Monday, February 18, 2013

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.

In Europe the anger has focused on big firms. Amazon and Starbucks have faced consumer boycotts for using clever accounting tricks to book profits in tax havens while reducing their bills in the countries where they do business…Congress has passed the Foreign Account Tax Compliance Act (FATCA), which forces foreign financial firms to disclose their American clients…

…Getting rich people to pay their dues is an admirable ambition, but this attack is both hypocritical and misguided. It may be good populist politics, but leaders who want to make their countries work better should focus instead on cleaning up their own back yards and reforming their tax systems.

The archetypal tax haven may be a palm-fringed island, but as our special report this week makes clear, there is nothing small about offshore finance. If you define a tax haven as a place that tries to attract non-resident funds by offering light regulation, low (or zero) taxation and secrecy, then the world has 50-60 such havens. These serve as domiciles for more than 2m companies and thousands of banks, funds and insurers. Nobody really knows how much money is stashed away: estimates vary from way below to way above $20 trillion.

Not all these havens are in sunny climes; indeed not all are technically offshore. Mr Obama likes to cite Ugland House, a building in the Cayman Islands that is officially home to 18,000 companies, as the epitome of a rigged system. But Ugland House is not a patch on Delaware (population 917,092), which is home to 945,000 companies, many of which are dodgy shells. Miami is a massive offshore banking centre, offering depositors from emerging markets the sort of protection from prying eyes that their home countries can no longer get away with. The City of London, which pioneered offshore currency trading in the 1950s, still specialises in helping non-residents get around the rules…London is no better than the Cayman Islands when it comes to controls against money laundering. Other European Union countries are global hubs for a different sort of tax avoidance: companies divert profits to brass-plate subsidiaries in low-tax Luxembourg, Ireland and the Netherlands.

Reform should thus focus on rich-world financial centres as well as Caribbean islands, and should distinguish between illegal activities (laundering and outright tax evasion) and legal ones (fancy accounting to avoid tax). The best weapon against illegal activities is transparency, which boils down to collecting more information and sharing it better. Thanks in large part to America’s FATCA, small offshore centres are handing over more data to their clients’ home countries—while America remains shamefully reluctant to share information with the Latin American countries whose citizens hold deposits in Miami. That must change. Everyone could do more to crack down on the use of nominee shareholders and directors to hide the provenance of money. And they should make sure that information about the true “beneficial” owners of companies is collected, kept up-to-date and made more readily available to investigators in cases of suspected wrongdoing. There are costs to openness, but they are outweighed by the benefits of shining light on the shady corners of finance.

What can I say? Buy a copy. Read it. Internalise it. Then start lobbying for change.

Malaysia more than most suffers from profits being shifted overseas to lower tax jurisdictions. Based on GFI’s numbers, a minimum of half the “illicit” capital outflows that Malaysia suffers is from corporate transfer pricing. What makes this more galling is that under the current law, it’s all perfectly legal.

If the full corporate tax rate on these monies were applied, we’re looking at RM100 billion in lost tax revenue for 2000-2008 – that’s enough to cut the cumulative fiscal deficit in half, or alternatively reduce Malaysia’s debt to GDP ratio by 10 percentage points.

There’s more sources of info on this (the OECD has just issued a much more detailed report), which I’ll try to cover later in the day.


  1. A good link but reforming tax systems, having international frameworks for information sharing and other such mechanisms for disclosure will only work if there is preparedness to wiled the big stick on tax-haven, secretive jurisdictions purveying and benefiting from such shenanigans. I mean, when the main actors pariah-rise a nation state for its recalcitrance, only then will nation states dare to use illegal means to line their national coffers and by default GDP numbers etc etc through money-laundering schemes(casinos, property speculation etc), tax evasion platforms and the like. and your take on why Malaysia has lost a lot is not surprising but lost where. Look no further than a neighbourhood culprit cited here: (a must read with some choice cuts below)

    2.Tax havens such as Switzerland, Singapore, and the Cayman Islands host an important wealth management industry which provides foreigners with an opportunity to evade taxes……

    3.A number of havens, however, do not participate in the Directive, most notably Singapore, Hong Kong, the Bahamas, and Bahrain. Strikingly, we find that deposit shifting in response to treaties only occurs to the benefit of the havens that do not participate in the EU Savings Directive.

    Reference for (2) & (3):

    and regarding all this, I hope some don maps UNCTAD figures on investment flow with GDP numbers plus geographical distribution to see how each continent or region has its money siphoning funnel. Plus look up fraudulent indices like those generated by Transparency International to notice ancillary linkages....if you get my drift....hopefully.

    1. If you read through the full special report (there's 6-7 articles all told), some of the issues you've mentioned have been raised.

      You might also be interested in this (ungated copy of the full report here). Reading through this now.

    2. "If you read through the full special report (there's 6-7 articles all told), some of the issues you've mentioned have been raised."

      Which full special report, dude? I am a bit confused. Thanks for the other link you provided, anyway been digesting it already.

      Quid pro quo, a bit off topic I guess but nonetheless interesting:

      and totally off topic but interesting nevertheless due to a recent controversy (,singapore8217s-ndf-scandal-ain8217t-what-you-think.aspx

      surprised no comments on the controversy or do you dismiss it as just ambient noise in a regression; random movements of minimal economic impact rather than a systematic manipulation supported by an invisible hand of authority aiming to reenact a "different version" of CLOB 98.

    3. In the print edition of the Economist, they typically have one section devoted to a special report, which goes into a topic in depth with multiple articles on various facets of an issue.

      The link I provided in the blog post is just the lead article; there are eight more in the special report. Here's a sampling:



      No, I didn't cover the NDF scandal, nor LIBOR before it. Both sounds nasty and corrupt and cater to the worst views of the financial system, but when you actually come down to it, neither the financial nor economic effects are very significant.

    4. LIBOR - a primer:

      There were economic effects:

      However, their quantification would be admittedly difficult as lending was largely illiquid anyway and the difficulty of modeling counterfactual data plus the assymetric effects of the whole scandal.

      NDF- more likely a economic sabotage attempt at the behest of an invisible hand with authority as the evidence thus far suggests with a major elections in the horizon. It smacks of a rehash of CLOB 1998 in a different guise although today's confab down South muay have eased strains. Better to err on the side of caution rather than be remorseful after the fact.

    5. The FT article is gated, and I'm well aware of the mechanics of LIBOR.

      For all the noise, the economic and financial damage is small - the key issue is more about market fairness and regulation than signficant losses.

      Note that LIBOR is an interest rate reference benchmark, and we're talking here about manipulation of a few basis points at worst. This is loss on the margin, not loss of capital. Second is that bank profits arising from this is aggregated across many, many customers and potentially offset by interest rate losses within each bank (profits were on the treasury portfolio, not overall assets and liabilities). Third of course, relative to overall bank revenue, this stuff is chicken feed.

      Same critique applies to the NDF scandal. I would tend to discount any idea of a CLOB-style attempt at manipulation because unlike the old CLOB shares, the Ringgit is still non-convertible offshore, and the onshore market is orders of magnitudes larger and far more liquid than CLOB ever was. Back then, it was individual stocks with limited float - the forex market is an entirely different beast.

  2. I mean, when the main actors pariah-rise a nation state for its recalcitrance, only then will nation states dare to use illegal means to line............

    should read as:

    I mean, when the main actors pariah-rise a nation state for its recalcitrance, only then will nation states cease daring to use illegal means to line............

  3. Only coz I sometimes like to nitpick...

    RM100bn over 9 years of illicit transfers (is this the GFI number you were quoting?) is on average, RM11.1bn/year and honestly is not nearly enough to put a dent into our public finances ~ admittedly it could be on an exponential growth rate so averaging the full number may be empirically wrong.

    Well my point here is that it's not nearly enough to close the fiscal deficit in half - my perspective here - if you were to apply the prevailing corporate tax rate (or the tax rate on the highest income bracket) on the figure....coz presumably even if the entire sum were declared in Malaysia they wouldn't be taxed for the full amount.

    * What would be REALLY, REALLY interesting is the fines (from tax evasion) that they can mete out in that respect

    1. Also like to add, that even though I'm not making much of a fuss about this number, I am definitely not condoning illicit cross border transfers.

    2. Jason, the GFI figure is USD32-33 billion a year, depending on which of their estimates you use. Sorry I didn't make that clear.

      Based on today's exchange rates (the figure would have been even higher back then), that roughly translates to RM100 billion a year.

  4. On GFI, transfer pricing and not directly related Malaysia.

    Not something mainstream with heavy doses of doom&gloom bias. But IMHO still worth a read.

    1. Thanks Oi Mun, good find.

      I wonder how much of our FDI is "round-tripped". Apparently its a huge problem for China as well.

  5. am not an economist. But I had a number of Chinese colleagues.

    Transfer pricing is a huge problem in China. But it is not like they did not know of MNC multiple PO/Invoice regime help book profit in low tax heaven.

    my guess is that their priority has always been employment.

    Especially now with rising wages for Chinese citizens. African or Indian factory workers are common sight in Shenzen as they are cheaper.

    To crack the whip big time on evading export tax(17% if I remember correctly), would mean losing more jobs to other countries like Vietnam.