ISSN 1940-204X
Caribbean Brewers: Transfer Pricing, Ethics and Governance
Douglas Kalesnikoff Suresh Kalagnanam
University of Saskatchewan University of Saskatchewan
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
IM A ED U C ATIO NA L C A S E JOURNAL
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.
1 VOL. 5, N O. 2, ART. 1, JUN E 2012
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
IM A ED U C ATIO NA L C A S E JOURNAL
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).
2 VOL. 5, N O. 2, ART. 1, JUN E 2012
• Domestically, a case of 24 Gera beer sells for $50, but the In addition to the requested reports, you have some
exported Gera beer is invoiced to Gera Caribbean for $25 concerns over the transfer pricing policy in relation to
per case. exports of Gera Beer. How is this affecting the minority
shareholders such as JJ? How will any presentation of
• In addition to the $50/case, Caribbean Brewers collects
adverse consequences to minority shareholders be received
a returnable bottle deposit of $8 per case on domestic
by the board, which is most heavily represented by the
sales and exported Tigua beer. Contrary to this normal
majority shareholder?
business practice, no deposit is invoiced to Gera
Based on the information provided, you ponder as to
Caribbean for exported Gera beer.
what you can do to address the concerns of JJ and prepare
• Gera Caribbean in turn invoices the other Islands in the for the board meeting. As a new, responsible professional,
eastern Caribbean for $50/case plus an $8/case deposit for you also wonder what management control and other issues
the bottles. you should bring up at the board meeting that relate to
matters of governance.
You quickly research the Antigua Income Tax Act (ITA)
and come across a general tax anti-avoidance section (see
Figure 5).
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You ponder everything that you have heard from JJ. You empowering accounting and finance professionals to drive
also reflect upon your new responsibilities, particularly with business performance. IMA provides a dynamic forum for
respect to new elaborate planning and budgeting processes professionals to advance their careers through Certified
that you will be spearheading. You have been told that Management Accountant (CMA®) certification, research,
these processes are extremely critical and will bring Gera professional education, networking and advocacy of the
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standard procedures for resource allocation, performance information about IMA, please visit www.imanet.org.
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.

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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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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.

IM A ED U C ATIO NA L C A S E JOURNAL 5 VOL. 5, N O. 2, ART. 1, JUN E 2012

Figure 4
Corporate Transaction Flow Chart

Gera International
Germany

Owns
100%
Management Owns of
and Others 75%
of

Own
25% Invoice Gera Caribbean
of
Bermuda

Caribbean Brewers Sale

Invoice
Antigua of Gera Export

Delivery Customers
Other Caribbean Islands

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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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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