MISUSE AND ABUSES OF TRANSFER PRICING
Misuses and abuses of transfer pricing
is a tropical issue that has gulped quality resources that could be used to
fend for other facets of the global economy. The central conclusion made by
Eccles (1985) is that transfer pricing is an integral aspect of implementing
strategies. What this means is that transfer pricing is a strong strategic tool
used by managements to achieve their objectives. Part of this objective could
be to pay lesser tax and returning more profits to the shareholders. Koch
(2009) pointed out that strategy is a useful tool that can be used at all
levels of management but, very vulnerable to abuses and misuse. Abuses and
misuse of transfer pricing as a strategic tool has been more pronounced in tax
strategies of companies. Sikka and Willmott (2010) supported this view by
arguing that even though transfer pricing has the potential of enabling
companies avoid double taxation, it is also open to abuse as companies use
transfer pricing to shift profit artificially from a high tax jurisdiction to a
low tax jurisdiction. They achieve this by manipulating expense and cost allocation
strategy.
Transfer
pricing practices according to Sikka and Willmott (2010) are responses to
opportunities that can be exploited in a bid to enhance personal or private
gain by reducing payable taxes in an inappropriate manner. This assertion is
supported by some evidences from both developing and developed economies. What
this recent evidence proving the abuse and misuse of transfer pricing did not
take into account is the recent developments and changes that have been made to
legislations and laws governing transfer pricing, information exchange agreement
and Advanced Pricing Agreement (APA). The discussion of these steps taken to
reduce the prevalence of the use of transfer pricing as a tax avoidance tool
will be the subject matter of section two of this chapter.
While
providing supportive evidence suggesting that tax avoidance is used as income
shifting tool among the OECD countries, Bartelsman and Beetsma (2001) held the
view that baseline estimates suggest that a substantial share of the revenues
from a unilateral increase in the corporate tax rate is lost because of a
decline in the figure reported as taxable profit.
Mehafdi
(2000) while probing into the ethics of transfer pricing observed that this
practice of spending resources in pursuit of cost allocation for tax purposes
does not add value, rather, it generates costs. Looking at this situation from
the economic point of view, it would be safe for one to conclude that
unnecessary cost incurred by managers as a result of tweaking mix of transfer
pricing is a good example of situations where transfer pricing practices are
abused and misused. These costs include the consultancy fees paid to
accountancy firms for transfer pricing services.
INTERNATIONAL TAX COMPETITION AS A
STIMULANT TO TAX AVOIDANCE
According
to Kassicieh (1980), (Brown 1972) shows that some multinationals have a much
larger gross sales figure than many countries’ gross national product. This
could be one of the numerous explanations that can be provided for the increase
in what Edwards and Rugy (2002) referred to as unhealthy international tax
competition. Countries in the bid to attract direct foreign investment
sometimes engage in unnecessary tax shelter and rebate. This practice is an
economic waste that the OECD set out to curb. The increased mobility of cash
flows that globalization brought about is the main catalyst of this problem.
Chen and Smekal (2004) proposed that a model of tax cooperation can solve the
problem of international tax competition and improve the welfare of participating
countries. The problem however according to the authors is the implementation
aspect of this tax cooperation agreement as every country of the world tries to
take advantage of the economic vulnerability of other countries. This proposed
solution of solving international tax competition made by Chen and Smekal
(2004) goes against the comment made by Edwards and Rudy (2002). Edwards and
Rudy (2004) argued that international tax cooperation as a solution to
international tax competition is a dead end as it does not make any economic
sense it does nothing to promote economic growth or solve the problem of
inefficiency in tax system. It is rather too early for one to make a sound
conclusion as to the beneficial effect of the current tax information exchange
that is in my opinion a form of international tax cooperation that may help
reduce the incidence of tax avoidance.
DOUBLE TAXATION TREATIES AS A WAY OF
REMOVING MNES MOTIVATION FOR GAMING TRANSFER PRICING
Double
taxation treaties are often viewed as a way of remedying the aftermath of
international tax completion. Chisik and Davies (2004) while examining the
evidences behind the asymmetric FDI and tax treaty bargaining warned that the
role of bargaining should not be ignored while signing double taxation treaties
as a way of eliminating international tax competition which is viewed by many
to be the major incentive that drives multinationals to indulge in activities
that would help them move profits out of territories where the tax landscape is
not so accommodating.
ROLE OF ACCOUNTING FIRMS IN THE
PROMOTION OF TAX AVOIDANCE SCHEMES
Accountancy
firms are the ones championing and encouraging companies to tailor their
transfer pricing strategies in a fashion that will shelter some of the company’s
profit that would have otherwise been taxable. Sikka and Hampton (2005)
provided some evidence of the involvement of accountancy firms in developing
and selling transfer pricing strategy packages to corporations and wealthy
individuals. A good example of accounting firm that does this is KPMG, as
reported in its 2010 annual report
“Our Tax practice performed well
as we put more of our resources into providing class-leading advice on
pensions, international tax structuring, transfer pricing and the management of
indirect taxes” KPMG 2010 annual report.
KPMG
is not alone in this practice of helping multinationals find a way around
taxation as PWC proudly parades them self as award winner in transfer pricing
strategies
“We are International Tax Review’s UK and European
transfer pricing firm of the year…” PWC, 2010
One would not have ordinarily complained if
this award was to be given by another body other than a tax review body. The
implication of this is that accounting firms’ transfer pricing products are
tailored to encourage tax avoidance which is even encouraged by a professional
body. One way or the other, it could be that the objective of the transfer
pricing products designed by these accounting firms for their clients helped
reduce taxes to the extent an award was given for it.
ECONOMIC AND SOCIAL SIDE EFFECTS OF
TRANSFER PRICING ON THE SOCIETY
According
to the estimate of the US Senate, over 100 billion dollars of revenue are lost
from tax evasion every year Organization
for Economic Cooperation and Development (OECD) website (2010).
The implication of this is that fewer resources will be at the disposal of
infrastructures and social welfare administrators such as educational sector,
defence ministry and health administrators.
A
Christian Aid report in May 2008 predict that illegal, trade-related tax
evasion alone will be responsible for about 5.6 million deaths of young and
vulnerable children in the developing world between 2000 and 2015. If this
estimate of the Christian Aid is anything to go by, it could then be concluded
that the over 100 billion dollars of revenue loses as estimated by the US
Senate contributes to the decaying welfare condition of the poor countries. Some
writers in recent time like Tuner (2010) have established a link between tax
avoidances and crime rate. Their argument is a sound one when considered from
the socio-economic perspective. Take the funding of police and other security
agencies for example. When underfunded, the police will have no choice but to
be short staffed and ill equipped to effectively carryout their duties. If not
for the fact that so much revenues has been lost in the form of tax avoidances,
what would have made the UK government to think of withdrawing police force
from the street? No wonder the UK Uncut refused to be put off the street in
their protest against public services cut. Sikka and Hampton (2005) noted that;
the ordinary citizens, equality, democracy, justice and fairness are all
invisible casualties of transfer pricing. They also stated that despite the
record corporate profits and economic growth, over four billion people still
live on less than $2 a day.
TAX HAVENS AND TAX AVOIDANCE
Tax
haven which according to Dharmapala and Hines Jr. (2007) is more predominant in
countries that are well governed is any country that is known for helping
individual and corporate bodies avoid paying taxes. Some tax havens now
advertise their status as safe tax haven – Belize for instance. What this means
is that by stacking your money in a safe tax haven or routing your funds
through their country, information about you and your financial dealings will
not be given out to tax authorities of other nations. On first thought, one
might think that all hope is lost as far as curbing the activities of tax
havens are concerned considering how Belize managed to escape sanctions that
would have crippled her economic activities to becoming the most sought after
safe offshore of tax avoiders, drug traffickers and money launders haven. As
real as this might look, things are beginning to change as countries like;
Austria, Switzerland, Luxembourg, Liechtenstein, and Andorra are beginning to
relax their bank secrecy laws which will allow certain movement of funds
tracked and reported to the relevant fiscal agency for necessary actions. More
of these positive steps will help ensure that tax dodgers will really have to
work hard before they will have economic justification for engaging in tax
avoidance. Also, the case of Belize is however an exceptional case as no other
country is known to have successfully replicated what Belize did.