1. Acme, Inc., a domestic corporation, manufactures goods at its U.S. factory for sale in the United States and abroad. Acme has established an IC-DISC. During the current year, Acme's qualified export receipts are $4,000, and the related cost of goods sold is $2,400. Acme has $1,200 of selling, general and administrative (SG&A) expenses related to the qualified export receipts. Acme's gross receipts from domestic sales are $96,000, the related cost of goods sold is $65,600, and the related SG&A expenses are $18,800. In sum, Acme's results for the year (before considering any income allocated to its IC-DISC via a commission payment), are as follows:
Qualified
export Other
Total receipts sales
Gross receipts $100,000 $4,000 $96,000
Cost of goods sold
(direct material and labor) - 68,000 - 2,400 - 65,600
Gross profit $32,000 $1,600 $30,400
SG&A - 20,000 - 1,200 - 18,800
Net income $12,000 $400 $11,600
What is the maximum amount of income that Acme can allocate to its IC-DISC?
(Assume combined taxable income equals the $400 of net income from qualified export receipts.)
2. Growco, a domestic corporation, is a tire manufacturer. Growco is planning to build a new production facility, and has narrowed down the possible sites for this new plant to eitherHappystan (a low tax foreign country) or Sadstan (a high tax foreign country). Growco will structure the new facility as a wholly owned foreign subsidiary, Sproutco, and finance Sproutco solely with an equity investment. Growco projects that Sproutco's results during its first year of operations will be as follows:
Sales ................................................................................... $400,000,000
Cost of goods sold ................................................................(290,000,000)
Selling, general and administrative expenses .......................... (60,000,000)
Net profit ..............................................................................$50,000,000
Assume that the U.S. corporate tax rate is 35%, the Happystan rate is 20%, and the Sadstan rate is 40%. Further assume that both Happystan and Sadstan impose a 5% withholding rate on dividend distributions, but neither country imposes withholding taxes on interest or royalty payments. Compute the total tax rate (U.S. plus foreign) on Sproutco's profits under the following assumptions:
a. The new production facility is located in Happystan and Sproutco repatriates none of its profits during the first year.
b. The new production facility is located in Happystan and Sproutco repatriates 30% of its profits during the first year through a dividend distribution.
c. The new production facility is located in Sadstan and Sproutco repatriates none of its profits during the first year.
d. The new production facility is located in Sadstan and Sproutco repatriates 30% of its profits during the first year through a dividend distribution.
e. The new production facility is located in Sadstan and Growco modifies its plans for Sproutco as follows:
(i) financeSproutco with both debt and equity, such that Sproutco will pay Growco $15 million of interest each year,
(ii) chargeSproutco an annual royalty of $10 million for the use of Sproutco's patents and trade secrets, and
(iii) eliminateSproutco's dividend distribution.
What do the results of these various scenarios suggest regarding the differential tax costs of operating in low versus high tax countries?
3. Six years ago, NewCo, Inc., a domestic manufacturer of mold-injection systems, established a sales and service operation in Madrid, Spain. The Madrid office was structured as a Spanish corporation, but NewCo made a check-the-box election to treat the operation as a branch in order to obtain a U.S. tax deduction for the branch's startup losses. The Spanish operation has become quite profitable and NewCo wishes to change its U.S. tax classification from a branch to a subsidiary by filing a new check-thebox election (this is feasible since five years had passed since the first election). At the time of the conversion, the Spanish operation's assets includes some local currency, accounts receivable from Spanish customers, an inventory of spare parts, and an extensive database of information regarding Spanish customers that the marketing personnel had painstakingly developed over the years. NewCo's CFO has asked you to brief her regarding the U.S. tax consequences of the incorporation transaction. Briefly outline your response.