OPINION:Authorities must tighten up on a tax system that costs developing countries billions, writes DAVID McNAIR
IT HAS been called the ugliest chapter in global economic affairs since slavery. And, as with slavery before abolition, it is so widely accepted that for years it has excited little or no comment.
It is the manner in which businesses trading internationally shift billions of euro of profits between jurisdictions to reduce, or even dodge completely, their tax bill.
With multinationals, a system called transfer pricing covers the sale between subsidiaries of the same parent company of everything from nuclear reactors to cornflakes. Also included are intangibles for which a price is levied, such as intellectual property rights, management services and insurance.
As long as the subsidiaries of the same multinational charge each other a fair market price, known as an “arm’s length price”, such transactions are perfectly legitimate.
However, with 60 per cent of world trade now taking place within, rather than between, multinational corporations, the way fees are determined has become increasingly opaque as arm’s length pricing is forgotten and the figures are manipulated to reduce tax.
Unrelated companies, meanwhile, make secret deals with each other for exactly the same reason. Collectively, the abuse is known as “trade mispricing”.
What makes this a matter of concern for all of us is the impact such tax dodging has on the global economy. Much of the illicit capital flows into the European Union and the United States, while the victims are all too often poorer countries where the revenue authorities have neither the expertise nor resources to fight back.
New research commissioned by Christian Aid highlights the true scale of trade mispricing for countries rich and poor alike and reveals for the first time how much each country loses to the EU and US, Britain and Ireland.
Examples include the import into Spain in 2007 of 40 million refrigerator-freezer units from China, ostensibly at a cost of just €0.27 each, and 26 million units at only €0.56 each. This resulted in €8.08 billion being shifted out of China.
In the same year, Malaysia exported huge quantities of fixed resistors (an electronic component) to the US through a total of 18 separate transactions at prices lower than one cent. This resulted in US$164 billion (€123 billion) being shifted out of Malaysia.
The figures are almost unbelievable, were it not for the fact that this research used the most robust methodology and the most comprehensive trade data available and was conducted by international expert Prof Simon Pak, president of the Trade Research Institute.
Prof Pak, who has advised US Congress on this issue, analysed bilateral trade in every tangible product between 2005 and 2007, calculated the parameters of the normal price range for products traded between countries, and estimated the amount of capital shifted by trades that are outside that normal price range.
The totals he arrived at included prices that had either been artificially depressed or artificially inflated for capital flight and tax purposes.
The research estimates that, between 2005 and 2007, this abuse resulted in a total amount of capital flow from non-EU countries into the EU and US of €850.1 billion. If tax had been levied on this capital at current rates, non-EU countries would have raised €279 billion in revenue.
Meanwhile, the world’s 49 poorest countries would have raised an additional €2.6 billion in tax. Among the low-income countries, the biggest tax losses occurred in Nigeria (€734 million), Pakistan (€446 million), Vietnam (€367 million) and Bangladesh (€272 million).
Together, the total tax loss by emerging and developing countries is more than the annual global development aid budget and much greater than the $40 billion to $60 billion the World Bank has estimated would be required annually to meet the millennium development goals aimed at halving extreme poverty by 2015.
Ireland has a role to play in this widespread practice, having successfully pursued a business- friendly tax strategy to attract foreign direct investment. Christian Aid’s research challenges the conventional wisdom that this practice is without cost.
While most of the estimated €5.8 billion mispriced capital that flowed into Ireland between 2005 and 2007 came from high-income countries, €268 million of that total came from the world’s 49 poorest countries. That figure was more than a quarter of Irish Aid’s total aid budget for 2008 (€899 million).
International accounting standards require multinational companies to report accounts on a global consolidated basis. This means no one – not government revenue departments, investors or civil society organisations trying to monitor the activities of big business – knows where taxable economic activity is occurring and where profits are declared. This makes it easy for firms to shift capital and pay tax (or not, as the case may be) where they choose.
The introduction of a requirement that businesses operating transnationally must reveal publicly how much profit they make, how many people they employ, and what they pay in tax in every country where they do business would enable the worst abuses to be identified quickly.
Such country-by-country reporting would show if a company was declaring unexpectedly high or low profits in different jurisdictions, including recognised tax havens. This would enable developing- country tax authorities to prioritise which financial flows to investigate further.
In addition, a requirement for all states to exchange automatically the tax information they hold from companies and individuals would enable revenue authorities to monitor transfer of beneficial assets. Compliance would be evaluated objectively.
In developing countries, the levying of proper taxes would help provide the revenue needed for education, healthcare and infrastructure, and go some way towards ending dependency on overseas aid, which at this time of crisis is already under pressure.
The evidence in our report is clear: clamping down on trade mispricing would bring global benefits to both rich and poor.
Dr David McNair is Christian Aid’s senior economic justice adviser