Part 1 Tax arbitrage

Products, Inc., Singapore (PI Asia) and Products, Inc. US (PI North America) are part of an affiliated group of companies, all of which have common ownership. These affiliates do business in Singapore and the US, respectively, and have regular transactions with each other. On such transaction involves assemblies that PI Asia produces and sells to PI North America. PI Asia purchases materials and labor from unrelated third parties for S$1000, incurs additional expenses of S$1000 and sells the partially completed assemblies that it produces to PI North America. PI North America incurs additional expenses of $500 to finish production and sells the completed product to unrelated customers for $2500.

The average exchange rate is USDSGD 1.2500. Assume the corporate income tax rate in Singapore is 17%, and in the US, 25% (combined state and federal).

Transfer pricing

1a. What price should PI Asia charge to minimize the total tax liability for the affiliated group of companies?

b. What is the general rule about the transfer price that minimizing taxes when a company from a low tax jurisdiction sells a product to a related company in a high tax jurisdiction?

Currency choice

Assume that, to resolve transfer pricing questions, PI Asia and PI North America agree with the taxing authorities in Singapore and the US that the partially completed assemblies will be priced each month at either S$2350 or $1880. On the last day of each month, PI Asia submits an invoice to PI North America and payment is made on that day.

2a. On the last day of July, the exchange rate is USDSGD 1.2650. In which currency should PI Asia invoice the assemblies to minimize the affiliated groups overall tax liability?

b. On the last day of August, the exchange rate is USDSGD 1.2350. In which currency should PI Asia invoice the assemblies to minimize the affiliated groups overall tax liability?

c. What is the general rule about the choice of invoice currency when a company from a low tax jurisdiction sell a product to a company in a high tax jurisdiction but can invoice the product in one of two currencies? (It will be either the company should invoice in the more expensive currency or the company should invoice in the more expensive or less expensive currency.) Explain.

Payment timing

Assume that PI Asia and PI North America agree with the taxing authorities in Singapore and the US that PI Asia will sell the partially completed assemblies to PI North America for S$2350. PI Asia submits invoices to PI North America on a monthly basis but allows PI North America to make payment within 30 days.

3a. At the time the monthly invoice is submitted, the exchange rate is USDSGD 1.2250. The company expects the exchange rate to decrease to USDSGD 1.2500 next week. When should PI North America pay the invoice if it is trying to minimize the affiliated groups overall tax?

b. When should PI North America make the payment if the exchange rate is currently USDSGD 1.2700 when the invoice is submitted but it is expected to be USDSGD 1.2500 next week?

c. What is the general rule about the timing of the payment when a company from a low tax jurisdiction sells a product to a company in a high tax jurisdiction but the date of payment is selected based on the exchange rate on that day? (It will be either: the company should pay when the currency is relatively more expensive or the company should pay when the currency that is relatively less expensive.) Explain.

4. Answer questions 3a through 3b assuming the price is set in US dollars, at $1880.

5. Using the total taxes payable on 3a, 3b, 4a and 4b, which currency should the price be set in (the high tax country currency or the low tax country currency) to take advantage of payment timing?

6. Using the answers to 1b, 2c, 3c, and 4c, what would the general rules be for transfer pricing and for payment timing or currency choice be if the company receiving the payment is in the high tax country?