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Major Logging Operator Charged K140M For Tax Evasion

June 26, 2023
Internal Revenue Commission of Papua New Guinea

Papua New Guinea, [26/06/2023] – The Internal Revenue Commission (IRC) has imposed a substantial K140 million tax assessment against a prominent logging operator (identity withheld) in Papua New Guinea for engaging in illicit tax evasion, specifically through transfer pricing. This amended assessment (tax bill) is a direct outcome of an extensive transfer pricing audit conducted on the taxpayer. This was revealed today by Commissioner General Sam Koim when announcing the outcome of the first of more than twenty audits initiated since he took office. 

The Commissioner General, in announcing this development, expressed, "The logging sector in PNG has long been suspected of involvement in tax evasion. Instead of turning a blind, we have initiated over twenty audits since I took office. Cross-border transfer pricing audits are intricate and time-consuming; hence it has taken some time. I am pleased to report that this is the first outcome of those audits."

Transfer pricing tax evasion, in simple terms, refers to the act of manipulating the prices at which goods or services are transferred between related parties or companies within a multinational group. The purpose of this manipulation is to reduce the taxable income of one party, typically in a high-tax jurisdiction, by artificially inflating expenses or lowering revenues. By doing so, the company aims to shift profits to lower tax jurisdictions, thereby evading or minimizing its tax liabilities. This practice can result in significant loss of tax revenue for governments and is considered illegal. 

Based on a risk assessment on the taxpayer, the taxpayer had significant volumes of transactions with related parties, did not file Schedule Seven (International Dealing Schedule), was disclosing annual and historical losses in its income tax returns, and had not paid any corporate taxes in PNG for several years.

The main transfer pricing issue uncovered by the audit is that the taxpayer sold log species to related parties at prices lower than international market prices and thus reported a lower income than if its logs would have been sold at arm’s length. This means an under-pricing of log species sold by the taxpayer to related parties with significant pricing differences compared to market prices prior to and during the audit period, therefore not generating the fair amount of revenue and consequently not paying any corporate income tax.

PNG is deeply and negatively affected by forgone tax revenues because of base erosion and profit shifting done by taxpayers. The negative impact affects PNG citizens because the much-needed infrastructure, health and education coverage, security, and other public goods and services will not be available to guarantee economic growth and social welfare. The IRC finds it unfair and is working to tackle these behaviours for the benefit of the country.

To address this situation, the IRC performed a financial analysis of the taxpayer, considering liquidity, solvency, operational efficiency, net profitability, and working capital indicators, among others. The IRC concluded that the taxpayer’s financial performance shows a business that is not sustainable as its liabilities exceed its assets, it is at risk of bankruptcy, its revenues are not enough to cover its costs, it is not in a financial position to commit capital to growth and expansion, and it is financially unable to operate on a day to-day basis. From a transfer pricing perspective, arguments such as these imply a non-arm’s length behaviour as it is difficult to understand that an independent business can maintain itself operating in the market with such a poor performance and such negative financial results.

During the audit, the taxpayer was not cooperative and provided limited information, which made the IRC’s audit, verification, and enforcement tasks more difficult and burdensome. The taxpayer even denied the existence of any association with the overseas parties and disclosed their residence to be in certain jurisdictions. However, thanks to the IRC’s progress in international tax cooperation in recent years, powerful tools like the exchange of information standard (which allows for the IRC to obtain information on foreign taxpayers from tax administrations in other jurisdictions) allowed the IRC to confirm the existence of the association, as stipulated under Section 4(1) of the Income Tax Act 1959, strengthening its position, as well as confirming that the information provided by the taxpayer regarding the residency of its log buyer was false. The taxpayer’s failure to disclose the truth about the actual corporate residency of its log buyer was an indication that it intended to hide something.

The IRC concluded that the taxpayer was related to the overseas parties based i) on management (same directors managing different entities), ii) on shareholding and common interests (same people holding shares in same entities), and iii) on arrangements that would never take place between independent persons. In addition, the taxpayer’s Notes to the Financial Statements listed both companies as related parties. However, the taxpayer denied this relationship, arguing that there had been a wrong classification of related parties. This means that during the audit period (and even before that), directors, shareholders, and the accounting firm did not recognize or correct the gross misstatement in the taxpayer’s audited financial statements. 

To determine the arm’s length price of the exported logs, the IRC performed a comparable search of log prices for the various species sold by the taxpayer, using a public source of tropical timber prices. Based on it, the IRC calculated the deemed revenues the taxpayer should have realized to reflect market conditions. 

In summary, for the years under audit, the taxpayer should have recorded additional revenues of K181 million and offset losses of K31 million. This implies that it must pay K46 million in corporate income taxes to the PNG Treasury, instead of claiming losses. After applying a 200% penalty (accounting for K95 million), the taxpayer is liable to pay K140 million.

The IRC continues to strengthen the capacity of its officials and the tools available to tackle tax fraud, evasion, and avoidance. Robust international instruments are about to change the way audits are performed and will allow for an increase in the exchange of information requests and joint audits. Penalties will also be tightened to ensure voluntary compliance.

Making false and misleading declarations to the IRC is a serious offence with a jail term of not more than four years. The IRC will prosecute not only the taxpayers but also those who are responsible for hiding information and making false declarations to the IRC to reduce their tax liabilities. 

In accordance with the taxpayer's right to the protection of the law and the appellate process to review the audit findings, the Commissioner General is unable to disclose the identity of the taxpayer at this time. However, the Commissioner General assured that the tax office has heard the clarion call for action and is taking action.