U.S.-based Unnecessary Roughness(URgh) produces rough-hewn wool shirts in Hong Kong for sale in the United States. The effective marginal tax rate is 35 percent in the U.S. and 17 percent in Hong Kong. URgh has excess FTCs from its other international operations, so no additional U.S. taxes are due from U.S. sales. URgh sells shirts in the U.S. for $100 and has annual sales of 10,000 shirts.
a. The production process is an intangible asset, and URghhas wide latitude in the transfer price that it can set on sales from H.K. to the U.S. UR's cost of goods sold is $10 per shirt in H.K. Calculate the effective tax rate on URgh's sales for transfer prices of $20 and $80 per shirt.
b. Suppose the cost of goods sold is $5 per shirt if URghmanufactures at its U.S. plant. Where should URghproduce in order to maximize after-tax profits? Conduct your analysis using both $20 and $80 transfer prices on sales from Hong Kong to the U.S. parent.