Transfer Pricing » Tax Research UK

Profits everywhere – except near the tax man

Country-by-country, Economics, Tax Havens, Tax planning, Transfer Pricing 1 Response »

May 142010

There’s a second article from Jesse Drucker in Bloomberg today. It reports:

Over the past three years, Pfizer Inc. was an earner without profit in its own country.

The maker of the cholesterol medication Lipitor, the world’s top-selling prescription drug, reported almost half its revenues in the U.S. for 2007 through 2009, while booking domestic pretax losses totaling $5.2 billion.

Abroad, it was another story. A Dutch subsidiary more than made up for New York-based Pfizer’s American losses. It reported pretax profits totaling $20.4 billion in 2007 and 2008 — with a tax expense of 5 percent, a seventh of the top U.S. rate. Overseas tax savings increased the drugmaker’s net income by $1 billion last year, according to Robert Willens, a tax consultant in New York.

Pfizer is one of thousands of American companies that bolster their profits by attributing income to subsidiaries in countries with lower income tax rates, legally cutting their tax bills. Eli Lilly & Co. and Oracle Corp. were among other big companies that helped drive a 70 percent increase in accumulated earnings abroad that weren’t taxed in the U.S. from 2006 to 2009, according to data compiled by Bloomberg.

“An inordinate concentration of profits in a low-tax country, way out of proportion to actual economic activity, is a sure sign of aggressive tax planning,” said Martin Sullivan, a tax economist who formerly worked for the U.S. Treasury and Arthur Andersen LLP.

Martin is a great guy.

He’s never wrong on these issues.

This is the economic reality of globalisation.

We could shatter it with country-by-country reporting.

That would shift some of the burden of the tax increases we’re going to have back onto capital.

What are we waiting for?

Companies Dodge $60 Billion in US Taxes

Country-by-country, Transfer Pricing 1 Response »

May 142010

A new report by Jesse Drucker for Bloomberg has explored just how it can be that $60 billion is lost to the US Exchequer each year from transfer mispricing.

The $60 bn figure is not one I have calculated. As Drucker notes:

$60 billion in annual U.S. tax revenue [is] lost to thousands of companies’ income shifting, according to a study published in December in the National Tax Journal by Kimberly A. Clausing, an economics professor at Reed College in Portland, Oregon.

I know Kim: we’ve had dinner a couple of times in the last year. And that convinces me this is solid academic stuff. It just happens to my view on the UK loss from this abuse, but that’s another issue.

I also agree with other quotes Drucker makes:

“Transfer pricing is the corporate equivalent of the secret offshore accounts of individual tax dodgers,” said Sen. Carl Levin, a Michigan Democrat and chairman of the Senate’s Permanent Subcommittee on Investigations, in a statement to Bloomberg News. Levin has overseen hearings on tax shelters including those sold to wealthy people by KPMG LLP. “Now that progress has been made in addressing offshore tax abuse by individuals, transfer pricing is an issue that deserves scrutiny.”

It certainly is. And Reuven Avi-Yonah – another massively respected US academic is right to say:

“If multinationals cannot be prevented from shifting profits to low-tax jurisdictions, then it becomes impossible to maintain the domestic corporate tax base,” said Reuven S. Avi- Yonah, director of the international tax program at the University of Michigan Law School in Ann Arbor. If that bleeding can’t be stanched, “we might as well abandon the income tax.”

That’s the significance of this issue. that’s why I say this abuse undermines democracy itself.

So what does Drucker add? This:

U.S. companies amassed at least $1 trillion in foreign profits not taxed in the U.S. as of the end of last year, according to data compiled by Bloomberg. That cumulative total, based on filings by 135 companies, increased 70 percent over three years, from $590 billion in 2006.

The scale of corporate tax abuse is increasing, and transfer pricing is at the core of it. And as Drucker chronicles in the case of US pharmaceutical Forest Laboratories Inc, the tale goes throught eh Netherlands and on to Ireland before heading back to Bermuda. As in Casablanca, all the usual culprits are present. And so is the usual distortion:

Overall, Forest’s Irish operations, which employ about 5 percent of its 5,200 workers, reported $2.5 billion in sales during fiscal 2009, the most recent year for which figures are available. That equals about 70 percent of the parent company’s $3.6 billion in net sales.

Of course that weird ratio may be appropriate. That’s for others to decide. Prima facie it allows the question to be asked, as it is time and again, about how it is that Irish workers are miraculously may, many times more productive than those any where else. Which, of course, has nothing at all to do with a 12.5% tax rate. Or favourable tax conduits and blind eyes to payments on licence fees.

I know Drucker spent months on this article: I spoke to him over many months as it developed.

This is the story of modern tax abuse: raiding the state for private gain. denying tax payment on capital whilst transferring the burden to labour.

And it is this that country-by-country reporting could stop. Which is precisely why business hates it so much.

HP’s woes continue with $325m Indian tax evasion claim

Development, Tax evasion, Transfer Pricing 1 Response »

May 052010

HP’s woes continue with $325m Indian tax evasion claim.

Information Age reports:

Hewlett-Packard’s difficult year continued this week when India’s Directorate of Revenue Intelligence accused the IT giant of customs duty evasion to the tune of Rs 1,450 crore ($325 million).

The company has strenuously denied what the Times of India describes as “the biggest customs duty evasion by any company in India”, saying it will challenge the allegations ‚Äòthrough the judicial process’.

The DRI alleges that HP’s Indian division, Hewlett Packard India Sales Pvt Ltd, undervalued computer equipment it imported

This is, of course, an allegation as yet. But it’s worth highlighting. Some (oh well, for the sake of the record – let’s call them Oxford University’s Centre for the non-Taxation of Business) claim that multinational corporations artificially transfer price into a location such as India, so creating a corporation tax liability there becasue this favours them.

As this allegation, however, reveals, and as those who have worked in such countries consistently report,

That’s not true. No doubt in this case it is alleged that the duty saving is greater than any additional tax paid on profits. So India will still be losing.

It’s a shame some tax academics really know so little about the complexities, comprehensiveness and inter-activity within tax systems when they write misleading reports and make incorrect claims.

Jersey Finance: promoting transfer mispricing

Jersey, Secrecy jurisdictions, Tax avoidance, Tax evasion, Tax Havens, Transfer Pricing 1 Response »

Apr 072010

It’s really very strange to note that Jersey Finance have issued a report criticising Christian Aid’s reports on transfer mispricing. There are a number of very good reasons for thinking it so, even before I turn to the deficiencies in the report they have issued.

First of all, what, might one ask, has this to do with Jersey? It’s a good question, because it does not feature in those reports Christian Aid have issued. Nor would it seem likely that it should. Christian Aid’s work relates to mispricing of goods, not services. More than 50% of Jersey’s GDP is generated from financial services. That is not a trade in goods. It is a trade in services. Jersey has remarkably little trade in goods – apart from the tax abusive trade in importing and immediately re-exporting low priced goods from and too the UK, purely to avoid UK VAT – and so the question has to be asked why they might have sponsored such a report on an issue of no apparent interest to them?

Second, one has to wonder why they used the services of Richard Teather to undertake this work. Teather is a man of my acquaintance who promotes almost any cause that will make the wealthiest richer and the poorest poorer, whether it be flat taxes, tax competition (or tax haven activity by any other name) or even (and this one is key), tax evasion. As I have noted time and again, in his book on tax completion for the Institute of Economic Affairs he said when discussing attacks on tax havens by democratically elected governments

This is attacking a classic use of a tax haven, as explained in the previous chapter, in which a person resident in (or otherwise subject to the taxation system of) a highly taxed country places his capital in a tax haven where it can earn untaxed income. While there are many cases where the home country does not tax foreign source income (such as the UK’s non-domicile exemption discussed above), most Western countries have a worldwide taxation system that seeks to tax the worldwide income of its residents (or all of its citizens in the case of the USA). This tax haven income therefore does not cease (legally) to become liable to tax merely by being earned offshore: it is still liable to tax and the investor has a duty to report it to his home tax authority. In practice, however, if the investor does not report his income, then the home country can have great difficulties in discovering and taxing it, particularly if the haven country has strong banking secrecy laws.

While I am not seeking to condone dishonesty or criminal activity, from an economic perspective this is merely another example of tax competition: indeed, it is often necessary behaviour in order to take advantage of tax havens. Without the willingness of some to engage in this sort of activity, tax competition would be much less effective and therefore reduce the benefits that flow from it for the rest of us.

Prima facie that looks like an endorsement of tax evasion. He has commented on this site that he does not support tax evasion in the UK. When I asked him in response in which he jurisdictions he was supporting it he did not respond. Based solely therefore on his own writing real question has therefore to be asked about Richard Teather’s ethics, let alone whether it is appropriate that he undertake work on behalf of a body representing the regulated financial services industry.

Third, whilst I note Teather is a chartered accountant I also note he has no background in economics, statistics or any other relevant subject.

Fourthly, and rather oddly, although Teather rather boldly claims that “unfortunately the underlying data has not, until this time, received …attention” this is simply not true. The issue was discussed – somewhat unsatisfactorily because the NGO side was precluded from the debate – in the pages of Taxation recently, and the comments I, Raymond Baker of Global Financial Integrity and Alex Cobham of Christian Aid made in response to challenge there can be found here. They deal with all the issues Teather raises and his claims are undermined at a stroke. They’re also undermined by the fact that much of a conference at the World Bank last year, which Raymond Baker, Alex Cobham and I attended, was devoted to this issue, and only the most biased of observers could say that any serious charges were made to stick against Christian Aid’s work. That does, though beg the question as to why Jersey Finance, funded as it is by the Jersey government, would want to fund a study that actually covers old ground at this time.

Fifth, if they did want to address an issue of no apparent concern to them, why was it they did so quite so remarkably inadequately? No one – and certainly not me, the Tax Justice Network, Christian Aid, Raymond Baker, Alex Cobham, or anyone else would say the view given in the two reports Teather refers to are definitive. No one would even claim Raymond Baker’s work – although constructed on wholly satisfactory methodological principles – was now either up to date or the latest word in this issue, because clearly it is not. Teather deliberately ignores new reports from Global Financial Integrity, funded by the Norwegian government, working on entirely different statistical bases from that which Christian Aid use which support (within reasonable limits making allowance for the quality of data, statistical methods and such things) the work of both Christian Aid and Raymond Baker’s earlier work. In other words, using a variety of methods, data and statistical approaches the data on transfer mispricing broadly triangulates.

Of course “broadly” is the right word. There are remarkable data deficiencies in this area, which all who work in it acknowledge. That is why those of us working in it produce data that we always think understates the claims we make. This has, for example, recently been evidenced by the IMF acknowledging that funds held offshore may now be at least $18 trillion a year – a significant leap upward from the $11.5 trillion estimate for which I was ridiculed for some time, quite erroneously as history is now proving. In the case of transfer mispricing the data we have produced is also bound to be understated, whatever the inaccuracies (and they exist) in the models used to estimate the losses arising within the trade for goods. There are three reasons for this.

First the estimate made includes no calculation for transfer mispricing in transactions for services. Most informed commentators now think this is an area where abuse is likely to be much larger than in the trade for goods where systems have improved during this century.

Second, much (but not all) of the work relates to transfer mispricing where the goods are reinvoiced between the point of first export and the final point of arrival. This is, of course, something that does happen in places like Jersey, is almost always abusive, and may explain their interest in this issue because this is the only role they can have in this activity – and if that is the explanation it is one that hardly becomes them. They might have been wise to keep their heads down in that case. However, a lot transfer mispricing will actually occur within an invoice i.e. the goods are shipped out at too low a price and arrive at their final destination at that under price as well but the methods used do not generally find this. This means the transfer mispricing estimate offered is bound to be understated.

Third, all issues relating to finance, interest, royalties and other such issues are excluded. Which is convenient for Jersey.

Teather ignores all these points, completely.

What he does do is nitpick. Since he adds little to the debate in doing so I will not spend long on the flaws in all he has written. Suffice to say that the data Christian Aid used is the best available in the world – it reflects much of the available data on world trade, no more or less. It may have weaknesses in it that may disguise errors, but that is all that is available. And given the enormous size of the population available any error one way is highly likely to be countered by an error the other way – that is the nature of large samples, rather conveniently.

To argue that the data is not good enough for the job in hand is also absurd – it is the data that is deemed decision useful for determining much of trade policy worldwide. That makes it fit or this purpose. To claim otherwise is firstly disingenuous.

Second, to argue in this way is to seek to deny the problem exists by claiming that only perfect data could prove the existence of a transfer mispricing problem. This flies in the face of all known experience of tax authorities and the triangulated data noted above, all of which shows the problem does exist.

Third seeking to demand, as Teather does, that there be data correction before use to eliminate certain transactions is absurdly arrogant. How, after all, does Teather know that outliers are either a) wrong and b) not compensated for, as I note previously?

Next, to use an interquartile range to estimate acceptably priced goods, as Christian Aid does, is not a random act of the researchers as Teather would seem to have it – it is the action of the IRS, who use the same method. If it is good enough for tax authorities to use it to identify risk, why shouldn’t Christian Aid use it?

Finally (for now), as Teather notes, the results do not say the abuse is all in the developing world. They’re not. We acknowledge that. That’s to the work’s credit, not discredit. It also signals that there is still a major problem of abuse – which he does not in any way seek to consider or address despite the obvious impact it might have on well being in developed countries. Why does he turn a blind eye to this finding? Is it because he is, as is noted to be his habit, happy to endorse such abuse as a beneficial facet of “tax competition”?

So, what does the report add to understanding? Well, nothing at all. Everything has been rehearsed before.

But what it does tell us is that Jersey Finance is worried about something – and since logically it can only be re-invoicing activity in the area of transfer mispricing of goods we have to assume as a result that this activity is substantially more significant to the financial services industry in the island than we previously thought.

What too does the report say? That Jersey Finance is undertaking – as we already know – a very strong campaign to seek to undermine those who question tax haven / secrecy jurisdiction abuse – precisely because they are still in favour of it. This makes their weasel words on compliance with international cooperation and rooting out of tax abuse look exactly like what they really are – weasel words.

Finally, in choosing to align themselves with a person who condones the beneficial social effects (as he sees them, and which they explicitly refer to them in their web biography of him) of tax haven / secrecy jurisdiction abuse Jersey Finance shows its true colours – as a friend of political extremism, as a supporter of tax structures designed to undermine the tax revenues of other places and as such as an opponent of the democratic right of sovereign states to tax in accordance with the democratic mandate their electorates have given them.

This suggests Jersey Finance still sees Jersey as a classic secrecy jurisdiction. Secrecy jurisdictions are defined as places that intentionally create regulation for the primary benefit and use of those not resident in their geographical domain that is designed to undermine the legislation or regulation of another jurisdiction. They do in addition create a deliberate, legally backed veil of secrecy that ensures that those from outside the jurisdiction making use of its regulation cannot be identified to be doing so.

Jersey Finance is saying leopards don’t change their spots and that Jersey is as ever it was.

And as a result Jersey Finance is openly promoting tax abuse – even if licit – that does, without doubt, harm the developing countries of the world and the poor wherever they are.

Jersey Finance might do that. But what one hopes is that the politicians of Jersey, the people of Jersey, maybe even those responsible people working in finance in Jersey will realise that Jersey Finance is failing them badly by doing all this.

Is that too much to hope?

A lack of will, not a lack of evidence

Country-by-country, Development, Secrecy jurisdictions, Tax Havens, Transfer Pricing, Transparency Comments Off

Mar 122010

On 17 February the editor of Taxation magazine, Mike Truman, wrote an article under the title ‚ÄòLack of Evidence’, the summary of which said:

The claim that poor countries lose $160 billion in tax from ‚Äòtransfer mispricing’ has been repeated endlessly. MIKE TRUMAN finds it hard to justify

KEY POINTS

Two Christian Aid reports claim $160 billion tax lost.

Raymond Baker’s 7% claim does not relate to TNCs.

Problems of methodology in Simon Pak’s study.

Real shortfall is homegrown tax evasion.

Raymond Baker of Global Financial Integrity, Alex Cobham of Christian Aid and I wrote a response, published this week. It is entitled ‚ÄòLack of Will’.

That response is behind a paywall and so is not on public record, even though the critical article is.

There is also apparently an on-line debate going on about the issue – which none of us can read or contribute to as it is also behind a paywall. So much for debate. In the circumstances I think it entirely appropriate to republish our response, below. I leave it to others to work out the ethics of publishing criticism on open pages and denying response and debate a similar airing.

—————————————————-

Lack of will

Transfer pricing abuse is a massive global problem, argue

Richard Murphy , Alex Cobham and Raymond Baker.

Mike Truman, in his comment article ‚ÄòLack of evidence’, Taxation, 17 February 2010, page 6, questioned work we have, in various and different ways, undertaken to estimate the loss arising to developing countries from transfer pricing abuse – or transfer mispricing as we prefer to call it.

We think Mike is saying three things. The first is that Raymond Baker’s work on this issue, published in his 2005 book Capitalism’s Achilles Heel, used an inappropriate interview-based methodology to establish a potential rate of transfer mispricing, which he anyway contends is now out of date.

Second, he challenges Christian Aid’s May 2008 report on transfer mispricing ‚ÄòDeath and taxes: the true toll of tax dodging’, which suggested that the loss to developing countries from transfer mispricing might be as much as $160 billion a year because that reports relies in part on Baker’s work.

Finally, Mike questions the findings of Christian Aid’s second report on the subject (published in March 2009), ‚ÄòFalse profits: robbing the poor to keep the rich tax free’, which relies on the statistical analysis of world trade data using a methodology developed by Professor Simon Pak of Penn State University.

Based on his analysis, Mike concludes:

¬? transfer mispricing is not the issue we claim it is;

¬? country-by-country reporting as proposed as one solution to this problem is not therefore as important as we claim it might be; and KEY POINTS

¬? Illegal flows out of developing countries could be up to $1 trillion annually.

Despite our high regard for Mike, we have to disagree with him on all counts, although in the space available cannot address all the issues he raises.

Methodology

First let us deal with methodology. Raymond Baker in his book only examined mispricing in arm’s length transactions, i.e. between unrelated entities. Having done so, and based on personal experience, he concluded that while it was highly likely that the rate of mispricing was higher in related party transactions, he would only use the figure his interviews had established to be likely between unrelated entities. Three things should be noted as a result: first this is likely to be a conservative estimate. Second, research based on semi-structured interviews is considered entirely suitable as a basis for research in all social science disciplines, including taxation. Third, while now relatively old research, subsequent work has corroborated the findings .

That subsequent research includes new work published by Global Financial Integrity (GFI), a project Baker now directs. Its study of illicit financial flows, published in 2008, defined illegal flight capital as funds intended to disappear from record in their country of origin, with the earnings on the stock of illegal flight capital outside of a country not normally returning to that country of origin.

The report recognised a number of mechanisms that that can be used for this purpose, of which transfer mispricing was just one. As it noted, since this activity is illicit, available data with which to assess its scale is oft en incomplete or inaccurate: the work accepted that risk, as do all other studies in this area. That said, GFI used several methodologies and databases to estimate both the legal and illegal components of flight capital, including the Hot Money, Dooley, and World Bank residual methods, IMF Direction of Trade Statistics, and the International Price Profiling System. All are widely used, recognised and considered by those bodies that have given their name to some of them as the best available methodologies.

Based on this work, GFI estimated that illicit financial flows out of developing countries are some $850 billion to $1 trillion a year. We believe this estimate is conservative. It does not, for example, include transfer mispricing within the same invoice, which cannot be picked up in mispricing models based on IMF Direction of Trade Statistics.

Such mispricing is entirely possible within multinational corporations which do not need to rely on reinvoicing. Nor does it provide any estimate of the loss due to transfer mispricing on services or intangibles, which are perhaps more open to abuse given the difficulty in identifying comparables to establish an accurate arm’s length price.

The IMF Direction of Trade Statistics on which the estimate of transfer mispricing is primarily based measures the difference in exports out of one country and imports into another country for all pairs of reporting countries. After subtracting the cost of freight and insurance, the only way to get a difference in export and import prices (other than mis-entering the data which might itself be indicative of mispricing) is to reinvoice, for example through tax haven locations. It is this reinvoicing that the GFI data records meaning that mispricing within the same invoices would have to be added to these figures to get a more accurate analysis of total mispricing.

Transfer pricing abuse

The GFI report in 2008 estimated that at least half of all illicit financial flows out of developing countries involved transfer mispricing. In February 2010 a further GFI report, ‚ÄòThe implied tax revenue loss from trade mispricing’ sought to quantify the tax loss arising from these illicit flows and concluded that the average tax revenue loss in developing countries was between US$98 billion and US$106 billion annually over the years 2002 to 2006. This figure represents an average loss of about 4.4% of the entire developing worlds’ total tax revenue.

The methodology used is one some commentators will challenge: it assumes that the identified flows of transfer mispriced funds would have been taxed at the marginal corporate tax rate of the location they fl owed from. This ‚Äòtax gap’ methodology, developed by Richard Murphy, has been challenged by some as misleading since its opponents argue that it ignores the availability of reliefs and allowances that might have reduced the effective tax rate below the nominal tax rate.

We do not agree for two reasons. First, if those reliefs had been available in respect of these profits, it would have been rational to have used them. We assume we are dealing with rational entities. They were not used, so presumably they were not available, meaning that tax would have been paid.

Second, to assume that the allowances and reliefs that multinational corporations enjoy in developing (or other) countries are independent of their considerable economic power in such places when negotiating inward investment, or are even independent of other illicit financial flows such as those resulting from bribery, is untenable. Numerous reports, including some by the authors of this article, for Christian Aid, Global Witness and others attest to this fact. As such we suggest that the methodology records a potentially recoverable loss, and that is its purpose.

Bilateral trade

Simon Pak’s approach to this issue is different from Raymond Baker’s. Christian Aid notes the OECD estimate that at least 60% of world trade now takes place within multinational corporations rather than between arm’s length bodies. For the years 2005-2007, Simon Pak analyses data on all bilateral trade on commodities with the US and European Union to determine the extent of losses arising on this intra-group trade. The US and EU provided the data for this purpose.

The data is the most granulated available: so detailed that HMRC would not provide it directly for the UK because identification of individual trades was possible in too many cases. 83.7 million EU trades were analysed by Pak in 2007, for example. Only data where price estimates per unit supplied could be calculated was used. By definition services are excluded, and given that the majority of transfer mispricing is now likely to be in this area this will result in any estimate we offer significantly underestimating total losses from this activity.

An important assumption in the price filter analysis method Pak uses on the resulting data is that the estimated inter-quartile price range per unit of product traded is an arm’s length price range. This assumption is suggested by some to be arbitrary. However, the assumption is considered reasonable as the US Internal Revenue Service transfer pricing regulation, Internal Revenue Code 482, specifies that an inter-quartile range is an acceptable arm’s length transaction range. We believe that provides credibility to the approach used but we accept that the point is debatable, but then everything in statistical analysis is. This does not invalidate statistical analysis as the basis of much, if not most, academic tax analysis and in turn a great deal of tax policy worldwide.

Lost tax revenue on capital flows as a result of trade mispricing is then calculated on a country-by-country basis by multiplying the capital flow by corporate marginal tax rate for each country in question: this approach accords with that used by Baker/GFI, noted above and acceptable for the same reasons.

Losses underestimated

This approach is reflected in the second Christian Aid report noted above, but not the first. As that second report notes, the approach seeks to use Pak’s methodology to estimate how many imports to the EU and US from non-EU countries are underpriced, and how many exports from the EU and US are overpriced to facilitate illicit capital transfer from non-EU countries. In doing so it is likely to underestimate the losses, partly because services are not considered and partly since the techniques used will underestimate mispricing because over and under pricing is aggregated by the methodology. There is also the risk that averagely priced transactions may be mispriced. This possibility is not detected.

In contrast, it is accepted (and noted in the relevant report) that there is an opposite risk with regard to products with highly volatile prices, e.g. oil. There, averaging over an annual period,

as the method does, might produce errors. Across the whole spectrum of trade this is assumed to be a counter-balancing error, but it does also explicitly recognise that the issue raised by Mike Truman in his article is a matter of concern, but not one considered likely to be material.

The result of the work is an estimate of lost tax revenue from all non-EU countries to the EU and the US between 2005 and 2007 of £190.8 billion or about £63.6 billion a year ($127 billion a year at 2007 exchange rates). Given that this implied lost revenue is based on EU and US trade, and assuming that trade between developing countries and the rest of the world is characterised by a similar level of mispricing, Christian Aid extrapolated this figure to find it consistent with their earlier estimate of $160 billion globally.

All of the estimates reviewed fall in the range $100 billion to $160 billion a year. As yet unpublished research by Richard Murphy for the World Bank undertaken in 2009 shows it is plausible for transfer mispricing of this scale to take place within multinational corporations.

Consistent estimates

Our point now is to suggest that we are presenting broadly consistent estimates within a range. We are not claiming spurious accuracy. As other studies have shown, e.g. that of Clemens & Fuest for the Department for International Development in June 2009, no one outside the small circle of NGO researchers noted here has even sought to do this work. Many have sought to criticise it. We accept it is open to improvement. We also accept, as should any researcher, that the flaws in available data make the results offered estimates. We would however stress, that if the data is fl awed it is likely to be because of trade mispricing, not its absence.

We would also add that the direction of this flow should be noted: overall additional funds arrive in the EU and USA. They may be taxed there, usually at lower rates than would have been paid in developing countries. Many will come through locations such as Switzerland and Hong Kong and in case study after case study we have seen this to be true. This lets us immediately dismiss the main thrust of Bill Dodwell’s assessment of our work as implausible: we do not know of tax authorities which take transfer pricing cases to argue down their revenues. This is what would be required if Dodwell’s assessment assertion was to be correct.

That said, Christian Aid does also show a transfer of capital from the US and Japan to Europe. Given the use made by corporations from both locations of European holding companies to act as worldwide sales agents, nothing surprises us about this. Indeed, work by Martin Sullivan for Tax Notes in the US has long documented this trend, noting in 2004 that American companies were able to shift $149 billion of profits to 18 tax haven countries in 2002, up 68% from $88 billion in 1999. This strongly suggests that this direction of flow is correct, the strength of the transfer pricing regimes of those countries notwithstanding.

All this being noted, the important thing is to ask what does potential transfer mispricing of this scale from developing countries imply? First, the losses are, even if the lower end of the estimate range is considered, more than twice the sum required to pay for the United Nation’s Millennium Development Goals.

In other words, we believe that reducing (but not eliminating) transfer pricing abuse could eradicate extreme poverty and hunger, achieve universal primary education, promote gender equality and empower women, reduce child mortality, improve maternal health, combat HIV/AIDS, malaria and other diseases, ensure environmental sustainability and help develop a global partnership for development. If that is the case, the argument for inaction has to be very strong indeed.

Any action does, however, have to recognise the reality of taxation in developing countries. It is essential to bring the poor into the tax base, as it is likely to result in stronger engagement in political processes, and strengthen accountability between state and citizen.

However, in the short term, income taxation will have limited revenue impact given the weak economic base. Taxing a small elite of individuals, civil servants, major corporations, international trade and natural resources when present is likely to have a much greater revenue impact. To be effective the largest available flows must be taxed.

Stricter tax reporting

We suggest three things to ensure that these flows are taxed as effectively as possible. The first is that, and here we agree with Mike, significant technical support to tax authorities in developing countries is needed – as well as cash to ensure their best staff are not continually poached by the biggest firms of accountants.

Second, we argue for country-by-country reporting by multinational corporations. Mike is entirely wrong to say this cannot help. HMRC now publicly concede that country-by-country reporting by multinational corporations would increase tax yield in the UK. We do not however argue it is the solution to transfer mispricing: it is not. What it does is provide the data that can show whether pursuing a case is likely to be worthwhile. When resources are scarce, as they are in developing countries, this is vital. The tiny experience of transfer pricing litigation in Africa to date suggests that the simple absence of data on differing profit rates by location within multinational groups – data we think was deliberately withheld by those multinational corporations to assist their cases – is a major inhibitor to any chance of success on this issue. Country-by-country reporting would help provide this data.

Country-by-country reporting does much more: it is now seen as a key component in effectively tackling corruption in the extractive industries, for example. It is, therefore, a key component in tackling the very issue Mike says is an impediment to progress. It also provides enormous value to shareholders concerning the timing and location of tax liabilities that their company faces. To dismiss country-by-country reporting because it cannot solve transfer mispricing by itself is absurd.

Lastly we promote massive increases in the range and scope of information exchange agreements available to developing countries so they can secure the data they need to address issues on transfer mispricing, which also impacts revenues from royalties, sales taxes, export levies and more besides. Developing countries are almost entirely excluded from the tax treaty network. They start with a massive asymmetric information disadvantage as a consequence, which makes their current task almost insurmountable. This economic externality has to be removed if they are to have any chance of building successful states.

In these circumstances to suggest the problems faced are the result of home-grown tax evasion misses the largest part of the picture. Nothing but abuse by those unscrupulous businesses can explain the data differences we have consistently found. We can argue about the scale of the abuse but not its existence. Even then, suppose we had overstated the scale of this issue twofold and only half the problem could be effectively tackled using the mechanisms we promote. That would still eradicate extreme poverty and hunger, achieve universal primary education, reduce child mortality and improve maternal health while leaving some over to tackle AIDS and other major diseases.

Can anyone give a good reason why the tax profession would not want to do that when all the evidence suggests that tax compliance by multinational corporations – where tax compliance means seeking to pay the right amount of tax (but no more) in the right place at the right time, where right means that the economic substance of the transactions undertaken coincides with the place and form in which they are reported for taxation purposes – could achieve these aims?

We don’t know of any.

AstraZeneca to pay £505m to settle UK transfer mispricing dispute| guardian.co.uk

Country-by-country, Transfer Pricing Comments Off

Feb 232010

AstraZeneca agrees to pay £505m to settle UK tax dispute | Business | guardian.co.uk .

As the Guardian notes:

AstraZeneca, the Anglo-Swedish drugs group today agreed to pay £505m to the British tax authorities in a move that could have far-reaching implications for other UK multinationals.

The pharmaceuticals company agreed to foot the bill in a case that involves the complex system of inter-company tax accounting known as transfer pricing, which enables companies to book profits from a subsidiary in a high-tax area to one in a low-tax jurisdiction, minimising tax payments.

I’m well aware Astra have long declared their innocence on these issues: not so it seems. The case adds to a string of successes on this issue for HM Revenue & Customs.

For Astra it’s an embarrassment. As the Guardian notes:

AstraZeneca said: “We draw a distinction between tax planning using artificial structures and optimising tax treatment of business transactions, and we only engage in the latter.” The company denied any wrongdoing.

I don’t dispute the wrong doing bit, but it clearly was not tax compliant in the opinion of HMRC. Tax compliance is seeking to pay the right amount of tax (but no more) in the right place at the right time where right means that the economic substance of the transactions undertaken coincides with the place and form in which they are reported for taxation purposes.

This is, of course an issue I have long been involved in. As the report also notes

Critics claim companies can reduce corporation tax rates by using transfer pricing, which sets the price at which one unit of a group sells goods or services to another unit of the same group in a different tax jurisdiction. Last year, it emerged that Google used a cross-border network of subsidiary companies to ensure it hardly paid any corporation tax on its £1.6bn advertising revenues in Britain. Such practices are legal, and Google said it made a substantial contribution in the UK via payroll and other taxes.

The Google expose was based on my work. As is the solution the Guardian clearly endorses:

Richard Murphy of lobby group the Tax Justice Network has long been campaigning for multinationals to be obliged to undertake country-by-country reporting to reduce the opportunities for transfer pricing.

He said the practice costs the developing world at least £100bn in lost revenues – three times the cost of the millennium development goals.

Murphy added: “The UK has promised to take a lead helping developing countries obtain the benefits of transparency and accountability. Country-by-country reporting can deliver more in that respect than anything else and the UK seems to understand that.”

They do: HM Revenue & Customs recently said that country-by-country reporting would unambiguously help increase UK tax revenue.

India gets it

Development, Secrecy jurisdictions, Tax Havens, Transfer Pricing 2 Responses »

Feb 182010

The Finance Minister of India Shri Pranab Mukherjee spoke to a seminar on transfer pricing yesterday and said:

The structure and the location of the group entities of the multinational enterprises exploit the favourable tax regime offered by the low tax jurisdictions and tax havens. This has lead to accumulation of wealth and shifting of intellectual capital to these jurisdictions. The role of tax havens and low tax jurisdictions has become an area of great concern for a country like India which is putting its all acts together to mobilize resources to attack on poverty and illiteracy.

The financial crisis faced by us has been unprecedented in recent history. It is widely believed that the tax havens and low tax jurisdictions were an important actors in the crisis. The opaque system of Exchange of Information in these tax havens and their non-compliant behaviour has been a matter of concern not only for revenue base but also linked to financing of activities which are detrimental to national security interest.

It is in our mutual interest to maintain a healthy global fiscal system which is self-sustainable and all important actors including the tax havens comply with the established norms of transparency and fiscal discipline.

I think that says a great deal in a very few words that summarise much of what the Tax Justice Network has been seeking to raise awareness of, and change.

The awareness is now commonplace. Change is happening.

We need to celebrate the good news sometimes.

Hat tip to Martin Hearson, Action Aid

New Report Finds $100 Billion Lost Each Year from Developing Countries Due to Trade Mispricing

Development, Transfer Pricing 1 Response »

Feb 132010

Developing countries are losing approximately $100 billion dollars every year due to trade mispricing, according to a new report from Global Financial Integrity (GFI).

“Every year crime, corruption, and tax evasion drain $1 trillion out of developing countries,” said GFI director Raymond Baker. “This report more closely examines one particular form of financial outflow and shows how illicit financial practices — in this case trade mispricing — deprive developing country governments of tax revenue.”

Report findings include:

The estimated range for tax revenue loss due to trade mispricing in developing countries, per year, is between $98 billion and $106 billion;
This estimated revenue loss is approximately 4.4 percent of the developing world’s total tax revenue;
The top five countries with the largest tax revenue loss are: Zimbabwe (21.5%), China (31%), Philippines(30.7%), Nicaragua (27.7%), and Mali (25.1%);
Rates of trade mispricing for the time period examined (2002-2006) nearly doubled from the first year of the range (2002) to the last (2006);
Trade mispricing is one of the most prominent drivers of illicit capital flight out of developing countries;

“Trade mispricing moves more illicit money across borders than any other single phenomenon,” noted Mr. Baker. “To curtail these tax losses, developing and developed countries alike must work to curb the global shadow financial system that facilitates illicit financial flows.”

Encouraging governments worldwide to take action, GFI recently launched its G20 Transparency Initiative which seeks to build massive grassroots support from around the world for increased transparency and accountability in the global financial system. “The G20 Transparency Campaign seeks to give people around the world the chance to weigh in on a crucial issue at a critical time,” said Baker.

Click here to download a full copy of the report, which adds to the growing literature on this subject and stresses the urgent need for action to tackle this abuse.

Note: This post is open for comments. Comments will only be accepted if they contribute positively to debate on this issue. Those that do not will be deleted.

The drugs don’t work for tax havens any more

Secrecy jurisdictions, Tax Havens, Transfer Pricing Comments Off

Dec 012009

Pharma industry faces rising tax burden, PwC says | Markets | Europe | Reuters .

On top of patent expiries and healthcare reform, drugmakers have something else to worry about — rising tax bills.

The effective tax rate for the pharmaceutical industry is set to increase as its business model changes and governments take an increasingly tough line on tax-reduction strategies, consultancy PricewaterhouseCoopers (PwC) said on Tuesday.

For the past 20 years Big Pharma has enjoyed a benign legislative and commercial environment that has enabled it to report low and stable tax rates, averaging just 23.8 percent across a sample of 12 global companies monitored by PwC.

But the sector’s current low level of taxation, which is less than is paid by most other industry sectors, now looks set to rise, PwC believes.

Why?

The global recession has made tax authorities around the world hungry for new revenue sources and governments are restricting the use of tax havens that allow multinationals, including drug companies, to move profits offshore.

Transfer pricing practices, which are often used to minimise tax liabilities, are receiving increased attention as authorities seek to limit any abuse of intra-company transfers of expenses or profits.

Which is absolutely the right direction of travel.

In many places in the world drug companies are effectively state funded: the UK is a good example. That is the most efficient model of health care supply measured by outcomes. Yet they have abused those states.

And no drug of note has ever, to my knowledge, been developed in a tax haven where the intellectual property rights to so many drugs are owned for the sole purpose of abusing tax.

So this attack on their abuse is overdue. I welcome it.