In the given sum, Phipps manufactures circuit boards in Division A, a country with a 30%

income tax rate, and transfers them to Division B, a country with a 40% income tax.

Moreover, an import duty of 15% of the transfer price is paid on all imported products.

Now, Phipps has two alternatives, either to transfer circuit boards to Division B at full cost

price method or to transfer circuit boards to Division B at variable cost price method.

It would be a rational decision to transfer circuit boards at full price method because:

1) Tax rate applicable for Division B is higher than that of Division A. Therefore, higher

the price of transfer, lower would be the profit earned in Division B and hence the tax

implication would also be low.

2) Even though import duty applicable in case of full cost price method is higher than

that of variable cost method, the benefit of saving tax @ 40% is more favourable than

that of benefit received by saving 15% import duty.