A multinational company operates a production facility in country A and a distribution outlet in country B.  The tax rates are 40% in country A and 50% in country B.  The production facility sells the goods to the distribution outlet, both of which are wholly owned by the multinational company.  The internal sale of goods occurs at a “transfer” price set by the multinational company.  Assuming no nontax considerations and no interference from the tax authorities of the two countries, the company should
A. Use a transfer price based on the market price for the product that other producers charge.
B. Establish a transfer price that results in the same profit margin for both operations.
C. Maximize the transfer price.
D. Minimize the transfer price.
Answer:C
C is corrent. The country where the producer is located has the lower tax rate so the overall tax burden is lowered by maximizing the transfer price. This will maximize reported taxable income in the lower tax country (by maximizing revenue) and minimize reported taxable income in the lower tax country (by maximizing expenses).
A is incorrect. Market-based pricing will not minimize total taxes and the question states that there are no nontax considerations to be taken into account in making this decision.
B is incorrect. Establishing a transfer price that results in the same profit margin for both operations will not minimize taxes. As explained in the correct answer, any transfer price lower than the maximum will result in higher total taxes paid.
D is incorrect. A low transfer price results in higher total taxes paid. The country where the producer is located has the lower tax rate, so the overall tax burden is higher when the minimum transfer price is used. With a lower transfer price, reported taxable income will be lower in the lower tax country and reported taxable income will be maximized in the higher tax country, since expenses there will be minimized.