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Assessing the potential impact of abnormal pricing violations on state corporate tax receipts
Abstract
This paper examines the state corporate tax implications of abnormal transfer-pricing by U.S. companies involved in international trade. The state corporate tax cost of improperly priced imports and exports is estimated through analysis of every import and export transaction for the years 2005 through 2009 using the interquartile range methodology provided in regulations to Internal Revenue Code Section 482. Calculation of the interquartile range using the entire population of international transactions addresses interpretive issues related to abnormal prices that occur with the smaller samples normally used in such analyses. A policy recommendation is made for improving tax compliance through more rigorous state involvement in transfer pricing enforcement and greater formal collaboration with the Internal Revenue Service with respect to transfer pricing.
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The manipulation of transfer prices changes the relative tax burdens multinational firms face in their different countries of operation. Transfer price manipulation also triggers changes in the tariffs that are levied on intra-company imports. For this reason, when tax rates change, as they did for many countries during the 1980s, the incentive to manipulate transfer prices varies substantially across products. I use products-level variation in tariff duties to identify transfer pricing changes in products imported to the U.S. The empirical results indicate that variations in the reported customs values of U.S. imports from Canada, France, Germany, Japan, and the U.K. were consistent with the transfer pricing incentives created by taxes and tariffs.
Most research on tax evasion has focused on the income tax. Sales tax evasion has been largely ignored and dismissed as immaterial. This paper explored the differences between income tax and sales tax evasion and demonstrated that sales tax enforcement is deserving of and requires the use of different tools to achieve compliance. Specifically, the major enforcement problem with sales tax is not evasion: it is theft perpetrated by companies that act as collection agents for the state. Companies engage in a principal-agent relationship with the state and many retain funds collected as an agent of the state for private use. As such, the act of sales tax theft bears more resemblance to embezzlement than to income tax evasion. It has long been assumed that the sales tax is nearly evasion free, and state revenue departments report voluntary compliance in a manner that perpetuates this myth. Current sales tax compliance enforcement methodologies are similar in form to income tax compliance enforcement methodologies and are based largely on trust. The primary focus is on delinquent filers with a very small percentage of businesses subject to audit. As a result, there is a very large group of noncompliant businesses who file on time and fly below the radar while stealing millions of taxpayer dollars. The author utilized a variety of statistical methods with actual field data derived from operations of the Southern Region Criminal Investigations Unit of the Florida Department of Revenue to evaluate current and proposed sales tax compliance enforcement methodologies in a quasi-experimental, time series research design and to set forth a typology of sales tax evaders. This study showed that current estimates of voluntary compliance in sales tax systems are seriously and significantly overstated and that current enforcement methodologies are inadequate to identify the majority of violators and enforce compliance. Sales tax evasion is modeled using the theory of planned behavior and Cressey’s fraud triangle and it is demonstrated that proactive enforcement activities, characterized by substantial contact with non-delinquent taxpayers, results in superior ability to identify noncompliance and provides a structure through which noncompliant businesses can be rehabilitated.
Money laundering can be defined, generally, as the process of concealing the existence, illegal source, or application of income derived from a criminal activity, and the subsequent disguising of the source of that income to make it appear legitimate. Deception is the heart of money laundering. The use of international trade to move money, undetected, from one country to another is one of the oldest techniques used to circumvent government scrutiny. International trade as a means of laundering money is also a technique generally ignored by most government law enforcement agencies. This article details how false international trade invoicing is used to move money across borders, undetected. This research details how the statistical analysis of the U.S. trade database can assist in measuring illegal money flows. It also details some statistical techniques that may be used to detect and monitor these abnormal transactions.
Estimates of money laundering and terrorist financing are based on the analysis of historical price data. This analysis could be conducted in real time to determine which transactions should be audited and which cargo shipments should be inspected. The US now requires that manifest information be sent to the US Customs Agency 24 hours in advance of shipment from a foreign port. This requirement will help facilitate real-time audits and inspections of abnormally priced imports and exports. The efficient evaluation of data will be crucial to winning the war on terrorism. Intelligence is an inexact science, but the utilization of information technology and data mining techniques applied to financial transactions can contribute to increasing the quality of intelligence information.
While regulations on tax evasion via transfer pricing have been thoroughly explored in the literature, little is known about the effects of domestic tax policies under a Bilateral Advanced Price Agreement (hereafter BAPA) on production decisions of multinational companies. I show that, even if BAPAs prohibit income shifting through transfer pricing, inefficiencies arise via distorted production when markets across countries are interrelated through intra-firm trade of multinational companies. The analysis provides governments with useful guidance for how to coordinate tax agreements.
Purpose
– As determined by the Financial Action Task Force, trade‐based money laundering (TBML) has become one of the three major money laundering methods used today. However, there has been very limited acknowledgment of the risk and counter‐measures against TBML until recently. This is particularly problematic with ever increasing trade volumes through transshipment and container shipping which is getting larger by the day. This paper aims to examine the role of TBML as a vehicle for terrorism financing and laundering proceeds of other criminal activity. It also examines the practice of transshipment, analyzes the challenges that this particular phenomenon poses to detection of TBML activity, and looks at possible alternative policy responses to mitigate additional money laundering risks.
Design/methodology/approach
– This paper analyzes reports made by international organizations and government bodies, particularly, the US Government, dealing with various aspects of financial crime, import/export activity, and world trade statistics, in order to identify major challenges and possible solutions to the problem. Interviews were also conducted with the same goals.
Findings
– Efforts to monitor and staunch the flow of illicit money through trade would be enhanced through more widespread coverage of customs cooperation and standardization of information sharing procedures between national customs agencies. Also, measures should be taken to make free trade areas more transparent to regulatory scrutiny.
Originality/value
– This paper serves to expand the limited amount of scholarship on TBML and to suggest a policy approach towards detection of this kind of money laundering activity to policymakers.
Governmental and international lending agencies, as well as private sector firms, who engage in international trade, have long been concerned with detecting and determining the magnitude of abnormal pricing in international trade. To detect such abnormal pricings, we present a framework analyzing millions of import/export transactions between the U.S. and Russia. The objectives of this study are to estimate the economic impact of over-invoiced/under-invoiced Russian imports/exports from/to the U.S. and to determine if capital movement/capital flight through trade is due to money laundering, tax evasion or some sort of portfolio consideration. Our results lead us to conclude that capital movement through trade in this case can be attributed to either money laundering and/or tax evasion.
This paper presents suggestive evidence of income shifting in response to differences in corporate tax rates for a large selection of OECD countries. We use a new method to disentangle the income shifting effects from the effects of tax rates on real activity. Our baseline estimates suggest that a substantial share of the revenues from a unilateral increase in the corporate tax rate is lost because of a decline in reported income.
Three interrelated aspects of U.S. multinational corporation activity are analyzed here: the ability to shift profits from high-tax countries to low-tax countries; the impact of host country taxes and tariffs on the distribution of real capital; and the influence of these policies on international trade patterns of the United States and host countries. The cross-sectional empirical analysis indicates that the observed pattern of reported profits in high and low-tax countries is consistent with income shifting behavior and that real investment responds to host country effective tax rates and tariffs. The United States appears both to import more from and export more to low-tax countries where MNC investment is greater, but this bilateral focus must be amplified to consider multilateral effects if trade benefits are to be projected. Copyright 1991 by MIT Press.
The objective of this research is to determine the impact of Switzerland's money laundering law on the movement of money through false invoicing in international trade. This study evaluates every reported import and export transaction between the USA and Switzerland during the period 1995-2000. The study indicates that there were significant changes in the degree of abnormal international trade pricing subsequent to the enactment of Switzerland's antimoney laundering law. The study supports the view that individuals and companies will find substitute techniques and channels to launder money when central banking authorities enact legislation that only focuses on financial institutions.
This paper analyzes monthly data on US international trade prices between 1997 and 1999 in order to investigate the impact of tax influences on intrafirm trade prices. Results indicate that there is substantial evidence of tax-motivated transfer pricing in US intrafirm trade prices. There is a strong and statistically significant relationship between countries’ tax rates and the prices of intrafirm transactions. Controlling for other variables that affect trade prices, as country tax rates are lower, US intrafirm export prices are lower, and US intrafirm import prices are higher. This finding is consistent with theoretical predictions regarding tax-motivated income shifting behavior.
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