Gamboa's Tax Averaging. Gamboa, Incorporated, is a relatively new U.S.-based retailer of specialty fruits and vegetables. The firm is vertically integrated with fruit and vegetable-sourcing subsidiaries in Central America, and distribution outlets throughout the southeastern and northeastern regions of the United States. Gamboa's two Central American subsidiaries are in Belize and Costa Rica. Maria Gamboa, the daughter of the firm's founder, is being groomed to take over the firm's financial management in the near future. Like many firms of Gamboa's size, it has not possessed a very high degree of sophistication in financial management simply out of time and cost considerations. Maria, however, has recently finished her MBA and is now attempting to put some specialized knowledge of U.S. taxation practices to work to save Gamboa money. Her first concern is tax averaging for foreign tax liabilities arising from the two Central American subsidiaries.

Costa Rican operations are slightly more profitable than Belize, which is particularly good since Costa Rica is a relatively low-tax country. Costa Rican corporate taxes are a flat 30%, and there are no withholding taxes imposed on dividends paid by foreign firms with operations there. Belize has a higher corporate income tax rate, 40%, and imposes a 10% withholding tax on all dividends distributed to foreign investors. The current U.S. corporate income tax rate is 35%.

a. If Maria Gamboa assumes a 70% payout rate from each subsidiary, what are the additional taxes due on foreign-sourced income from Belize and Costa Rica individually? How much in additional U.S. taxes would be due if Maria averaged the tax credits/liabilities of the two units?

Earnings before taxes Corporate income tax rate Dividend withholding tax rate Belize $2,000,000 40% 10% Costa Rica $2,500,000 30% 0% Belize Costa Rica Combined Subsidiary Income Statement Earnings before taxes $ 2,000,000 Less corporate income taxes Net income $ Distributed earnings Less withholding taxes on dividends Net dividend remitted to U.S. parent U.S. Tax Calculation Net dividend remitted $ Withholding income taxes Proportion of foreign income taxes Grossed-up dividend $ Theoretical U.S. tax liability $ Foreign tax credits $ Additional U.S. tax due Excess foreign tax credits $