Descend into the Asian Snake’s Lair: Occult Offshore Centers, Tax-Tunneling, and Consolidation Craftiness
February 2, 2015 Leave a comment
|“Bamboo Innovators bend, not break, even in the most terrifying storm that would snap the mighty resisting oak tree. It survives, therefore it conquers.”|
|BAMBOO LETTER UPDATE | February 2, 2015|
|Bamboo Innovator Insight (Issue 68)
|Dear Friends,Descend into the Asian Snake’s Lair: Occult Offshore Centers, Tax-Tunneling, and Consolidation CraftinessLike the ancient legendary Painters descending into the clay pits to study the rudiments of colour, we need to hold our hands together – tightly! – as we descend into darkness, into the Asian Snake’s lair. We need to go deep into the underworld of accounting tunneling to study the occult offshore financial centers, the tax-tunneling mechanism and see up close the consolidation craftiness in accounting of the Asian Snake.This week, we get to observe accounting tunneling and income diversion using “spaceman”, which involves the creation of SPVs (special purpose vehicles), often in offshore financial centers. It is called “spaceman” because it comes from seemingly nowhere, does not perform any real activities, pays almost no taxes, and disappears (“flies into space”) in one-half to two years. This type of firm is also called a “dump”, “flash-light”, “bruise”, “hedgehog”, or “fly-by-night company”. Tax evasion and accounting tunneling using spaceman often involves a long chain of transactions, with each transaction appearing to be legitimate; however, the entire scheme is illegal.
Last week, we shared that In practice, the controlling owner and insiders net less than the full amount that they have tunneled and expropriated because of lawyer fees, tax consultants, payment for discrete financial services etc. We will unearth some shocking empirical findings that can possibly help investors to detect and avoid Asian accounting frauds ahead of the curve, in the form of abnormal levels of professional fee. These include Big 4 audit firms receiving more audit and non-audit fees when their clients transfer more money to fraudulent entities. However, it is difficult to distinguish if the excess fees are a form of price protection by the Big 4 auditors when they take on risky clients or represent payments for not constraining their clients’ fraudulent transfers. A one standard deviation increase in income diversion is said to correspond to 9.4% increase in audit fees at the Big 4 and a one standard deviation increase in income diversion corresponds to 24.1% increase in non-audit fees at the Big 4…
Still, this “professional fee” pales in comparison to that enjoyed by another important capital market participant in the Asian jungle. First understand this: How much money can be tunneled and diverted from such “spaceman” schemes? Typically 40%. Because the amount diverted and tunneled can be large and is usually paid in cash, spaceman schemes require the collaboration of bank officials. These bank officials often charge fees of as much as 5% for customers to withdraw cash and it is a lucrative business.
Over the weekends, shocking news broke out that China Minsheng Banking Corp (600016 CH, MV $49.6bn) chief Mao Xiaofeng had resigned and was taken away by the Communist Party’s Central Commission for Discipline Inspection in connection to the anti-corruption probe of Ling Jihua, former top aide to ex-president Hu Jintao. The investigation into the youngest-ever Chinese listed-bank president has exposed the tip of the iceberg of rampant power-for-money deals between senior officials and financial leaders.
It is estimated by the International Consortium of Investigative Journalists (ICIJ) that between $1 trillion and $4 trillion in untraced assets have left China since 2000. Nearly 22,000 offshore clients with addresses in mainland China and Hong Kong appear in leaked files obtained by ICIJ. Among them are some of China’s most powerful men and women. The files come from two offshore firms — Singapore-based Portcullis TrustNet and BVI-based Commonwealth Trust Limited — that help clients create offshore companies, trusts and bank accounts. Confidential documents obtained through ICIJ’s “Offshore Leaks” investigation show that Big 4 firms had a close relationship with Portcullis TrustNet, a Singapore-based offshore services firm that sets up hard-to-trace offshore companies for clients around the world. PwC, for example, helped incorporate more than 400 offshore entities through TrustNet for clients from mainland China, Hong Kong and Taiwan, the records show.
We will examine the off balance-sheet entities and financing such as VIE (variable interest entity) and operating leases, and revisit the reverse mergers. We will also look into the consolidation craftiness in accounting in intercorporate investments with regards to affiliates and JVs in Chinese firms, Korean chaebols and Japanese keiretsu and appreciate the mechanics of equity method vs the proportional consolidation method.
As we descend this week into the dark Lair, our spines tingle – we know we are closer to the Asian Snake.
The Moat Report Asia
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