Group-Report-Final - Final report as per requested in the assignment guidelines PDF

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Final report as per requested in the assignment guidelines...

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ACCG315 GROUP REPORT – Accounting and the Tax Practice

Vijay Narayana

43787657

David Jesuthasan 43628729 Goh Eik Tun

44328311

Chen Jui Khai

443856753

Kho Jun Yin

44328222

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Contents Executive Summary...............................................................................................................................2 Introduction:..........................................................................................................................................2 Methodology.........................................................................................................................................3 Transfer Pricing Issues............................................................................................................................3 Transfer price manipulation...............................................................................................................3 Foreign exchange risk........................................................................................................................4 Intangible asset..................................................................................................................................5 Tax Avoidance....................................................................................................................................5 Ethical Problems regarding Transfer Pricing.......................................................................................6 Research Questions...............................................................................................................................7 Factors that influence an organisation’s work practice and expectations of an accounting professional.......................................................................................................................................7 How does an accounting professional engage with the community to add value to stakeholders and oneself?......................................................................................................................................7 Strategies and development for an accounting professional to sustain a competitive advantage in terms of employment and level of competence?..............................................................................8 Conclusion and Recommendation.........................................................................................................8 References:............................................................................................................................................9

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Executive Summary This research report provides an analysis on five issues on transfer pricing and research questions based on accounting professionals. The methods in which the information has been collected are through reliable journal articles, internet blogs and the industry partners present throughout the course. Transfer pricing is the internal selling price used when goods and services are transferred between departments of an organisation. Through thorough research, our group has found five key issues which are transfer mispricing, tax avoidance, foreign exchange risk, intangible assets and finally the ethical issues. Transfer mispricing is the illegal issue where firms agree to manipulate their internal transaction prices to declare less profit and hence are taxed less. Foreign exchange risk is a commercial challenge as if a firm’s transfer price doesn’t react to the competitive pressure, their profit would become distorted. Intangible assets are an issue as many companies are using the transfer pricing of intangibles to reduce the high tax jurisdictions to low tax jurisdictions. Tax avoidance is an issue where MNC’s minimise their profit in a high tax country, while maximising their profit in low-taxes country. The final issue of ethics refers to how each action taken by firms can have its consequences on labour and households. The three research questions on professional accounting discuss factors influencing an organisation’s work practice and expectations such as advanced technology and skills required of new graduates, how accountants can engage with the community to add value to stakeholders through economic sustainability and financial advisory and finally strategies and tools appropriate for an accounting professional to sustain a competitive advantage which talks about reward systems and knowledge. The findings discussed in the report explain how each issue must be given heavier considerations and addressed quickly to ensure they do not happen again in the future.

Introduction: Transfer pricing is the internal selling price used when goods and services are transferred between departments of an organisation. This area of the tax practice while having its benefits, bares various issues which affect its viability. This report will explain multiple issues which have been discovered over the years of the transfer pricing, how they’ve affected society and the accounting practice and any potential methods in which we may be able to solve these issues. Whilst explaining some of the issues transfer pricing raises, this report will also discuss the influences of work practice and expectations of accountants, how accountants can add value to stakeholders and oneself and the competitive advantages in employment for accounting professionals.

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Methodology The research and collection of relevant information on transfer pricing issues consists of several steps. First is the allocation of the research area amongst the group members and the discussion on how to decide on the most appropriate way to obtain this information, which has been mainly published and reliable journal articles. By using reliable sources such as journal articles and blogs, research on the issues were conducted. Through the information provided by the industry partners of the course, information on professional accountants was obtained.

Transfer Pricing Issues Transfer price manipulation Transfer Mispricing is an illegal issue where firms abuse the system and agree to manipulate their internal transaction prices to then declare less profits in high-tax jurisdictions and hence decrease their taxation. This manipulation is not just for firms and their subsidiaries but has been evident between unrelated firms who have been reported to make secret deals with other firms. An example of transfer mispricing is when “goods from the industrialised are sold to developing countries at hugely inflated prices to enable the company that is the ‘buyer’ to shift substantial amounts of capital abroad while reducing the company's profit margin and minimising its tax liability” (McNair and Hogg, 2009). Transfer mispricing is largely evident in production and trading and transportation. Africa is an example of those being substantially impacted by this manipulation in transfer pricing. About 60% of capital flight has reported to be due to transfer mispricing. This is around 10 times the size of the aid it receives and twice their debt. We consider this a key issue within the transfer pricing bracket as victims of the manipulation, who are often the poorer third world countries, are unable to act as their revenue authorities are often unable to fight back due to a lack of auditing due to large administrative costs and the requirement of in depth understanding of the specific economic context. This will then lead to a substantial long-term detriment to a country's foreign exchange reserves and revenue raising process. There is a significant impact on the accounting profession due to the breaches in accounting standards such as AASB. There’s an effect on financial reporting and has a direct impact on a company’s tax provision. Companies have a lack of transparency which doesn’t allow the company to be accountable for their impact on communities. Many of those taking place in transfer mispricing are operating without transparency which then means that many of those transactions are nearly impossible to track back. Tackling this type of tax evasion requires government capacity, so it is important that the strategy presented is taken seriously. Currently, most countries are using the “arms-length 3|Page

principle” which is the idea that a transfer price should be the same as if the two companies involved were two unrelated parties negotiating in a normal market, and not part of the same corporate structure. Over the years this has seen to be restricting the amount in which large corporations manipulate transfer pricing but as of this stage, it is still an issue as not every country has got this principle implanted which means there are still chances for companies to do so.

Foreign exchange risk Foreign exchange risk for transfer pricing is one of the key issues because it is a troublesome commercial challenge for an effective inter-company pricing policy. When depreciating the Australian dollar, the export of Australia manufactures will increase. If a multinational firm’s transfer price does not react to changing competitive pressures, the composition of the firm’s worldwide profit will become distorted. These distortions can interrupt a multinational firm’s production and financial and tax planning. In addition to this, there are several types of exchange-rate exposure. These are Translation exposure, Transaction exposure and Economic exposure (PWC, 2013). Translation exposure is the risk that a company’s assets, liabilities and equities will change in value due to exchange rate changes (Investopedia, 2017). Transaction exposure concerns the impact of unexpected exchange-rate changes on cash flows over a brief time. It measures the gains or losses arising from the settlement of financial obligations, the terms of which are stated in a foreign currency. Economic exposure caused by the influence of unexpected exchange-rate fluctuations on company’s future cash flow (Investopedia 2017). The change in the firm’s value depends on the effect of the exchange-rate movement on future prices, costs and volumes. Factors that identify the degree of economic exposure are government policies, market structure, nature of competition and general business conditions (PWC, 2013). Foreign exchange risk must to addressed because when the domestic exchange rate drops, it can increase costs for importers, which will reduce the company’s profits. It will reduce dividends and fall in the market value of the business. In addition, it can raise the cost of capital expenditure such as importation of machinery. Besides that, a rising domestic exchange rate will make exports less competitive which lead to the profitability of exporters decreasing and the cost of investing overseas also reducing (CPA, 2009). Suggestions for the accounting profession on this issue are foreign currency options and forward exchange contract (CPA 2009). Foreign currency options are an entity to buy or sell foreign currency under an agreement that allows for the right but not the responsibility to guarantee the transaction at an agreed future date. For example, an importer can enter into a foreign currency option transaction, then the option will prevent the importer from downward movements in the value of local currency against the other currency (CPA, 2009). In addition to this, forward exchange contracts enable the business to protect itself from adverse movements in exchange rates by locking in an agreed exchange rate until an agreed date (CPA, 2009).

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Intangible asset The next key issue of transfer pricing is intangibles assets. Intangible assets are not a physical item or invisible item in the company such as the company’s copyright, trademark and goodwill. Our group consider intangible assets as a key issue as, there are many multinational groups using the transfer pricing of intangible to reduce the high tax jurisdictions to low tax jurisdictions as they add the intangible assets to the company’s balance sheet in the assets section which as mentioned above, are the company’s trademark, brand and so on, so that the company can buy or sell the intangible assets as equipment or machine. On the other hand, under the Internal Revenue Service instruction, the company can amortize the intangible assets over 15 years. For example: the company can use the straight-line method which the amount of each intangible assets dividend 15 years such as the trademark’s value is $100,000 the company can dividend it 15 years to get the tax deduction amount $6,666. Besides that, we consider this issue because the OECD has released the new guidelines for the transfer pricing of intangible assets. As above just mentioned tax problem, OECD found out there are many multinational group are using the transfer pricing of intangible assets to get low or no tax payment so that they come out of the new guideline to ensure the profit is related to the transfer or the use of intangibles are accurately allocated with the value creation. This new guideline will have an implication on the budgeting accounting plan which call off the intangible assets in the balance sheet under the assets section and reduce the tax issue when doing the tax account. On the other hand, it also has a significant impact for those multinational group IP’s (intellectual property), which the IP no longer follow the legal ownership as It is associated with the economic right and IP can be transferred to a centralized IP holding entity. Besides that, the IP legal owner does not have the income which related to the development IP but they will have the full right of the profit derived from the use of intangible. OECD is trying to make the entity of multinational group get involved in the development of IP to avoid the tax jurisdiction from happening and set the barrier for the IP legal owners so they can get the development IP profit as they can only receive the use of intangible profit. This issue needs to be addressed because those multinational group are using this “loophole” for get an unethical accounting activity to achieve an aim and it is an illegal activity for company.

Tax Avoidance Tax avoidance is an issue where Multinational Company’s (MNC) minimise their profit in a high tax country, while maximising their profit in low-taxes country. This issue is not illegal like tax evasion, but these giant MNCs come up with strategies that will further enhance their ability to avoid paying more taxes (M.V., 2012). Most of these company transactions are usually guided by arm’s-length principles. The application of the arm’s-length is often problematic. It is very hard for the arm’s -length principle to work as the products are new and unique to the market and there is no comparable market price for it to be compared with. The company can use this as their advantage to avoid income being taxed by the 5|Page

country they are operating in (Barker, 2017). As they’re operating in a low-taxes country, it allows these MNC to report earnings from these countries instead of the country they are operating allowing them to set a lower transfer price between two subsidiaries. (Simmons, 2016) Our group seen this as a key issue, as government of various parts of the world are struggling to deal with such a problem and it costs the government around $1 trillion for coming up with tax minimization schemes. Australia have also been hit hard by tax avoidance issue. Large companies in Australia reduce the overall income tax that’re supposed to pay to government by around $50 billion Australian dollars. (There is one way to put a stop to BHP’s tax avoidance, 2016). There is a certain way to fix this tax avoidance problem that has arisen due to transfer pricing. This problem has arisen due to the current tax law which has proved to be ineffective as most of this tax does not follow common sense. It follows government rules. The government should tighten its “tax laws” to tackle the problem they face by setting the benchmark ratio of the interest expenses against the earnings instead of a debt-to-asset ratio, as most of the MNCs have no problem when it comes to satisfying the debt-to-asset ratio that are set by the tax law and they still have plenty space for them to shift the profit out from where they are operating (Ting, 2016). It is believed that tax avoidance in transfer pricing will continue, unless some significant solution came from the government regarding the structure of tax and incentives.

Ethical Problems regarding Transfer Pricing In accordance to the various issues outlined above regarding illegal activities i.e. transfer mispricing and tax avoidance; ethical issues also plague this area. Ethical issues may be unavoidable in some cases as organisations attempt to balance profitability and cost reduction through above mentioned avenues with overall business perception. An enterprise that decreases costs of an offshore product so that the domestic revenue is less, leading to lower taxable: is a strategy implemented by managers that outline the discrepancies between working under regulations but also escaping ethical boundaries. Ethical issues will arise in numerous circumstances under the transfer pricing umbrella and poses consequences and implications to stakeholders and to accountants themselves. A report published by “ActionAid” on the effects of transfer pricing in Ghana have outlined some of the potential shortcomings ethical operations can produce. One consequence of tax avoidance is the shift of burden towards households. ActionAid states that the Government may be forced to re-target taxation income from households, even though they may not fall in the tax income bracket due to their poorer income which directly impacts government expenditure in the long term. Furthermore, according to the study, manual-labourers from organisations that undertake unethical transfer pricing are also disadvantaged. As “materialcosts” are incorrectly overstated, the “value-addition” made my employees towards the product is seen to be minimised. This results in the potential loss of bargaining power and the power to negotiate wage levels (Addo E, ActionAid).

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Accountants also have a responsibility to act ethically in their practice. CPA Australia outlines ethical practices and standards that out Accountants need to adhere to when dealing with situations such as the management of transfer pricing. In addition, the code of ethics outlines 5 key principles that need to be adhered too along with 5-step model on how to ethically make decisions.

Research Questions Factors that influence an organisation’s work practice and expectations of an accounting professional There are a lot of factors that may influence an organisation work practices, factors such as, using an advance accounting system. Nowadays large companies are using technology to prepare their financial statements. It is very easy for any accountant to commit fraud since they are the one maintaining the accounting system for the company. With advancing technology, basic accounting work is being outsourced to other countries that have a cheaper wage structure as they become less cost effective and might lose their competitive position in the market. The following factor will be the mental quality of the new accountant that just entered the workforce. They should have an idea on what are they supposed to do and be “open-minded” on accepting new challenges. It’s good for them to get themselves into as many projects as possible, allowing them to gain the experience and development. Government policy plays a vital role when it comes to setting the standards for accounting profession sector bodies. These settings will affect any accounting organisation as they are the one who set the standard for accountants to follow. There are certain expectations from the accounting professional bodies for fresh graduates. They expect them to have self-learning skills. Fresh accountants can progress in a smoother way in this competitive world. Newcomers should be proactive when it com...