Litchfield Corporation is a U.S.-based manufacturer of fashion accessories that produces umbrellas in its plant in Roanoke, Virginia, and sells directly to retailers in the United States. As chief financial officer, you are responsible for all of the company's finance, accounting, and tax-related issues. Sarah Litchfield, chief executive officer and majority shareholder, has informed you of her plan to begin exporting to the Caribbean region, where she believes there is a substantial market for Litchfield umbrellas. Rather than selling directly to umbrella retailers in the Caribbean, she plans to establish a wholly-owned sales subsidiary in the Bahamas that would purchase umbrellas from its U.S. parent and then distribute them throughout the Caribbean. Yesterday, you received the following memo from Sarah Litchfield. Memorandum SUBJECT: Export Sales Prices It has come to my attention that the corporate income tax rate in the Bahamas is zero, as compared to the much higher rate we pay here in the United States. Since our average production cost is $15.00 per unit and the price we expect to sell our umbrellas to Caribbean retailers is $25.00 per unit, why don't we plan to sell to our Bahamian subsidiary at $15.00 per unit? That way we make no profit here in the United States and $10.00 of profit in the Bahamas, where we would pay no income tax. We have plans to invest in a factory in the Bahamas in the next few years anyway, so we can keep the profit we earn over there for that purpose. What do you think? Required: Draft a memo responding to Sarah Litchfield's question by explaining U.S. income tax regulations related to the export sales described in her memo. Include a discussion of any significant risks associated with her proposal. Make a recommendation with respect to how the price for these sales might be determined. Litchfield Corporation is a U.S.-based manufacturer of fashion accessories that produces umbrellas in its plant in Roanoke, Virginia, and sells directly to retailers in the United States. As chief financial officer, you are responsible for all of the company's finance, accounting, and tax-related issues. Sarah Litchfield, chief executive officer and majority shareholder, has informed you of her plan to begin exporting to the Caribbean region, where she believes there is a substantial market for Litchfield umbrellas. Rather than selling directly to umbrella retailers in the Caribbean, she plans to establish a wholly-owned sales subsidiary in the Bahamas that would purchase umbrellas from its U.S. parent and then distribute them throughout the Caribbean. Yesterday, you received the following memo from Sarah Litchfield. Memorandum SUBJECT: Export Sales Prices It has come to my attention that the corporate income tax rate in the Bahamas is zero, as compared to the much higher rate we pay here in the United States. Since our average production cost is $15.00 per unit and the price we expect to sell our umbrellas to Caribbean retailers is $25.00 per unit, why don't we plan to sell to our Bahamian subsidiary at $15.00 per unit? That way we make no profit here in the United States and $10.00 of profit in the Bahamas, where we would pay no income tax. We have plans to invest in a factory in the Bahamas in the next few years anyway, so we can keep the profit we earn over there for that purpose. What do you think? Required: Draft a memo responding to Sarah Litchfield's question by explaining U.S. income tax regulations related to the export sales described in her memo. Include a discussion of any significant risks associated with her proposal. Make a recommendation with respect to how the price for these sales might be determined
