Cotton Comfort Corporation is a U.S. shirt manufacturer with a foreign subsidiary in Country X. Cloth to make shirts is woven in the United States, at a cost of $14 per shirt and shipped to Country X where it is cut and sewn at a cost of $15 per shirt. These shirts are sold in Europe for $90 per shirt. The profit on each shirt is $61, a portion of which is U.S. source income and a portion of which is foreign source in-come, depending on the price at which the cloth is transferred from the United States to Country X.
a. If the tax rate in Country X is lower than the U.S. tax rate, would Cotton Comfort prefer a high transfer price or a low transfer price? At what transfer price would all of the profit on these shirts be tax in Country X? Explain briefly.
b. If the tax rate in Country X is higher than the U.S. tax rate, would Cotton Comfort prefer a high transfer price or a low transfer price? At what transfer price would all of the profit on these shirts be tax in the United States? Explain briefly.