Question 1

Acme, Inc., a domestic corporation, manufactures goods at its U.S. factory for sale in the United States and abroad. Acme has established an IC-DISC. During the current year, Acme's qualified export receipts are $4,000(all amounts in thousands), and the related cost of goods sold is $2,400. Acme has $1,200 of selling, general and administrative (SG&A) expenses related to the qualified export receipts. Acme's gross receipts from domestic sales are $96,000, the related cost of goods sold is $65,600, and the related SG&A expenses are $18,800. In sum, Acme's results for the year (before considering any income allocated to its IC-DISC via a commission payment), are as follows:

Qualified Total export receipts Other sales Gross receipts $100,000 $4,000 $96,000 COGS (direct material and labor) (68,000) (2,400) (65,600) Gross profit $32,000 $1,600 $30,400 SG&A expenses (20,000) (1,200) (18,800) Net income $12,000 $400 $11,600

What is the maximum amount of income that Acme can allocate to its IC-DISC? Assume combined taxable income equals the $400 of net income from qualified export receipts.

Question 2

Growco, a domestic corporation, is a tire manufacturer. Growco is planning to build a new production facility, and has narrowed down the possible sites for this new plant to either Happystan (a low tax foreign country) or Sadstan (a high tax foreign country). Growco will structure the new facility as a wholly owned foreign subsidiary, Sproutco, and finance Sproutco solely with an equity investment. Growco projects that Sproutcos results during its first year of operations will be as follows:

Sales ................................................................................... $400,000,000 Cost of goods sold ............................................................... (290,000,000) Selling, general and administrative expenses ..................... (60,000,000) Income before income taxes.................................................. $50,000,000

Assume that the U.S. corporate tax rate is 35%, the Happystan rate is 20%, and the Sadstan rate is 40%. Further assume that both Happystan and Sadstan impose a 5% withholding rate on dividend distributions, but neither country imposes withholding taxes on interest or royalty payments.

I - Compute the total tax rate (U.S. plus foreign) on Sproutcos profits under the following assumptions:

a. The new production facility is located in Happystan, and Sproutco repatriates none of its profits during the first year.

b. The new production facility is located in Happystan, and Sproutco repatriates 30% of its profits during the first year through a dividend distribution.

c. The new production facility is located in Sadstan, and Sproutco repatriates none of its profits during the first year.

d. The new production facility is located in Sadstan, and Sproutco repatriates 30% of its profits during the first year through a dividend distribution.

e. The new production facility is located in Sadstan, and Growco modifies its plans for Sproutco as follows: (i) finance Sproutco with both debt and equity, such that Sproutco will pay Growco $15 million of interest each year, (ii) charge Sproutco an annual royalty of $10 million for the use of Sproutcos patents and trade secrets, and (iii) eliminate Sproutcos dividend distribution.

II - What do the results of these various scenarios suggest regarding the differential tax costs of operating in low versus high tax countries?