Provide quantitative and qualitative factors to justify

Question

Assignment:

Willowmill Clothing

Willowmill Clothing, a multinational clothing chain, has operations that span around the world.  The jeans-making process starts in Bermuda, where they spin natural fibers into cloth that is used to make jeans.  They purchase raw material for $3.00 per jean and incur a cost of $7.00 per jean to spin the cloth.  As such, the total cost of the spinning process equals $10.00 per jean.  The second phase of the jeans-making process occurs at two manufacturing plants, one in China and one in Hong Kong.  There, they manufacture the jeans for distribution.  Generally, 75% of the jeans are manufactured in China and 25% are manufactured in Hong Kong.  The cost incurred to make the jeans, not including the price paid to purchase the cloth made in Bermuda, is $20.00 per jean at the China facility and $25 per jean at the Hong Kong facility.  The jeans are then sent to the distribution center in France, where they sell the jeans to retailers around the world for $45 per pair of jeans.  An additional cost of $5.00 per jean is incurred at the distribution center.

Willowmill has called you in as a tax consultant to help them minimize its tax burden on the production of jeans.  You are aware of the following tax information about the countries in which Willowmill operates.

Bermuda	No Income Tax
Hong Kong	16.5% income tax
China	25% income tax
France	33.33% income tax

Additionally, you researched the clothing industry to determine the standard markup for each phase of production to ensure that transfer prices are not set at levels which would be not be considered arm's length.

Cloth Spinning	15-25%
Manufacturing	10-15%
Distribution	5-10%

In order for Willowmill to set transfer prices to its advantage without committing tax evasion, the prices need to be set so that the markup at each stage is between the standard values found in the industry.  The company must also continue to produce 75% in China and 25% in Hong Kong.

Requirements:

1. Assume Willowmill currently is using a 25% markup at the cloth spinning stage, a 10% markup at the manufacturing stage, and a 6.83% markup at the distribution stage. Assuming that Willowmill produces 1,000 units, use the Excel spreadsheet provided to calculate the income recognized under your transfer pricing structure and the overall tax burden.
2. Assuming that Willowmill produces 1,000 pairs of jeans, use the Excel spreadsheet provided to determine the transfer price that should be set at each stage in order to minimize the tax burden for Willowmill and calculate the income recognized under your transfer pricing structure and the overall tax burden. Remember that at the end, the distribution center needs to be able to sell the product for $45.00 per pair of jeans.
3. Willowmill is considering the following alternatives for its manufacturing facilities in China and Hong Kong: 
   1. produce 50% in China and 50% in Hong Kong
   2. produce 25% in China and 75% in Hong Kong
   3. close the Hong Kong facility and produce 100% in China
   4. close the China facility and produce 100% in Hong Kong

Assuming that Willowmill produces 1,000 pairs of jeans, use the Excel spreadsheet provided to determine the transfer price that should be set at each stage in order to minimize the tax burden for Willowmill and calculate the income recognized under your transfer pricing structure and the overall tax burden  

4. Which if any of these alternatives is feasible and which alternative should Willowmill choose? Provide quantitative and qualitative factors to justify your decision. 

5. Assume that neither the China facility nor the Hong Kong Facility can be closed due to legal considerations and that Willowmill produces 1,000 pairs of jeans, use the Excel spreadsheet provided to determine the percentage of jeans that should be manufactured in China and Hong Kong and the transfer price that should be set at each stage in order to minimize the tax burden for Willowmill and calculate the income recognized under your transfer pricing structure and the overall tax burden to propose an alternative to take the place of the alternatives in Requirements 3c and 3d above. Provide quantitative factors to justify your alternative.