Question - Multinational Transfer Prices

Cambridge International has production and marketing divisions throughout the world. It produces one particular product in Ireland, where the income tax rate is 12%, and transfers it to a marketing division in Japan, where the income tax rate is 40%. Assume that Japan places an import tax of 10% on the product and that import duties are not deductible for income tax purposes. The variable cost of the product is £200 and the full cost is £400. Suppose the company can legally select a transfer price anywhere between the variable and full cost.

1. What transfer price should Cambridge International use to minimize taxes? Explain why this is the tax-minimizing transfer price.

2. Compute the amount of taxes saved by using the transfer price in requirement 1 instead of the transfer price that would result in the highest taxes.

Horngren, C.T., Sundem, G.L., Sratton, W.O., Burghstaler, D. & Schatzberg, J. (2011). Introduction to management accounting. (15th ed.). Upper Saddle River, NJ: Prentice Hall.