Time for firmer stance against legal tax dodges

FOR decades, Malaysia has sought to attract and retain foreign direct investments (FDIs), with the hopes of building up the country's capabilities, competitiveness and trade, while at the same time creating jobs and transferring technology. For the most part, this strategy has worked like a charm as Malaysia continues to be counted among the top 25 trading nations in the world.

But there is an angle to this that has never been fully explored. The February 16th issue of the Economist magazine featured a special report on tax havens, with as much as US$20 trillion (RM62 trillion) sitting in offshore accounts. A huge chunk of this is from perfectly legal tax avoidance schemes by companies and multinationals although a tiny portion of it is from overtly illegal activities.

A company could make most of its sales or manufacturing in one country and, through internal transfer pricing, creative trade invoicing, intellectual property (IP) fees, management fees and the like, post most of the profits in another country with a lower corporate tax rate and/or laxer tax regime.

From a company's point of view, this is perfectly reasonable behaviour - minimising the tax burden is a pretty cheap way of improving shareholder value. It's great for the tax haven too, as money flows to places with no particular economic advantages. For instance, the Cayman Islands and the British Virgin Islands are popular as bases for corporate holding companies.

But for the host country where the sales and economic activity are actually taking place, this state of affairs is unjust. The profits (and tax revenues) shifted overseas are in part supported by domestic infrastructure, which tax revenues help pay for.

Moreover, foreign investors tend to benefit from tax incentives designed to attract FDIs. With multinationals avoiding domestic tax liabilities, the burden of taxation is also unfairly tilted towards domestic producers and consumers.

So what relevance does this have for Malaysia? For starters, we're one of the biggest victims in this global game of accounting magic.

According to last year's report by Global Financial Integrity (GFI), Malaysia lost an average of about US$40 billion a year from 2001-2010. More than 80 per cent of this loss came from creative trade invoicing - not corruption, not money laundering, but through a perfectly legal accounting trick. This doesn't even include the potential loss from other forms of profit-shifting such as IP fees.

For some perspective, applying the corporate tax rate to GFI's estimate of Malaysia's trade mis-invoicing results in estimated uncollected taxes equivalent to 76.4 per cent of the government's fiscal deficit over the same period. Put another way, Malaysia's debt to GDP ratio would be closer to 30 per cent instead of over 50 per cent as it is now.

In the global economic environment we are in today, everyone needs to shoulder their share of the burden.

Malaysia has made strides in improving financial transparency and governance, and attacking illegal money laundering.

As one of the biggest victims of illicit capital outflows, it's time we took a firmer stance against legal tax dodges.

The writer is vice-president of Economic Research with the Malaysian Rating Corporation Bhd (MARC). The article represents the author's personal views and opinions and do not necessarily represent those of MARC.