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D. Murali

AMONG the top 25 countries that have milked Uncle Sam of his due share of tax revenues, India ranks 19th, with $1.8 billion income shifted eastward through abnormal trade pricing. At 34 per cent taxation, this works out to $606 million revenue loss to the US. Japan occupies the top slot of culprits, with a shifted income of $36 billion, Canada running a distant second at $15 billion. China occupies the 7th position.

The mischief is caused by transfer pricing, one of the most controversial and often least understood of concepts. Transfer price is what is charged by one part of a multinational organisation when it sells goods, services or knowhow to another part in another country. As the Web site of a Big Four explains, transfer pricing is a term used to describe all aspects of inter-company pricing arrangements between related business entities, and commonly applies to inter-company transfers of tangible and intangible property. However, since the deal is `within', it usually happens that the transfer price is a purely arbitrary figure, unrelated to costs incurred, or value added.

There are stringent laws in many countries to ensure that transfer price is not a whimsical figure. Yet, there have been `transfer' transactions at `abnormal' prices. For instance, the UK could sell razors to the US at $113 a piece, while Israel could import missile and rocket launchers at $52 per unit. Briefs and panties from Hungary cost $739 per dozen, Italian tiles came in for $4,480 per sq.m., while the US exported non-industrial diamonds to India at $13 per carat. Cotton dishtowels from Pakistan landed in the US for $154 per piece, and Australia could shear off the US revenue by exporting lawnmower blades priced at $2,327. For less than $100 you can get ATM (automatic teller machine) from the US, as France did for $97. And, the US exported aluminium ladders to Japan for less than $5.

All this and more is in a recent study by two researchers Mr Simon J. Pak and Mr John S. Zdanowicz - of Pennsylvania State University and Florida International University. Their paper titled `An Estimate of 2001 lost US federal income-tax revenues due to over-invoiced imports and under-invoiced exports' shows that fake pricing schemes for import-export transactions are defrauding the federal Government of well over $53 billion annually. And, the top 25 countries accounted for more than $49 billion of tax swindle in 2001.

The research, funded by a $2 million grant, is based on the US import and export data produced by the Department of Commerce, Bureau of Census, and contained in the US Merchandise trade database.

How does transfer pricing affect the taxman? Accounting Web illustrates the rip-off: A Japanese automaker manufactures a car radio for $100, but its US subsidiary buys it for $199, then sells it for $200. The company's bottomline has not changed, but the taxable profit in the US is now just $1 instead of $100. A tax bill that would have been $34 is reduced to 34 cents.

Conversely, if a US manufacturer exports a bulldozer to its Colombian subsidiary for $1,742; the Colombian company sells it to a buyer for $28,000. The US company's cost of producing the bulldozer can be written off its income taxes, but the profit from the sale would reside in Colombia. That profit would be subject to US taxes only after it is `repatriated' across the border, presumably in a bad economic year when the company's taxable US income is low or non-existent.

Abnormally high prices of US imports and exports make an interesting reading. The estimate of revenue loss could be conservative because only quantifiable commodities that have units of measure such as kilograms, tonnes, units and so on have been analysed. A similar study of Indian trade may reveal interesting facts.

According to Zdanowicz, the US Government is shutting down the front door on the illegal movement of money, focusing on banks, insurance companies and other financial institutions. But the back door is wide open, international trade.

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