December 2009 ACCA P5 Paper-International Transfer Price – Tax issue

Dear Sir / Madam,

After considerable internal discussion concerning quotation 2 by the management of SSA Group Division A is not prepared to supply 18000 Ankles to Division B at 10.50 per unit ( when market price of the same is 9 per unit). A is in Nearland with 40% taxation rate and B in Distalnd with 20% tax rate. Advise management which option to be sought after !

Answer – I have solved this in my way as I am unable to understand ACCA solution. Broad answer of mine tallies with ACCA that is its better to buy from Local suppliers at 9 per unit, however calculations differ.
Kindly advise whether my method is acceptable.

My answer
Since taxation in Nearland ( Division A) is 40% and Distland ( Division B) is 20% we should allow ( as a Group) to make maximum profit to Division B ( Distland) so that taxation liability of Group as a whole comes to minimum.

On this maxim I calculated Tax Liability of both options as under

Option 1 ( When A supplies at 10.50 per unit -18000 units)
By this A makes profit of 1,329,000 and pays tax at 40% 531,600
By this B makes loss of ( 10.50 per unit minus 9 market price) X 18000 units = (27000). Thus no tax liability . So group Tax liability comes to 531,600

Option 2 ( When B buys from market at 9 per unit- B does not make any profit no loss so no tax liability) & A makes maximum profit of 1,320,000 by selling it in local market without worrying about Division B and makes tax payment of 528,000.

Thus considering both the options , It makes sense
1) To allow B to buy from Local Market &
2) Group as whole saves tax of 3600

Is this answer correct. Kindly advise

with regards

Deep