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Corporate governance in Bangladesh part-IV

Profit transfer under legal cover hinders corporate governance

M SHAMSUR RAHMAN
Present government policy disallowing 'consolidated tax return' has opened gates for shifting of profits of companies where there are more public holdings. These profits are transferred to companies with sole ownership of sponsors and directors to deprive general shareholders from getting their share of profit.
Such non-acceptance of consolidated tax returns is setting bad corporate governance as it gives a legal cover to sponsors who redirects profits to another company within the group to minimise overall tax liability, according to a final draft report of the Asian Development Bank (ADB), which was prepared under an ongoing ADB technical assistance project.
"Maximising profits and dividends to the sponsor group through such investments are done at the expense of minority shareholders. This manipulation, when done through intercompany transactions, does not appear to violate Bangladeshi law or accounting standards and
therefore it is difficult or impossible for minority shareholders to seek any legal remedy for losses incurred," the report said.
The report pointed out that failure to consolidate could lead to "at least the appearance of fraud".
The paper also highlighted on an investigation report of the Securities and Exchange Commission (SEC) where the Commission through a second audit of a loss making listed company found out that though there was no direct link between the sponsors of two companies yet the listed company in textile business was making all its sales to a particular company at a lesser price than market rate.
The report observed the selling agent has been granted a longterm contract with no apparent benefit to the company. "Sales occur at prices that appear to be below market rates."
Another interesting aspect is that the textile company was also sourcing cotton from the same selling agent at a much higher than market price.
"A surcharge of even Tk five per pound of cotton costs shareholders of the textile company approximately Tk 29 million, an amount equal to nearly half the operating deficit of the company during 2001."
"There is no formal agreement for purchase of cotton. The prices that the textile company pays for cotton and charges for yarn appear to be more in the nature of transfer prices than market prices and are subject to manipulation and the shifting of profits to the agent at the expense of the public shareholders and employees," the ADB final draft report said.
It said while reporting financial statements such facts should be disclosed in the regular audited accounts and the accounts of the textile company and the selling agent concerned should not be treated differently.
"Due to the adverse incentives, unconsolidated entities make poor investments and only a nai ve investor would be willing to invest money into a stock market composed of such firms and failure
to consolidate entities under common control is a violation of international accounting standards (IAS)," the report observed.
It recommended changing of the tax code to permit consolidated tax returns. Unless such provisions are made there will always be strong incentives to shift profits within the group to minimise the total tax bills.
"This creates a climate where financial manipulation is acceptable to the detriment of the minority shareholder. However, even if the tax code is not changed, the listing rules of the stock exchange should be changed so that only the consolidated entity is listed using financial statements prepared according to IAS," the report said.
The report said without addressing this critical issue it will not be possible to provide fair and equitable market operations or establish corporate governance. (Concluded)