Hubs and Exploitation
Lee Kuan Yew, who died recently, was a pretty remarkable politician. He led Singapore first into and then out of the Malaysian Federation after independence from Britain and presided over the little island state’s emergence as a major trading centre and economic giant despite its tiny physical presence. In fact, he was seriously concerned that Singapore, with no natural resources and a water supply dependent upon Malaysia, would struggle to survive independently when the Malaysian Parliament passed the law expelling the island province from the Federation and confessed in his memoirs to sleepless nights at that period as he worried about the fate of his new island nation. With the benefit of hindsight, he could have slept soundly; the Singaporean economy is envied from around the world, with a vibrant financial sector supporting a healthy (although some critics may say over-controlled) society that attracts businesses from around Asia and indeed beyond.
So as his loyal people saluted him at his death, is all well? Mmm, well, there may be some clouds beginning to appear on the otherwise sunny horizon.
Regular readers of this column may recall that I have a couple of times referred to my view that it is only a matter of time before political pressure is brought to bear on resource companies over their tax domiciles, resource bases and the interaction between those two. In other words, I don’t believe that meddling politicians will be able to resist the temptation to try to prevent the washing of profits on resources through low-tax jurisdictions. (Incidentally, for the avoidance of doubt, that statement is not supposed to declare a preference on my part; I’m neutral on this issue. There’s undoubtedly some good and some bad.) It appears that certain governments are beginning to look more closely at Singapore, where several major international trading and producing companies have based regional ‘hub’ offices. BHP Billiton, for example, relocated its former Hague-based trading operation to Singapore a while ago, and others – like Trafigura, Rio, Vitol, for example – also have extensive marketing, sales and logistic operations in the City State.
Now, both the Australian and Indonesian governments are understood to be looking at the impact these operations may be having on the exploitation of their resource bases. Both those countries are of course heavily resource-dependant and have a clear interest in seeing the profit generated from those resources contributing to their own economy. Their concern is partly that transfer pricing is used in such a way as to leave the profit sitting offshore, in a low-tax area. But the days of being able to use an offshore entity to buy resources from a producing country for a pittance and then sell them on at market price to a consumer are – supposedly – long gone. The ability to use transfer prices set to benefit this type of transaction is pretty much covered by international tax conventions. I think, though, that the governments in question – and I’m sure there will be increasingly more of them – are looking at something slightly more nuanced than that crude tax-evasion policy.
Typically, a resource producing country will levy a fee on the exploiter of the resource. You can call that a mining tax, a royalty fee or frankly anything else you choose, but the intention is the same – it’s to try and secure in the country of origin a value from the exploitation of the geological bounty in its soil. That’s pretty clear and, ignoring the corruption that sometimes manifests itself, it’s a system that works. The level of the tax or royalty is, naturally enough, an issue of domestic politics – in the same way that any country’s levels of income, corporation or capital gains taxes are as well. The point concerning Australia and Indonesia (and probably others) is slightly different. What they are concerned they are missing is the benefit – in economic terms – of the presence in the country of the whole infrastructure of the downstream elements of the mining (or drilling) operations. In other words, they see the benefit of the crude extraction tax or levy but they don’t gain any added value from the logistics or marketing element of the deal. That passes to the low-tax hub, in Singapore or Switzerland or wherever. It’s an interesting debate, and clearly linked very closely with the issues raised by Indonesia with its ore export ban. Countries want to secure – as well as the extraction fee – some part at least of the added value generated by ‘their’ geological good fortune.
I can actually see two sides to this. On the one hand, there would obviously be an economic benefit to the country with the resource deposit if the whole operation were conducted there – think of the tax generation from the presence of fully staffed marketing/sales/logistic functions, for example. On the other side, it’s fair also to accept that where a miner is operating in various different locations, it makes perfect sense to centralise those functions to cover several markets. If you’re doing that, then it further makes good economic sense – and is in the shareholders’ interest – to put that centralised operation in a jurisdiction where there are substantial tax advantages.
So it’s not a simple question of “evil western capitalists exploiting developing countries”; it’s more nuanced than that, because the diversified nature of the mining industry (geographically as well as by product) does push them toward these centralised marketing and logistic hubs.
Clouds on the Horizon
Both sides of the debate have a case. I don’t have an answer, but for sure the voices and the clamour for the ‘added value’ to stay at home are only going to get louder, and places like Singapore and Switzerland, together with companies quartered there, are going to be right in the firing line. Those are the clouds on the horizon.