Transfer pricing is a tricky game
The resurgent interest in transfer pricing abuse by multinationals might be missing the first “link in the chain” – the shifting of profits inside South Africa to the detriment of empowerment partners, workers, communities and the economy.
This is the emerging line from a prominent think-tank, the SA Mining Development Association and one that is supported by the department of trade and industry and others.
The Alternative Information and Development Centre (AIDC), a union-friendly think-tank, this past week released a new report on platinum producer Lonmin and its alleged export of profits to dodge taxes.
The new report is a longer, updated version of the contentious “Bermuda connection” report the AIDC released last year.
It is based on the financial evidence submitted to the Marikana Commission of Inquiry.
By now, the disclosure of the financial statements of Lonmin subsidiaries and various other documents has made the company possibly the most closely scrutinised one in South Africa.
AIDC lead researcher Dick Forslund’s updated report still accuses Lonmin of moving an average R400 million a year out of its operating subsidiaries in South Africa through two “profit shifting” agreements.
One is a management fee paid to Lonmin’s London headquarters and the other is a marketing fee paid to a subsidiary in Bermuda.
This week Lonmin answered with a terse statement saying it “notes with disappointment the report released … which contains unfounded and false allegations about the company”.
The company says it pays all its taxes properly and “hopes that AIDC stops making these baseless allegations”.
The updated report also develops a new line of thinking about where the resurgent transfer pricing debate should be heading.
“Profit shifting starts at the domestic level and should be studied from the point of view of stakeholders in subsidiaries,” says the AIDC.
These include the BEE partners, workers and communities that are often formally entitled to some stake in a mine due to South Africa’s Mining Charter.
Forslund coined the term “wage evasion” to accompany the more familiar “tax evasion” to describe the alleged practice of pleading poverty at its mines in wage talks after removing significant resources that could “easily” have paid for higher wages
Transfer pricing is rapidly entering the political lexicon with the Davis Tax Committee investigation, the wider concept of tax “base erosion” and Parliament’s recent hosting of a number of hearings on the issue.
The Davis committee released a first report on “base erosion and profit shifting” in December and was so overwhelmed by comments that it sent out a new request for submissions on the issue two weeks ago.
The AIDC recently made a submission to the Davis committee arguing for a greater scrutiny of domestic transfers.
“It is actually misleading to direct all attention to cross-border transfer pricing,” said the AIDC.
“Transfer pricing, profit shifting and the depletion of funds to support wages, finance investments and pay minority shareholder dividends start domestically.”
In its submission it also revealed new research into Total Coal SA, which it says illustrates the point.
According to the AIDC, Total’s BEE partner Mmakau Mining is subject to two layers of marketing fees – a 4% one paid to the multinational’s local holding company and a 7% one paid by it to another London-based Total company,
Without digging deeper, AIDC questions whether theses fees make sense considering that Total already has exclusive rights to the coal from the mines it co-owns with Mmakau.
Former president Thabo Mbeki has taken on transfer pricing and other illicit financial flows as his major legacy project after he led a high-level African Union panel on the issue.
The term “transfer pricing” shot to prominence in the 1960s after the decolonisation of much of the world and the rise of mostly Western, multinational corporations.
The abuse of transfer pricing hasn’t been this high on the poor world’s agenda since the 1970s and 1980s.
This was when the ill-fated UN code on transnational corporations was developed.
It sketched a wide-ranging set of rules around how the rich world’s corporations should treat the poor world – including a prohibition on abusive transfer pricing.
However, from those early days, the Organisation for Economic Cooperation and Development (OECD), which is mostly a club of developed countries, has been at the forefront of guiding global policy on this and other matters around multinationals.
It still is, with its latest guidelines serving as the Davis committee’s point of departure.
An obvious concern is that the OECD represents the countries that find themselves on the other side of the abuse that is usually associated with transfer pricing – lost revenues in commodity-exporting poor countries.
Most statistics on transfer pricing abuse come from one place, the NGO Global Financial Integrity (GFI), created by US businessman Raymond Baker.
GFI is responsible for the estimates used by most advocacy groups.
Baker’s argument is that these practices are “capitalism’s Achilles heel” and undermine the capitalist system he otherwise believes in.
The idea is that transfer pricing abuse makes corporations intentionally inefficient and unprofitable in some places to benefit in other places.
That leaves much of the world with capitalism without the benefits.
In the process of avoiding tax, the profits that could be reinvested, paid to shareholders or would have benefited the economy leave the country’s shores.
According to a recent presentation in Parliament, the SA Revenue Service has recovered R5.8 billion from companies that dodged taxes through this kind of profit misstatement between 2011 and last year.
This implies that about R20 billion in profit was “shifted” by the 28 companies involved.
This is small change compared with the estimates that exist for South Africa’s losses to all forms of illicit financial flows.
The GFI estimate for outflows due to “trade misinvoicing” from South Africa in the decade up to 2012 comes to a staggering $118 billion (R1.46 trillion), a third of the total for sub-Saharan Africa.
The GFI estimate would exclude intangible services like the management and marketing fees that Lonmin allegedly uses to shift profits out of South Africa and focuses only on real, physical commodities.