Reference no: EM132376174

Question 1: In each of the following independent situations involving transfers of tangible property, determine which transfer pricing methods applies and compute a transfer price using the appropriate method. Show all of your computations.

a. Dougco, a domestic corporation, owns 100% of Thaico, a Thailand corporation. Dougco manufactures top-of-the-line office chairs at a cost of $300 per unit and sells them to Thaico, which resells the goods (without any further processing) to unrelated foreign customers for $450 each. Independent foreign distributors typically earn commissions of 20% (expressed as a percentage of the sales price) on the purchase and resale of products comparable to those produced by Dougco.

b. Clairco, a domestic corporation, owns 100% of Shuco, a foreign corporation that manufactures women's running shoes at a cost of $30 each and sells them toClairco. Clairco attaches its trade name to the shoes (which has a significant effect on their resale price), and resells them to unrelated customers in the United States for $80 each. Independent foreign manufacturers producing similar running shoes typically earn a gross profit mark-up (expressed as a percentage of the manufacturing costs) of 15%.

c. Tomco, a domestic corporation, owns 100% of Swissco, a Swiss corporation. Tomco manufactures riding lawn mowers at a cost of $2,500 per unit, and sells them to unrelated foreign distributors at a price of $3,750 per unit. Tomco also sells the equipment to Swissco, which then resells the goods to unrelated foreign customers for $4,250 each. The conditions of Tomco's sales to Swissco are essentially equivalent to those of the sales made to unrelated foreign distributors.

Question 2: Mikco, a foreign corporation, owns 100% of Flagco, a domestic corporation. Mikco manufactures a wide variety of flags for worldwide distribution. Flagco imports Mikco's finished goods for resale in the United States. Flagco's average financial results forthe last three years are as follows:
Sales ............................................................................ $20 million
Cost of goods sold .........................................................($15 million)
Operating expenses ....................................................... ($4 million)
Operating profit ..............................................................$1 million

Flagco's CFO has decided to use the comparable profits method to assess Flagco's exposure to an IRS transfer pricing adjustment by testing the reasonableness of Flagco's reported operating profit of $1 million. An analysis of five comparable uncontrolled U.S. distributors indicates that the ratio of operating profits to sales is the most appropriate profitability measure. After adjustments have been made to account for material differences between Flagco and the uncontrolled distributors, the average ratio of operating profit to sales for each uncontrolled distributor is as follows: 6%, 8%, 10%, 10%, and 14%. Using this information regarding comparable uncontrolled U.S. distributors, apply the comparable profits method to assess the reasonableness of Flagco's reported profits. In addition, if an adjustment to Flagco's reported profits is required, compute the amount of that adjustment.