Problem:
Sigma Corporation of Boston is contemplating establishing an affiliate operation in the Mediterranean. Two countries under consideration are Spain and Cyprus. Sigma intends to repatriate all after-tax foreign-source income to the United States. At this point, Sigma is not certain whether it would be best to establish the affiliate operation as a branch operation or a wholly owned subsidiary of the parent firm.
In Cyprus, the marginal corporate tax rate is 15 percent. Foreign branch profits are taxed at the same rate. In Spain, corporate income is taxed at 35 percent, the same as in the United States. Additionally, foreign branch with the U.S. income in Spain is also taxed at 35 percent. The withholding tax treaty rates with the U.S. on dividend income paid from Cyprus is 0 percent and 10 percent paid from Spain.
The financial manager of Sigma has asked you to help him determine where to locate the new affiliate and which organizational structure to establish. The location decision will be largely based on whether the total tax liability would be smallest for a foreign branch or a wholly owned subsidiary in Cyprus or Spain.