2014 Scienceweb Publishing Journal of Economics and International Business Management Vol. 2(2), pp.

xxx-xxx, March 2014 ISSN: 2315-9832 Research Paper

Offshore tax evasion and tax avoidance: A business perspective from Indonesia
Sukanto Tanoto
Institut Akrobat Pajak, Jalan Bebas Pajak No. 1, Pekan Baru, Indonesia. E-mail: sukanto.tanoto@gmx.com.
Accepted 13th February, 2014

Abstract. Tax management was a term that is used more and more often nowadays. When illegal measures are used to lessen the tax to the government, it is frequently referred to as "tax evasion" and considered illegal. Tax authorities are now more uncompromising all over the globe and doing their best to ensure that companies have no excuses for the state of having no knowledge about their tax liability. The increased use of offshore tax evasion companies and offshore banking is illustrated in a case study in Indonesia, Asian Agri using a popular tactic to create confusion between legal tax avoidance and criminal tax evasion. Offshore financial centres used tax competition and put under pressure to throw out all legislative provisions offering tax breaks and bank secrecy to international investors. The alternative structure for conducting foreign operation is additionally influenced by a countrys incentives to encourage style bound forms of activities thought of useful to the financial set-up. The situation of production and distribution systems additionally offers tax benefits. This final sale of products or services is often channelled through associates placed in legal management that supply reduction or putting off one thing till later. Keywords: Offshore processing, tax haven, tax evasion, Asian Agri.

INTRODUCTION Tax management provides a creation of tax controls, fundamentally the process of arranging a companys actions in light of its tax liabilities (Owens, 2007; Cobham, 2005). Tax management was a term that was used more and more often. It is also called tax risk management for compliance. It should be given a special attention on how a particular transaction is structured in a tax report. The obvious goal of most tax management is the efficient/the minimization of the amount that a company must move (from one place to another) to the government. The legal efficient or underestimation of taxes is usually referred to as "tax avoidance". Meanwhile when illegal ways are used to lessen the tax to the government, it is frequently referred to as "tax evasion" and considered illegal. Tax authorities are now more uncompromising all over the globe and doing their best to ensure that companies have no excuses for the state of having no knowledge about their tax liability (Skinner and Slemrod, 1985). Tax-motivated transfer pricing has attracted global interest owing to the existence of low-tax jurisdictions and the volume of the activities of multinational corporations (Kirchler et al., 2003; Jones, 2004). Such corporations have many instruments available for shifting profits through transfer pricing, and tax havens provide ample opportunity for this. Tax havens pose the threat of asset flight and income shifting from high-tax countries (Kirchler et al., 2003). A phenomenon that has emerged from the philosophy that foreign source income should not be taxed at all or should be taxed only when declared a dividend is the tax haven. A tax haven is defined as a state, country or territory where certain taxes are levied at a low rate or not at all (Jones, 2004). Tax havens offer a variety of benefits, including low taxes or no taxes on certain

classes of income. Because of these benefits, thousands of so-called mailbox companies have sprung up in such exotic places as Lichtenstein, Vanuatu, and the Netherlands Antilles (Jones and Rhoades-Catanach, 2004). Some examples of tax haven countries are as follows: 1. Countries with no income taxes, such as Bahamas, the Cook Islands, Bermuda, and the Cayman Islands. 2. Countries with taxes at low rates, such as the British Virgin Islands. 3. Countries that tax income from domestic sources but exempt income from foreign sources, such as Hong Kong, Liberia and Panama. 4. Countries that allow special privileges, such as Singapore, generally their suitability as tax havens is limited. To take advantage of a tax haven, a corporation would ordinarily set up a subsidiary in the tax haven country through which different forms of income would pass. The goal is to shift income from high-tax to tax haven countries. This is normally accomplished by using the tax haven subsidiary as an intermediary (Jones and Rhoades-Catanach, 2004). The enormous flow of offshore money can distort economies and ruin nations. For example, Europes financial crisis was fuelled by the Greek fiscal catastrophe exacerbated by offshore tax evasion and by a banking meltdown in tax haven of Cyprus, where local banks assets have been inflated by rays of cash coming from Russia.

multinational company entities and sometimes, entire countries. Governments around the globe require transfer pricing methods base on the arms-length principle. That is a multinationals company in different countries are taxed if they were independent firms operating at arms length from each other. The complex calculation of arms -length prices is less useful nowadays for global companies because fewer of them operate this way. An arms -length price is one that an unrelated party would receive for the same or similar item under identical or similar circumstances. Acceptable arms-length pricing method includes: 1. Comparable uncontrolled pricing 2. Resale pricing 3. Cost-plus pricing, and 4. Other pricing methods. An emerging consensus among governments views arms-length pricing as the appropriate standard in calculating profits for tax purposes. However, countries vary in how arms-length pricing is interpreted and implemented, As a result, it is somewhat fluid concept internationally Transfer Pricing schemes designed to minimize global taxes often distort the multinational control system. When each subsidiary is evaluated as a separate profit center, such pricing policies can result in misleading performance measures that generally lead to conflicts between subsidiary and enterprise goals. The international transfer pricing system must also attempt to accomplish objectives that are irrelevant in a purely domestic operation. These objectives include: 1. Global income tax minimization 2. Minimization of global import duties 3. Avoidance of financial restrictions, 4. Managing currency fluctuations, and 5. Winning host country government approval. It is unlikely that a MNC will be able to accomplish all objectives with a single transfer pricing strategy. Priorities usually include the minimization of global income taxes and import duties (Fuest and Riedel, 2009).

REVIEW: TRANSFER PRICING According to a new survey conducted by KPMG International, transfer pricing is the most important international tax issue that multinational enterprises (MNEs) now face (Jones and Rhoades-Catanach, 2004; Fuest and Riedel, 2009). Transfer pricing involves the price at which transactions between units of huge company companies happen, including the intercompany move (from one place to another) of goods, property, services, loans, and leases. Transfer pricing has attracted increasing global interest. The importance of the issue is obvious when we recognize that transfer pricing as follows: (1) is conducted on a relatively larger scale internationally than domestically (2) is affected by more variables than are found in a strictly domestic setting (3) varies from company, industry to industry, and country to country, and (4) affects social, economic and political relationships in

METHODOLOGY This paper will present a Case Study from Asian Agri Company in Indonesia. Asian Agri is an Indonesianbased, international oil palm company that has operations in 3 provinces in the Sumatra Island with 100,000 hectare of plantation, and partners with smallholders operating 60,000 hectare of plantation. It is one of the biggest oil palm company in Indonesia. Its

subsidiary PT Inti Indosawit Subur, served as a member of the Roundtable on Sustainable Palm Oil (RSPO), a global multi-stakeholder initiative that promotes growth and use of sustainable palm oil. Asian Agri could sell goods directly to a distributor in Europe and concentrate the profits in Indonesia, or it could sell the goods to a tax haven subsidiary at cost and then sell the goods to the US distributor, thus concentrating the profits in the tax haven subsidiary with no income taxes or with tax at low rates. Every tax haven has advantage, such as having a low or zero rate of tax on all or certain categories of income, and offering a certain amount of banking or commercial secrecy and disadvantages depending on what you hope to achieve. The 13 indicators identified here for judging a tax havens potential will help you gauge how each potential tax haven stacks up against your goals. The object, of course, is to find a tax haven with the maximum number of advantages that satisfy your requirements: (1) tax structure, (2) political and economic stability, (3) exchange controls, (4) tax treaties, (5) government attitude, (6) modern corporation laws, (7) simple incorporation procedures and competitive fees, (8) communications and transportation, (9) banking and professional services, (10) English common law, (11) secrecy and confidentially, (12) investment incentives and opportunities, (13) location. Asian Agri owned by myself has 16 subsidiary companies in Indonesia that most of these companies produced Crude Palm Oil (CRUDE PALM OIL) for export and 5 companies in Tax Havens countries as affiliated companies (so-called mailboxes company) to minimize corporate taxes for the group as a whole. A necessary element of such strategy is the prices at which goods and services are transferred between group companies. Profits for the corporate system as a whole can be increased by setting high transfer prices on components shipped from subsidiaries in relatively low tax countries, and low transfer price on component shipped from subsidiaries in relatively high tax countries Asian Agri Profit Shifting. The transfer pricing system can be used to shift taxable profits from a country with a high tax rate to a country with a lower tax rate: the result is that after taxes the MNC retain more profits. There are 16 (sixteen) Asian Agri Group Companies in Indonesia, manufactures goods (CRUDE PALM OIL) and most of the CRUDE PALM OIL for sale overseas. Finished goods (CRUDE PALM OIL) are transferred from Asian Agri Group to its wholly owned sales affiliate for overseas sales through 5 (five) so-called mailbox companies in Tax Havens country, using a low markup policy and using a high markup policy for the real buyer. The low markup policy results in larger pretax income, income taxes, and net income per unit in the selling country. On the other hand, the high markup policy has

the opposite effect, that is, higher taxable income, income taxes, and net profit per unit in the manufacturing country. The affiliate companies in Tax Havens Country are likely represent the manufacturing company, there is no problem of larger pretax income since the tax rate imposes in tax havens country are very low: the result is that after taxes profit the Asian Agri Group retain a big profit. The choice of organizational form for conducting foreign operation is also influenced by country incentives encourage to design certain types of activities considered beneficial to the national economy. The location of production and distribution systems also offers tax advantages. Thus final sales of goods or services can be channeled through affiliates located in jurisdiction that offer tax shelter or deferral. In these case, parent corporation (Asian Agri Indonesia) ships the product (CRUDE PALM OIL) directly from 16 (sixteen) factories Asian Agri Group Companies in Indonesia to the European buyer, but also makes a paper sale of the goods to its wholly owned affiliate as foreign sales corporations (FSCs) in Macao, Mauritius, and British Virgin Island. The payment from the buyer is routed through Hong Kong Companies that arrange how much money will be sent to Asian Agri Indonesia as an income for tax purposes (Plasschaert, 1994; RaimondosMller and Scharf, 2002).

RESULTS AND MODES OF OPERATIONS Fictitious cost Various types of costs complete with fictitious receipts for auditing purposes are created. Dozens of fictitious Asian Agri Group subsidiaries include building roads, cleaning lawns, contractors, etc. Annually, fictitious cost entries could be as much as US$10-20 million. Once, they even reached US$60-70 million but were warned by the auditor that this method was too crude. These fictitious costs at ASIAN AGRI were known as Jakarta costs, because a team in Jakarta planned them. Payments were recorded as cost for scores of ASIAN AGRIs subsidiary companies in Medan. Payment checks were also issued, for example to build roads and cut grass. Costs are not paid but deposited into a personal account under the name of Haryanto Wisastra / Luke Eddy (HAREL) and Lukas Eddy / Djoko Oetomo (ELDO). Subsequently, the money was transferred to Tanotos overseas investment company (offshore company). The evidence is that after the funds were converted into dollars, there were a large number of deposits from the HAREL account into Goalead Ltd (Hong Kong). And its connection with Tantoto is clearly evident. The First Island Trust Company Ltd (owned by the Tanoto family) also once requested that ASIAN AGRI dividends be

deposited into Goalead.

These companies are just mailbox companies, because: 1. In Hong Kong, a staff is just placed on the phone receiver. The phone number is different, but the fax number uses the same line as the East Trade Ltd hunting at 2701 Gloucester Tower, The Landmark, Hong Kong. 2. Authority signature for the bank accounts in Hong Kong and Macao are the same. 3. Of the audit report in Hong Kong known before 2004, these companies were non-active. In fact, in the report Asian Agri Group reported almost all palm oil exports are sold to Hong Kong companies. Presumably, these are one-sided transactions, not reported income in Hong Kong.

Hedging transactions Transaction hedging is a sale and purchase forward contract between two parties at a jointly agreed price. Transaction hedging contracts / hedging (forward contract) CRUDE PALM OIL sale or exchange between the Asian Agri Group companies in Indonesia with affiliates abroad, are created. These hedging transactions may also be fictitious. Transactions should only be on paper and made based on backdating. This allegedly fictitious transaction was backdated. This method enables forward contract transactions to be made in such a way that the Indonesia-based companies would always incur a loss and must therefore transfer money to an affiliated overseas company. Transactions are made in such a way (an Indonesian company selling at a low price and buy at high prices, otherwise foreign companies selling at a high price and buy at low prices) so that the Indonesian companies always losses and company abroad is always profit. Consequently, there is a transfer of money from Indonesia to overseas companies.

Where does the money flow? Each year, five of the Raja Garuda Mas Group (RGM) or Royal Golden Eagle (RGE) companies always make a plan: how much money to be cashed in to RGM. In 2006, for example, two-parent company Asia Pacific Resources International Ltd (APRIL) and Asian Agri Group, each has set a deposit of 70% of its annual cash flow to the RGM. Its value is approximately U.S. $ 30 million (Rp 273 billion) for APRIL and U.S. $ 8 million (USD 72.8 billion) per month for the Asian Agri. To achieve the targets, a variety of ways can be done, including among others, by raising the (fictitious) cost and reduced revenue (transfer pricing) or reduced profit, so the Asian Agri tax burden in the country will be reduced. The results from the profit transfer companies in Indonesia to affiliated companies abroad (presumably through transfer pricing and fictitious edging contracts transactions), such as the Global Advance Oil & Fats Ltd. (Macao) and the Asian Agri Abadi Oils and Fats Ltd. or AAAOF (British Virgin Islands). The money was then forwarded to the Asian Agri as a dividend payment. Asian Agri deposited the dividends to First Island Trust Company Ltd./Fitco (Mauritius) and Treston International Ltd (British Virgin Islands). According to the document of the Declaration of Ultimate Beneficial Ownership Treston (21 April, 2004) and the Declaration of Trust Fitco (26 September, 2003), the two companies are owned by Sukanto with Tinah Bingei (wife) and their two daughters: Imelda Tanoto and Belinda Tanoto. At the request of Treston and Fitco, dividends were transferred to a number of Sukantos overseas companies: Goalead Ltd, Headcorp International Ltd. Deposit payment from the fictitious companies to accounts held by Haryanto Wisastra & Luke Eddy (HAREL) in Bank Permata and Luke Eddy & Djoko Oetomo (ELDO) at Bank Bumiputera. This money is eventually deposited into the Goalead Ltd. account (Banca Intesa Bank, Hong Kong), which was owned by Tanoto.

Transfer pricing The modus operandi was to sell crude palm oil (CPO) at low prices to affiliated companies in the British Virgin Islands, Hong Kong and Macao. But five of the Hong Kong companies are actually just paper companies. All that exists is one person to answer the phone. From financial reports that have already been audited, it is known that before 2004 these companies did not even register any income. The Asian Agro Abadi International Ltd financial report audited by the offices of Ernst & Young, it cites a significant number of transactions carried out with these Hong Kong companies (Plasschaert, 1994, Raimondos-Mller and Scharf, 2002). CRUDE PALM OIL was sold at low price to affiliated (fictitious) companies in Hong Kong, British Virgin Islands, Macao. From this fictitious company, the CRUDE PALM OIL was sold at a higher (market) price to real buyers. By doing so, they are free from paying higher taxes in the country. Before 2003, the transaction was directly through BVI companies, but since 2003 by companies in Hong Kong and Macao.

Paper companies Asian Agri setup paper (mailbox) companies in order to perform a variety of transactions abroad, in Tax Haven countries: Hong Kong, British Virgin Islands, and Macao.

CONCLUSIONS The increase use of offshore tax evasion companies and offshore banking by Asian Agri is a major problem for the high-tax regimes, and offshore money laundering. A popular tactic in use by Asian Agri is to create confusion between legal tax avoidance and criminal tax evasion. Offshore financial centres used tax competition and put under pressure to throw out all legislative provisions offering tax breaks and bank secrecy to international investors. The alternative of structure for conducting foreign operation is additionally influenced by a countrys incentives encourage to style bound forms of activities thought of useful to the financial set-up. The situation of production and distribution systems additionally offers tax benefits. This final sale of products or services is often channelled through associates placed in legal management that supply reduction or putting off one thing till later. In this case study, the parent company (Asian Agri) ships the product (CRUDE PALM OIL) directly from 16 (sixteen) factories Asian Agri Group Companies in Indonesia to the European buyer, but also makes a paper sale of the goods to its completely owned business partner as foreign sales corporations (FSCs) in Macao, Mauritius, and British Virgin Island. The payment from the buyer is routed through Hong Kong Companies that arrange how much money will be sent to Asian Agri Indonesia as an income for tax purposes. The matter of shifting of money/income and conjointly demands of a growing free enterprise, the ensuing increase within the range of taxpayers, and therefore have to be compelled to establish the realness/respect/truth of assembling. From 2007 to 2010, Indonesia has reformed four tax laws, that is, General Provisions and Tax Procedure Law, Income Tax Law, Value Added Tax and Sales Tax on Luxury Goods Law and Regional Tax Law. While in relation with the transfer pricing, for a certain companies my country also arranges an Advance Pricing Agreements (APAs) whereby a multinational and our taxing authority voluntarily negotiate an agreed transfer pricing methodology that is binding on both parties (Raimondos-Mller and Scharf, 2002; McGee, 2006).

REFERENCES Cobham A (2005). "Tax evasion, tax avoidance and development finance." Queen Elizabeth House, Srie documents de travail p. 129. Fuest C, Nadine R (2009). "Tax evasion, tax avoidance and tax expenditures in developing countries: A review of the literature." Report prepared for the UK Department for International Development (DFID) Jones SM (2004). Principles of Taxation- For Company and Investment Planning The McGraw- Hill Companies.,Inc. 1221 Avenue of the Americas, New York.N.Y.10020 Jones SM, Rhoades-Catanach SC (2004).Principles of Taxation-Advance Strategies The McGraw-Hill Companies .,Inc. 1221 Avenue of the Americas, New York.N.Y.10020 Kirchler E, Boris M, Friedrich S (2003). "Everyday representations of tax avoidance, tax evasion, and tax flight: Do legal differences matter?." J. Econ. Psychol. 24(4):535553. McGee R (2006). "The ethics of tax evasion: a survey of international business academics." Available at SSRN 803964 Owens J (2007). Tax Havens, and Tax Competition. "Offshore Tax Evasion." Testimony, May 3 Plasschaert SRF (1994). The multiple motivations for transfer pricing modulations in multinational enterprises and governmental- counter-measures: an attempt at clarification, in: Manage. Int. Rev. 34(2):36-50. Raimondos-Mller P, Scharf K (2002). Transfer pricing rules when governments compete, in: Oxford Econ. Pap. 54(2):230-246. Skinner J, Slemrod J (1985). "An economic perspective on tax evasion." National Tax J. pp. 345-353.

APPENDIX Examples of transfer pricing transactions:

Transaction 1: October 2004 a) PT Inti Indosawit Subur sell 3500.34 metric tons of CRUDE PALM OIL to Twin Bonus Edible Oil & Fats Ltd. (Hong Kong) for U.S. $ 370/MT or worth a total of U.S. $ 1,295,125.8 (Invoice No.. 10018/I/10/02/04) b) Double Bonus CRUDE PALM OIL selling it to Global Advance (Macao) for U.S. $ 372.5 / MT valued at a total of U.S. $ 1,303,876.65 (Invoice No.. 101 052 908 Twin-I). Gains recorded U.S. $ 8,750.85. c) Global Advance (Macao) and then sell it to the CRUDE PALM OIL M / S Manickam Enterprises (India) with a price of U.S. $ 444.5 / MT valued at a total of U.S. $ 1,555,901.13 (Invoice No.. GAO/410/16-03210101). Gains recorded U.S. $ 252,024.48

Transaction 2: October 2005 a) PT Supra Matra Abadi sell 2500 MT palm kernel oil (PKO) to Twin Bonus Edible Oil & Fats Ltd. (Hong Kong) at a price of U.S. $ 460/MT or worth a total of U.S. $ 1,150,000 (Invoice No.. 09602/I/21/14/05). b) Double Bonus PKO then sell it to Asian Agri Eternal Oils & Fats Ltd. (BVI) at a price of U.S. $ 462.5 / MT valued at a total of U.S. $ 1,156,250 (Invoice No.. 09,138,005 TWIN-I). Gains recorded U.S. $ 6,250. c) AAAOF (BVI) and then sell PKO to Palmco Oil Mill Sdn Bhd. (Malaysia) for U.S. $ 535/MT or worth a total of U.S. $ 1,310,750 (Invoice No.. 10001/I/95/14/05). Gains recorded U.S. $ 154,500.

Transaction 3: August 2001 a) PT Inti Indosawit Subur sell 999.3 metric tons of crude palm oil to Asian Agri Eternal Oils & Fats Ltd. (BVI) for U.S. $ 192.5 / MT or U.S. $ 192,365.25 (Invoice No. 004/E/IIS-JB/08/01) b) AAAOF (BVI) to sell 999.3 metric tons of CRUDE PALM OIL to Cargill (Singapore) for U.S. $ 220/MT or U.S. $ 219,846 (Invoice No. 23,108-SCRUDE PALM OIL / I). AAAOF profit from this transaction (BVI) of U.S. $ 27,480.75.