Global Electronics Company

Global Electronics Company

Global Electronics Company (GEC), a U.S. taxpayer, manufactures laser guitars

in its Malaysian operation (LG-Malay) at a production cost of $120 per unit. LG-

Malay guitars are sold to two customers in the United States—Electronic Super-

stores (a GEC wholly owned subsidiary) and Walmart (an unaffliated customer).

The cost to transport the guitars to the United States is $15 per unit and is paid

by LG-Malay. Other Malaysian manufacturers of laser guitars sell to customers

in the United States at a markup on total cost (production plus transportation) of

40 percent. LG-Malay sells guitars to Walmart at a landed price of $180 per unit

(LG-Malay pays transportation costs). Walmart pays applicable U.S. import duties

of 20 percent on its purchases of laser guitars. Electronic Superstores also pays

import duties on its purchases from LG-Malay. Consistent with industry practice,

Walmart places a 50 percent markup on laser guitars and sells them at a retail price

of $324 per unit. Electronic Superstores sells LG-Malay guitars at a retail price of

$333 per unit.

LG-Malay is a Malaysian taxpayer, and Electronic Superstores is a U.S. tax-

payer. Assume the following tax rates apply:

U.S. ad valorem import duty . . . . . . . . . . . . . . . . . . . 20%

U.S. corporate income tax rate . . . . . . . . . . . . . . . . . 35%

Malaysian income tax rate . . . . . . . . . . . . . . . . . . . . . 15%

Malaysian withholding tax rate . . . . . . . . . . . . . . . . . 30%

Required

1. Determine three possible prices for the sale of laser guitars from LG-Malay to

Electronic Superstores that comply with U.S. tax regulations under ( a ) the com-

parable uncontrolled price method, ( b ) the resale price method, and ( c ) the cost-

plus method. Assume that none of the three methods is clearly the best method

and that GEC would be able to justify any of the three prices for both U.S. and

Malaysian tax purposes.

2. Assume that LG-Malay’s proftsare not repatriated back to GEC in the United

States as a dividend. Determine which of the three possible transfer prices maxi-

mizes GEC’s consolidated after-tax net income. Show your calculation ofconsol-

idated net income for all three prices. You can assume that Electronic Superstores

distributes 100 percent of its income to GEC as a dividend. However, there is a

100 percent exclusion for dividends received from a domestic subsidiary, so GEC

will not pay additional taxes on dividends received from Electronic Superstores.

Only Electronic Superstores pays taxes on the income it earns.

3. Assume that LG-Malay’s profts are repatriated back to GEC in the United

States as a dividend and that Electronic Superstores profts are paid to GEC as a

dividend. Determine which of the three possible transfer prices maximizes net

after-tax cash fow to GEC. Remember that dividends repatriated back to the

United States are taxable in the United States and that an indirect foreign tax

credit will be allowed by the U.S. government for taxes deemed to have been

paid to the Malaysian government on the repatriated dividend. Show your cal-

culation of net after-tax cash flow for all three prices.

4. Assume the same facts as in (3) except that a United States/Malaysia income tax

treaty reduces withholding taxes on dividends to 10 percent. Determine which

of the three possible transfer prices maximizes net cash fow to GEC. Don’t for-

get to consider foreign tax credits. Show your calculation of net cash flow for all

three prices.