Guari Company, based in Melbourne, Australia, has a wholly owned subsidiary in Taiwan. The Taiwanese subsidiary manufactures bicycles at a cost equal to A$20 per bicycle, which it sells to Guari at an FOB shipping point price of A$100 each. Guari pays shipping costs of A$10 per bicycle and an import duty of 10 percent on the A$100 invoice price. Guari sells the bicycles in Australia for A$200 each. The Australian tax authority discovers that Guari's Taiwanese subsidiary also sells its bicycles to uncontrolled Australian customers at a price of A$80 each. Accordingly, the Australian tax authority makes a transfer pricing adjustment to Guari's tax return, which decreases Guari's cost of goods sold by A$20 per bicycle. An offsetting adjustment (refund) is made for the import duty previously paid. The effective income tax rate in Taiwan is 25 percent, and Guari's effective income tax rate is 36 percent.
Required:
a. Determine the total amount of income taxes and import duty paid on each bicycle (in Australian dollars) under each of the following situations:
(1) Before the Australian tax authority makes a transfer pricing adjustment.
(2) After the Australian tax authority makes a transfer pricing adjustment (assume the tax authority in Taiwan provides a correlative adjustment).
(3) After the Australian tax authority makes a transfer pricing adjustment (assume the tax authority in Taiwan does not provide a correlative adjustment).
b. Discuss Guari Company management's decision to allow its Taiwanese subsidiary to charge a higher price to Guari than to uncontrolled customers in Australia.
c. Assess the likelihood that the Taiwanese tax authority will provide a correlative adjustment to Guari Company.