Question

Company G, which has a 35 percent marginal tax rate, owns a controlling interest in Company J, which has a 15 percent marginal tax rate. Both companies perform engineering services. Company G is negotiating a contract to provide services for a client. Upon satisfactory completion of the services, the client will pay $86,000 cash.

1. Compute the after-tax cash from the contract assuming that Company G is the party to the contract and provides the services to the client.
2. Compute the after-tax cash from the contract assuming that Company J is the party to the contract and provides the services to the client.
3. Compute the after-tax cash from the contract assuming that Company J is the party to the contract, but Company G actually provides the services to the client.

Answer 1

Ans:

a) Cash Receipt After Tax = Cash Receipt - Tax on Cash Receipt

= $86000 - 35% of $86000

= $86000 - $30100

= $55900

b) Cash Receipt After Tax = Cash Receipt - Tax on Cash Receipt

= $86000 - 15% of $86000

= $86000 - $12900

= $73100

c) The $86,000 income generated by the service contract must be taxed to company G

Because company G performed the services.

Therefore

Company G must pay $30100 tax (negative cash flow), even though company J receives the

$86000 Cash.