The transfer pricing conflict is about profit shifting
- Dick Forslund
- 23 Oct 2014 11:21 (South Africa)
Some of Lonmin’s statements in September have been confusing. To say so is not “defamation” and I will not waste space by giving examples. Mail & Guardian’s centre for investigative journalism, AmaBhunghane, has done an excellent job in pointing to them.
Transfer pricing arrangements are never advertised – they usually remain below the radar. Nevertheless, the AIDC report doesn’t argue that profits are “hidden” from present or prospect shareholders of Lonmin Plc, the parent company in United Kingdom. The report speaks of profit shifting. Shareholders in Lonmin Plc can suffer economically only if transfers are made to entities whose books are not integrated in Lonmin Plc’s public group accounts. Normally, however, shareholders in a multinational mining company, with a main listing in London and running operations in South Africa, benefit from transfer pricing.
These arrangements shift money upwards, away from local subsidiaries. It is local interests that are negatively affected. Profit shifting is done at the expense of both mine workers fighting for a living wage of R12,500, for example, and the South African Revenue Services (SARS) which collects tax on the profits of these subsidiaries. Transfer pricing also moves money away from Black Economic Empowerment (BEE) minority shareholders. They expect to be paid dividends from the local entities – the subsidiaries that produce all new value in the group and where they hold shares.
Seen from this view, the two transfer arrangements criticised in the AIDC report are one part of a flexible organisation that can convince Lonmin Plc shareholders around the world that they will, eventually, get a hefty return on investments. Evidently, old and new incoming investors have been very convinced of that, even after the killings and the massacre in Marikana in August 2012. And before 2012 they voted with their money to bring in Shanduka as the majority owner of the BEE partner Incwala Resources. They gladly contributed new risk capital to a net of $229-million in 2010, as a part of the $304-million loan that made it possible for Shanduka to take control of Incwala by buying out some old BEE shareholders: This is where that cash went.
One exception to the rule of narrowly focused profit-making was the decision by the International Finance Cooperation (IFC) to invest in Lonmin Plc. The IFC is a part of the World Bank Group. According to a report (30 August 2013) from the Compliance Advisor Ombudsman (CAO) the IFC favoured such an investment because Lonmin was “undertaking an aggressive programme of housing development and hostel conversion so as to be able to provide improved living conditions of its staff”. This was “expected to be complete by 2011”, adds the CAO. IFC provided new equity of $50 million to Lonmin, starting from 2007.
The housing programme that the IFC referred to was an obligation under the Mining Charter. It has been scrutinised by the Marikana Commission of Inquiry. Lonmin’s local subsidiaries, Western Platinum Ltd (WPL) and Eastern Platinum Ltd (EPL), committed to build 5,500 new houses for mine workers and their families. To date only three show houses have been built. This blatant failure corrupted the hostel conversion programme. If no houses are built in parallel to the conversion of hostels, then some three out of four workers staying in a hostel move to the informal settlements after a conversion is done.
The unsustainability of the situation was already clear in 2011 when Lonmin was hit by “community unrest”. Lonmin dismissed 9,000 workers after a two week wild cat strike for higher wages in May, and then again rehired 8,200 workers. Lonmin doesn’t provide a cost figure in dollars or rand for the 2011 strike in its annual reports, but the monetary cost for the worker upheaval in 2012 was $159-million, according to Lonmin, or close to R1.3-billion.
It is the local subsidiaries that have the mining licences and are obliged to honour their Social Labour Plan commitments. In addition, they face increasing pressure to end low wage labour. In this situation, instead of financing their legal obligations, Lonmin, via its local subsidiaries, has to ‘afford’ huge bills sent from a tax planning outfit in Bermuda in “sales commissions” and from the head office in “management fees”. Even after accepting a part of the exorbitant management fees, we calculate that these two arrangements imposed a cost on the local subsidiary Western Platinum that is well over R400-million per year.
There are several reasons for being very critical of this arrangement. The question of whether the “structure” in Bermuda has been nothing but a bank account guarded by the law firm Appleby Services is one of them. In addition to Western Platinum paying more than R1.7-billion internally in ‘commissions’ and ‘fees’ 2009-2012, Lonmin also paid over R1-billion for marketing and management services to external providers over the same period, according to the 2013 annual report (page 174). When asked why by the Mail & Guardian, Lonmin repeated twice that it doesn’t have any external service providers of these two services, while not clarifying why the annual report points to the opposite.
The transfer pricing arrangements of South African mining companies are not at all only a matter of lower taxes and tax planning. While a R100-million ‘transfer’ from South Africa to a tax haven gains R28-million in lower tax obligations, the rest (R72-million) potentially is at the expense of better wages and effective implementation of social labour plans.
In that context it matters little if a transfer arrangement is “in no way illegal”, not the least unusual (as testified at the Commission hearings by Lonmin director Mr M Seedat) and fully accepted, or at least tolerated by the SARS in terms of current legislation. The legal issues are complicated, but the effect these practices have on the workers, on the mining communities and on the SA economy, calls, in our opinion, for a major overhaul of corporate governance, capital controls and tax legislation.
Finally, Lonmin says the “structure” of Western Metal Sales (WMS), registered in 1987 in Bermuda, “did not benefit Lonmin from a tax perspective as Lonmin remained liable for the payment of taxes in the UK arising from legitimate and reasonable commission paid to WMS”. (letter to the Mail & Guardian, 26 September).
Lonmin here refers to the ‘Controlled Foreign Company’ legislation in the UK, which makes a UK parent company liable for tax on dividends distributed by a subsidiary in a tax haven. Despite this legislation, Lonmin has paid no tax in UK from 2000 to 2013 and obviously found a way out. To be liable for tax isn’t the same thing as actually having to pay tax. This also goes for Lonmin Insurance Ltd (LIL) in Bermuda, to which Lonmin subsidiaries have paid and are paying premiums.
In 2013 LIL was moved from Bermuda to another legendary tax haven: Guernsey in the English Channel. Lonmin says to Mail & Guardian’s AmaBunghane that LIL doesn’t have any staff on Guernsey. Asked for the commercial motive for the move of LIL, Lonmin says that it moved to the same time zone as Lonmin’s other companies and adds, “It is more practical to have LIL located in Guernsey so that these Board meetings can be held at the same time as the relevant Lonmin executives responsible for LIL are travelling to London on other Lonmin business”.
Tax authorities around the world are increasingly questioning registrations in tax havens if there are no real activities on the site. “Where does the board have its meetings?” has become one of the test questions. To Lonmin’s assertion that we are not tax legislation experts, we have to admit we are neither experts of geography, but if the motive for the relocation was only geographic, isn’t London closer to London than Guernsey? DM
Dick Forslund is senior economist at Alternative Information and Development Centre in Cape Town.