOR $2000= SGD 2,500

SO THE PI ASIA SHOULD CHARGE SGD 2,500 TO PI US TO MINIMIZE TAXES , YOUR SITUATION WOULD BE AS FOLLOWS

	PI ASIA(SINGAPORE)	PI US(NORTH AMERICA)
SALE PRICE	SGD 2500	$2500
LESS COST:
MATERIAL AND LABOUR	SGD 1000	$0
ADDITIONAL EXPENSES	SGD 1000	$ 500
TRANSFER PRICE FROM PI ASIA (EXCHANGE RATE 1$=$1.25 SGD)	0	$2,000
PROFIT BEFORE TAX:	SGD 500	$0
TAX RATE	17%	25%
TAXES:	SGD 85	$0
INCOME AFTER TAX	SGD 415	$0

SO IN BOOKS OF ACCOUNT , WHEN PI ASIA CHARGED SGD 2500 OR $2000 (THE HIGHEST) FOR PI US

THE TAXES ARE ONLY SGD 85. THUS MINIMIZING THE TAX LIABILITY OF THE AFFILIATED GROUP