draining development.pdf - Khazar University

The Role of Transfer Pricing in Illicit Financial Flows 251transfer pricing policy at different points within the ALP range or else torestructure their businesses in a way that increases reported profits in thetaxing country.For developing countries, Kar and Cartwright-Smith (2008) andChristian Aid (2009) provide estimates of trade misinvoicing practicesby which profits are shifted out of developing countries. The formerstudy suggests that, between 2002 and 2006, approximately US$370 billionin profits were shifted out of the developing world every year, andthe latter study suggests that the figure for the period between 2005 and2007 is more than US$1 trillion. The headline number in these reports isthe estimated tax revenue loss, which is calculated at close to US$120billion per year. (This compares with global flows of official developmentassistance of roughly the same magnitude in 2008.)These figures are not widely accepted, and the academic literaturehas raised important questions with respect to the methodology andthe strength of the conclusions. 18 For our purposes, these studies do notallow any conclusions on the role of transfer pricing because theydo not use company-level data; given that transfer pricing is intrinsicallyfact-dependent, the extent of non-ALP transfer pricing canonly be determined by analyzing transaction-level data to ensure thatapparent income shifting in the aggregate data is not caused by (1) reasonablecomparability differences, (2) variations in product quality, or(3) a reflection of shifts in assets, functions, and risks. 19 In fact, thesestudies do not even distinguish between transactions involving unrelatedand related parties.Impact on local economies and tax collectionsWhat is also less clear is the impact on the economies and on tax collectionsof developing countries. In fact, during the recent globalizationdrive that included a substantial increase in the number of MNEs and inthe share of intrafirm transactions in trade flows, corporate tax revenuesremained stable across the world. So, why are there differences in theperceived widespread effects of transfer pricing practices and the availableempirical analyses? First, the existing estimates are derived fromstudies with substantial methodological shortcomings, and, second, theevidence of these studies runs counter to the observed response of FDIto tax rates and the recent buoyancy in corporate tax revenues.