Question

Zen Manufacturing Inc. is a multinational firm with sales and manufacturing units in 15 countries. One of its manufacturing units, in country X, sells its product to a retail unit in country Y for $352,000. The unit in country X has manufacturing costs of $182,500 for these products. The retail unit in country Y sells the product to final customers for $482,500. Zen is considering adjusting its transfer prices to reduce overall corporate tax liability.

Required:

1. Assume that both country X and country Y have corporate income tax rates of 40% and that no special tax treaties or benefits apply to Zen. What would be the effect on Zen’s total tax burden if the manufacturing unit raises its price from $352,000 to $422,400?

2. What would be the effect on Zen’s total taxes if the manufacturing unit raised its price from $352,000 to $422,400 and the tax rates in countries X and Y are 20% and 40%, respectively?

Answer 1

	X	Y	Total
Sales Revenues	352,000	482,500
Less: Costs	182,500	352,000
Profit before tax	169,500	130,500
Tax rate	40%	40%
Total Taxes	67,800	52,200	120,000
After raising prices
	X	Y	Total
Sales Revenues	422,400	482,500
Less: Costs	182,500	422,400
Profit before tax	239,900	60,100
Tax rate	40%	40%
Total Taxes	95,960	24,040	120,000
Hence, there will be non change in taxes as tax rate is same for both the countries
2.Taxes will now be as follows:
	X	Y	Total
Sales Revenues	422,400	482,500
Less: Costs	182,500	422,400
Profit before tax	239,900	60,100
Tax rate	20%	40%
Total Taxes	47,980	24,040	72,020
Hence, total taxes will reduce by 120,000-72020 = $47,980