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Seminar on Public Finances and Tax Evasion in Latin America

Seminar on Public Finances and Tax Evasion in Latin America ICEFI, Tax Justice Network and Poder Ciudadano Under the auspices and participation of the European Union, ITC-GTZ, SOMO, KEPA and Latindadd Antigua, 25-26 August 2010.

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Seminar on Public Finances and Tax Evasion in Latin America

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  1. Seminar on Public Finances and Tax Evasion in Latin America ICEFI, Tax Justice Network and Poder Ciudadano Under the auspices and participation of the European Union, ITC-GTZ, SOMO, KEPA and Latindadd Antigua, 25-26 August 2010 A case study of abnormally priced trades between the U.S. and the LACMethodology, results, and their implications for Partner CountriesSimon J. PakAssociate Professor of FinanceThe Pennsylvania State UniversitySchool of Graduate Professional StudiesTel: (610)725-5343 email: SimonPak@psu.edu

  2. Outline • Abnormally priced export and import • Guatemala’s export examples – Bananas and Coffee • Guatemala’s import examples – Wheat and Light Crude Oil • Causes and Effects of abnormal trade pricing • Detection methods of abnormal pricing • Arm’s length price (ALP) data • Price filter matrix – a statistical approach • Estimates of capital flows through abnormal pricing: LAC countries vs. U.S. • Non-quantified trades • Commodities with volatile price movements • Summary • Detection system – Price filter matrix & its limitation

  3. Low Priced Banana Export from Guatemala • In June 2009, Guatemala Exported Bananas to the U.S. 5,098 tons for $1.018 million • Export price: $0.20/Kg • Worth $4.338 mm at an Arm’s Length Price* of $0.85/Kg • Underpriced by $3.32 mm • $3.32 mm wealth outflow • $3.32 mm less taxable income Photo Source: http://freefoto.org/images/04/29/04_29_8_prev.jpg * IMF Primary Commodity Prices - Bananas, avg of Chiquita, Del Monte, Dole, US Gulf delivery http://www.imf.org/external/np/res/commod/index.asp

  4. 2009 Guatemala Export to the U.S.BANANAS, Fresh (HS code: 0803002020) IMF price data All Underpriced! Total Bananas export in 2009: export value = $431 mm amount underpriced = $514 MM (=120% of total export value)

  5. Bananas Export - Underpriced Amounts 10-year total: export amount $2.75 BN Underpriced amount: $3.3 BN (120% of exp amt) (Reference monthly prices from IMF Primary Commodity Prices)

  6. Guatemala Coffee Export – Abnormally Priced • Underpriced by $56,828 • $56,828 wealth outflow • $56,828 less taxable income • Overpriced by $1.63 mm • $1.63 mm wealth inflow • $1.63 mm more taxable income Photo fromhttp://t1.gstatic.com/images?q=tbn:ANd9GcRPJx5oD_V-khSV-Mud4ppc8NN3opoGeilZBOoW7bSg5tA64tc&t=1&usg=__bBNVm4pnnWKpUxWTtODqYp2TUus=

  7. 2009 Guatemala Export to the U.S.COFFEE, ARABICA, NOT ROASTED, NOT DECAFFEINATED (HS code: 0901110010) Total for 2009: exp value= $287 mm amount underpriced = $5.4 MM (1.9% of exp amt) amount overpriced = $21 MM (7.3% of exp amt)

  8. Coffee Export: under-, over- priced amounts 10-year total amount (Export value $1,897 mm): $69 mm (underpriced, 3.6%) $278 mm (overpriced, 14.7%) (Reference monthly prices from IMF Primary Commodity Prices)

  9. Guatemala Oil Import – Abnormally Priced • Underpriced by $4.81 mm • $ 4.81 mm wealth inflow • $ 4.81 mm more taxable income • Overpriced by $1.89 mm • $ $ 1.89 mm wealth outflow • $ $ 1.89 mm less taxable income Photo from http://www.freefoto.com/images/13/07/13_07_10_prev.jpg • * EIA Ref Price: No.2 Fuel Oil, not Diesel, monthly max/min prices

  10. 2008 Guatemala Import from the U.S.LIGHT FULE OILS 25 DEG API (HS code: 2710191005) Total for 2008: exp value = $ 502 mm Overpriced amount = $6.0 MM (1.2%) --- negligible Underpriced amount = $11.7 MM (2.3%) --- negligible

  11. Light Fuel Oil Import: under-, over- priced amounts 7-year total amount: import value = $769 mm underpriced = $24 mm (3.1%) overpriced = $11 mm (1.5%) (Reference monthly prices from IMF Primary Commodity Prices)

  12. Guatemala Wheat Import – Abnormally Priced • Underpriced by $319,694 • $ 319,694 wealth inflow • $ 319,694 more taxable income • Overpriced by $2.16 mm • $ $ 2.16 mm wealth outflow • $ $ 2.16 mm less taxable income Photo fromhttp://www.freefoto.com/images/9905/07/9905_07_5_prev.jpg

  13. 2009 Guatemala Import from the U.S.Wheat (HS code: 1001902055, m. ton) Total for 2009: Import value = $ 85.9 mm overpriced amount = $12.5 MM (14.6%)

  14. Wheat Import: under-, over- priced amounts 10-year total amount: imp value = $675 mm underpriced = $7.6 mm (1.1%) overpriced = $63 mm (9.3%) (Reference monthly prices from IMF Primary Commodity Prices)

  15. Effects of Abnormally Priced Trades

  16. What Causes Trade Abnormal Pricing? • May be related to • Capital flight • Import duty fraud • Income tax avoidance / Transfer pricing • Money laundering • Other Explanations: • Clerical/Recording errors • Product heterogeneity for a given HS10 code • $25,000 fax machine from Japan – prototype industrial sample

  17. Outline • Abnormally priced export and import • Guatemala’s export examples – Bananas and Coffee • Guatemala’s import examples – Wheat and Light Crude Oil • Causes and Effects of abnormal trade pricing • Detection methods of abnormal pricing • Arm’s length price (ALP) data • Price filter matrix – a statistical approach • Estimates of capital flows through abnormal pricing: LAC countries vs. U.S. (tax haven?) • Non-quantified trades • Commodities with volatile price movements • Summary • Detection system – Price filter matrix & its limitation

  18. How to Detect Abnormal Pricing? “Money Laundering and Income Tax Evasion: The Determination of Optimal Audits and Inspections to Detect Abnormal Prices in International Trade,” Journal of Financial Crime, Vol. 12, No. 2, 2004. (de Boyrie, M.E., Pak, S.J., and Zdanowicz, J. S.) • Audits & Inspections • Customs Agents • Lack of benchmark pricing data (arm’s length price) - Difficult to determine abnormality • Pre Shipment Inspection firms • All specified inbound cargos inspected • Challenges in Detection • Over 70 million transactions annually in U.S. Exports and Imports • Examination of trade documents • Physical inspection of cargo • Delays in the movement of goods

  19. How to Detect Abnormal Pricing? • Alternative Approaches: • Computerized Filtering based on benchmark prices if available • Low cost & efficient • Accurate • A statistical approach by estimating upper & lower bounds if benchmark prices not available • Low cost and efficient • Accuracy depends on the quality of the historical data in estimating the benchmark upper & lower bound prices

  20. How to Detect Abnormal Pricing? • Statistical Approach • Estimate the benchmark upper and lower bounds of prices (Price filter matrix) • Based on statistical Analysis of historical prices • For each commodity category by country • Transactions with prices outside the benchmark prices • Higher probability of being abnormal than the population • The narrower bounds of the benchmark prices, the more numerous the transactions with prices outside the benchmark prices • Suspected trades with abnormal prices require inspections by Customs agents

  21. DATA SOURCE • Import and Export data from U.S. Customs and Border Protection • Most detailed import and export records • Not publicly available • U.S. Merchandise Trade Data from U.S. Census Bureau • Publicly available • Import and export records grouped by HS10, Partner country, customs district, and month • 8,750 export HS10 codes and 16,703 import HS10 codes in 2009 • 233 countries in 2009 • 44 customs district codes • Quantity & Dollar value

  22. Price Filter Matrix - Criteria for Price Abnormality • Price Filter Matrix may be constructed from the U.S. Merchandise Trade data: • For each commodity code and each country The average price, the standard deviation, upper- and lower- bound prices Upper bound = the mean + as or Upper Quartile Price Lower bound = the mean - as or Lower Quartile Price • Total Number of Cells in 2009: 5.86 million cells Export: (8,750 items)x (233 countries) = 2.04 mm cells Import: (16,703 items) x (229 countries) = 3.82 mm cells

  23. Price Filter Matrix - Bananas • U.S. Bananas import • US-World price filter: • Upper and Lower quartile prices based on all U.S. import records from all countries • US-Guatemala price filter: • Upper and Lower quartile prices based on all U.S. import records from Guatemala • Compare the results with IMF Bananas price

  24. U.S.-World Quartile Prices (Bananas 2009) Overpriced Upper Quartile Price US-World data Normal Underpriced

  25. U.S.- Guatemala Quartile Prices (Bananas 2009) Upper Quartile Price US-Guatemala data Normal Lower Quartile Price US-Guatemala data

  26. Which Arm’s Length Price?IMF, US-World, US-Guatemala

  27. Over/Under-priced Amounts, 2000-2009

  28. 2009 Guatemala Export to the U.S.COFFEE, ARABICA, NOT ROASTED, NOT DECAFFEINATEDHS10 code: 0901110010

  29. Over/Under-priced Amounts, 2000-2009

  30. 2009 US Import Prices (cif) from GuatemalaCOFFEE, ARABICA, NOT ROASTED, NOT DECAFFEINATED (HS code: 0901110010)

  31. 2009 Coffee Prices (IMF vs. US Import Price Statistics,cif)IMF: Coffee, Other Milds, El Salvador and Guatemala, ex-dock New YorkUS-Guatemala Price: Coffee, Arabica, not roasted, not decaff HS10: 0901110010

  32. 2009 Coffee Prices (IMF vs. US Import Price Statistics, cif)IMF: Coffee, Other Milds, El Salvador and Guatemala, ex-dock New YorkUS-World Prices: Coffee, Arabica, not roasted, not decaff HS10: 0901110010

  33. 2009 Guatemala Import Prices (f.o.b. US) from the U.S.Wheat (HS: 1001902055, USD/MTon)

  34. Over/Under-priced Amounts, 2000-2009

  35. 2008 Guatemala Import Prices (fob US) from the U.S.Light Fuel Oils, not Diesel, 25 DEGREES API (HS: 2710191005)

  36. Over/Under-priced Amounts, 2000-2009

  37. Detection of Abnormal Pricing • Physical auditing/inspection • Too many to inspect – costly & delayed cargo flow • Benchmark prices available for limited number of items • Computerized detection with benchmark prices • Low cost and accurate • Benchmark prices available only for limited number of items • Computerized detection with statistically estimated Price Filter Matrix • Less accurate than with benchmark prices • Possible underestimation of abnormality • Efficient and low cost detection of importers/exporters with frequent mispricing when combined with inspection/audit by Customs specialist

  38. Outline • Abnormally priced export and import • Guatemala’s export examples – Bananas and Coffee • Guatemala’s import examples – Wheat and Light Crude Oil • Causes and Effects of abnormal trade pricing • Detection methods of abnormal pricing • Arm’s length price (ALP) data • Price filter matrix – a statistical approach • Estimates of capital flows through abnormal pricing: LAC countries vs. U.S. (tax haven?) • Non-quantified trades • Commodities with volatile price movements • Summary • Detection system – Price filter matrix & its limitation

  39. Estimates of Capital Flows using Price Filter Matrix METHOD: • Estimate upper and lower quartile prices for: • Every commodity • Every country • Calculate overpriced amount and underpriced amount for every trade with prices outside the interquartile range • Aggregate overpriced amounts and underpriced amounts for all trades CAUTION: • The method can’t be applied to non-quantified trades • The price filter method will not work for commodities with volatile benchmark prices such as crude oil in 2008

  40. 2009 US Export to LAC - 1 * Tax haven country list from OECD Progress Report 2April2009, http://www.oecd.org/tax/progressreport

  41. 2009 US Export to LAC - 2

  42. 2009 US Export to LAC - 3

  43. 2009 US Import from LAC - 1 * Tax haven country list from OECD Progress Report 2April2009, http://www.oecd.org/tax/progressreport

  44. 2009 US Import from LAC - 2

  45. 2009 US Import from LAC - 3

  46. Price Filter Application to a Court Case • Chen/Sunrider was accused of over-invoiced imports • Imported herbs at very high prices from China and Taiwan between 1989 and 1991 to evade U.S. income tax • Two Court Cases • IRS vs. Chen/Sunrider: IRS Section 482 violation • The US vs. Chen/Sunrider: US Customs Document Fraud case (Simon Pak was the expert witness consultant for the U.S. Attorney’s office along with Dr. John Zdanowitz)

  47. Other mushrooms TSUSA: 0712302000(KG) CHINA(TAIWAN) $120 $100 $80 $60 $40 $20 $0 890223 890420 890516 890814 890920 891019 891025 891026 891026 891031 891208 900214 900302 900404 900706 900719 900809 900828 901010 901019 901121 901206 901224 910110 Price I Price-rev Price II UpQ-country UpQ-world

  48. Chart 5-1: Proportion of Imports with Prices Higher Than U.S. - Country Upper Quartile Prices 89% 95% 100% 83% 82% 80% 53% 53% 60% 40% 20% 0% Period 1 - Orig Period 1 - Rev Period 2 - Orig No. of Trans. $ Amount

  49. Chen/Sunrider case - The Results • IRS vs. Chen/Sunrider • On the IRS Section 482 violation charge, Mr. Chen paid IRS over $48 million for tax and penalty (6 Transfer Pricing Report 842, 3/25/98) • According to the Wall Street Journal (7/3/1997), Mr. Chen paid $93 million without admitting any wrongdoing. • The US vs. Chen/Sunrider On the Customs Document Fraud charge, Mr. Chen Paid $4 million fine to US Customs and sentenced to a two-year jail term

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