Carson, Inc., which produces electronic parts in the United States, has a very strong local market for part no. 54. The variable production cost is $40, and the company can sell its entire supply domestically for $110. The U.S. tax rate is 30%.Alternatively, Carson can ship the part to a division that is located in Switzerland, to be used in a product that the Swiss division will distribute throughout Europe. Information about the Swiss product and the division's operating environment follows: Selling price of final product: $400 Shipping fees to import part no. 54: $20 Labor, overhead, and additional material costs of final product: $230 Import duties levied on part no. 54 (to be paid by the Swiss division): 10% of transfer price Swiss tax rate: 40%Based on U.S. and Swiss tax

Question

laws, the company has established a transfer price for part no. 54 equal to the U.S. market price. Assume that the Swiss division can obtain part no. 54 in Switzerland for $125.Required: A. If you were the head of the Swiss division, would you be better off financially to conduct business with your U.S. division or buy part no. 54 locally? Why? Show computations.B. Carson's accounting department has figured that the company will make $66.40 for each unit transferred and used in the Swiss division's product. Rather than proceed with a transfer, would Carson be better off to sell its goods domestically and allow the Swiss division to acquire part no. 54 in Switzerland? Show computations for both U.S. and Swiss operations to support your answer.C. Generally speaking, when tax rates differ between countries, what income strategy should a company use in setting its transfer prices? If the seller is in a low tax-rate country, what type of price should it set? Why?

What will be an ideal response?

Answer 1

A. Courtesy of the shipping fee and import duty, both of which can be avoided, it is cheaper to purchase in Switzerland at $125. The shipping fee and import duty raise the cost to acquire parts from the U.S. operation to $141 ($110 + $20 + $11).
B. Yes. Carson will make $76 ($49 + $27) if no transfer takes place and part no. 54 is sold in the U.S. 
U.S. operation: $110 - $40 = $70; $70 - ($70 × 30%) = $49
Swiss operation: $400 - $125 - $230 = $45; $45 - ($45 × 40%) = $27
C. When tax rates differ, companies should strive to generate more income in low tax-rate countries, and vice versa. Thus, if the seller is in a low tax-rate country, it should set a high transfer price (within allowed limits) to increase that country's income.