Treasure Islands - Nicholas Shaxson [9]
One of the first things to understand about offshore business is that it is, at heart, about artificially manipulating paper trails of money across borders. To get an idea of how artificial it can be, consider the banana.
A bunch of bananas typically takes two routes into your home: a real route and an artificial offshore paper trail. On the first route a Honduran worker, say, is employed by Big Banana, a U.S. multinational I’ve just invented, to pick the bananas, which are then packaged and shipped to Britain, sold to a supermarket, and sold on to a customer.
The second route—the accountants’ paper trail—is different. When a banana is picked in Honduras and shipped to Britain and sold, where are the final profits generated? In Honduras? In the British supermarket? In the multinational’s U.S. head office? And how do you work this out? How much do the corporation’s management expertise, or the brand name, or the insurance, or the accounting business, contribute to profits and costs? Which country ought to tax each component of the final profit? Nobody can say for sure, so the accountants can, up to a point, decide for themselves.
Here, in simple form, is what they might do. They advise Big Banana to run its purchasing network from, say, the Cayman Islands, and put a financial services subsidiary in Luxembourg. The Big Banana brand might be parked in Ireland; its shipping subsidiary in the Isle of Man; it might locate certain parts of its “management expertise” in Jersey, and its insurance arm in Bermuda. All are tax havens.
Next, each part of this multinational charges the other parts for the services they provide. So Big Banana’s Luxembourg finance subsidiary might lend money to Big Banana Honduras, then charge that Latin American subsidiary $10 million per year in interest payments for that loan. The Honduran subsidiary will deduct this $10 million from its local profits, cutting or wiping out its local profits (and consequently its tax bill) there. The Luxembourg finance subsidiary, however, will record this $10 million as income—but because Luxembourg is a tax haven, it pays no taxes on this. With a wave of an accountant’s wand, a hefty tax bill has disappeared. Who is to say that the $10 million charged by Big Banana Luxembourg is the real going rate—or just an accountant’s invention? Quite often it is hard to tell, although sometimes these prices are adjusted so aggressively that they lose all sense of reality: A kilo of toilet paper from China has been sold for $4,121.81, a liter of apple juice has been sold out of Israel at $2,052, and a ballpoint pen has been recorded leaving Trinidad valued at $8,500.
Though most examples are far less blatant than this, the cumulative total of these shenanigans is vast. About two-thirds of global cross-border world trade happens inside multinational corporations. And it is poor countries in particular, with their underpaid tax officials, that always lose out to multinationals’ aggressive, highly paid accountants.
What Big Banana has done here is transfer pricing (or mispricing), a common offshore trick that U.S. Senator Carl Levin calls “the corporate equivalent of the secret offshore accounts of individual tax dodgers.” The general idea is that by adjusting its internal prices a multinational can shift profits offshore, where they pay little or no tax,