Transfer (mis)pricing
TRANSFER pricing — the pricing of commodities traded between or within multinational enterprises — is a legal practice and a key feature of cross-border and intra-firm transactions. The United Nations prefers to use the broader phrase ‘trade pricing’ in addressing this practice and defines it as a ‘normal incident of the operations of multinational enterprises.’ Because the word ‘incident’ evokes concern, it should not go unnoticed.
One of the most disruptive consequences of transfer pricing is that international transactions are now governed by the monopolistic interests of an MNE group. That is, market forces no longer control transactions because, with transfer pricing, an increasing percentage of global trade (this includes the international transfer of goods and services, capital, and intangible goods, or intellectual property) now occurs as an internal practice between affiliated entities.
Theoretically, internal transfer pricing is supposed to follow the arm’s length principle, which is that transfer prices should be controlled and recorded as if internal trades were happening amongst independent entities, or at ‘arm’s length.’ But as the IRS case against Amazon.com reveals, proving arm’s length is not so straightforward. So while the “arm’s length principle” is very much written into place (Brazil is listed as the only country without domestic legislation or regulation that makes reference to the arm’s length principle), even research from the Organisation for Economic Cooperation and Development and the United Nations recognises that this principle is very much impossible to implement.
Unable to ignore the ease with which a company could engage in abusive transfer pricing, the OECD and the G20 countries first drafted the BEPS Action Plan in 2013 as part of a broader effort to enhance transparency for tax administrations to assess transfer pricing. Base erosion and profit shifting undermines the integrity of any tax system. But the direct harm BEPS creates for individual taxpayers and governments was only part of the motivation for implementing the 2013 action plan. The other motivating factor was the added risk to businesses, including the risk to an MNE’s reputation in the event that their effective tax rate was viewed as being ‘too low’ thereby impeding ‘fair competition’ locally. With this latter motivation, little promise ought to be expected from the plan as it maintains a focus on risks brought to MNEs themselves rather than to wider society.
Setting potential reputational risks aside, the incentive for companies to strategically misprice trade or shift their profits is to avoid tax or duty payments and shield wealth. And while there is no single way to avoid tax payments and dues, there is one necessary component: tax haven subsidiaries.
The art of creating political asylum networks for wealth.
Tax haven subsidiaries function as cash canals to transport taxable profits with the goal of lowering or, if you are Amazon Inc., entirely avoiding tax payments. But this requires a financial sleight of hand. Take for instance the ‘Goldcrest’ method Amazon used in Luxembourg. It shifted its intellectual property rights (or intangibles) that were held by its US parent company to its subsidiary, Amazon Lux. The subsidiary then collected royalties tax-free on international sales. Google and Ikea similarly decided to play the ‘Going Dutch’ move, using their subsidiaries in the Netherlands.
The ‘Swiss Sidestep’ is another tax play, and rather than royalty payments, ‘management service fees’ are the key element. By paying a value-added service fee to a sister company in a European tax haven, a company can ‘side-step’ tax payments by converting profits into fees. And, then, of course there is the privacy and protection that a company gets on the island of Mauritius — with the ‘Mauritius manoeuvre’ a person can send their cash to Mauritius to avoid income tax and then bring it back — without a trace — as ‘foreign investment.’
Each of these fictional narratives that frame the legal movement of cash across borders has one theme in common: wealth-protection and, therefore, poverty-production.
Colonial undertones of transfer pricing
IT IS not the case that some industries are more prone than others to transfer mispricing, or even that developed countries are immune to this manipulative business practice – the IRS case against Amazon is a great example of this. But, it is the case that developing countries are more vulnerable to the impact of transfer mispricing. Suppose a company extracts 2 megatons of cobalt from Papua New Guinea and then exports the 2 MT (or 1 million kilograms) at the price of $5 a kilogram, but imports into Canada — by way of Mauritius or the Netherlands — the same 2 MT of cobalt at the price of $10. The result for PNG is the loss of tax revenue on 5 million dollars. Even at a mere 5 per cent tax rate with these modest and imaginative figures, a loss of $250,000 USD for PNG is significant.
The impact of trade and transfer mispricing on developing countries is not just monetary. There are a series of moral effects as well. In the hypothetical PNG scenario, for instance, one glaring concern that arises from this manipulative business practice is the implication that the people of PNG are somehow unaware of the value of their own resources. A red flag must be raised to the psychological impact of pricing discrepancies that suggest cobalt, somehow, has a lesser value within the borders of PNG than within, say, Canada or Belgium.
Trade and transfer (mis)pricing are symptoms of an ongoing colonial hangover. Given that transfer (mis)pricing is at the centre of operations of MNEs, then the only way to remove this jewel in the crown of every MNE is to dismantle the multinational enterprise as it exists today. A first necessary step would be to introduce strict and enforceable regulations that help guide us away from such damaging relations of production.
