Case 12-2

Global Electronics Company

Global Electronics Company (GEC), a US taxpayer, manufactures laser guitars in its Malaysian operation (LG-Malay) at a production cost of $120 per unit. LG-Malay guitars are sold to two customers in the US Electronic Superstores (a GEC wholly owned subsidiary) and Walmart (an unaffiliated customer). The cost to transport the guitars to the US is $15 per unit and is paid by LG-Malay. Other Malaysian manufacturers of laser guitars sell to customers in the US at a markup on total cost (production plus transportation) of 40%. LG-Malay sells guitars to Walmart at a landed price of $180 per unit (LG Malay pays transportation costs). Walmart pays applicable US import duties of 20 percent on its purchases of laser guitars. Electronic Superstores also pays import duties on its purchases from LG-Malay. Consistent with industry practice, Walmart places a 50% markup on laser guitars and sells them at at a retail price of $324 per unit. Electronic Superstores sells LG- Malay guitars at a retail price of $333 per unit.

LG-Malay is a Malaysia taxpayer, and Electronic Superstores is a US taxpayer. Assume the following tax rates apply:

US ad valorem import duty 20%

US corporate income tax rate 35%

Malaysian income tax rate 15%

Malaysian withholding tax rate 30%

Required:

Determine three possible prices for the sale of laser guitars from LG-Malay to Electronic Superstores that comply with US tax regulations under the (a) the comparable uncontrolled price method, (b) the resale price method, and (c) the cost-plus method. Assume that none of the three methods is clearly the best method and that GEC would be able to justify any of the three prices for both US and Malaysian tax purposes.

Assume that LG-Malays profits are not repatriated back to GEC in the US as a dividend. Determine which of the three possible transfer prices maximizes GECs consolidated after-tax net income. Show your calculation of consolidated net income for all three prices. You can assume that Electronics Superstores distributes 100% of its income to GEC as a dividend. However, there is a 100% exclusion for dividends received from a domestic subsidiary, so GEC will not pay additional taxes on dividends received from Electronic Superstores. Only Electronic Superstores pays taxes on the income it earns.

Assume that LG-Malays profits are repatriated back to GEC in the US as a dividend and that Electronic Superstores profits are paid to GEC as a dividend. Determine which of the three possible transfer prices maximizes net after-tax cash flow to GEC. Remember that dividends repatriated back to the US are taxable in the US and that an indirect foreign tax credit will be allowed by the US government for taxes deemed to have been paid to the Malaysian government on the repatriated dividend. Show your calculation of net after-tax cash flow for all three prices.

Assume the same facts as in (3) except that a US/Malaysia income tax treaty reduces withholding taxes on dividends to 10%. Determine which of the three possible transfer prices maximizes net cash flow to GEC. Dont forget to consider foreign tax credits. Show your calculation of net cash flow for all three prices.