By Kavaljit Singh

28 May, 2007
Countercurrents.org
The large-scale tax avoidance practices used by transnational corporations (TNCs)
came into public notice recently when the giant drug TNC, GlaxoSmithKline, agreed to
pay the US government $3.4 billion to settle a long-running dispute over its tax dealings
between the UK parent company and its American subsidiary. This was the largest
settlement of a tax dispute in the US. The investigations carried out by Internal Revenue
Service found that the American subsidiary of GlaxoSmithKline overpaid its UK parent
company for drug supplies during 1989-2005 period, mainly its blockbuster drug,
Zantac. These overpayments were meant to reduce the company's profit in the US and
thereby its tax bill. The IRS charged the Europe’s largest drugs company for engaging
in manipulative “transfer pricing.”
What is transfer pricing? Transfer pricing is the price charged by one associate of a
corporation to another associate of the same corporation. When one subsidiary of a
corporation in one country sells goods, services or know-how to another subsidiary in
another country, the price charged for these goods or services is called the transfer
price. All kinds of transactions within the corporations are subject to transfer pricing
including raw material, finished products, and payments such as management fees,
intellectual property royalties, loans, interest on loans, payments for technical
assistance and know-how, and other transactions. The rules on transfer pricing requires
TNCs to conduct business between their affiliates and subsidiaries on an “arm's length”
basis, which means that any transaction between two entities of the same TNC should
be priced as if the transaction was conducted between two unrelated parties.
Transfer pricing, one of the most controversial and complex issues, requires closer
scrutiny not only by the critics of TNCs but also by the tax authorities in the poor and the
developing world. Transfer pricing is a strategy frequently used by TNCs to book huge
profits through illegal means. The transfer price could be purely arbitrary or fictitious,
therefore different from the price that unrelated firms would have had to pay. By
manipulating a few entries in the account books, TNCs are able to reap obscene profits
with no actual change in the physical capital. For instance, a Korean firm manufactures
a MP3 player for $100, but its US subsidiary buys it for $199, and then sells it for $200.
By doing this, the firm’s bottom line does not change but the taxable profit in the US is
drastically reduced. At a 30 per cent tax rate, the firm’s tax liability in the US would be
just 30 cents instead of $30.
TNCs derive several benefits from transfer pricing. Since each country has different tax
rates, they can increase their profits with the help of transfer pricing. By lowering prices
in countries where tax rates are high and raising them in countries with a lower tax rate,
TNCs can reduce their overall tax burden, thereby boosting their overall profits. That is
why one often finds that corporations located in high tax countries hardly pay any
corporate taxes.
A study conducted by Simon J. Pak of Pennsylvania State University and John S.
Zdanowicz of Florida State University found that US corporations used manipulative
pricing schemes to avoid over $53 billion in taxes in 2001. Based on US import and
export data, the authors found several examples of abnormally priced transactions such
as toothbrushes imported from the UK into the US for a price of $5,655 each, flash
lights imported from Japan for $5,000 each, cotton dishtowels imported from Pakistan
for $153 each, briefs and panties imported from Hungary for $739 a dozen, car seats
exported to Belgium for $1.66 each, and missile and rocket launchers exported to Israel
for just $52 each.
With the removal of restrictions on capital flows, manipulative transfer pricing has
increased manifold. According to UNCTAD’s World Investment Report 1996, one-third
of world trade is basically intra-firm trade. Because of mergers and acquisitions, intra-
firm trade, both in numbers and value terms, has increased considerably in recent
years. Given that there are over 77,000 parent TNCs with over 770,000 foreign
affiliates, the number of transactions taking place within these entities is unimaginable.
Hence, it makes the task of tax authorities extremely difficult to monitor and control each
and every transaction taking place within a particular TNC. The rapid expansion of
Internet-based trading (E-commerce) has further complicated the task of national tax
authorities.
Not only do TNCs reap higher profits by manipulating transfer pricing: there is also a
substantial loss of tax revenue to countries, particularly developing ones, that rely more
on corporate income tax to finance their development programs. Besides, governments
are under pressure to lower taxes as a means of attracting investment or retaining a
corporation’s operation in their country. This leads to a heavier tax burden on ordinary
citizens for financing social and developmental programs. Although several instances of
fictitious transfer pricing have come to public notice in recent years, there are no reliable
estimates of the loss of tax revenue globally. The Indian tax authorities are expecting to
garner an additional US$111 million each year from TNCs with the help of new
regulations on transfer pricing introduced in 2001.
In addition, fictitious transfer pricing creates a substantial loss of foreign exchange and
engenders economic distortions through fictitious entries of profits and losses. In
countries where there are government regulations preventing companies from setting
product retail prices above a certain percentage of prices of imported goods or the cost
of production, TNCs can inflate import costs from their subsidiaries and then charge
higher retail prices. Additionally, TNCs can use overpriced imports or underpriced
exports to circumvent governmental ceilings on profit repatriation, thereby causing a
drain of foreign exchange. For instance, if a parent TNC has a profitable subsidiary in a
country where the parent does not wish to re-invest the profits, it can remit them by
overpricing imports into that country. During the 1970s, investigations revealed that
average overpricing by parent firms on imports by their Latin American subsidiaries in
the pharmaceutical industry was as high as 155 per cent, while imports of dyestuff raw
materials by TNC affiliates in India were overpriced in the range of 124 to 147 per cent.
Given the magnitude of manipulative transfer pricing, the Organization for Economic
Co-operation and Development (OECD) has issued detailed guidelines. Transfer pricing
regulations are extremely stringent in developed countries such as the US, the UK, and
Australia. In the US, for instance, regulations related to transfer pricing cover almost
300 pages, which dent the myth that the US espouses “free market” policies.
However, developing countries are lagging behind in enacting regulations to check the
abuse of transfer pricing. India framed regulations related to transfer pricing as late as
2001. However, many countries including Bangladesh, Pakistan, and Nepal, tax
authorities have yet to enact regulations curbing the abuse of transfer pricing
mechanisms. The abuse of transfer pricing mechanisms could be drastically curbed if
there is an enhanced international coordination among national tax authorities.

Kavaljit Singh is Director, Public Interest Research Centre, New Delhi. The above
article is based on his latest report, Why Investment Matters: The Political Economy of
International Investments (FERN, The Corner House, CRBM and Madhyam Books,
2007). The full report could be downloaded from:
http://www.thecornerhouse.org.uk/pdf/document/Investment.pdf

Coke Slammed At Shareholders Meeting For Practices

In India
By Haider Rizvi
22 April, 2006
OneWorld.net

NEW YORK - As the level of anger and resentment against Coca Cola touches new
heights throughout India, rights activists in the U.S. have increased pressure on the
company to mend its ways of doing operations in rural areas. At a shareholders meeting
in Delaware Wednesday, activists demanded the company disclose the full extent of its
liabilities in India, but failed to receive any positive response from the company.

Despite enormous efforts to improve its public image through advertising, Coca Cola
continues to be the prime target of attacks from rights groups in India who consider the
multinational soft drink company a consistent violator of the right of local communities to
have unhindered access to water.
With the summer heat wave just a few weeks away, people in more than 20 villages
have come together in northern India to organize an indefinite vigil against Coca Cola in
the town of Mehdiganj, where they are calling for the government to shut down the
company's bottling plant.
The situation is similar in the desert state of Rajasthan, where people in more than 50
villages are facing acute water shortage, allegedly due to Coca Cola operations. Official
accounts suggest that water levels in that area have dropped up to 10 meters since
2001 when the company started its operations there.
And in the southern state of Tamil Nadu, thousands of community members are
organizing a series of protests against Coca Cola's plans to build a new plant in the
town of Gangaikondan. Campaigners fear that the proposed bottling operations will
cause soil pollution and water shortage.
"Coca Cola is culpable, and therefore liable for the serious problems that are affecting
the lives and livelihoods of our people," said Amit Srivastava of the India Resource
Center, a rights advocacy group that works with peasants and local communities.
"The longer the Coca Cola company waits to genuinely address the issues in India, the
larger their financial liability becomes," Srivastava added. "It just doesn't make good
business sense."
Thousands of villagers whose livelihoods have been affected by Coca Cola operations
are demanding the company bear the financial cost of their losses.
Srivastava, who spoke inside the Coca-Cola shareholders meeting and presented
statements from Indian communities, said Coca Cola's sales in India did not account for
its reported profits, which amounted to more than $1 billion in the first quarter of this
year.
The company's volume sales in India have shrunk in the past several months. Aside
from India, the company is also running into trouble with consumer groups, student
bodies and labor organizations in many other parts of the world, including the United
States and Europe.
Activists in the United States claim that more than 100 colleges and universities already
have anti-Coke programs in place, and about 20 schools have either banned Coke
products or axed their exclusive contracts with the company.
Also, increased pressure from student bodies throughout Europe is pushing hundreds of
schools to cancel their contracts with the company, they say.
For its part, the multibillion dollar corporation has repeatedly denied that it bears direct
responsibility for questionable practices in places like India, arguing that its business "in
each country is a local business."
With about one million employees, the company says it operates in nearly 200 countries
worldwide.
In India, the company has tried to deflect criticism by turning to image-making firms for
help. But it seems that even on that front it is being defeated by activists.
Last week, for example, the company suffered a major setback when its primary
spokesperson and Bollywood star Aamir Khan announced that he will be looking into
the issues surrounding Coca Cola operations in India.
Coca Cola has reportedly tried to calm its critics in India by suggesting that rainwater
harvesting programs could replenish the water use, but activists remain unmoved by
such reasoning.
"The facts surrounding Coca Cola's operations speak for themselves," said Srivastava.
"We suggest that the company rethink its approach to the campaign. It must come up
with genuine ways to address the issues."
"Acknowledging that it is part of the of the problem is the first step," he added. "Until
then the campaign to hold Coca Cola accountable will continue to grow and cost the
company millions in profit as well as tarnish their image immensely."