Princeton International has production and marketing divisions throughout the world. It produces one particular product in Ireland, where the income tax rate is 24%, and transfers it to a marketing division in Japan, where the income tax rate is 45%. Assume that Japan places an import tax of 13% on the product and that import duties are not deductible for income tax purposes.
The variable cost of the product is £500 and the full cost is £800. Suppose the company can legally select a transfer price anywhere between the variable and full cost.
1. What transfer price should Princeton International use to minimize taxes? Explain why this is the tax-minimizing transfer price.
2. Compute the amount of taxes saved by using the transfer price in requirement 1 instead of the transfer price that would result in the highest taxes.