An interesting problem in international taxation: could @richardjmurphy help here?

A problem in fact about transfer pricing. A problem that perhaps the internationally reknowned expert on matters taxation could help with.

No it\’s all a bit ethereal at present. I don\’t know whether it\’s going to happen, I don\’t know whether it will happen in any volume if it does and don\’t know if it will continue for any substantial amount of time even if that does happen.

However, we reach an interesting problem in transfer pricing and thus the taxation of international business.

The concern is over two minerals that may or may not get exported from a Third World country.

One has a value to a small number of mineral collectors and no industrial value at all. Except to me, to whom it is really quite valuable for industrial purposes. And I emphasise this point: it\’s valuable to me for industrial purposes but to no one else for industrial purposes. That industrial value is a great deal higher than the value minerals collectors will put on it.

Why it has no value to anyone else is because they don\’t know about it, have no method of processing it and couldn\’t sell the resultant product even if they did have the knowledge and the capacity.

I think you can see the problem coming here: how should I value it for the purposes of transfer pricing? For the whole point of such transfer pricing is that it must be valued as an arms length transaction. I should not take account of any internal to my multi-national company (well, we haven\’t set that up yet but will if all of this becomes a reality) considerations. I must, under the rules, price the mineral on export from that Third World country at whatever someone else, not me, will be willing to pay for it.

The second mineral is slightly different. This is a well known, traded, market priced ore for a particular two metals. There\’s a well known pricing calculation that can be done (you\’ve got x% of this metal A, y% of the other metal B, the price is $z per lb of A2O5 + B2O5 contained, delivered Rotterdam duty unpaid where $z is a changeable quoted international price although not an exchange quoted one).

Now, the thing is that this specific mineral from one or two specific places in this Third World country could be (I\’m checking to see) worth a lot more to me than it is to everyone else. For this specific mineral from these couple of specific places could also have, in addition to the A+B, some measure of C2O3 in it. The volume of C is small, but the value is hugely higher (like, 40x A+B).

Which makes this mineral worth a great dfeal more to me than it does to anyone else. Again, because they don\’t know about it, couldn\’t process the C if they did and wouldn\’t be able to sell the C if they could.

Now in terms of fairness and economics, minerals are indeed part of the national patrimony. Yes, it is right that national governments get a chunk of the value of those minerals dug up in their jurisdiction. And the big question is, how are we to determine that value aso that the appropriate amount of tax is to be paid?

The answer is, this is the answer urged upon us both by campaigners and by the law, that we should regard that just and righteous valuation as being what would be an open market, arms length, transaction. One that is not between two related entities who are shifting cash around, but between two unrelated entities who are operating in an open market. Which is just fine.

So in order to set the price of this mineral for export from the Third World country I should therefore, in the first case, try selling some pieces to mineral collectors. Go on Alibaba, e-Bay, and see what prices I am offered. This then becomes that just and righteous export price. For the second I should ignore that higher to me value and work solely with the international and published price of the mineral.

Please do note that there\’s no offshore in here. There\’s no black hole into which excessive profits disappear: all will be taxed, what we\’re trying to work out is how much gets taxed in that Third World country and how much gets taxed inside the EU where the minerals will be processed.

But here\’s the thing. By obeying the law (and, if you like, the spirit of it) on transfer pricing I am quite deliberately according a much lower value to those minerals than their actual value to me. The profit declared in that Third World country will be hugely lower than the actual profit that will come from the whole process of extracting and processing those minerals.

It\’s entirely possible, just to give you an idea of the scale of this, that the observable global value of the second mineral is $20 a kg while the value to me is $80 per kg. Or of the first, $50 a kg to a minerals collector and $500 a kg to me (those are not actual pricings, just illustrations of the scale of the gap).

So, what actually is it that a poor boy like me is supposed to do? Obey the law and thus use an arms length transfer price and so grievously underestimate true value? Or ignore the law and do something else?

Obne possible solution would be that I have to tell everyone else what\’s in the mineral, teach them how to extract it and where to sell it when they have done so, create competition for myself and thus enable a true market price to be derived from arms length transactions.

But that would be insane, wouldn\’t it?

So what\’s the solution?

18 comments on “An interesting problem in international taxation: could @richardjmurphy help here?

  1. Follow the law, but also use Tax Haven, then remit the excess profit as aid/charity work back to the 3rd world, or give your 3rd world worker big pay rises so that the cost of production increases so more value are left in the 3rd world ?

  2. I think you are talking about the well-known concept of consumer surplus, are you not? The value the individual consumer places on what he buys is not necessarily the same as the market price. This applies in all markets for all goods, I suppose, not just your hypothetical ones. So the answer must be to use the market price, as in other markets.

  3. The answer is to stop mentally anguishing about tax nonsense, and get on with becoming Portugals answer to Oleg Deripaska, with a f*ck off floating gin palace the size of the isle of Wight, complete with hot and cold running Portuguese lovelies.

  4. I’m fairly confident I can identify A, B and C from the information you’ve given. I find I can look up how to extract C (albeit there may be unpublished or patented improvements). I suppose the miners of the ore must be unaware of the high content of C in it, or else unaware of the value of it.

    As an open and honest trader, anxious to secure full value for the Third World country in question, you could make good this gap in their knowledge. Perhaps a grateful nation will allow you to reap some financial reward.

  5. To ensure you are completely tax compliant, just do the opposite of whatever Ritchie claims you must do.

  6. I assume that all figures (notional as they are) make allowance for any added value you give the ore by way of transport, process, marketing etc.
    If you are proven right and you remain the only consumer of the ore then there is no true market for it and any duty received by the producing regime is better than none.
    If, on the other hand, some one else eyes up your huge profit margin and enters the fray against you, you will be bid up as demand increases against supply, the duty will rebalance and the producer see rightful increase in income.
    It’s hard to see that creating a false market price bases on your profits alone is feasible. On the other hand, entering into a partnership with the sovereign producer would be fair and might guarantee you sole access to the ore, at the same time as ensuring a fair return to the producer.
    Dunno really, I never had this problem with brewers, in the old days there was no market pricing for beer it was sold on the basis of what they jointly thought they could get away with.

  7. What Nick Luke said about competition eyeing up excess profits and it all coming out in the wash.

    i.e. there’s no problem with the transfer price being the (lowish) market rate. (Unless you are our favourite WGCE, in which case the question is also irrelevant because you are asking it and therefore whatever it is that you is wrong – even, probably especially, if it is what Ritchie says you should do)

  8. PG, Nick,
    Your solve seems to be “this problem should go away over time”. Maybe or maybe not, but it doesn’t really address the issue.

    To resolve this from a left/RM perspective, one must of course hold the ethics of the decision front and centre. “Labour is a moral crusade or it is nothing” and all that. So would the left prefer the tax accrues mainly to a foreign govt proping up corruption overseas or to a Tory-led govt clearly in the grip of the Global NeoCon Conspiracy (TM).

    Hard choices never were the left’s big strength.

  9. What should you do. Ignore the problem. Carry on as you want to. It need not be a stop/go type situation. It’s more like a stop, start crawling, start walking, start running, and go type situation. In other words, a process of change not a step change.

    Eventually others will find out your methods and setup their own factories. They will then start to demand the mineral. The sellers will then have more than one buyer and can start to increase the price in response to the demand. At that point in time you will have a proper market – until then take advantage of your lead.

  10. In the absence of a market price for the mineral at point of transfer from country A to country B, you could follow the old-fashioned practice of attributing the profit pro-rata to the work done in country A and country B. So if it cost G to get it out of the ground, H to semi-process it within A, J to transport it, K to process in country B, and you sell it for L, giving a profit M. Then M=L-K-H-G. Profit in B = MxK/(K+G+H) and profit in A=Mx(H+G)?(K+H+G).
    You are not allowed to pretend take a profit on the transport phase (although the shipping company does).
    Regrettably the share of the profit allocated to the EU country is inflated by the higher wages in the EU than in the third world, but the local tax collector will jump on you if you say that’s not fair.

  11. Unitary taxation, making allowance for source/origin of the mineral in the formula

    We campaign against arm’s length pricing

    Tim adds: well, that’s an answer. Not the one I was expecting, but an answer.

    But I don’t see how unitary taxation solves this problem. How do we decide, who decides even, how much of the value add is attributable to the source/origin of the mineral when we haven’t got market pricing to tell us what the value division is?

    I agree that I’ve outlined some slightly weird cases but they are true ones. The value add is in the knowledge of the mineral contents, it’s entirely humnan capital. So how can we apportion that across the different jurisdictions?

  12. The man has spoken. So the effective transfer price should effectvely be nil. No?

    In the absence of a Unitary Tax framework applied globally, the nearest approximation (and therefore the best legally available option) is to atribute as much profit as possible to your country of incorporation.

    Yes I know that aggravates global poverty and inequality, but that it would appear is not so important.

  13. The value of the ore isn’t its value to you, but its opportunity cost.

    The gov’t should auction off the ore in a second-price sealed-bid auction. What “Richard Murphy” should advocate based on the post above is a first-price sealed-bid auction. It provably raises the same amount of money but never mind that.

  14. Banks have the answer, as usual. In the absence of adequate market information to price your goods, you develop your own model and price them yourself. It’s called “marking to model”.

  15. of course the local tax rates in the applicable jurisdictions will not colour your approach in any way whatsoever!

  16. And you will of course be patenting your extraction process and all imaginable variations thereof to keep there from being a market in this for as long as humanly possible I hope? Crazy if you don’t…

  17. “Richard Murphy” does NOT answer your question – he answers a completely different one which he seems to think that you ought to have asked. (I am not actually sure what question he *is* answering – it seems to be “On how much tax should I pay tax?” answered as “sale price less value in ground ignoring processing and transport costs” rather than “how do I split the amount of taxable income between countries?”)

  18. Negotiate a special low rate for the mineral (or equivalently some sort of tax break for related activities) in the 3WC and pay all the tax there.

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