Transfer Pricing and Illicit Money Flows

I wonder how many people caught this, and how many of those understand the significance (excerpt):

Singapore updates corporate tax guidelines to better align with West

SINGAPORE: Singapore is updating guidelines on an accounting practice mired in controversy for helping multinational companies minimize their tax bills, as the city-state moves more in line with a crackdown by Western governments on aggressive tax avoidance.

International taxation has come under scrutiny since a quirk of "transfer pricing" was found to have helped lower the tax bills of a number of multinationals, including Starbucks Corp , Google Inc and Amazon.com Inc.

Such issues prompted the Organisation for Economic Co-operation and Development to call on governments to revise tax treaties, tighten rules and share more information, in a project due for completion by the end of this year.

In transfer pricing, a company sets a price for a good or service to be sold between two of its subsidiaries.

The company can use the price to minimise its tax bill by having a subsidiary in a low-tax jurisdiction such as Singapore sell products to a subsidiary in a higher-tax jurisdiction at a high price. This allows the company to book more of its profit in the low tax location.

From Jan. 6, the Inland Revenue Authority of Singapore (IRAS) will require related parties to keep contemporaneous records to support the pricing of such transactions.

The IRAS also detailed methods by which transactions are benchmarked to show that prices charged would be similar if the transactions had been with a party outside of the company….

Approximately a fifth of the “illicit” capital outflows recorded by GFI from Malaysia due to trade mispricing run through Singapore. If Singapore fixes its transfer pricing rules, that’s one positive step towards fixing the practice, not just for Malaysia, but for the region as a whole.

Note to LHDN and Customs: we should be doing the same.

Singapore: Tax Evasion = Money Laundering

What with all the election news, how many caught this article on Singapore’s crackdown? (excerpt)

Banks in Singapore agonize over rich clients in tax evasion clampdown

The authorities are keen to ensure the city-state is not seen as a tax haven for the wealthy from Europe, China, Indonesia, Malaysia and elsewhere without dulling its allure as an oasis for the rich, replete with casinos, luxury properties and high-end boutiques and restaurants. More than 70 percent of Singapore's S$1.34 trillion ($1.08 trillion) in assets under management at the end of 2011 came from overseas, an MAS survey showed.

Profit-Shifting and Transfer Pricing

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):

Reining in cross-border profit shifting

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.

The Economist On Tax Avoidance: Corporate Transfer Pricing Hits The Mainstream

From the Special Report in last week’s issue (excerpt):

The missing $20 trillion
How to stop companies and people dodging tax, in Delaware as well as Grand Cayman

CIVILISATION works only if those who enjoy its benefits are also prepared to pay their share of the costs. People and companies that avoid tax are therefore unpopular at the best of times, so it is not surprising that when governments and individuals everywhere are scrimping to pay their bills, attacks are mounting on tax havens and those that use them.

Transfer Pricing: A Global Problem

From the December issue of Third World Resurgence comes this accessible, and potentially explosive, article (excerpt; warning: pdf link):

Transfer Pricing and Tax Evasion: Beyond the trans-Atlantic furore
Smitha Francis

...The charge facing US TNCs [sic] like Google, Amazon and Starbucks is that despite generating billions of dollars in revenue in the EU, they get away with paying little or no corporate income taxes in Europe by distributing their income between different tax jurisdictions. They use complex tax accounting strategies to exploit tax loopholes and differences in national corporate tax rates across Europe, which range from less than 10% to more than 30%...

Capital Flows Inside MNCs

A new research paper from the NBER working paper series looks at debt-shifting within MNCs, and finds that – surprise! – tax rates matter a great deal more than previously thought (abstract):

Corporate Taxes and Internal Borrowing within Multinational Firms
Peter Egger, Christian Keuschnigg, Valeria Merlo, Georg Wamser

This paper develops a theoretical model of multinational firms with an internal capital market. Main reasons for the emergence of such a market are tax avoidance through debt shifting and the existence of institutional weaknesses and financial frictions across host countries. The model serves to derive hypotheses regarding the role of local versus foreign characteristics such as profit tax rates, lack of institutional quality, financial underdevelopment, and productivity for internal debt at the level of a given foreign affiliate. The paper assesses hypotheses in a panel data-set covering the universe of German multinational firms and their internal borrowing. Numerous novel insights are gained. For instance, the tax-sensitivity found in this paper is many times higher than previous research suggests. This accrues mainly to three things: the consideration of the boundedness of the internal debt ratio as a dependent variable in comparison to its treatment as an unbounded variable in most of the previous work; the coverage of all (small and large) multinationals here rather than a focus on large units in previous work; and the inclusion of endogenous characteristics in other countries multinationals are invested in (due to endogenous weights) while previous work did not consider such effects at all or assumed them to be exogenous. Moreover, local and foreign (at other locations of a given affiliate) market conditions matter more or less symmetrically and in the opposite direction. There is a nonlinear trade-off between institutional quality or financial development on the one hand and higher profit tax rates on the other hand, and the strength of this trade-off depends on the characteristics of one location relative to the other ones a multinational firm has affiliates (or the headquarters) in.

Tax Avoidance: Intellectual Property Edition

The tech industry is innovative in more ways than one, and has found quite a tax dodge (excerpt):

Microsoft and HP rapped by US Senate over tax havens

The US Senate has criticised Microsoft and Hewlett-Packard for their use of tax avoidance schemes, which it says is rampant in the tech sector.

The Senate's Permanent Subcommittee on Investigations said the companies used places such as the Cayman Islands so they did not have to pay US taxes…

…Microsoft and HP denied any wrongdoing…

Illicit Money Flows: Where Are They?

You might remember Global Financial Integrity’s report on illicit money flows early last year, where they reported Malaysia as being the fifth highest victim of uncategorised capital outflows in the last decade.

At the time, I partially validated their findings at least in terms of the trade mispricing channel – wildly different reported values for exports and imports between different trade partners.

So since I had a bit of time, and lots of curiosity, I decided to take a bit of a deeper look into the question of Malaysian trade mispricing, using the United Nations Commodities Trade database (Comtrade), which carries data on both imports and exports as reported by nearly every trading nation (Taiwan not included).

Did I find capital outflows? Yes, I did, and on a scale that conforms to the GFI report.