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Chapter 12 - International Transfer Pricing
Answers to Questions
1. Transfer prices must be determined for the following intercompany transfers:
2. Cost minimization objectives that companies might wish to achieve through transfer pricing
include:
3. The performance evaluation objective of transfer pricing refers to the use of intercompany
4. To achieve a specific cost minimization objective, headquarters management might need to
5. Withholding taxes are paid to a foreign government by a foreign subsidiary when it pays
dividends (or interest or royalties) to its parent located in another country. In contrast,
6. The five methods acceptable under U.S. tax regulations for determining an arm’s length
price for the sale of tangible property are:
7. The “arm’s length range” of transfer prices refers to the fact that the application of a single
method could result in a range of transfer prices that are equally reliable. No adjustment will
be made by the IRS if the transfer price falls within this range.
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Chapter 12 - International Transfer Pricing
8. An international transfer price determines the amount of income taxable in the country of
9. An “advance pricing agreement” is an agreement between a company and a national tax
10. The major benefit to a company from entering into an advance pricing agreement is the
Solutions to Exercises and Problems
13. Lahdekorpi OY
a. The best transfer pricing method in this case is the comparable uncontrolled price
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Chapter 12 - International Transfer Pricing
b. The best transfer pricing method in this scenario is the resale price method. Lahdekorpi
c. The best transfer pricing method in this case is the cost plus method. An acceptable
14. Superior Brakes
Superior Brakes sells directly to truck manufacturers in the United States, and to its 100%-
owned sales subsidiary in Brazil. The Brazilian sales subsidiary sells directly to Brazilian
truck makers. Superior Brakes does not sell to unaffiliated distributors in Brazil so there is
15. Akku Company
a. $1.50 transfer price b. $1.80 transfer price
Germany U.S Total Germany U.S Total
Sales price $1.50 $4.50 $4.50 $1.80 $4.50 $4.50
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Chapter 12 - International Transfer Pricing
c. The lower transfer price ($1.50 vs. $1.80) results in the smaller amount of total income
16. Smith-Jones Company
a. (1) The reliability of the comparable uncontrolled price method is reduced by the fact
that Smith-Jones is a retailer of Joal handbags in the United States, whereas Joal’s
(2) The reliability of the resale price method is reduced by the fact that other U.S.
(3) The reliability of the cost plus method suffers from the fact that there are no other
b. The resale price method might be the best of the three methods because the
17. Guari Company
a. Computation of the total amount of income taxes and import duty paid on each
bicycle:
1. Before transfer pricing adjustment
Taiwan Australia
2. After transfer pricing adjustment; with correlative adjustment:
Taiwan Australia
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Chapter 12 - International Transfer Pricing
3. After transfer pricing adjustment; without correlative adjustment
Taiwan Australia
17. (continued)
b. The company obtains very little benefit (A$0.92 per bicycle) from establishing the
transfer price for sales from its Taiwanese subsidiary to Guari at a price higher than it
c. Whether the Taiwanese tax authority will grant a correlative adjustment might depend on
18. ABC Company
Sale from X to Y. Strategy: transfer at a relatively high price.
Low price: $10.00 High price: $13.00
X Y Total X Y Total
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Chapter 12 - International Transfer Pricing
18. (continued)
Sale from X to Z. Strategy: transfer at a relatively high price.
Low price: $10.00 High price: $13.00
X Z Total X Z Total
Sale from Y to X. Strategy: transfer at a relatively low price.
Low price: $10.00 High price: $13.00
Y X Total Y X Total
Sale from Y to Z. Strategy: transfer at a relatively high price.
Low price: $10.00 High price: $13.00
Y Z Total Y Z Total
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Chapter 12 - International Transfer Pricing
2.00 1.70
18. (continued)
Sale from Z to X. Strategy: transfer at a relatively low price.
Low price: $10.00 High price: $13.00
Z X Total Z X Total
Sale from Z to Y. Strategy: transfer at a relatively low price.
Low price: $10.00 High price: $13.00
Z Y Total Z Y Total
Sale 10.00 15.00 Sale 13.00 15.00
Summary of strategy: X should always transfer at a high price; Z should always transfer at
19. Denker Corporation
a. The only possible transfer prices that will maximize Denker’s after tax cash flow are the
two extremes in the arm’s length range -- $5 or $6.
Transfer price = $5.00 Transfer price = $6.00
Sri
Lanka Denker Total
Sri
Lanka Denker Total
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Chapter 12 - International Transfer Pricing
19. (continued)
b. The only possible transfer prices that will maximize Denker’s after tax cash flow are the
two extremes in the arm’s length range -- $5 or $6.
Transfer price = $5.00 Transfer price = $6.00
Sri
Lanka Denker Total
Sri
Lanka Denker Total
Sales price 5.00 12.00 12.00 Sales price 6.00 12.00 12.00
20. Ranger Company
Yery’s operating income, excluding royalties, is $200,000 ($800,000 - $600,000). Under the
residual profit split method, the amount of Yery’s operating income attributable to Yery’s
operating assets is first determined. This amount is $60,000 ($300,000 operating assets x
20% return on operating assets). Therefore, $140,000 of Yery’s operating income is
attributable to intangibles. The next step is to determine how much of this amount is
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Chapter 12 - International Transfer Pricing
Case 12-1 Litchfield Corporation
The memo to Sarah Litchfield should include the following points:
Section 482 of the U.S. Internal Revenue Code gives the Internal Revenue Service (IRS)
the authority to adjust any intercompany transfer prices that it determines are not at
arm’s length. This would include sales from Litchfield Corp. to its U.K. subsidiary.
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