Fairfood Matters: ‘The curious case of the 20 cents fridges’

Transfer mispricing and its global consequences

Forty million fridges

Have you ever seen a fridge sold for just twenty euro cents? Well, me neither. Still, forty million of such exceptionally cheap fridges were imported from China into the EU between 2005 and 2007. As you might guess, none of these fridges were sold to European consumers for such a ridiculously low price. What is actually going on here is a legally accepted accounting ‘trick’, a scheme officially known as ‘transfer mispricing’.

Transfer mispricing

So why do some multinational companies deliberately decide to set such low prices? The answer is actually quite simple: using transfer mispricing allows them to avoid large tax payments. Let’s take a closer look at the fridge example to clear this up. When a department of a multinational that produces fridges in country A, wants to transfer these to a different department in country B, it is obliged to set transfer prices. Because both departments are part of the same multinational, these prices can be determined by the company itself. Of course for the fridge company in question it makes sense to set the prices at an artificially low level. In this way it can ensure it only has to pay a minimum amount of taxes. And this form of tax avoidance is also used by companies that produce the products which go inside these fridges.

Consequences

Surely there must be a downside to these practices. And indeed there is. Because of transfer mispricing governments are deprived of multibillions of euros in yearly tax income. Especially for developing countries this is a worrisome situation. Since these lack the knowledge, funds, capacity and power to address companies on these issues, they are hit hardest by transfer mispricing and false invoicing. Their total loss in tax revenues is estimated at as much as US $160 billion a year.

Solution?

So what is the solution to this harmful situation? Well, regrettably at the moment there is no global answer. International differences in tax systems, an asymmetric division of information, and the powerful position of companies make transfer mispricing particularly hard to tackle. As yet an international solution for this officially legal, but morally irresponsible conduct of companies has still to be developed. Until then, we seem at the mercy of corporate social responsibility.

Want to read more on transfer mispricing? Check out the websites of the following organizations:
Tax Justice
OECD Observer

Please feel free to comment on this blog!

Shan Kai The

About me: I am project assistant fairness criteria at Fairfood International. Through my work for Fairfood I try to incorporate more economic issues in the Fair-trade area. In addition to the environment, health and safety of workers, and minimum wages, it is important to also pay attention tot economical issues such as trade relations, market power, corruption, and taxes.