Vol.3 No.2, 28 January 2003

Wealth and Tax Transfers by Multinational Corporations to Home Country

By Mark Hennesey

Dear SANE Viewer

Here is a contribution from a new SANE Views subscriber, Mark Hennesey. Mark was formerly the Director of Strategy and Business Development for ISM (i.e. IBM operating at arm's length in South Africa during the apartheid years). He makes the very important point that it is in the interest of multi-national companies to maximise profit declared in the home country. With this focus a transfer of wealth from the subsidiary country to the rich home country will occur. Clearly South Africa must be on its guard against this trend. The transfer of company listings from the Johannesburg stock exchange to those of overseas markets is not a good sign. Measures should be taken to ensure that South Africa is not deprived of its fair share in this process.

Aart Roukens de Lange
Editor, SANE Views.

Why is it that no one in South Africa seems to realise the fact that when a South African Company is taken over by a foreign based company and becomes either a wholly owned subsidiary or a majority owned subsidiary, South Africa loses control of the flow of profit and hence the potential tax base that arises from that company's operations in this country?

The key measurement by share holders and the investment community of the management of a corporation that operates internationally is the before tax profit that is declared in its results in it's home country. The home country then benefits from the resulting taxation.

There are many ways that the corporation can manipulate the flow of profitfrom subsidiaries. In addition to the generally recognised charges such as royalties and licences there are a range of internal charges by means of which funds flow from the subsidiary to the corporation. Internal transfer prices within the overall corporation are not market related and are usually confidential. Hence products or services sold to the subsidiary can be priced high while the transfer prices of products and resources bought from the subsidiary can be kept low. Then there are all sorts of nebulous charges which can be manipulated and abused such as management fees, 'know how' transfer charges, administrative charges, IT charges, costs of education courses and materials, publications and advertising material - an almost endless list. All these are means of reducing the profit and hence tax paid locally by the subsidiary while adding to the income and hence the before tax profit of the corporation as measured in the 'home country'. This profit is then taxed by the home country. This amounts to the export of potential taxation from the country of the subsidiary to the home country of the corporation.

This fact, the potential export of the South African tax base, never seems to be taken into account in discussions or comment when South African companies are taken over or sold to foreign corporations. For example it has not been mentioned in the current negotiations to sell Iscor to LNM. It did not seem to figure in the decisions when holders of a major share of South African assets such as Anglo, Mutual, SAB and Billiton were allowed to change their address to London. Is it ignorance or naivety on our part?

The Australians on the other hand refused to allow BHP Billiton to be registered in London and insisted that it's home base be in their country. So now we have to accept that the control of the flow of profit, and therefore potential tax revenues, of the South African national assets that reside in Billiton have been handed to Australia. Was the unnecessary run out in the last World Cup not enough?

But seriously it is high time that our authorities and, it seems, the press understood the internal workings of International companies. The way management are measured by the market place will determine how they behave. They will therefore use the cost structures available to them in their dealings with their subsidiaries to do all they can to increase the declared profit in the home country. This means a reduction of the declared profit of the subsidiary for tax purposes in the subsidiary's country.

While there may be a 'swings and roundabouts' effect between first world countries, the system of the national measurement and taxation of corporations that operate globally holds the potential for significant and long-term disadvantages for developing and underdeveloped nations who are being encouraged to open their equity markets to global corporations in the name of seeking foreign direct investment. In effect developing nations are subsidising the social services of the first world. Another form of economic colonialism?

We need to be a little more circumspect about handing over the control of the profit flow from our assets to others and ensure that the taxation benefits that should accrue to South African do in fact do so.

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