Govt moves to curb illegal capital flight
Multinational companies' transactions with their associated enterprises overseas are set to come under strict scrutiny.
The government has designed rules to check illicit capital transfer by foreign companies through misuse of a mechanism, known as 'transfer pricing'.
Transfer price is the price at which divisions of a company transact with each other for goods or services.
It takes place when two related companies -- such as a parent company and a subsidiary, or two subsidiaries controlled by a common parent -- engage in international trade with each other for goods and services.
Transfer pricing is not illegal, but 'transfer mispricing' is, analysts say.
Sometimes, related entities of a multinational firm show artificially high prices for an imported product or service in an attempt to deflate profits to evade taxes. This practice is known as 'transfer mispricing'.
Bangladesh loses a huge amount of taxes because of the abuse of the transfer pricing mechanism by foreign firms, several studies show.
Global Financial Integrity (GFI), a Washington-based firm, said a total of $34.12 billion flew out of Bangladesh between the years 1990 and 2008. It means the country lost $1.8 billion in capital a year during this period, causing the tax authority to lose a huge amount of revenue.
The government designed the rules to ensure that profits taxable in Bangladesh are not understated (or losses overstated) by declaring low receipts or higher outgoings than those actually are.
The rules exist in around 60 countries, including India, Sri Lanka, China and Vietnam.
Under the new rules, which became effective from July I, any international transaction above Tk 3 crore by a multinational or its associated entities from Bangladesh will come under scrutiny of the National Board of Revenue (NBR).
A report from a chartered accountant will have to be submitted to the NBR for transactions above Tk 3 crore in a financial year, according to Finance Act 2012.
Firms will need to provide proof that transactions have been done on the basis of 'arm's length price' -- a price at which two independent or unrelated entities trade with each other.
The arm's length price reflects the price of a genuine negotiation in a market and it is usually considered to be acceptable for tax purposes, according to Tax Justice Network (TJN), a UK-based independent organisation.
But when two related companies trade with each other, they may wish to artificially distort the price at which the trade is recorded, to minimise the overall tax bill. This might, for example, help it record as much of its profit as possible in a tax haven with low or zero taxes, adds the TJN.
An NBR official said companies in Bangladesh related with other firms abroad will have to pay more taxes if the value of its transaction is above the arm's length price of the particular product or service.
As per the provisions, the NBR will establish a transfer pricing cell to audit transactions by firms. The tax authority will also appoint officers to act as transfer pricing officers for auditing and determining arm's length prices in relation to any international transactions.
The finance act says foreign firms engaged in trading with their associated entities abroad will have to keep records and documents.
The law also provides scope for the NBR to impose penalty if a firm fails to comply with the rules of keeping records or providing information.
The NBR official, who is closely associated with the drafting of the rules, said trained manpower will be required to audit international transactions.
"We may need the current fiscal year for taking preparations, the official said, adding that audits might begin from the next fiscal year.
"We are losing a huge amount of taxes because of the abuse of transfer pricing. So our main job will be to prevent the abuse and earn more revenue," said the official, who is also a member of an NBR taskforce on transfer pricing and anti-money laundering.
The rules on transfer pricing come at a time when a steady growth of Bangladesh's economy has already attracted a large number of multinational enterprises.
Their number is likely to rise further in the near future, observes a Centre for Policy Dialogue (CPD) work paper -- adopting transfer pricing regime in Bangladesh: rationale and the needed initiatives -- published in November 2011.
Prof Mustafizur Rahman, executive director of the CPD, Md Shabbir Ahmed, deputy director general of Central Intelligence Cell of the NBR, and Towfiqul Islam Khan, senior research associate of the CPD, jointly prepared the paper.
It said Bangladesh, with 160 million of population, is a lucrative market for multinational enterprises.
The growing presence of multinational operations has increased the exposure of the country's tax system to the risk of transfer pricing abuse, said the study.
The growing openness of Bangladesh economy to global trade also increases the risk of transfer pricing abuse as about 40 percent of total global trade is conducted among related parties.
Citing a 2009 study of Christian Aid, an international development charity, the paper said Bangladesh lost around 186 million pounds ($359 million) in taxes between 2005 and 2007 due to mispricing in bilateral trade with the EU and US, said the CPD.
Mohammad Iqbal Chowdhury, head of finance and corporate affairs of Marico Bangladesh Ltd, a subsidiary of Marico Ltd in India, welcomed the government move. He said the enactment of the transfer pricing law is 'perfect and a timely decision' by the NBR.
Chowdhury said quite often, companies in Bangladesh face conflicting role by three wings of the NBR -- Customs, VAT and Income Tax.
He said customs departments tend to increase the value of import for getting higher duty at the import level. It ultimately reduces value addition at the local manufacturing stage, lowering the amount of VAT and also profitability for the entity.
Therefore, for all practical purposes, the revenue officials need to focus more on arm's length pricing of any transaction instead of using discretionary practices of determining prices, he said.