Question

Widgets Plus is a wholly owned German subsidiary that manufactures light weight plastic frames for several toy manufacturing companies. The company operates in the UK and generated earnings before tax (EBT) of £4,438,000.

The UK corporate income tax rate is 27%, and the German corporate income tax rate is 29%.

Required:

1. If Widgets Plus repatriates 100% of its net UK income to Germany, calculate the effective tax rate assuming no foreign tax credits or withholding taxes?
2. What is the effective tax rate if foreign tax credits are available?

Answer 1

Part a)

Tax in UK = EBT*UK tax rate = 4,438,000*27% = 1,198,260

Repatriates of its net UK income to germany = EBT-Tax in UK = 4,438,000-1,198,260 = 3,239,740

Tax in germany = Repatriates*german tax rate = 3,239,740*29% = 939,524.60

Total taxes = Tax in UK + Tax in germany = 1,198,260+939,524.60 = 2,137,784.60

Effective tax rate = Total taxes/EBT = 2,137,784.60/4,438,000 = 48.17%

Part b)

Tax in UK = EBT*UK tax rate = 4,438,000*27% = 1,198,260

Repatriates of its net UK income to germany = EBT-Tax in UK = 4,438,000-1,198,260 = 3,239,740

Tax in germany after foreign tax credit = (Repatriates*german tax rate)-tax in UK = (3,239,740*29%)-1,198,260 = 939,524.60-1,198,260 = Nil (Since foreign tax credit is more than germany tax, tax is nil)

Total taxes = Tax in UK + Tax in germany = 1,198,260+Nil = 1,198,260

Effective tax rate = Total taxes/EBT = 1,198,260/4,438,000 = 27%