International Transfer Pricing.

Question
A multinational has a subsidiary that manufactures a key component for
its subsidiaries located around the world. The multinational and the
subsidiary that manufactures the key component are resident for tax in
France.
The multinational's subsidiary in Malaysia was recently approached by a
local company interested in manufacturing the key component.
After a series of meetings, the local manufacturer offered a price
equivalent to $48 per component. The Malaysian subsidiary
subsequently contacted head office for permission to source supply with
the local company since its price is $2 less than the price charged by the
subsidiary in France.
The following information was obtained by head office for this proposal:
 Number of components used by Malaysian subsidiary: 50,000 a year
 Price charged by French subsidiary: $50 per component
 Variable costs incurred by French subsidiary: $40 per component
 French corporation tax rate: 30%
 Malaysian corporation tax rate: 20%.
The French subsidiary informed head office that if the components were
sourced in Malaysia the surplus capacity would be used to make
products for a non-group company.
Sales to the non-group company are expected to be 40,000 components
a year and contribution from these sales would be same as its Malaysian
business. The subsidiary's fixed costs would remain at the same level.
Required
(a) Prepare a financial appraisal for the proposal by the Malaysian
company to source its components with the local company.
(b) Identify other issues that would be considered by the multinational in
relation to this proposal.

Solution
Part (a)
While the French subsidiary would lose sales of 50,000 components to
Malaysia, it would be able to sell 40,000 components to the other
company.
The loss to the French company, before tax, would be $100,000 (10,000
x $10) since the contribution is the same if the French company sells to
either company.
 The net loss after tax to the French company would be $70,000 since it
would no longer pay tax of $30,000 ($100,000 x 30%) on the higher level
of sales previously made to the Malaysian subsidiary.
The Malaysian subsidiary's costs would reduce by $100,000 (50,000 x
$2 per component) if it sourced the components locally. However, this
figure would be reduced by $20,000 ($100,000 x 20%) to $80,000 since
the subsidiary would have to pay tax on its higher profits.
The multinational's after tax profits would be increased by $10,000 if it
gave permission to the Malaysian subsidiary to source its components
locally. This increase arises due to the differing levels of corporation
taxation in France and Malaysia since the before tax gain/loss to each
subsidiary is $100,000.
Part (b)
The multinational would need to consider a number of issues before it
reached a final decision about allowing the Malaysian subsidiary to
source its components locally, including:
 What rate of corporation tax will be charged by Malaysia and France in the future?
 Can dividends be readily remitted from the Malaysian subsidiary to its foreign shareholders?
 Are the components manufactured by the Malaysian subsidiary of an equivalent quality to those produced by the
French subsidiary?
 How secure is the local source of supply?
 Will the French subsidiary (which will have obtained replacement business) be able to supply sufficient components
to the Malaysian subsidiary at short notice if the local supplier decides to stop supply?
 Is the local company offering a low price in order to gain business in the expectation of raising the price in the future?
 Is it possible to enter into a long-term contract with the local supplier?