Mr Kang is diplomatic in not pointing out Malaysia’s own situation, but this article in today’s paper takes a highly educational look into the mechanics of profit shifting and transfer pricing, and a potential solution to the problem (excerpt; emphasis added):
A RECENT statement by George Osborne, the British Chancellor of the Exchequer, was given wide media coverage in the United Kingdom and elsewhere when he said that he wanted to see “international action” taken against multinational companies which engaged in “profit shifting”...
...The case of Amazon highlights how profits are “shifted” and the international tax rules that are in play.
Amazon revealed to the UK's Parliamentary Committee that all its European sales, including those to UK customers, are made by its affiliates in Luxembourg.
Its UK affiliate operates the order fulfilment, customer support and logistics services and earns a margin for these services. Since these are low-margin businesses, the profits earned by [sic] the UK entity are understandably low.
The bulk of the profits from its substantial sales volumes are attributable to the Amazon affiliates in Luxembourg, a low-tax location.
Amazon's business model thus exploits fully a number of key international tax rules.
The first is the “separate entity” principle, which treats a company within a global group as separate and distinct from other companies in that group...
...The separate entity rule, therefore, has the perverse effect of permitting the fiction of separate businesses.
The second is the arm's length rule, which operates to complement the first rule. It requires that transactions between companies in a group are made at arm's length i.e. as if they are made with third parties.
Amazon had not been accused of breaking the law so that they would have adhered to these rules in arriving at profits for each of its entities in the United Kingdom and in Luxembourg. Having done so, “it is difficult if not impossible to challenge the attribution of low profits to Amazon UK and high profits to Amazon Luxembourg” in the words of Sol Picciotto, an emeritus professor at Lancaster University and adviser to the Tax Justice Network, an activist group calling for greater transparency and fairness in tax systems...
...The global spread of these rules stems in part from the process of globalisation as well as the realisation that transfer pricing is a zero-sum game. Transfer pricing issues are really issues involving the split of taxes between two countries one where the selling company is located and the other where the buying company is; both being companies in the same group…
…It is also a reason why multinational companies find it incumbent on them to play by these rules, but in a way which benefits them.
They do this by locating subsidiaries in low-tax jurisdictions (the Amazon model) and justify this by claiming that they have a responsibility towards their shareholders legally to reduce the taxes their companies pay...
...Professor Picciotto, clearly thinks not and through the Tax Justice Network, strongly advocates the adoption of Unitary Taxation to replace the current international system. The unitary system first came into the limelight in the late 1990s and is still part of the California state tax system.
Under unitary tax, a company operating a business line globally, as in the Amazon example, will have to report a single set of worldwide consolidated accounts to each country where it has a business presence. The overall global profit is then apportioned to the various countries according to a weighted formula reflecting say payroll, assets and sales. Each country will levy tax on its part of the world-wide profit so carved out...
Pace BNM’s press announcement last week and the GFI reports, it’s clear from the above that a part of the “illicit” capital flows from Malaysia are perfectly legitimate and legal, just not ethical, exploitation of loopholes in international tax law.
Given the vested interests involved, I wouldn’t expect a whole lot of progress any time soon – neither the multinationals involved nor the countries benefiting from tax shifting would stay passively on the side-lines while international tax reform takes root.
Would unilateral adoption of unitary taxation help? Perhaps, though without multilateral acceptance and cooperation, it would be difficult to enforce.
Looking at this and other global problems, I can’t help thinking that there will come a time when the logic of having global monetary and fiscal authorities will outweigh concerns over sovereignty and feelings of nationalism. We’re nowhere near that solution though, and we’ll just have to muddle through as best we may in the meantime.