Question

You are the chief negotiator for Country M in working out the terms of an investment by Acme International (“Acme”), a U.S. corporation. The investment will be made through Subsid Ltd., a wholly owned subsidiary of Acme, which is incorporated in Country M. The pro forma financial statements of Subsid Ltd. Show profits of $1 million per year and dividend distributions to Acme of $700,000 per year. To the extent its cash flow is greater than $700,000 per year Acme will reinvest the balance in Country M.

(a) So far the negotiations have been proceeding on the assumption that the standard Country M tax rates of 22% on profits and 10% withholding on dividends will apply to the project. Should you try to negotiate something different? As a matter of Country M law you can provide for special tax rates on this project. Is there any way you can raise the rates without costing Subsid Ltd. Or Acme anymore? (Assume a U.S. tax rate of 35%)

(b) Compare results, raising the Country M corporate tax rate to 25%?

(c) Now compare results, leaving the Country M corporate tax rate at 22% but raising the withholding rate to 15%.

Answer 1

Situation 1)

Country M tax Rate 22% on profits, 10% on withholding on Dividends. U S tax rate 35%

so Tax on $700000, $70000(700000*10%)

Tax on remaining $300000, $66000(300000*22%)

Tax by US $700000, $245000(700000*35%)

-DTAA if there with country M then $245000-$70000= $175000

So total Tax for acme group (175000+66000+75000)=$316000

Situation 2

Corporate tax 25 % other remains same

$300000*25%=75000

10% tax on withholding =70000

Tax by US $700000, $245000(700000*35%)

-DTAA if there with country M then $245000-$70000= $175000

So total Tax for acme group (75000+70000+175000)=$320000

Situation 3

Withholding tax raised to 15% other tax remains the same

so Tax on $700000, $105000(700000*15%)

Tax on remaining $300000, $66000(300000*22%)

Tax by US $700000, $245000(700000*35%)

-DTAA if there with country M then $245000-$105000= $140000

So total Tax for acme group (140000+66000+105000)=$311000

Situation 3 as its least of all options.so it would be best to increase withholiding tax to 15% rather than raising corporate tax to 25%