Tech Sonic Inc. is a large multinational computer chip manufacturer with headquarters in Okayama, Japan. The company's production and manufacturing facilities are located in Europe, East Asia, Germany, and the United States. The company's products are distributed primarily through contracted retail establishments and company-owned outlets around the world. Because of Tech Sonic's vertically integrated global operations, the company has achieved a competitive advantage when it comes to adapting to new and changing market conditions. Approximately 40 percent of the company's products are transferred to facilities in the United States.
Transfer Pricing Policy
Prices of goods transferred between divisions are equal to the current market price less a 15 percent discount. However, due to a recent increase in the corporate tax rate in Japan, the CEO is considering whether alternative transfer prices in conjunction with differences in tax rates between countries might help improve the company's worldwide after tax earnings.
Among the memory chips that sell well in the United States is the Tech960 which is manufactured by Tech Sonic in both Taiwan and Malaysia. Due to differential cost structures in the Malaysian and Taiwanese subsidiaries, prices quoted for the Tech960 by these two subsidiaries can vary by as much as 20 percent. The Malaysian subsidiary is currently quoting a price of US$ 175 per unit while the Taiwanese subsidiary is quoting a price of US$ 205 per unit. The US subsidiary must pay an import duty of 10 percent on these chips. Tech Sonic USA is able to sell these chips at retail in the United States at US$350 per unit. Tech Sonic Japan (the parent) sets transfer prices among its various units based on what it considers to be best for the overall company.
Mr. Satoh, the chief financial officer of Tech Sonic, has been asked to look into the tax ramifications of the intra-company transactions. His research indicates that the relevant effective tax rates for the Tech Sonic subsidiaries in Malaysia, Taiwan, and the United States are 18 percent, 22 percent, and 38 percent, respectively. He expects these tax regimes to stay fairly stable in the foreseeable future (although things could change in the United States depending on who wins the forthcoming presidential and congressional elections). Mr. Satoh has also done some research on the likely impact of exchange rate changes. Tech Sonic's bankers have informed Mr. Satoh that the following is the range of exchange rates that are currently projected for the next few months:
Spot
30 days
90 days
180 days
Japanese yen/US$
105
104
103
102
Japanese yen/Malaysian ringgit
27.6
27.4
27.2
26.9
Japanese yen/Taiwan dollar
3.31
3.52
3.70
3.94
1. What are the issues that Mr. Satoh must consider in setting intra-firm transfers and transfer pricing policies within Tech Sonic?
2. Discuss various transfer pricing scenarios that Tech Sonic might adopt and the likely impact of each on the Tech Sonic subsidiaries as well as the parent company.