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INTRODUCTION

It is April 2011 and you have used your newly acquired

business degree to secure a management job as advisor to the

chief financial officer with Caribbean Brewers Inc., located

in Antigua in the Caribbean Sea. Caribbean Brewers Inc. is a

75%-owned subsidiary of Gera International, a conglomerate

in the business of brewing and distributing beer. It is barely

a week since you started your job and you already have major

projects to deal with.

GERA INTERNATIONAL

Gera beer has been a well-established international brand of

beer for over half a century, usually ranked among the top

three selling brands of beer in the world. Up until 2005, Gera

International, head-quartered in Munich, Germany, brewed

Gera beer for the Caribbean region at a brewery located

in Jamaica. As transportation costs continued to increase,

the logistics of shipping from Jamaica, which is located in

the western Caribbean, to islands in the eastern Caribbean

became problematic. In the early 2000s, Gera International

set out to find a suitable location for a plant in the eastern

Caribbean. After due diligence investigations on a number of

locations, Gera International decided on Antigua.

Antigua, with the population of 68,000, is the largest

of the English-speaking Leeward Islands of the eastern

Caribbean. Antigua became Great Britain’s most important

Caribbean base when Admiral Horatio Nelson sailed there

in 1784. Situated in the middle of the eastern Caribbean

chain of Islands, Antigua often serves as a business and

transportation hub between the Windward Islands of St.

Lucia, Grenada, Dominica, and St. Vincent and the Leeward

Islands of St. Kitts, St. Martin, Montserrat, and Anguilla. It is

also in reasonable physical proximity to the more populated

islands of Puerto Rico and Dominican Republic to the north

and Barbados and Trinidad to the south.

Antigua already had a successful brewery that produced

Tigua beer, a popular brand in Antigua and throughout

the eastern Caribbean. In 2000, the Antiguan brewery

had negotiated a 15-year income tax holiday with the

government of Antigua on income earned from sales of Tigua

beer. The combination of the central location of Antigua

in the eastern Caribbean, the success of the Tigua beer

line, and the tax concession on Tigua beer made Antigua a

good choice for Gera International; it purchased 75% of the

Antiguan brewery, Caribbean Brewers Inc., in 2005. The

remaining 25% of the common shares of Caribbean Brewers

remained held by senior management and other employees.

Caribbean Brewers is one of the many subsidiaries of varying

sizes under Gera International’s control.

The production facilities of Caribbean Brewers were

expanded in 2008, thereby effectively doubling the

productive capacity. This expansion was funded through a

10-year amortized loan from Gera International at a fixed

interest rate of 10%. All of the production of Gera beer for

the eastern Caribbean region was transferred to Caribbean

Brewers after the plant expansion. The resulting production

figures for Caribbean Brewers are provided in Figure 1.

I M A E D U C AT I O N A L C A S E J O U R N A L V O L . 5 , N O . 2 , A R T. 1 , J U N E 2 0 1 21

ISSN 1940-204X

Caribbean Brewers: Transfer Pricing, Ethics and Governance

Douglas Kalesnikoff

University of Saskatchewan

Suresh Kalagnanam

University of Saskatchewan

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RECENT ISSUES

Upon arrival in your new position, you discover that all is not

rosy at Caribbean Brewers. On only your second day in the

office, the production manager, Jason Joseph, affectionately

known as JJ, comes into your office and shuts the door. JJ has

been production manager for decades and has been heralded

as a master brewer, having won multiple awards for Tigua

beer in the late 1990s and early 2000s. It is clear during the

meeting that JJ is unhappy and distressed. He explains that

prior to Gera International’s involvement in the brewery,

things were better; JJ previously had a 25% ownership in

Caribbean Brewers, which is now reduced to 8%. He had

always received a salary of about $100,000 as the production

manager, but had also benefited by a bonus and an annual

dividend. Since Gera International became the majority

shareholder, there have been no dividends. In addition,

JJ’s bonus, which is based on a combination of controlling

average total production costs and quality control, has all

but been eliminated since the plant expansion. With respect

to production costs, JJ and other production personnel are

eligible for a bonus provided that total production costs do

not exceed 43% of sales. Figure 2 contains the format of

the report that is used to assess production efficiency and

bonus calculations.

JJ explains that the production process for brewing beer

has been fundamentally the same for decades, as outlined in

Appendix 1. The first two steps, i.e., milling and mash tun,

account for 50% of the total production overhead costs. Tigua

beer has a longer and more time-intensive production process

up to the stage where the wort is created; this results in the

Tigua beer consuming 100% more overhead resources up to this

stage compared to Gera beer. After the creation of the wort, the

process and cost are the same regardless of the brand.

The direct costs of the beer are not all that significant;

98% of the beer is water and the cost of the raw materials

is only about $3 per case of 24. The costs of the bottle cap

and label are as much as raw materials, about $3 per case.

The cost of the bottles is $8 per case of 24; however, this

is not normally treated as a cost because a deposit of $8

per case of 24 is collected for all returnable markets, which

include all domestic markets and export of Tigua. Contrary

to this normal business practice, no deposit is collected on

the export market for Gera beer; as a result, the cost of the

bottles pertaining to Gera beer exports are expensed.

As a result of the decline in production efficiencies, as

measured in Figure 2, JJ’s bonus has suffered. JJ is adamant

that the production facility is operating as efficiently as, if not

more efficiently than, before the expansion, and is concerned

that the cost allocations used in Figure 2 for production costs

are penalizing his bonus. “Prior to the expansion, I focused

on production cost per case. Gera International now holds us

accountable for production cost as a percentage of sales – this

has taken away control from the production people. I also

don’t understand why the exported Gera beer bottle costs

are charged to our plant,” JJ exclaimed in sheer frustration.

He also explained that Gera International has on occasion

complained about the quality of Gera beer exported to other

Caribbean countries, thereby refusing to pay Caribbean

Brewers for some shipments. JJ is adamant that the quality

of the beer is consistent and desperately wants to be able

to prove the allegations of poor quality as groundless. He is

concerned that Gera International is making false allegations

about the quality to justify not paying for some of the

shipments. “I do not understand how head office can say that

our quality is poor; I have not heard any complaints from our

local customers of Gera beer. I have been in the business

long enough to know when quality is bad; I am able to and

usually do take corrective actions during the process itself

before things go out of hand.”

Before leaving your office, JJ explains that he is very

frustrated and is seriously considering leaving the company

to be the master brewer and production manager of a

brewery in Trinidad, a major competitor of Caribbean

Brewers. This would be a major loss to the company.

Later the same day, the head accountant provides you with

a letter from the Inland Revenue Department (IRD) of Antigua

(equivalent to IRS in the United States of America) explaining

that tax auditors will be coming out next month to review the

tax filings for the years ending December 31, 2008, 2009, and

2010. You investigate and find that in order to benefit from

the tax exemption of Tigua beer, Caribbean Brewers prepares

profitability statements along taxable and nontaxable product

lines when filing the annual tax return. This allocation between

the two product lines is provided in Figure 3.

Caribbean Brewers is a tax resident of Antigua and thus

subject to taxes of 30% of profits. As you begin preparing

for the tax audit you find out the following:

• All export sales of Gera beer are made to Gera Caribbean,

a wholly-owned subsidiary of Gera International, which is

located in Bermuda, a tax-free jurisdiction. (See Figure 4

for a chart of the transactions.)

• For cost and logistical reasons, the exports are shipped

directly to the Island where the beer will be sold in

the eastern Caribbean while only the invoice is sent to

Bermuda (see Figure 4).

I M A E D U C AT I O N A L C A S E J O U R N A L V O L . 5 , N O . 2 , A R T. 1 , J U N E 2 0 1 22

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• Domestically, a case of 24 Gera beer sells for $50, but the

exported Gera beer is invoiced to Gera Caribbean for $25

per case.

• In addition to the $50/case, Caribbean Brewers collects

a returnable bottle deposit of $8 per case on domestic

sales and exported Tigua beer. Contrary to this normal

business practice, no deposit is invoiced to Gera

Caribbean for exported Gera beer.

• Gera Caribbean in turn invoices the other Islands in the

eastern Caribbean for $50/case plus an $8/case deposit for

the bottles.

You quickly research the Antigua Income Tax Act (ITA)

and come across a general tax anti-avoidance section (see

Figure 5).

THE CHALLENGES AHEAD (OR THE ROAD AHEAD)

You ponder everything that you have heard from JJ. You

also reflect upon your new responsibilities, particularly with

respect to new elaborate planning and budgeting processes

that you will be spearheading. You have been told that

these processes are extremely critical and will bring Gera

Caribbean in line with the other segments in terms of using

standard procedures for resource allocation, performance

measurement, evaluation, and reward. “Is a corporate

group standard approach the right way to go, or should each

subsidiary have some flexibility?” you wonder.

There is a board of directors meeting scheduled for

next week. Frederik Verstam, a long-time executive of

Gera International, has been parachuted in as the CEO and

chairman of the board of Caribbean Brewers. The other

members of the board of directors of Caribbean Brewers are

Grandview Goerdler and Delores Garstad from the head

office, who fly in for the quarterly meetings from Munich;

Edward Woods, a local politician; and Byron Jackson, a local

businessman in Antigua with a 2% ownership interest in

Caribbean Brewers.

You receive an agenda for the board meeting and note

that you are required to prepare the following reports:

1. Report addressing the rising costs of production, as

illustrated in Figure 2.

2. Report on the performance measurement system for

production personnel with respect to both cost and

quality control.

3. Report on any vulnerability or risks associated with the

upcoming income tax audit.

In addition to the requested reports, you have some

concerns over the transfer pricing policy in relation to

exports of Gera Beer. How is this affecting the minority

shareholders such as JJ? How will any presentation of

adverse consequences to minority shareholders be received

by the board, which is most heavily represented by the

majority shareholder?

Based on the information provided, you ponder as to

what you can do to address the concerns of JJ and prepare

for the board meeting. As a new, responsible professional,

you also wonder what management control and other issues

you should bring up at the board meeting that relate to

matters of governance.

I M A E D U C AT I O N A L C A S E J O U R N A L V O L . 5 , N O . 2 , A R T. 1 , J U N E 2 0 1 23

ABOUT IMA With a worldwide network of more than 60,000 professionals,

IMA is the world’s leading organization dedicated to

empowering accounting and finance professionals to drive

business performance. IMA provides a dynamic forum for

professionals to advance their careers through Certified

Management Accountant (CMA®) certification, research,

professional education, networking and advocacy of the

highest ethical and professional standards. For more

information about IMA, please visit www.imanet.org.

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I M A E D U C AT I O N A L C A S E J O U R N A L V O L . 5 , N O . 2 , A R T. 1 , J U N E 2 0 1 24

Figure 1 Sales Volume (cases of 24)

Gera Tigua

Domestic Export Domestic Export

2007 380,000 55,000 875,000 45,000

2008 389,000 59,000 868,000 48,000

2009 401,000 825,000 897,000 51,000

2010 411,000 1,190,000 911,000 53,000

Figure 2 Production Costs as a Percentage of Sales

2007 2008 2009 2010

Sales $66,375,000 $66,725,000 $88,075,000 $98,500,000

Production Costs:

Variable Cost:

raw materials $ 4,037,900 6.1% $ 4,078,360 6.1% $ 6,587,220 7.5% $ 7,874,550 8.0%

bottles 440,000 0.7% 472,000 0.7% 6,600,000 7.5% 9,520,000 9.7%

caps and labels 4,092,100 6.2% 4,146,560 6.2% 6,630,700 7.5% 7,823,250 7.9%

Total Variable Costs: $ 8,570,000 12.9% $8,696,920 13.0% $19,817,920 22.5% $25,217,800 25.6%

Overhead:

utilities $4,539,250 6.8% $ 4,433,000 6.6% $ 6,739,400 7.7% $ 7,695,000 7.8%

plant maintenance 1,084,000 1.6% 1,050,280 1.6% 1,521,800 1.7% 1,539,000 1.6%

personnel 7,452,500 11.2% 7,229,200 10.8% 10,435,200 11.8% 11,286,000 11.5%

depreciation 5,420,000 8.2% 5,456,000 8.2% 8,696,000 9.9% 10,260,000 10.4%

Total Overhead: $18,495,750 27.9% $18,168,480 27.2% $27,392,400 31.1% $30,780,000 31.2%

Total Production Costs $27,065,750 40.8% $26,865,400 40.3% $47,210,320 53.6% $55,997,800 56.9%

Note: For simplicity it is assumed that sales units are equal to production units.

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I M A E D U C AT I O N A L C A S E J O U R N A L V O L . 5 , N O . 2 , A R T. 1 , J U N E 2 0 1 25

Figure 3 Allocation of Taxable and Non-taxable Streams

2008 Total Non-taxable Tigua Taxable - Gera

Volume in cases of 24 1,364,000 916,000 448,000

Sales $66,725,000 $45,800,000 $20,925,000

Production Costs $26,865,400 $18,041,574 $ 8,823,826

Sales Costs 4,670,750 3,206,000 1,464,750

Administrative Costs 4,003,500 2,748,000 1,255,500

Interest Costs 543,000 372,715 170,285

Net profit $30,642,350 $21,431,712 $ 9,210,638

2009 Total Non-taxable Tigua Taxable - Gera

Volume in cases of 24 2,174,000 948,000 1,226,000

Sales $88,075,000 $47,400,000 $40,675,000

Production Costs $47,210,320 $20,586,653 $26,623,667

Sales Costs 5,284,500 2,844,000 2,440,500

Administrative Costs 4,844,125 2,607,000 2,237,125

Interest 3,257,000 1,752,845 1,504,155

Net profit $27,479,055 $19,609,502 $ 7,869,553

2010 Total Non-taxable Tigua Taxable - Gera

Volume in cases of 24 2,565,000 964,000 1,601,000

Sales $98,500,000 $48,200,000 $50,300,000

Production Costs $55,997,800 $21,045,567 $34,952,233

Sales Costs 5,614,500 2,747,400 2,867,100

Administrative Costs 5,220,500 2,554,600 2,665,900

Interest 2,932,000 1,434,745 1,497,255

Net profit $28,735,200 $20,417,688 $ 8,317,512

Notes: Sales price of Gera Exported beer is $25 while all others are $50 Total production costs allocated on the basis of volume (# of cases). Sales and Administrative and Interest expense allocated on the basis of sales dollars.

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I M A E D U C AT I O N A L C A S E J O U R N A L V O L . 5 , N O . 2 , A R T. 1 , J U N E 2 0 1 26

Figure 4 Corporate Transaction Flow Chart

Gera International Germany

Gera Caribbean Bermuda

Customers Other Caribbean Islands

Caribbean Brewers Antigua

Management and Others

Owns 75%

Owns 100%

Invoice

Sale

of Gera Export

Delivery

Invoice

Own 25%

Figure 5 Antigua ITA Section 23 Related Party Transactions Involving Liability to Tax

Where a resident corporation carries on business with a non-resident corporation and by reason of the relationship between such corporations

the course of business between them has been so arranged that the business done by the resident produces less profits than those which could

be expected to arise from that business if such relationship had not existed, Inland Revenue may determine in a reasonable fashion whether

any additional profits should be deemed to be assessable income of the resident corporation.

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I M A E D U C AT I O N A L C A S E J O U R N A L V O L . 5 , N O . 2 , A R T. 1 , J U N E 2 0 1 27

Appendix 1 The Nine-Step Process of Beer Making

1. Milling – Beer brewing begins with polished barley grains called malt, which are passed through a milling machine to crack the dried kernels and grind them into a coarse powder.

2. Mash tun – The milled grain is dropped into the mash tun with warm water of a certain temperature, depending on the brew recipe; the grain and water are mixed together to create a mash - a thick, sweet liquid called wort.

3. Lautering – The wort is then drained off in a vessel called a lauter tun (German for “purification tank”) where the husks are used like a giant sieve or filter bed for filtering out the “spent” grain.

4. Boiling – The wort is boiled and spiced with hops for up to 90 minutes in a large kettle, or wort copper.

5. Fermenting – After it is cooled, the wort is then transferred to a fermentation tank where the sugars are metabolized into alcohol and carbon dioxide, and the resulting mixture is then called young beer.

6. Conditioning – The beer is cooled to around freezing point, which encourages settling of the yeast and causes proteins to thicken; the beer becomes crisp and clean.

7. Filtering – In this stage the filtering removes excess yeast, protein, and other insolubles, as well as stabilizes the flavor so that the beer becomes bright and clear.

8. Pasteurizing – The beer is pasteurized to kill off any of the remaining yeast and any other microorganisms.

9. Packaging – The finished beer is then mechanically filled into bottles or kegs.

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