Case 11-2 Global Electronics Company

1. Determine transfer prices under three different methods.

a. Comparable uncontrolled price method

LG-Malay sells the same product to a related party (Electronic Superstores) and an unrelated party (Wal-Mart). The sale to Wal-Mart is a comparable uncontrolled transaction. The comparable uncontrolled price method results in a transfer price of $180.

b. Resale price method

The transfer price under the resale price method can be determined by reviewing the calculation used by Wal-Mart to determine its retail price of $324 per laser guitar:

Invoice price $180

plus: import duty (20% x invoice price) 36

Total cost $216

plus: Markup (50% x total cost) 108

Retail price $324

The relationship between invoice price and retail price can be modeled as:

(x + .2x) x 1.50 = y, where x = invoice price and y = retail price.

This can be further reduced as: 1.8x = y or x = y/1.8

Electronic Superstores retail price is $333. Substituting $333 for y in the formula results in an invoice price of $185 ($333/1.8). This is the transfer price under the resale price method.

c. Cost plus method

The transfer price under the cost plus method is determined as follows:

Production cost $120

plus: Transportation cost 15

Total cost $135

plus: Markup (40% x total cost) 54

Transfer price $189

Case 11-2 Global Electronics Company (continued)

2. Given this set of facts, the highest price ($189 cost plus method price) results in the greatest amount of consolidated after-tax net income.

			Malaysia		U.S.		Consolidated
	Comparable Uncontrolled Price Method - $180
	Sales		$180.00		$333.00		$333.00
	Less: Cost of sales		120.00		180.00		120.00
	Less: Transportation cost		15.00		-0-		15.00
	Gross profit		45.00		153.00		198.00
	Less: Import duty (20%)		-0-		36.00		36.00
	Taxable income		45.00		117.00		162.00
	Less: Income tax		6.75	15%	40.95	35%	47.70
	Net income		$38.25		$76.05		$114.30
	Resale Price Method - $185
	Sales		$185.00		$333.00		$333.00
	Less: Cost of sales		120.00		185.00		120.00
	Less: Transportation cost		15.00				15.00
	Gross profit		50.00		148.00		198.00
	Less: Import duty (20%)				37.00		37.00
	Taxable income		50.00		111.00		161.00
	Less: Income tax		7.50	15%	38.85	35%	46.35
	Net income		$42.50		$72.15		$114.65
	Cost Plus Method - $189
	Sales		$189.00		$333.00		$333.00
	Less: Cost of sales		120.00		189.00		120.00
	Less: Transportation cost		15.00				15.00
	Gross profit		54.00		144.00		198.00
	Less: Import duty (20%)				37.80		37.80
	Taxable income		54.00		106.20		160.20
	Less: Income tax		8.10	15%	37.17	35%	45.27
	Net income		$45.90		$69.03		$114.93
							highest

Case 11-2 Global Electronics Company (continued)

3. When Malaysian profits are repatriated to the United States, the addition of Malaysian withholding taxes causes the lowest price ($180 comparable uncontrolled price method) to yield the greatest amount of after-tax cash flow for GEC. In this case, the analysis must consider the fact that the repatriated dividend is subject to U.S. income taxation (refer back to Chapter 10). However, given that the effective tax rate (income tax plus withholding tax) paid to the Malaysian government exceeds the U.S. income tax rate, no additional U.S. taxes are due on the dividend paid by LG-Malay. The Malaysian effective tax rate is 40.5% [15% + 30% (1 - .15)].

Transfer Price

		$180		$185		$189
	Malaysian net income	$38.25		$42.50		$45.90
	Less: Withholding tax (30%)	11.48		12.75		13.77
	Dividend to GEC	$26.78		$29.75		$32.13
	Plus: U.S. net income	76.05		72.15		69.03
	Net cash flow	$102.83		$101.90		$101.16
		highest
	Additional U.S. tax on dividend:
	Dividend to GEC	$26.78		$29.75		$32.13
	Plus: Withholding tax	11.48		12.75		13.77
	Grossed-up for w/h tax	38.25		42.50		45.90
	Plus: Income tax	6.75		7.50		8.10
	Grossed up for income tax	$45.00		$50.00		$54.00
	x U.S. tax rate = U.S. tax before FTC	$15.75		$17.50		$18.90
	- FTC allowed**	15.75		17.50		18.90
	= Additional U.S. tax	$0.00		$0.00		$0.00
	** FTC allowed is lesser of:
	a. foreign taxes deemed paid	$18.23		$20.25		$21.87
	b. overall FTC limitation	$15.75		$17.50		$18.90

Case 11-2 Global Electronics Company (continued)

4. Even with the Malaysian withholding tax rate reduced to 10%, the lowest transfer price still results in the greatest amount of after-tax cash flow for GEC. Note that in this case, additional U.S. income tax must be paid on the dividend received from LG-Malay because the effective Malaysian tax rate 23.5% [15% + 10%(1 - .15)] is less than the U.S. income tax rate of 35%.

Transfer Price

		$180		$185		$189
	Malaysian net income	$38.25		$42.50		$45.90
	Less: Withholding tax (10%)	3.83		4.25		4.59
	Dividend to GEC	34.43		38.25		41.31
	Plus: U.S. net income	76.05		72.15		69.03
	Subtotal	110.48		110.40		110.34
	Less: Additional U.S. tax *	5.17		5.75		6.21
	Net cash flow	$105.31		$104.65		$104.13
		highest
	*Calculation of Additional U.S. Tax:
	Dividend to GEC	$34.43		$38.25		$41.31
	Plus: Withholding tax	3.83		4.25		4.59
	Grossed-up for w/h tax	38.25		42.50		45.90
	Plus: Income tax	6.75		7.50		8.10
	Grossed up for income tax	$45.00		$50.00		$54.00
	x U.S. tax rate = U.S. tax before FTC	$15.75		$17.50		$18.90
	- FTC allowed**	10.58		11.75		12.69
	= Additional U.S. tax	$5.17		$5.75		$6.21
	** FTC allowed is lesser of:
	a. foreign taxes deemed paid	$10.58		$11.75		$12.69
	b. overall FTC limitation	$15.75		$17.50 Can I please get the References for this paper		$18.90