Transfer Mis-pricing: Game Over?
More than 300 tax information exchange agreements – three quarters of the total number in existence – were signed last year. As well as helping tax authorities chase down individual evaders, the agreements allow tax authorities to request information from offshore financial centres on margins and other matters relevant to “transfer pricing” enquiries, which determine how multinationals split taxable profits between countries.
As a result, according to the FT:
Multinationals are increasingly shying away from using tax havens in favour of routing transactions through low tax countries that have the benefit of tax treaties. Those treaties already contain provisions giving overseas tax authorities the scope to request tax information.
Does this mean the game's over for MNCs? The OECD's Jeffrey Owens, quoted in the article, seems fairly bullish: “I think the world is in the process of changing. It will have a big impact on corporations and high net worth individuals.”
In support of the potential shift of power away from the corporations in the direction of the state, the FT cites the case of a successful use of an information exchange treaty by the Chinese tax administration:
It concerned a Chinese shoe manufacturer which it suspected of under-declaring profits because it was related to a big US customer. It discovered “important evidence” allowing it to increase its tax demand after it issued an information exchange request that allowed it to show that payments were made to an overseas bank account controlled by one of the company’s biggest shareholders.
For many years TJN has argued that transparency is crucial to tackling abusive tax practices. Information exchange is an important part of creating a transparent operating environment. But we see tax information exchange agreements as only part of the process since they perpetuate the cat and mouse process of tax authorities chasing after information that MNCs have not been required to disclose in the first place. This is why we advocate accounting standards that require basic reporting on a country-by-country basis. This is what the FT article is referring to when it notes:
Over the past year, campaign groups have succeeded in persuading the OECD to consider new guidelines on transparency after claiming that transfer pricing abuses allow companies to divert revenues from developing countries to tax havens.
But our concerns about transfer pricing abuse run deeper. While information exchange will help tackle some forms of abusive practise, the problem remains that transfer pricing is a fundamentally flawed system for determining profits and tax liabilities between the different parts of multinational company.
The OECD has produced guidelines for how transfer pricing should be carried out, but these are phenomenally complex and don't overcome the problem of how to arrive at a world market price for a product or service that is only traded within the confines of an MNC. Worse, the existing guidelines don't even begin to tackle the vexed problem of how to price the value of an intellectual property right like a brand name or logo. Oil giant Royal Dutch Shell, for example, recently packaged its shell logo into a special purpose vehicle located in the Swiss canton of Zug. Who is to say what the value of that logo is, and how much can be charged to each and subsidiary in every country where the company operates, for the use of that logo? Critics of the existing system are bang on the button when they call it "a licence to print money."
And before you dismiss this as some minor matter of little importance to the real world, just bear in mind that the OECD has recently stated that 70 per cent of cross-border trade occurs between subsidiaries of MNCs. So there's plenty of scope for mispricing to cause mayhem.
TJN thinks this issue calls for fresh thinking. We have started an enquiry into the whole issue of transfer pricing, and in due course we will report back with our recommendations. Meantime, watch this space.