Chapter 8, Problem 21EP

Heraklion Company (a U.S.-based company) is considering making an equity investment in an Australian manufacturing operation. The total amount of capital, in Australian dollars (A$), that Heraklion would need to invest is A$1,000,000. Heraklion has three alternatives for financing this investment:

• percent equity.
• percent equity and 20 percent long-term loan from Heraklion (5 percent interest rate).
• percent equity and 50 percent long-term loan from Heraklion (5 percent interest rate).

Heraklion estimates that the Australian operation will generate A$200,000 of income before interest and taxes in its first year of operations. The operation will pay 100 percent of its net income to Heraklion as a dividend each year.

Required:

1. a. Assume there is no tax treaty between the United States and Australia. Using the information on Australian tax rates found in Exhibit 8.1 and Exhibit 8.3, determine the total amount of taxes that will be paid in Australia under each of the three financing alternatives. Which alternative results in the least amount of taxes being paid in Australia?
2. b. The United States/Australia tax treaty provides reduced withholding tax rates on certain payments made to a foreign parent company. Using the information on Australian tax rates found in Exhibit 8.1 and Exhibit 8.4, determine the total amount of taxes that will be paid in Australia under each of the three financing alternatives. Which alternative results in the least amount of taxes being paid in Australia?