It is possible that companies that need to purchase carbon credits to offset their emissions may also have investments in derivatives trading and in businesses responsible for generating carbon credits. This raises the potential for those related companies to engage in transfer mispricing, warns a new report by Interpol. The intangible nature of the global carbon trading markets puts them at risk for exploitation by criminal networks, according to a new law enforcement guide produced by INTERPOL.
Transfer mispricing, also known as transfer pricing manipulation, refers to trades between two related parties at artificial prices for the purposes of tax avoidance. If two unrelated companies trade with each other (known as “arms-length” trading), it is generally accepted that they will deal with each at the market price for the transaction because it is the product of genuine negotiation in a market.
But when two related companies – that is, a parent company and a subsidiary, or two subsidiaries controlled by a common parent – trade with each other, they may artificially distort the price at which the trade is recorded, to minimise the overall tax bill. This might, for example, help the company record as much of its profit as possible in a tax haven with low or zero taxes.
In the case of the carbon market, for example, a company (the “parent company”) may need to purchase carbon credits to offset its own emissions. It may invest in an offset project in Africa to generate those carbon credits. But first it establishes a trading company in a tax haven (with zero taxes). The subsidiary company in Africa sells its carbon credits (at a very low price) to the trading company, who then sells those carbon credits (at a very high price) to the parent company. In this case the subsidiary company in Africa receives an artificially low price for the carbon credits, resulting in low profits – and consequently an artificially low tax bill in Africa. The company in the tax haven sells the credits at a high price – artificially transferring all of the profits there, but being a tax haven, no tax is paid.70