Case Scenario:
Gamboa Inc. is a relatively new U.S. based retailer of specialty fruits and vegetables. The firm is vertically integrated with fruit and vegetable sourcing subsidiaries in Central America and distribution outlets throughout the southeastern and northeastern regions of the United States. Gamboa's two Central American subsidiaries are in Belize and Costa Rica.
Emilia Gamboa, the daughter of the firm's founder, is being groomed to take over the firm's financial management in the near future. Like many firms of similar size, Gamboa has not possessed a very high degree of sophistication in financila management because of time and cost considerations. Emilia, however, has recently finished her MBA and is now attempting to put some specialized knowledge of U.S. taxation practices to work to save Gamboa money. Her first concern is tax averaging for foreign tax liabilities arising from the two Central American subsidiaries. Costa Rican operations are slightly more profitable than Belize operations, because Costa Rica is a relatively low-tax country. Costa Rican corporate taxes are a flat 30%, and no withholding taxes are imposed on dividends paid by foreign firms with operations there. Belize has a higher corporate income tax rate, 40%, and imposes a 10% withholding tax on all dividends distributed to foreign investors. The current U.S. corporate income tax rate is 35%.
Belize Costa Rica
Earnings before taxes $1,000,000 $1,500,000
Corporate income tax rate 40% 30%
Dividend withholding tax rate 10% 0%
Q1) If Emilia Gamboa assumes a 50% payout rate from each subsidiary, what are the additional taxes due on foreign-sourced income from Belize and Costa Rica individually? How much in additional U.S. taxes would be due if Emilia averaged the tax credits/liabilities of the two units?
Q2) Keeping the payout rate from Belize subsidiary at 50%, how should Emilia change the payout rate of the Costa Rican subsidiary in order to most efficiency manage her total foreign tax bill?
Q3) What is the minimum effective tax rate Emilia can achieve on her foreign-sourced income?