Large corporations use several strategies to minimize their

Question

Large corporations use several strategies to minimize their tax payments, without doing anything explicitly illegal. One such strategy involves the use of transfer pricing, when subsidiaries in different countries charge each other for goods or services “sold” within the group. This is particularly popular among technology and drug companies that have lots of intellectual property, the value of which is especially subjective. These intra-company royalty transactions are supposed to be arm’s-length, but are often priced to minimize profits in high-tax countries and maximize them in low-tax ones.

If the above statements are true, then which of the following could be a strategy adopted by a company that wants to get the maximum benefit out of transfer pricing?

(A) Sell its subsidiary located in a high tax rate country products at low prices

(B) Charge its subsidiary located in a low tax rate country higher prices for products sold

(C) Pay its subsidiary located in a high tax rate country high prices for products bought

(D) Pay its subsidiary located in a low tax rate country low prices for products bought

(E) Pay its subsidiary located in a low tax rate country high prices for products bought

Tagger · Accepted Answer

Hello, I'm not a Tax expert but I tried to summurize the strategy described on the stem and the answer choices. Please guys, tell me if I'm wrong :wink:

Carcass · Answer

Ok guys here we are to takle this really and wordy tough question.

Before diving into the question I would like to share what for for me is the major  takeaway  from this such question (and actually from all questions):

- whenever you see a question like this first of all is important to understand what's going on, even reading the stimulus two times. On average you should be able to solve a question in two minutes but this is "on average" so do not be afraid to spend even 2.50 or 3.00 minutes. For sure such question pop-up in front of the screen if you do well on the test, no matter what.

- when a question is blury and confused and wordy try to spot an anchor word or sentence or part of the stimulus that leads you on the right track.

Now back to the quesyion at stake:

the stem says

the last part of the stimulus says

So this lead us to B D and E

(B)  Charge  its subsidiary located in a low tax rate country higher prices for products sold

Here the key word is charge. This means that the company  receives  money but from the argument we need an answer where the comany  pays  the associate company of the holding

D) Pay its subsidiary located in a low tax rate country low prices for products bought

If this were true the tax rate would be low but due to the low prices paied by the company the  OVERALL  gain of the holding would be low, no matter what

(E) Pay its subsidiary located in a low tax rate country high prices for products bought

This is what we are looking for..........the tax rate is low the company pay an high price to the subsidiary AND at the same time the expenditure in taxes is low. In other words: if the company pays 100 and the taxes are 10 the gain is 90. Therefore, the OVERALL situation gains from this scenario (i.e. the holding)

E is the OA.

Thanks guys for discussion.

DoItRight · Answer

I was between B and E, and I picked E. This one is tough because I am having trouble with the wording. Who does the selling/charging/paying in the answers?

(E) Pay its subsidiary located in a low tax rate country high prices for products bought
The low tax subsidiary buys products from the high tax subsidiary at high prices. This reduces profit from the high tax subsidary and increase profits from low tax subsidiary.

madhurvashisht · Answer

Large corporations use several strategies to minimize their tax payments, without doing anything
explicitly illegal. One such strategy involves the use of transfer pricing, when subsidiaries in
different countries charge each other for goods or services “sold” within the group. This is
particularly popular among technology and drug companies that have lots of intellectual
property, the value of which is especially subjective. These intra-company royalty transactions
are supposed to be arm’s-length, but are often priced to minimise profits in high-tax countries
and maximise them in low-tax ones.

If the above statements are true, then which of the following could be a strategy adopted by a
company that wants to get the maximum benefit out of transfer pricing?

(A) Sell its subsidiary located in a high tax rate country products at low prices
 Selling the subsidiary weakens the argument because then transfer pricing cannot take place . Wrong

(B) Charge its subsidiary located in a low tax rate country higher prices for products sold
 If the Corporation charges higher prices for the products sold to its subsidiary then the corporation will have to pay more tax . Wrong

(C) Pay its subsidiary located in a high tax rate country high prices for products bought
 If the Corporation pays its subsidiary high prices in a high tax rate then it is paying more taxes in a high priced country . Wrong

(D) Pay its subsidiary located in a low tax rate country low prices for products bought
 If the corporation pays low prices to its subsidiary in a low price country then it is not maximizing its profits .Wrong

(E) Pay its subsidiary located in a low tax rate country high prices for products bought 
 Correct . If a corporation pays high prices in a low tax country then its profits are maximized as the transactions can be showed as expenses 
in which the corporation is located and hence save tax and the subsidiary will pay low taxes as the tax rate is low in the country in which the subsidiary is located .

waris1987 · Answer

this question is especially easy if you studied international business

not sure if we'll be able to see this kind of question in gmat?

Carcass · Answer

First of all do not assume that if you can bring info from outer context is the solution. If I am a doctor would be fine with an RC passage that talks about a new cure.... but for a passage about astronomy? what could I do?

The moral is this: handle a question as you don't know nothing about, using the logic.

After all the gmat says that you don't need a specific knowledge about the argument at stake.

Secondly, this is a really good GMAT-like question and I don't understand why it can't appear on the test considering that talks of something related to biz and this is a test for BS.......

instead to care about if the question is simple or not or if it would appear or not, trying to learn the most from the question, squeezing good insights.

Regards

Nexus 4 with Tapatalk

pqhai · Answer

Tough one not because of the logic, but because of the confusion between high and low, low and high.

The logic of transfer pricing is that you transfer tax from high tax countries to low tax countries. So in high tax countries, you pay less than you have to. For more details, the strategy is:
 - High tax countries: Low revenue, High cost.
- Low tax countries: High revenue, Low cost.

E is correct: because you recognize high revenue in low tax countries, it means you recognize low revenue in high tax countries. That's why the strategy names "transfer pricing".

Hope it's clear.

chanakya84 · Answer

My take is Option E. Looks very simple to me. Approach explained below: The gist of the question stem is "Companies use transfer pricing to minimize their tax payments". How??? Only if the companies can get higher prices for products in low tax countries so that they can pay low income tax and earn max. profits

Now let's evaluate Options (A) Sell its subsidiary located in a high tax rate country products at low prices - "Low price in high tax rate country, okay but still the company is at loss as they are getting lower prices (though they are paying low tax)" (B) Charge its subsidiary located in a low tax rate country higher prices for products sold - "It's a catch. Charging subsidiary in low tax rate country higher prices for products sold. In the cash flows are not going to the low tax country but but infact its outside the low tax country" (C) Pay its subsidiary located in a high tax rate country high prices for products bought - "High prices in high tax country will attract high income tax." (D) Pay its subsidiary located in a low tax rate country low prices for products bought - "Low prices in low tax country. Okay, this leads to lower tax but again not a good way to maximize profit" (E) Pay its subsidiary located in a low tax rate country high prices for products bought - "Bingo..High prices in low tax country. Low income tax and high profit

Hence the correct answer" Thanks, Chanakya Hit kudos if you like the explanation!

gmatexam439 · Answer

Large corporations use several strategies to minimize their tax payments, without doing anything 
explicitly illegal. One such strategy involves the use of transfer pricing, when subsidiaries in 
different countries charge each other for goods or services “sold” within the group. This is 
particularly popular among technology and drug companies that have lots of intellectual 
property, the value of which is especially subjective. These intra-company royalty transactions 
are supposed to be arm’s-length, but are often priced to minimise profits in high-tax countries 
and maximise them in low-tax ones.

If the above statements are true, then which of the following could be a strategy adopted by a 
company that wants to get the maximum benefit out of transfer pricing?

1. To maximise the profits in low tax countries, the SP (selling price) to the subsidiary in high tax country should be high.
2. To maximise the profits in low tax countries, the CP (selling price) to buy a thing from the subsidiary in high tax country should be low.
3. To minimise the profits in high tax countries, the SP (selling price) to the subsidiary in low tax country should be low.
4. To minimise the profits in high tax countries, the CP (selling price) to buy a thing from the subsidiary in low tax country should be high.

(A) Sell its subsidiary located in a high tax rate country products at low prices - Incorrect. Opposite of 1 
(B) Charge its subsidiary located in a low tax rate country higher prices for products sold - Incorrect. Opposite of 2 
(C) Pay its subsidiary located in a high tax rate country high prices for products bought - Incorrect. Opposite of 3 
(D) Pay its subsidiary located in a low tax rate country low prices for products bought - Incorrect. Opposite of 1 
(E) Pay its subsidiary located in a low tax rate country high prices for products bought -  Correct. Matches our point 1

dcummins · Answer

Don't overcomplicate it. You just need to apply the rules defined by the stem. No outside knowledge is needed.

Higher revenue = more beneficial to be in lower tax country
Lower revenue = better to be in higher tax country

E - correct. The subsidiary earns more revenue (remember Price*Quantity =Revenue) therefore its more beneficial to be in a lower tax country. E is the only answer that correctly parallels the reasoning/ logic.

Bunuel · Answer

Official Explanation

Answer: E

To get the maximum benefits out of transfer pricing, a company would want to show maximum earnings in a low tax country or minimum earnings in a high tax country. E states that the company would pay high prices to its subsidiary in a low tax country, that is, the earnings of the subsidiary will be high and these will be taxed at a low rate, so the company will benefit overall.

(A) When the company sells products, it receives money. Since we have no idea about the tax rate in the country where the company is located, this option is irrelevant.

(B) Same as A. (When the company charges its subsidiary, it receives money)

(C) If the company pays high prices to its subsidiary in a high tax rate country, the income of the subsidiary will be high and the tax on this income will also be high. So the company will lose money.

(D) In this case, even though the subsidiary will pay lower taxes, its revenues will also be less because of the low prices charged.

(E) The correct answer.

VerbalBot · Answer

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Large corporations use several strategies to minimize their

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