A firm has affiliates in both Japan, whose corporate income tax rate is equal to 40 percent, and Ireland, whose corporate tax rate is equal to 15 percent. The major activity of the Irish affiliate is to produce a special component, with $12 of costs, that it sells to the Japanese affiliate, initially at $18 per unit. The Japanese affiliate uses $20 of labor to assemble the final good which is sold to the final consumer for $50.

A) In the current way that the MNE does business, calculate pre-tax profits in each affiliate, and the total amount of taxes paid.

B) Imagine you are an accountant for KPMG, an accounting firm recently hired by the MNE for consultation purposes. What advice could you give in order to lower the total taxes paid by the MNE? Spell out some specific advice: what exactly would you do and how would that affect the pre-tax profits of the Japanese and the Irish affiliates? Explain using your own numerical example -- what would the new pre-tax profits be in each affiliate given your advice? What is the total tax paid now?

C) In the article we read, the IRS actually went after Microsoft to recover some of those taxes they claimed were evaded. From your example above, what would you need to make sure is rationalized correctly? Can all the numbers be completely made up?