Part A:
The subsidiary in Jifi produces Tech-Plough. Annually it produces 800 units and sells all of them to the subsidiary in Camaija for £10,000 each. It incurs variable costs of £5,000 for each unit and total annual fixed costs of £400,000. The subsidiary in Camaija builds additional functionality to Tech-Plough to make Tech-Plough Plus. The company incurs variable costs of £8,000 each and annual fixed costs of £450,000. It then sells all the units of Tech-Plough Plus to customers in Camaija at £30,000 each.
Corporation tax in Jifi is 40% with a withholding tax on dividends of 6%. Corporation tax in Camaija is 20% with no withholding tax. Camaija, however, imposes an import duty of 5% on Tech-Plough. Greenfields plc is liable to UK Corporation tax at the rate of 25%. A double taxation agreement exists for both countries whereby credits are given for overseas taxation against UK taxation. Any unrelieved credits from any individual income streams can be offset against other overseas income.
Both companies remit all profits in the form of dividends to the UK.
It has been suggested that the Jifi subsidiary should reduce its selling price to £8,000. It is argued that the Jifi company can charge the Camaija company whatever it chooses as all its products are sold to the Camaija company. This would be an effective way, therefore, of reducing Greenfield plc’s global tax bill.
You may ignore any foreign exchange implications.
Required:
A1) Calculate the combined tax bill of Greenfields plc and its subsidiaries in Jifi and Camaija for the current prices. (10 marks)
A2) Calculate the combined tax bill for the proposed prices. (8 marks)
A3) Evaluate the effect of the change in prices on Greenfield plc’s global tax bill and explain the logic underlying the suggestion. (7 marks)
A4) Explain whether or not Greenfields plc is likely to succeed in its tactic of reducing the tax bill using the transfer price to the Camaija subsidiary. (10 marks)
Marks for Part A: 35
Part B
On 1st March 2022, the US subsidiary of Greenfields plc signed a contract to sell two batches of seed drills to Jordanian company Palermo Plc for JD12,000,000, with JD7,000,000 payable on 1st June 2022 and JD5,000,000 on 1st September 2022. The US subsidiary’s director of finance now wonders if the company should hedge against a reversal of the recent trend of the Jordanian Dinar. The current spot rate is $1.10/JD.
The US subsidiary has three hedging alternatives available:
a) Hedge in the forward market. The 3-month forward exchange quote is $1.1060/JD, the 6-month quote was $1.1130/JD, the 9-month quote was $1.1134/JD, and the 12-month quote was $1.1138/JD.
b) Hedge in the money market. The company could borrow Jordanian Dinars from the Munich branch of Deutsche Bank at 8%
c) Hedge with foreign currency options. June put options are available at a strike price of $1.13/JD for a premium of 2% per contract and September put options are available for the same strike price of $1.13/JD at a premium of 1.2%. June call options are available at strike price of $1.1000/JD for a premium of 3% per contract, September call options are available at strike price of $1.1000/JD for a premium of 2.6%.
The US subsidiary has a cost of capital of 12%.
Required:
B1) Indicate the factors that influence changes in exchange rates between currencies. Describe a theory to estimate future spot rates. (5 marks)
B2) Calculate the expected US$ value of the contract based on:
a) Forward contract (5 marks)
b) Money market hedge (10 marks)
c) Foreign currency options (10 marks)
B3) Advise the US subsidiary of Greenfields plc on the hedging strategy that should be adopted for the contract with Palermo Plc based on your analysis.
(5 marks)
Marks for part B 35
Part C
There has been a political shift in the UK where Greenfields plc is headquartered. This has new implications for Greenfields plc, in terms of changes to regulations on trade tariffs including additional compliance requirements. New regulations will come into effect from 1st January 2023 at 00:01 hours.
Tractors manufactured in Greenfields plc’s subsidiary in Italy have the biggest market in the UK. New regulations and import tariffs will mean an additional import cost of £3,500 per tractor (annual estimate: £10million) imported from the subsidiary in Italy to the UK. There is also an additional requirement to obtain import certification along with having to pay a processing fee of £200 per consignment of tractors. Besides this, there is also a possibility of administrative delays in obtaining import certificates.
Required:
C1) Prepare a report on behalf of the general manager for central treasure of Greenfields plc in London with recommendations to address:
a. The new import tariff implications (15 marks)
b. Processing fees and possible administrative delays in obtaining import certificates (5 marks)
