The complexity in the global trade of commodities presents a major obstacle to understanding how supply chains are linked to undesired outcomes, such as environmental degradation and poor working conditions. Greater transparency in the flow of commodities from production areas to traders, processors and finally to consumers, can help supply chain actors better understand and address the risks they are exposed to.
Supply-chain data sharing and disclosure between some producer and consumer countries is already a strategic area of cooperation on sustainability issues like the fight against deforestation linked to commodity trade. But the potential power of transparency to address challenges does not stop there. Illuminating trade flows can also, for example, assist governments in monitoring financial risks associated with a commodity sector.
This insight offers an example of how supply chain data could be used by governments to better understand the risk of tax avoidance by companies sourcing, trading or operating in their jurisdictions. Using data from the Indonesian palm oil sector, it demonstrates how greater supply chain transparency could help countries better capture tax revenue related to commodity production, processing and trade.
Tax avoidance and lost revenue in the trade of palm oil
In 2019, 29.4 million tonnes of palm oil were exported from Indonesia to China, India, the European Union, Pakistan and many other countries. Prior to reaching these destination markets, significant volumes of palm oil were traded first through companies based in Singapore and Hong Kong. These key intermediaries happen to be known tax havens.
Multinational companies often sell goods to their own subsidiaries and affiliates based in other countries to access overseas markets and facilitate regulatory compliance. In fact, studies have estimated that related party transactions account for at least a third of global trade.
However, concerns have been raised about multinationals utilising related-party transactions to minimise tax obligations in high tax jurisdictions and increase overall profits. The multinational company Royal Golden Eagle was convicted in the Indonesian supreme court of evading over USD 112 million in taxes over several years due to fraudulent accounting practices through its Asian Agri subsidiary. Recent investigations of the Belgian agribusiness Socfin have also unearthed evidence of potential abusive transfer pricing in the trade of rubber and palm oil from Africa.
What is transfer pricing?
Transfer pricing refers to the price that an enterprise charges to an associated entity, such as a subsidiary or between divisions of the same company, for goods or service rendered. External market forces determine the price and condition of a transaction between unrelated entities. However, transactions between related entities may not be affected by market forces in the same way. The arm’s length principle provides a standard for transfer pricing. The principle states that transactions between two associated parties should be at the same price as comparable transactions between two unrelated parties.
Transfer pricing is not illegal, however, this practice can be abused to manipulate profits and (fraudulently) reduce tax liability. Abusive transfer pricing occurs when companies sell goods to a subsidiary or related enterprise based in a lower tax jurisdiction at an artificially lower price with the intent of tax avoidance. This leads to lower revenues for the company based in the higher tax jurisdiction and higher revenues for the one in the low tax jurisdiction, which reduces the total tax burden. Profit shifting results in lost tax revenue for governments in producing countries and final destination countries, reflecting a prioritisation of short-term corporate gains over long-term investment in the areas where companies source from. A lack of transparency makes it difficult to assess whether companies are engaging in transactions with related entities legitimately or as a means of tax avoidance.
How to detect possible tax avoidance via transfer pricing
Commodity trade flows provide a first indication of potential transfer pricing abuse. A pattern of transactions made first through low tax areas, where further processing of the commodity is not done, and before reaching the destination market, signals higher risk of corporate tax avoidance via transfer pricing in a sector.
Flow of Indonesian exported crude palm oil traded mostly via tax havens in 2019 (Source: Trase data)
Flow of Indonesian exported refined palm oil traded mostly via tax havens in 2019 (Source: Trase data)
When exploring trade data on crude palm oil exports (HS code 15119000, -41, -42, -49) from Indonesia, we see that 75% of the 9.2 million tonnes exported in 2019 were traded through Singapore before being sold on to other destinations.
Percentage of crude palm oil exports from Indonesia traded via tax havens in 2019.
Similarly, of the over 20 million tonnes of refined palm oil (HS code 15119020, -31, -32, -36, -37, -39) exported from Indonesia in 2019, a large portion (84%) was traded via companies based in Singapore and Hong Kong before reaching destination markets in Italy, Spain, Pakistan and 19 other countries. Most of these transactions, covering 16 million tonnes, were conducted through Singapore.
84% of refined palm oil exports from Indonesia in 2019 were traded through tax havens.
Export prices are, of course, key to offer further evidence of tax avoidance. If we zoom into export prices for refined palm oil classified under HS code 15119020 , of which over four million tonnes were exported from Indonesia in 2019, we observe a lower average export price for those volumes that were traded via a known tax haven compared to those volumes traded through non-tax havens.
Average export prices by tax haven status
This pattern is present when comparing export prices between companies that only trade via tax havens with companies trading via non-tax havens. It also exists when comparing average export prices for those exporters who only traded portions of their supply through Singapore or Hong Kong.
This difference in export prices raises the possibility that some companies may be attempting to shift profits to tax havens to minimise tax burdens in Indonesia. Given corporate tax rates are about 25% lower in Singapore and Hong Kong than in Indonesia, companies taking advantage of transfer pricing for tax avoidance would sell at a lower price to related entities based in those tax havens, leading to lower overall tax obligations and greater profits for the parent company.
This brief analysis is not intended to provide definitive evidence of illegal practices in the sector. However, it demonstrates how existing supply chain data may be used to better understand the risks of corporate tax avoidance via transfer pricing using the case of the trade of palm oil from Indonesia. Using the same data, we estimate this international transfer pricing may have cost USD 12 million in lost tax revenue for the Indonesian Government in 2019 for refined palm oil exports alone (HS code 15119020). Further investigations of transactions between companies, and specifically between related entities, would be needed to establish whether companies have engaged in abusive transfer pricing practices as a means of corporate tax avoidance.
Cooperation with consumer countries, to compare the final import prices of the same commodity flows, would help to identify possible instances of abusive transfer pricing more systematically and efficiently. Ensuring companies are fulfilling their tax obligations with the perspective of mutual benefits of increased tax revenues can become another good reason to cooperate on supply-chain data sharing and disclosure for producer and consumer countries.