Curbing the over and under invoicing

Over- and under-pricing of goods is very common in the business world. This illegal practice takes place between related parties having mutual self-interest. Importers and exporters having control, influence, and ownership on each other are the related parties. On the contrary, a fair price known as arm's length price (ALP) is an open market price between independent and unaffiliated parties. 

ARMS' LENGTH PRICE (ALP) IS A DIFFICULT CONCEPT: Governments in many countries have policies regarding ALP (for example, comparable uncontrolled price) which is open and independent market price where the market is situated at arm's length or at shorter distance. ALP is practically a difficult concept. There are wide varieties of products and prices vary accordingly. It is difficult to keep track of these varieties. Second, multinational companies can influence government policies of developing and least developed countries. Third, in countries where business is owned and controlled by MPs, ministers, and political leaders, law and order and government policies are hampered and government agencies like the NBR cannot work independently.

OVER-INVOICING AT IMPORT: Businesses have motivations to import goods over-invoicing their price. This exercise increases their cost of goods sold and reduces reported profit. Say, an importer imports raw materials showing invoice price of Tk 80 million but its market price at the exporter's market is Tk 60m. Here money laundered is foreign currency worth of Tk 20m, and corporate tax evasion is Tk 5m at the rate of 25 per cent.

UNDER-INVOICING AT EXPORT: A Bangladeshi company exports goods showing Tk 50m but its market price in Bangladesh is Tk 55m. Here under-invoicing (revenue under reported) is Tk 5m, money laundered is foreign currency worth of Tk 5m (because importer sent less foreign currency than actual), and corporate tax evasion is Tk 1.25m at the rate of 25 per cent. 

INTERNATIONAL TRANSACTIONS INCREASED AND SO TRANSFER PRICING REGULATIONS: Export-to-GDP increased from 4.1 per cent in 1980 to 16.2 per cent in 2010. Import increased from 13.1 per cent to 23.7 per cent. There are widespread evidences of over and under-pricing of inventories and other assets around the world. World Integrated Trade Solution (WITS) has shown $3545m worth of goods from China alone was either smuggled or not imported at all although LC was opened for these in 2015. As per their records, NBR lost tax revenue of 2.05 per cent of GDP which was significant if compared total tax revenue of around 10 per cent of GDP at that time.

DISCLOSURE REGULATIONS UNDER ITA 2023 FOR TAX PURPOSE: ITA 2023 u/s 236 requires that related parties shall submit a statement of international transactions in detail (u/s 236 of ITA 2023) to the transfer pricing officer of National Board of Revenue.  These include per unit price, total quantity and total value. The officer will then attempt to compare this actual transfer price with the arm's length price according to the regulations u/s 235. Arm's length price (comparable uncontrolled price) will be available in the Internet. The NBR then uses the ALP data for calculating right amount of taxes. However, researchers do not have access to these NBR dataset.

DISCLOSURE REGULATIONS FOR FINANCIAL REPORTING PURPOSE: IAS 24 (international accounting standard for related party disclosures) requires that related parties shall disclose the related party transactions in companies' annual reports. IAS 2 for accounting policy regarding inventory discloses whether FIFO or average pricing used. These standards however do not require per unit price and quantity information. It says only about aggregate value of the related party transactions. As a result, shareholders, researchers and the public cannot find out whether the related parties used arm's length price or not by using comparable uncontrolled price. 

IAS/IFRS REQUIRE UNIT PRICE FOR INTERNAL MANAGEMENT PURPOSE ONLY: IAS 2, Inventory requires details of costs of purchase of inventories (unit cost, quantity, import duties and other taxes, transport, handling and other costs. All these information is available in the costs records for internal purpose. Financial statements for external purpose require only the aggregate value of inventory. IAS 24 related party disclosures also require the disclosure of purchase and sale of goods and property and other assets.  IFRS 13 (international financial reporting standard) for fair value measurement requires fair value (market value) of an asset at initial recognition (price paid to acquire an asset). But this standard mainly requires the price received to sell an asset or paid to transfer a liability. Since there are many items of assets including various inventories, for practical purpose all these accounting standards require only the aggregate value, not the details of these assets. Details of purchase of various assets are, however, available in the cost department for internal purpose of the management.

DEVELOPED VERSUS LESS DEVELOPED COUNTRIES: RESEARCHERS' ACCESS TO DETAILED IMPORT-EXPORT DATASET: In USA and UK, there are commercial databases who have access to a wide pool of possible comparable public and private company data including undisputable arm's length pricing. Public can buy these data for research purpose. But in countries where parliament and law and order are nonfunctioning, researchers do not have access to this dataset in spite of regulation like Right to Information Act. 

EVIDENCES FROM ANNUAL REPORTS: Since IAS and IFRS do not mandate disclosure of unit price, publicly listed companies at home and abroad do not disclose import and export price per unit in their annual reports including financial statements and Notes. They disclose the aggregate value of import and export. As a result, shareholders, loan providers, and researchers cannot compare actual transfer price (per unit) and arm's length price. Thus money laundering through over-invoicing and under-invoicing cannot be detected. Only the government authority, the National Board of Revenue has access to this dataset. 

Auditors when auditing transfer pricing transactions of their clients have access to their detailed international transactions like import and export of goods, services, and equipment. Audit firms give a separate audit report on transfer price transactions to client management which the NBR requires under ITA 2023. However, the report is not published by the clients in their annual reports and therefore is not publicly available.

IAS 2, IAS 24, IFRS 13 should be revised to include disclosure of unit invoice price for major assets in financial statements.

Financial statements are meant for external purpose for various stakeholders like shareholders, lenders, and researchers. The stakeholders do not have access to the internal information. Since the problem of money laundering, over and under-invoicing, and corporate tax evasion are major problems particularly in developing and least developed countries, the unit invoice price of at least major inventories and assets purchased should be disclosed in the financial statements, at least in the Notes section of these statements. The Notes section has space for showing the derivation of various accounts that are ultimately disclosed in financial statements as aggregate values (closing balances) of these accounts. This will create an extra pressure on management to follow ALP that may help mitigate money laundering and corporate tax evasion.

Dhiman Chowdhury PhD is Professor of Accounting, Dhaka University. chowdhurydhiman91@gmail.com