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Litchfield Corporation is a U.S.-based manufacturer of fashion
accessories that produces umbrellas in its plant in Roanoke, Virginia,
and sells directly to retailers in the United States. As chief financial
officer, you are responsible for all of the company’s finance,
accounting, and tax-related issues.
Sarah Litchfield, chief executive officer and majority shareholder,
has informed you of her plan to begin exporting to the United Kingdom,
where she believes there is a substantial market for Litchfield
umbrellas. Rather than selling directly to British umbrella retailers,
she plans to establish a wholly owned UK sales subsidiary that would
purchase umbrellas from its U.S. parent and then distribute them in the
United Kingdom. Yesterday, you received the following memo from Sarah
SUBJECT: Export Sales Prices
It has come to my attention that the corporate income tax rate in
Great Britain is only 28 percent, as compared tothe 35 percent rate we
pay here in the United States. Since our average production cost is
$15.00 per unit and the price we expect to sell to UK retailers is
$25.00 per unit, why don’t we plan to sell to our UK subsidiary at
$15.00 per unit? That way we make no profit here in the United States
and $10.00 of profit in the United Kingdom, where we pay a lower tax
rate. We have plans to invest in a factory in Scotland in the next few
years anyway, so we cankeep the profit we earn over there for that
purpose. What do you think?
Draft a 1-2 page essay responding to Sarah Litchfield’s question by
explaining U.S. income tax regulations related to the export sales
described in her memo. Include a discussion of any significant risks
associated with her proposal. Make a recommendation with respect to how
the price for these sales might be determined.