08/30/2012 08:30 am ET Updated Oct 30, 2012

Worldwide Curbs Loom On Offshore Corporate Tax Avoidance

By Chris Vellacott

LONDON, Aug 30 (Reuters) - Cash-strapped governments keen to replenish their coffers and international bodies such as the OECD are stepping up efforts to claw back revenue lost when companies shift profit overseas to cut their tax bills.

A legal and routine practice known as transfer pricing, whereby subsidiaries of the same company in different countries trade with each other, is sometimes used by companies to move cash to jurisdictions with lower tax rates, such as tax havens.

But the process can be abused by inflating the price of goods and services traded with overseas units in order to shift more money offshore and evade corporate taxes, and authorities now want to toughen up their policies and close loopholes.

"Tax base erosion and profit shifting are real problems, they need to be dealt with," Joe Andrus, head of the transfer pricing unit at the Organisation for Economic Co-operation and Development, which sets the international guidelines on the practice, told Reuters.

Campaigners say economic damage caused by aggressive use of transfer pricing extends far beyond depriving governments of developed countries of revenue in fiscally straightened times.

The charity Christian Aid estimates the world's poorest countries are deprived of $160 billion in tax revenues every year by multinationals transferring profit beyond borders. The practice also distorts the economies of tax havens into which multinationals shift the profits.

Joao Pedro Martins, a Lisbon-based economist and author of a book about the Portuguese autonomous region of Madeira, says the "exports" of hundreds of multinational subsidiaries registered in the island have distorted its GDP at the locals' expense.

Though unemployment runs at more than 14 percent, the island's per capita GDP is 103 percent of the EU average, compared with 78 percent for the whole of Portugal, making it the second-richest part of the country after the capital Lisbon.

This means Madeira loses out on millions of euros of EU support it might otherwise get under a programme of grants for regions with per capita GDP of less than 75 percent of the European average, Martins says.

The OECD champions a set of guidelines known as the "arm's-length" method which permits transfer pricing only when transactions between affiliates at are struck at market rates.

However, organisations can skirt this rule through trade in intangible assets or services where pricing can be arbitrary and much harder to benchmark against a global market rate.

"There is no such thing as an arms length price. The idea of the arms length price is fundamentally flawed from the outset," says John Christensen, director at pressure group Tax Justice Network which campaigns against aggressive tax avoidance.

The OECD is consulting on how to tighten guidelines on pricing of intangibles and has invited key developing economies that are not members of the rich country club, such as China, India and Brazil to contribute.


"It is a multi-faceted, complicated problem and it is going to require a lot of work and cooperation by a lot of countries. But it is clear that it is at the top of everybody's agenda and it is one of the most important things we are working on," Andrus said.

National tax authorities are stepping up scrutiny of companies in their jurisdiction, meanwhile.

The U.S. Internal Revenue Service has gone on a recruitment drive to boost capacity in tackling transfer pricing abuse starting with the appointment of Samuel Maruca last year to the newly created post of transfer pricing director.

The European Union is planning legislation to revise accounting and transparency standards, aimed at resource and mining companies with overseas operations, requiring them to report payments to governments broken down by country.

The EU reform follows a similar requirement included in the Dodd-Frank act in the United States.

"From a compliance point of view, groups are coming under much more pressure to make sure their house is in order from a transfer pricing perspective," said Robert Langston, senior tax manager at accountants Saffery Champness.

By making corporations report accounts on a country-by-country basis, they should find it harder to shift profit around the world out of sight of European or U.S. tax authorities, campaigners say.

Last week, a cross-party committee of British lawmakers also called on the government to consider unilaterally introducing a country by country accounting rule.

Some accountants warn this would greatly encumber the companies and do more harm than good.

"It would create a lot of paperwork," said Langston.

Campaigners welcome the latest tentative steps towards reform but remain sceptical.

"There has been a lot of talk and discussion. There has been little in terms of actual action ... But (transfer pricing) has got on the agenda," said Joseph Stead, Christian Aid's senior economic justice adviser. (Reporting by Chris Vellacott; Editing by Sinead Cruise and Jon Loades-Carter)