PROBLEM 1
In each of the following independent situations involving transfers of tangible property, determine which transfer pricing methods applies and compute a transfer price using the appropriate method. Show all of your computations.
- Dougco, a domestic corporation, owns 100% of Thaico, a Thailand corporation. Dougco manufactures top-of-the-line offi ce chairs at a cost of $300 per unit and sells them to Thaico, which resells the goods (without any further processing) to unrelated foreign customers for $450 each. Independent foreign distributors typically earn commissions of 20% (expressed as a percentage of the sales price) on the purchase and resale of products comparable to those produced by Dougco.
- Clairco, a domestic corporation, owns 100% of Shuco, a foreign corporation that manufactures women's running shoes at a cost of $30 each and sells them to Clairco. Clairco attaches its trade name to the shoes (which has a signifi cant effect on their resale price), and resells them to unrelated customers in the United States for $80 each. Independent foreign manufacturers producing similar running shoes typically earn a gross profi t mark-up (expressed as a percentage of the manufacturing costs) of 15%.
- Tomco, a domestic corporation, owns 100% of Swissco, a Swiss corporation. Tomco manufactures riding lawn mowers at a cost of $2,500 per unit, and sells them to unrelated foreign distributors at a price of $3,750 per unit. Tomco also sells the equipment to Swissco, which then resells the goods to unrelated foreign customers for $4,250 each. The conditions of Tomco's sales to Swissco are essentially equivalent to those of the sales made to unrelated foreign distributors.
PROBLEM 2
Mikco, a foreign corporation, owns 100% of Flagco, a domestic corporation. Mikco manufactures a wide variety of fl ags for worldwide distribution. Flagco imports Mikco's fi nished goods for resale in the United States. Flagco's average fi nancial results for the last three years are as follows:
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Sales
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$20 million
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Cost of goods sold
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($15 million)
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Operating expenses
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($4 million)
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Operating profi t
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$1 million
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Flagco's CFO has decided to use the comparable profi ts method to assess Flagco's exposure to an IRS transfer pricing adjustment by testing the reasonableness of Flagco's reported operating profi t of $1 million. An analysis of fi ve comparable uncontrolled U.S. distributors
indicates that the ratio of operating profi ts to sales is the most appropriate profi tability measure. After adjustments have been made to account for material differences between Flagco and the uncontrolled distributors, the average ratio of operating profi t to sales for each uncontrolled distributor is as follows: 6%, 8%, 10%, 10%, and 14%.
Using this information regarding comparable uncontrolled U.S. distributors, apply the comparable profi ts method to assess the reasonableness of Flagco's reported profi ts. In addition, if an adjustment to Flagco's reported profi ts is required, compute the amount of that adjustment.
PROBLEM 3
USAco, a domestic corporation, owns all of the stock of FSubco, a foreign corporation. FSubco manufactures widgets and sells them at a price of $100 to USAco, which then resells the widgets to U.S. customers. USAco's gross receipts for the year are $200 million. Under what circumstances would USAco be potentially subject to the Code Sec. 6662(e) substantial valuation misstatement penalty?
PROBLEM 4
Stoolco, a domestic corporation, produces a line of low cost bar stools at its facilities in Missouri for sale throughout the United States. During the current year, Stoolco's management has decided to begin selling it stools overseas and has begun exploring the idea of establishing branch sales offi ces in some key countries in Europe and Asia. If possible, Stoolco's management would like to avoid establishing a taxable presence in these countries.
Stoolco's management has asked you to advise them on the types of marketing activities they can conduct within these countries without creating a taxable nexus. For purposes of this analysis, assume that the United States has entered into an income tax treaty with the countries in question that is identical to the United States Model Income Tax Convention of November 15, 2006.
PROBLEM 5
Erica is a citizen of a foreign country, and is employed by a foreign-based computer manufacturer. Erica's job is to provide technical assistance to customers who purchase the company's mainframe computers. Many of Erica's customers are located in the United States. As a consequence, Erica consistently spends about 100 working days per year in the United States. In addition, Erica spends about 20 vacation days per year in Las Vegas, since she loves to gamble and also enjoys the desert climate. Erica does not possess a green card. Assume that the United States has entered into an income tax treaty with Erica's home country that is identical to the United States Model Income Tax Convention of November 15, 2006.
How does the United States tax Erica's activities? How would your answer change if Erica were a self-employed technician rather than an employee?