PART A

Multinational transfer pricing, global tax minimisation

Derwent Ltd manufactures telecommunications equipment at its plant in Geelong. The company has marketing divisions throughout the world. A Derwent Ltd marketing division in Dallas, USA, imports 10 000 units of product B12 from Australia. The following information is available:

Australian income tax rate on the Australian divisions operating profit	35%
US income tax rate on the US divisions operating profit	40%
US import duty	15%
Variable manufacturing cost per unit of product B12	$550
Full manufacturing cost per unit of product B12	$800
Selling price (net of marketing and distribution costs) in the United States	$1150

Suppose that the Australian and US tax authorities only allow transfer prices that are between the full manufacturing cost per unit of $800 and a market price of $950, based on comparable imports into the USA. The US import duty is charged on the price at which the product is transferred into the USA. Any import duty paid to the US authorities is a deductible expense for calculating US income taxes due.

Required

1. Calculate the after-tax operating profit earned by the Australian and US divisions from transferring 10 000 units of product B12: (a) at full manufacturing cost per unit and (b) at market price of comparable imports. (Income taxes are not included in the calculation of the cost-based transfer prices.)

2. Which transfer price should Derwent Ltd select to minimise the total of company import duties and income taxes? Remember that the transfer price must be between the full manufacturing cost per unit of $800 and the market price of $950 of comparable imports into the USA. Explain your reasoning.

PART B

Multinational transfer pricing, goal congruence (continuation of PART A)

Suppose that the Australian division could sell as many units of product B12 as it makes at

$900 per unit in the US market, net of all marketing and distribution costs.

Required

1. From the viewpoint of Derwent Ltd as a whole, would after-tax operating profit be maximised if it sold the 10 000 units of productB12 in Australia or in the USA? Show your calculations.

2. Suppose that division managers act autonomously to maximise their divisions aftertax operating profit. Will the transfer price calculated in requirement 2 of Scenario 1a) result in the Australian division manager taking the actions determined to be optimal in requirement 1 of this exercise? Explain

3. What is the minimum transfer price that the Australian division manager would agree to? Does this transfer price result in Derwent Ltd as a whole paying more import duty and taxes than in the answer to requirement 2 of Scenario 1a)? If so, by how much?