Question

corporation A has a marginal tax bracket of 21% it has a wholly owned foreign subsidiary that has a marginal tax bracket of 10%. Company A sells its output to Company B at cost generating $2M in revenues. Company B than sells the output to third parties with a 50% mark up generating $3M in revenues. What are the tax implications of this arrangement? What doctrines might the IRS apply to attack this arrangement?

Answer 1

Tax Implications of this arrangement: It appears that the holding company is trying to evade tax by shifting its revenue to its subsidiary. Holding company is taxed at 21% whereas its subsidiary at 10%.

As per Transfer pricing rules, holding company has to transfer goods to its subsidiary at arm’s length prices. Following are the methods to determine arm length prices:

• The Comparable Uncontrolled Price (CUP) Method.
• Cost Plus Method
• Resale Price Method
• Profit based methods

• Comparable Profit method
• Transactional Net Margin Method
• Profit Split Method

The rules of nearly all countries permit related parties to set prices in any manner but permit the tax authorities to adjust those prices (for purposes of computing tax liability) where the prices charged are outside an arm’s length range.