Growco, a domestic corporation, is a tire manufacturer. Growco is planning to build a new production...

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Growco, a domestic corporation, is a tire manufacturer. Growco is planning to build a new production facility, and has narrowed down the possible sites for this new plant to either Happystan (a low tax foreign country) or Sadstan (a high tax foreign country). Growco will structure the new facility as a wholly owned foreign subsidiary, Sproutco, and fi nance Sproutco solely with an equity investment. Growco projects that Sproutco’s results during its first year of operations will be as follows:

Sales	$400,000,000
Cost of goods sold	(290,000,000)
Selling, general and administrative expenses	(60,000,000)
Net profit	$50,000,000

Assume that the U.S. corporate tax rate is 35%, the Happystan rate is 20%, and the Sadstan rate is 40%. Further assume that both Happystan and Sadstan impose a 5% withholding rate on dividend distributions, but neither country imposes withholding taxes on interest or royalty payments. Compute the total tax rate (U.S. plus foreign) on Sproutco’s profits under the following assumptions:

a. The new production facility is located in Happystan and Sproutco repatriates none of its profits during the first year.

b. The new production facility is located in Happystan and Sproutco repatriates 30% of its profits during the first year through a dividend distribution.

c. The new production facility is located in Sadstan and Sproutco repatriates none of its profits during the first year.

d. The new production facility is located in Sadstan and Sproutco repatriates 30% of its profits during the first year through a dividend distribution.

e. The new production facility is located in Sadstan and Growco modifi es its plans for Sproutco as follows:

(i) finance Sproutco with both debt and equity, such that Sproutco will pay Growco $15 million of interest each year,

(ii) charge Sproutco an annual royalty of $10 million for the use of Sproutco’s patents and trade secrets, and

(iii) eliminate Sproutco’s dividend distribution.

What do the results of these various scenarios suggest regarding the differential tax costs of operating in low versus high tax countries?

David · Accepted Answer

Particulars   Amount($)                                  �                                      �Sales   400,000,000                                   �Cost of goods sold   290,000,000                                   �Selling, general, and administrati
Particulars   Amount($)                                  
                                      
Sales   400,000,000                                   
Cost of goods sold   290,000,000                                   
Selling, general, and administrative expenses   60,000,000                                   
                                      
Net Profit   50,000,000                                   
                                      
                                      
                                      
1. The new production facility is located in Happystan and Sproutco repatriates none of its profits during the first year.                                      
                                      
Particulars   Amount($)                                  
                                      
Net Profit   50,000,000                                   
                                      
Income tax in Happystan @ 20%   10,000,000                                   
                                      
Available and declared as dividend   40,000,000                                   
                                      
Dividend withholding tax @ 5%   2,000,000                                   
                                      
   38,000,000                                   
                                      
Total Taxes   12,000,000                                   
                                      
Total Tax rate (%)   24.00                                   
                                      
                                      
2. The new production facility is located in Happystan and Sproutco repatriates 30% of its profits during the first year through a dividend distribution.                                      
                                      
Particulars   Amount($)                                  
                                      
Net Profit   50,000,

Growco, a domestic corporation, is a tire manufacturer. Growco is planning to build a new production facility, and has narrowed down the possible sites for this new plant to either Happystan (a low...

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