Monday, September 17, 2007

Taking a Closer Look

Investment by Multinational Corporations

By Emma Lochery

For low-income countries around the world, investment by multinational corporations (MNCs) could represent hope – in the form of royalty payments, tax revenue, and employment. Instead, in the vast majority of cases, it leads to increased poverty, corruption, and conflict. Time and time again the relationships between countries and corporations have resulted in more human suffering and environmental damage.

Without serious changes in MNC behaviour, poor countries will continue to be stripped of their assets while receiving little in return except repressive governments and minimal offers of aid from culpable Western governments – aid which adds to the problems of corruption and unaccountable governance. The time has come to implement a comprehensive and mandatory multilateral regulatory framework which includes country by country reporting to monitor the way these corporations interact with governments and their citizens.

Governments and Corporations: Mechanisms of Exploitation

To understand why most MNCs’ investments in low-income countries increase human suffering instead of alleviating poverty, it is important to examine the relationships which exist behind the investments. In particular, it is important to pay attention to the contracts signed by governments and corporations.

Examining the contracts reveals how governments desperate to attract foreign investment offer conditions favourable for multinational corporations – but highly detrimental to their countries’ wellbeing. Contracts grant extended tax holidays and allow MNCs to avoid regulations protecting labour rights, other human rights, and environmental conditions. The World Bank, IMF, and donors have frequently lauded such concessions for creating “positive investment climates”**.

In addition, the contracts themselves are often vaguely written and contain loopholes companies can exploit in the future. Through these omissions and embedded confidentiality clauses, they create space for crime, unaccountability, and corruption both inside and outside the country in question.

Corporate Structures: The Role of Mispricing and Tax Havens

The structure of corporations around the world is another reason they find it so easy to exploit countries’ natural resources while providing little benefit to the people of that country. Many multinational corporations (MNCs) set up structures to avoid paying taxes in the jurisdictions where they are exploiting resources.

MNCs are generally families of sister companies called subsidiaries – separate parts of a company which can be registered in different jurisdictions but which are controlled ultimately by the parent company. This business model is very dominant in the global economy: around 60% of world trade today is composed of transactions between different parts of the same company*. Because these transactions happen between two affiliated companies, the prices involved are not set by the market. Instead, prices are under the companies’ control – such a price is known as a transfer price.

Under rules laid down by the Organisation for Economic Cooperation and Development (OECD), transfer pricing is supposed to follow the “arm’s length rule”. That is, the price should be equal to the market price – it should be set as if the companies were not affiliated.

In reality, as researched by businessman and author Raymond Baker, around 45-50% of these transactions are mispriced. Affiliates in this case are not following the arm’s length rule but manipulating prices in order to control which affiliated company registers the most profit. For example, if a subsidiary mining in a country sells the resource on to an affiliated company at a very low price, then it will not make a very large profit and therefore won’t pay much tax. Instead, because of the artificially low price, the profit will accrue to the affiliate buying the resource. If this affiliate is registered in a tax haven, that is, a location where some taxes are levied at a very low rate or not all, it will not have to pay much tax on that profit. Through this process of tax avoidance, the multinational corporation as a whole benefits.

Meanwhile, government revenues in the country where the mine is located remain low. Public services remain underfinanced and reliance on foreign aid is not reduced. Local people also often suffer the results of environmental degradation, low labour rights standards, and other abusive multinational practices.

Mittal and Firestone: A Clear Pattern

This newsletter includes a discussion of two examples of corporate abuse from Liberia. Robtel Pailey’s article reveals the crimes of Firestone Tire Company. The contract between Firestone and the government and the corporate structures related to this contract lie at the heart of the problem. The article on Mittal Steel Company’s new contract with the Sirleaf government in Liberia discusses similar issues. It profiles a report by NGO Global Witness which revealed self-proclaimed “socially responsible” Mittal Steel’s original 2005 contract with the transitional government in Liberia as another example of corporate abuse and moral corruption.

Time to Face up to the Systematic Abuse

The cases of Firestone and Mittal are only two examples of the way huge multinationals are exploiting citizens and societies around the word. In his article on the need for tax justice in Malawi, Mwaona Nyirongo uses the term “economic tourism”, an apt way to describe the way he says multinational corporations have “reduced Malawi to a country for profit-making rather than development.”

Today capital is increasingly mobile and more of the world’s largest economies are corporations rather than countries. It is crucial that a mandatory (non-voluntary) international regulatory framework be created and enforced to monitor MNC behaviour, financial transactions, and interactions with governments. This framework must encompass mandatory Country-by-Country reporting standards which would require MNCs to declare in which countries they operate, what they are called in each location, what their financial performance is in each of those countries, and how much tax they pay to government locally as a result.

At the same time, the role of tax havens and other parts of the international financial system that enable the pillaging of developing countries’ resources must be recognised and countered. Without this change, corporate social responsibility rhetoric will continue to be pitifully empty.

* See the Tax Justice Network briefing on Country-by-Country reporting. Also see Christian Aid, The Shirts off Their Backs: How Tax Policies Fleece the Poor, September 2005, p 14.
**See the TJN publication, tax us if you can, p. 17 for more information.

For more information on transfer pricing, also watch Tax Research UK's Richard Murphy's explanation:

A Hopeful Step: Mittal Steel’s Renegotiated Contract

In October 2006, Global Witness released the report “Heavy Mittal”* critiquing the 2005 Mineral Development Agreement between Mittal Steel and the National Transitional Government of Liberia (NTGL). They explain how Mittal and other MNCs “seek to maximize profit by using an international regulatory void to gain concessions and contracts which strongly favour the corporation over the host nation.”

Aside from whether the transitional government had the authority to negotiate and sign the contract, the contract itself gave Mittal Steel complete freedom to set the price of iron ore – and therefore the amount of royalties to be paid to the government – as well as a five year tax holiday. It also transferred two important public assets – a major port and an important railway line – to the company. Apart from damaging Liberia’s chances of economic recovery, the agreement threatened to harm the present and future rights of Liberian citizens. One of most worrying aspects of the agreement was that it granted the company the right to choose which new laws it would comply with – as well as the right to possess public and private land, potentially without adequately compensating the previous owners of the land.

Fortunately, the elected government of Liberia renegotiated the contract earlier this year with the company, now known as Arcelor Mittal: the $1bn deal was announced at the end of April 2007. The new deal requires that the price of iron ore be determined by market forces and does not include the five year tax holiday or give Mittal the right to possess the port and railway line. Mittal is also no longer exempt from new human rights or environmental laws. Unfortunately, the new contract still gives the company exemption from new laws related to income tax, royalties and other payments. Most crucially, the contract includes a confidentiality clause that will make it very difficult for citizens to access information about royalty payments and other financial flows. Such an omission is a serious challenge for transparency or accountability campaigns.

*The report is available here. For a more recent update, also go here.

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