draining development.pdf - Khazar University

The Role of Transfer Pricing in Illicit Financial Flows 249countries, and companies operating in such corrupt environments facethorny issues on the legality and licit nature of certain transactions. Incountries with highly corrupt regimes or stringent exchange controls(the two often go hand in hand), companies may consider the manipulationof transfer prices—which is particularly easy in the absence of specifictransfer pricing regulations—as an acceptable method of profitrepatriation. In the case above of the large petroleum company, this considerationwas likely important given the state of the business environmentand the existence of severe restrictions on profit repatriation at thetime. It is questionable whether such a technically illegal attempt to shiftincome out of a corrupt regime should be considered an illicit flow offunds.More recently, with the substantial reduction in exchange controlsacross the world, the concern of tax authorities, particularly in OECDcountries, has shifted to how easy it has become for taxpayers to concealforeign-based income on which residents should pay national tax. Byaccessing foreign jurisdictions offering low or zero tax rates and failingto report the proceeds to their home authorities and then not reportingthe foreign-based income, these taxpayers evade their tax obligationswith respect to their country of residence. Required reporting underexchange controls has provided information that is helpful in trackingthe flows of funds and, therefore, in assessing tax obligations. Withouttransfer pricing regulations or exchange controls in the country in whichthe income is earned, taxpayers may find it particularly easy to evade taxobligations through a combination of transfer price manipulation andaccess to a tax haven. 16Empirical Evidence on Illicit Financial Flows fromDeveloping CountriesThe wide variations in tax rates across the globe certainly lead MNEs torespond to the incentives created by these differences. We have good evidencethat recorded profits of MNEs shift among countries after achange in tax rates. 17 Of course, MNEs are likely to respond in a similarfashion to comparable arbitrage opportunities created by the differentmix of skills and costs among different locations within countries andacross countries. After all, their performance is judged by shareholders