“We don’t pay taxes. Only the little people pay taxes.”

Yesterday, the European Commission’s call for evidence on country-by-country financial reporting drew to a close. The Commission is investigating whether the EU should require multinational companies to disclose, on a country-by-country basis, sales, costs, profits, assets, number of employees, total employee remuneration, and taxes paid. If these new standards are adopted, this would be an important step towards combating international accounting fraud, tax evasion and tax avoidance.

Christian Aid has estimated that approximately $160 billion of potential tax revenue in developing counties is lost each year as a result of “transfer pricing” abuse. Given the global nature of production and business, there is ample opportunity for different subsidiaries of a company to trade with one another. For example, a company could have a marketing team based in the UK, intellectual property rights or trademarks based in Switzerland, and production facilities based in China. Multinationals can manipulate transfer prices by mispricing the products traded between subsidiaries, which thus facilitates the flow of capital between countries. For example, a company may overstate the price of a product being sold from a subsidiary in a high-tax country to a subsidiary in a low-tax country. This is particularly prevalent when dealing with hard-to-value intangible assets, such as trademarks, which can be assigned any geographical location. “Management fees” to individuals and entities domiciled in tax havens are also commonly deployed, and the rates at which different subsidiaries lend to each other also often differ.  In 2009, even Forbes admitted that “intra-company pricing crosses the line from tax avoidance into outright tax evasion”.

For example, research by Sikka & Willmott in 2010 noted that within WorldCom: “The paying subsidiaries treated royalty charges as an expense that qualified for tax relief whilst the income in the hands of the receiving company attracted tax at a low rate. This transfer pricing arrangement may have saved the company between US$100 million and US$350 million in taxes.” Many big-name global corporations, such as GlaxoSmithKline and Shell, have also been criticized by tax authorities and have had to make settlement payments.

It is very expensive for regulators to investigate transfer mispricing, and developing countries, in particular, do not have the resources or expertise to probe and thus curb abuse. Consequently, such fraud currently rarely comes to light because, in today’s world of opaque accountancy, we are reliant on whistleblowers, undercover reporters, or someone taking legal action against a firm (as was the case with WorldCom).  Furthermore, this practice means that corporations do not need to incur the cost of relocating to a tax haven. Instead they simply set up a small idle subsidiary (a “shell company”) in a tax haven and subsequently abuse intra-firm trade. To add insult to injury, many accounting firms openly advertise their expertise in such maneuvers. For example, Ernst & Young boast of “creative and practical solutions for . . . transfer pricing needs”.

Money retained by multinationals through strategic transfer pricing is lost tax revenue that should be going towards, for example, the fight against poverty. It is also fundamentally unjust that small and medium sized businesses, which are too small to have overseas subsidiaries, pay their full tax bill, whilst large corporations dodge their social obligations. Many of the multinationals that engage in transfer mispricing simultaneously claim to be firm believers in corporate social responsibility. This hypocrisy should not be borne; big business must be forced to stop manipulating taxes at the expense of the vulnerable.

Naturally, implementing country-by-country reporting would impose a burden on multinational corporations, due to increased auditing fees.  However, the benefits to the wider community far exceed this limited private cost. The new information would help draw attention to companies evading or avoiding taxes. It would also help quantify the impact of tax havens. As many tax havens are extremely reluctant to disclose information to foreign tax authorities, countries currently have limited knowledge of how tax havens precisely impact on tax revenues. Country-by-country reporting would also benefit investors. As many multinational companies operate across the globe under differently named subsidiaries, it is currently often difficult for investors to determine all the locations in which a company operates. This means that many investors are unaware of the geopolitical risks to their investments. Country-by-country reporting would also help ethical investors make informed decisions when deciding which companies they wish to invest in.

Crucially, these new rules would help increase transparency in developing countries, where corruption is rife. For example, citizens would be able to see how much their governments make exporting natural resources to the West. These numbers could then be directly compared to public spending figures. This would shine a light on the large sums of money that go directly into officials’ pockets. It would also help ethical investors avoid companies that collaborate in this practice. In May, the Hong Kong Stock Exchange acknowledged that the extractive industry is facilitating corruption, and mandated that all extractive industry companies applying to be listed must disclose “payments made to host country governments in respect of tax, royalties and other significant payments on a country by country basis.” The Dodd-Frank act has introduced a similar measure in the US. The EU must follow suit.

Let us hope that the European Commission’s consultation heralds a new era of transparent accountancy. Let us also hope that the major accountancy firms support this move and live up to what used to be the watchwords of the profession: “true and fair”.