The Zanello Company manufactures telecommunications equipment at its plant in Ottawa, Ontario. The company has marketing divisions throughout the world. A Zanello marketing division in Vienna, Austria, imports 1,000 units of Product 4A36 from Canada. The following information is available:
Canadian income tax rate on the Canadian division’s operating income… 40%
Austrian income tax rate on the Austrian division’s operating income… 44%
Austrian import duty……………….. 10%
Variable manufacturing cost per unit of Product 4A36…….. $350
Full manufacturing cost per unit of Product 4A36…….. $500
Selling price (net of marketing and distribution costs) in Austria….. $750
Suppose the Canadian and Austrian tax authorities only allow transfer prices that are between the full manufacturing cost per unit of $500 and a market price of $650, based on comparable imports into Austria. The Austrian import duty is charged on the price at which the product is transferred into Austria. Any import duty paid to the Austrian authorities is a deductible expense for calculating Austrian income taxes due.
1. Calculate the after-tax operating income earned by the Canadian and Austrian divisions from transferring 1,000 units of Product 4A36 (a) at full manufacturing cost per unit and (b) at market price of comparable imports. (Income taxes are not included in the computation of the cost-based transfer prices.)
2. Which transfer price should the Zanello Company select to minimize the total of com pany import duties and income taxes? Remember that the transfer price must be between the full manufacturing cost per unit of $500 and the market price of $650 of comparable imports into Austria. Explain your reasoning.