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ACCA Strategic Professional · Advanced Financial Management · Dividend policy in multinationals and transfer pricing

Division A (country X) makes a component with variable cost $40 and fixed cost $20 per unit and has spare capacity. Division B (country Y) can buy the same component externally at $75. A transfers 10,000 units to B. The tax rate in X is 20% and in Y is 40%. Ignoring other costs, what transfer price per unit, chosen between $40 and $75, minimises group tax and what is the group tax saving per unit relative to a $40 price?

Group tax is minimised by transferring at the highest permissible price of $75, which puts more profit in the 20% country rather than the 40% country. The 20 percentage point difference on a $35 increase gives a saving of $7 per unit.

  1. ATransfer at $75; saving $7 per unitCorrect
  2. BTransfer at $40; saving $7 per unit
  3. CTransfer at $75; saving $3 per unit
  4. DTransfer at $40; saving $15 per unit

Explanation

Raising the price shifts profit from Y (40%) to X (20%). Each $1 of price increase saves 0.40 - 0.20 = $0.20 tax. Moving from $40 to $75 is $35 x 0.20 = $7 per unit. The $40 option is wrong because it keeps profit in the high-tax country.

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