Three Accounting Problems Solution

1....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 Sproutco’s 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)
Net profit....................................... .............................. $ 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. Compute the total tax rate (U.S. plus foreign) on Sproutco’s profits under the following assumptions:
The new production facility is located in Happystan and Sproutco repatriates none of its profits during the first year.
The new production facility is located in Happystan and Sproutco repatriates 30% of its profits during the first year through a dividend distribution.
The new production facility is located in Sadstan and Sproutco repatriates none of its profits during the first year.
The new production facility is located in Sadstan and Sproutco repatriates 30% of its profits during the first year through a dividend distribution.
The new production facility is located in Sadstan and Growco modifies its plans for Sproutco as follows:
finance Sproutco with both debt and equity, such that Sproutco will pay Growco $15 million of interest each year, charge Sproutco an annual royalty of $10 million for the use of Sproutco’s patents and trade secrets, and eliminate Sproutco’s dividend distribution.
What do the results of these various scenarios suggest regarding the differential tax costs of operating in low- versus high-tax countries?

2...Six years ago, NewCo, Inc., a domestic manufacturer of mold- injection systems, established a sales and service operation in Madrid, Spain. The Madrid office was structured as a Spanish corporation, but NewCo made a check-the-box election to treat the operation as a branch in order to obtain a U.S. tax deduction for the branch’s start-up losses. The Spanish operation has become quite profitable and NewCo wishes to change its U.S. tax classification from a branch to a subsidiary by filing a new check-the-box election (this is feasible since 5 years had passed since the first election). At the time of the conversion, the Spanish operation’s assets includes some local currency, accounts receivable from Spanish customers, an inventory of spare parts, and an extensive database of information regarding Spanish customers that the marketing personnel had painstakingly developed over the years. NewCo’s CFO has asked you to brief her regarding the U.S. tax consequences of the incorporation transaction.

3...A foreign corporation can structure its U.S. operations as either a branch or a subsidiary. What are the tax advantages of operating in the United States through a separately incorporated subsidiary? What are the tax advantages of operating in the United States through an unincorporated branch? What general business factors should be considered when choosing between the branch and subsidiary forms of doing business in the United States?