The Analyst Lent Term 2013

FOREWORD

CREDITS

This edition seeks to explore a diverse range of issues related to our glob-al economy. In the Markets section, a wide range of issues are being dis-cussed, ranging from battery electric vehicles to China’s financial market. With the volatile fuel prices that we face today, many countries are explor-ing alternative fuel options. Can delves into a detailed analysis of the eco-nomic viability of battery electric vehicles. Xiaoli, on the other hand, pro-vides an opinion about the financial market of Asia’s rising dragon, China.

In the Fundamentals section, Vinh explores the impact of tax avoidance and transfer pricing on worldwide economies. Common names like Starbucks and Google are known to utilise this strategy in a bid to reduce their tax liabilities.

Lastly, we also present an in-depth analysis from Oxford Business Group regarding transport investment in Thailand, a rising economy in Asia.

While there have been signs of improvement in the global economy, it remains pretty volatile with subdued growth. The outlook of the economy would very much depend on the critical decisions by global leaders in the months ahead.

Content EditorsAtin Dhawan

Low Shu HangEve Chen

ContributorsCan Karapence

Melissa Luki AndreanyYe Xiaoli

Vinh Nguyen QuangFernando Fernandez

CONTENTSMARKETS

Are battery electric vehicles cost effective?By Can Karapence

Turn the PageBy Melissa Luki

China’s Financial Market: Peaceful ocean or dynamic volcano?By Ye Xiaoli

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FUNDAMENTALSTransfer pricing and tax avoidanceBy Vinh Nguyen Quang

The boom of Brazilian venture capitalBy Fernando Fernandez and Can Karapence

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INSIDE ANALYSISThailand: Transportation InvestmentBy Oxford Business Group

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Recent concerns about fluctuations in oil prices and greenhouse gas emissions have led to a rise in interest in electric vehicles since the mid-2000s. As of 2012, there are numerous automotive companies such as Nissan and Chevrolet that currently pro-duce electric cars, varying from companies that are only focused on producing BEVs (battery electric vehicles) and other com-panies that are larger in size and producing EVs, HEVs (hybrid electric vehicle) and ICE-Vs (internal combustion engine vehicles). EVs have a number of benefits compared to ICEVs such as a substantial reduction in urban air pollution, lower greenhouse gas emissions and a decline in dependence on foreign oil. On the other hand, several fac-tors pose limitations against the potential success of the electric vehicles over the conventional internal combustion engine vehicles. BEVs are significantly more expen-sive than ICEVs due to the expense of the battery packs. Lack of recharging infrastruc-ture throughout the world is another main obstacle against the electric car industry.

To compare the cost effectiveness of BEVs and ICEVs, we need to make some assump-tions. These assumptions are based on cur-rent energy prices, and they will be used in order to determine the current total net pre-sent cost (NPC) and NPC per mile of BEVs and ICEVs. The main objective is to observe the economic viability of BEVs in the future from the consumer standpoint under a number

of scenarios. Since economic feasibility of electric vehicles depends on variables such as gas prices, electricity prices, cost of bat-teries etc., it is essential to implement a cost analysis under different circumstances that might arise in the not-too-distant future.

Under the scenario according to current energy prices, fuel price per gallon is $3.67; price of electricity per kWh is $0.12, and the battery capacity of a lithium-ion bat-tery is 4.5 miles per kWh. Additionally, a regular car (both ICEVs and BEVs) drives approximately 13,500 miles per year over a total lifespan of 10 years. BEV maintenance costs is assumed to be $500 per year while ICEV maintenance costs is $1,000 per year1.

Assumptions of the Key VariablesBattery Pack Cost ($/kWh)

$600

Fuel Price per Gallon $3.67

Price of Electricity ($/kWh)

$0.12

Average ICEV MPG 35

Miles per kWh 4.5

Miles Driven per Year 13,500

Lifespan (Years) 10

ICEV Maintenance Costs per Year

$1,000

BEV Maintenance Costs per Year

$500

Discount Factor 12%

Table 1: Assumptions of the Key Variables in the Cost Analysis

05| the analystMarkets

1 Lee, Henry and Lovellette, Grant, “Will Electric Cars Transform the U.S. Vehicle Market? An Analysis of the Key Determinants,” Discussion Paper 2011-08, Cam-bridge, Mass.: Belfer Center for Science and International Affairs, July 2011.

ARE BATTERY ELECTRIC VEHICLES COST-EFFECTIVE: AN ANALYSIS OF THE ELECTRIC VEHICLE INDUSTRY

BY CAN KARAPENCE

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According to current purchase costs and en-ergy prices, net present cost (NPC) and net present cost per mile (NPC/mile) of ICEVs and BEVs are compared in Table 2 below. Cost of the battery reflects an approximate figure of the lithium-ion battery pack of an aver-age BEV. Operating cost consists of main-tenance cost, fuel cost and electricity cost.

These cost components are discounted by the discount rate of 12%, and hence dem-onstrate the present value of each through-out the vehicles’ total lifespan of 10 years.

Cost Component ICEV BEVGlider $15,000 $15,000

Total Powertrain (ex-cluding the battery)

$6,000 $2,000

Battery $0 $13,000

Charging Plug & Instal-lation

$0 $1,500

Total Purchase Costs $21,000 $31,500

Maintenance $5,650 $2,825

Fuel $7,998 $0

Electricity $0 $2,034

Total Operating Costs $13,648 $4,859

Total Net Present Cost $34,648 $36,359

Total Net Present Cost per mile

$0.257 $0.269

Table 2: Cost Analysis under Current Energy Prices

Table 2 displays that the total net present cost (NPC) of the average ICEV is $1,711 lower than the total net present cost (NPC) of an average BEV. Furthermore, for eve-ry mile, a conventional engine vehicle is $0.012 cheaper than its electric counterpart. As a consequence, BEVs are not economi-cally viable to purchase under current en-ergy prices from the consumer standpoint.

In order to predict the economic feasibility of BEVs against ICEVs from the consumer’s point of view, some of the assumptions are altered according to historical trends.

Cost of lithium-ion battery packs is ex-pected to decline in the future due to an expected increase in its energy density (which is negatively associated with theunit price)2. In the next scenario, which makes an effort to predict the cost-effec-tiveness of BEVs in the near future, the battery pack cost is assumed to be $400 per kWh. Furthermore, a possible future 30% rise in the price of electricity and fuel price per gallon are added, making the future price of electricity $0.16 per kWh and the fuel price per gallon $4.77. Table 3 presents the results for the future case.

Cost Component ICEV BEVGlider $15,000 $15,000

Total Powertrain (exclud-ing the battery)

$6,000 $2,000

Battery $0 $8,670

Charging Plug & Instal-lation

$0 $1,500

Total Purchase Costs $21,000 $27,170

Maintenance $5,650 $2,825

Fuel $10,396 $0

Electricity $0 $2,712

Total Operating Costs $16,046 $5,537

Total Net Present Cost $37,046 $32,707

Total Net Present Cost per mile

$0.274 $0.242

Table 3: Cost Analysis under Predicted Future Energy Prices

Table 3 shows that the total net present cost (NPC) of the average BEV will be $4,339 lower than the total net present cost (NPC) of an average ICEV under predicted fu-ture circumstances. Furthermore, for eve-ry mile, a BEV will be $0.032 cheaper than the conventional engine vehicle. It is not very difficult to observe that the predicted transformation in the cost-effectiveness of the BEV against the ICEV is driven by the reduction in the cost of the battery pack. As a result, BEVs are expected to become economically viable if the price of the bat-tery packs actually goes down in the future.

06 | the analystMarkets

2 Simonsen, T., “Density Up, Price Down,” Electronic Business, 23 September 2010

Break-Even Points Fuel Price per Gallon $4.46

Price of Electricity ($/kWh) $0.019Table 4: Break-Even Points under Possible Scenarios

The electric vehicle industry is not very distant from becoming a cost-effective business from the consumer standpoint. Unfortunately, cost-effectiveness of elec-tric cars is not the only issue to be taken into account. Lack of infrastructure is a large-scale problem, which negatively af-fect the demand of the BEVs. The role of the government in promoting the use of BEVs is also linked to the lack of in-frastructure, and it is one of the key is-sues that are integral to the future suc-cess of the electric vehicle industry.

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Surely, the opportunity to acquire a better climate is the key reason why some individu-als prefer buying electric vehicles despite their prices. As the analysis and the discus-sion of other key issues demonstrate, electric vehicle industry is not distant from becom-ing much more common among consum-ers. As they be come more cost-effective and economically viable from both the consum-er and the business standpoint, it is almost certain that many of us will be driving BEVs.

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There has been lots of chatter about the ex-plosion of e-books as of late: how they are set to displace print books and spell doom for brick-and-mortar bookstores such as Bor-ders. This article assesses the extent to which such claims about market trends can be be-lieved, as well as identify and evaluate the responses of print publishers and retailers to the disruption the rise of e-books can poten-tially cause to their existing business model.

Putting down that book… because of an e-book?It is not hard to imagine the substitution of print books for e-books. After all, e-books are often cheaper than their printed coun-terparts, more portable, and easily accessi-ble through slim and lightweight e-readers and tablets. Market trends provide evidence of such a scenario with data showing a de-cline in print book sales alongside the rapid emergence of e-book consumption. Pub-lishers Weekly reported a 10% drop in the sales of printed books from 2010 to mid-2011 in the US, while e-book sales rose to $2 billion from $0.87 billion in the same period. The effect is most pronounced on the adult fiction genre. According to Nielsen, adult fiction print experienced a decrease of 26% in sales during the afore-mentioned period, whilst nonfiction print sales fell by only 2% (O’Reilly Media, 2011).

Meanwhile, the relative performances of different types of book retailers further sup-port the substitution hypothesis. The fall in book sales through brick-and-mortar book-stores saw a drop of 12% between 2010 and 2011 whilst online retailers, whose sales include e-books, reported sales growth of 35%. Accompanying such bleak trends in print book sales is the demise of physical book retail chains like Borders. Borders had been struggling to make profits for years as it faced stiff competition against online retailers. Its administrator in 2009, MCR, highlighted the ‘severe cash flow pressures’ the chain faced whilst trying to capture sales. Eventually, the business gave way and Borders filed for bankruptcy in 2011.

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TURN THE PAGEBY MELISSA LUKI

But how accurately do such trends reflect any changes in consumer preferences? Sur-veys produced by the Pew Research Center revealed that nearly 90% of e-book readers continue to read physical volumes, contra-dicting the idea of consumers replacing print books with e-books. Perhaps the two mediums do ‘serve different purposes’, with each satisfying a demand for a distinct read-ing experience. Avid readers are more likely to appreciate print and e-books in different ways, such that their preferences for read-ing can boost the demand for both types of reading material simultaneously. In contrast, substitution is more likely amongst the mass of non-habitual readers, who are attracted by the steeply discounted prices offered by e-books to make their occasional pur-chases. However, the core of book demand is still largely supported by avid readers, and perhaps the size of this consumer base pro-vides a more fundamental explanation for the trends observed in print versus e-books.

Nevertheless, there is little doubt that e-books have shaken up the literary industry in some way, destabilizing the traditional busi-ness model for certain players and providing new growth opportunities for others. Differ-ent retailers and publishers have reacted to the industry developments in varied ways.

Drafting responses to e-books: defend, embrace or separate?The threat that e-book publishers and re-tailers pose on traditional players in print mainly banks on a leaner cost structure that does away with much of the expenses on overheads, printing and materials. This al-lows e-books to be produced more cheap-ly than their printed counterparts, harm-ing the print publisher and/or the physical bookstore chain under both the wholesale or agency models of book retail. Under the wholesale model, the retailer in particular suffers because while the publisher still re-ceives the recommended retail price it sets

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Source: http://socialmediachimps.com/infographics/infographic-ebook-readers-book-publishing-industry/


for the books from retailers, retailers may have to slash final sale prices to compete with cheaper e-books and thereby make losses. Under the agency model, both print pub-lishers and retailers lose because both par-ties receive a cut of lower book prices made competitive against e-book price tags.

Given this situation, some players try to circumvent the problem by cutting costs. In particular, two major household names in the publishing industry, Pen-guin and Random House, are trying to save costs and boost sales through a merg-er. The merged entity, Penguin RandomHouse, is touted to be the ‘biggest book publisher ever seen, accounting for about one in four of all books sold’. John Makin-son, CEO of Penguin, said that increasing each player’s size would ‘help both pub-lishers make the transition from printed word to e-book’ by giving both players the ‘resources, capacity and confidence to pub-lish a broad array [of content] and to take risks’. A merger of capabilities and capital potentially allows Penguin and Random

to undertake the necessary investments in e-book technologies, as well as reduce combined fixed costs and increase sales through greater market reach. It is hoped that both companies will be able to pre-serve their profits in the midst of stiff com-petition from e-books with this merger.

Whilst publishers Random-Penguin are focusing on the defence, some brick-and-mortar retailers are instead focusing much more on embracing the e-book phenom-enon as a strategy. Barnes and Noble (B&N) is one such retailer, having released its own line of NOOK e-readers since 2009. These devices were introduced along with B&N’s very own NOOK e-book store in a bid to capture a share of the exploding e-book market. Currently, B&N’s biggest competi-tors in the e-book industry include Ama-zon with its Kindle e-readers and tablets, and Apple with its iPads and iBooks store.

We may perhaps, however, wonder to what extent traditional players in print are willing to continue embracing the new opportuni-ties presented by e-books. B&N expects the

How can players in the e-book market attract customers?

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NOOK business to make even greater losses this year, over the $262 million EBITDA loss incurred in FY2012. Despite having been a revenue-driver since its launch, NOOK’s product development and marketing costs have ‘spiked’ so that the product line’s com-petitiveness may keep up with Amazon and Apple, eroding the division’s profits (Sapru, Reuters, 2013)1. Marketing costs, in particu-lar, weigh down on NOOK profits. If this per-sists, B&N’s dependence on NOOK to tide the business through may well be unsustainable.

While we contemplate the fate of B&N’s NOOK division, we can consider the implica-tions of another retailer’s ongoing attempt at disinvesting its e-book business – Indi-go Books and Music of Canada. Indigo has reached a deal to sell its tablet and e-reader manufacturing division, Kobo, to Japanese e-commerce company Rakuten for $315 mil-lion. Again, the costs incurred by the e-book business can help explain Indigo’s turning away from Kobo despite the massive growth in e-book sales we saw earlier. Indigo found that Kobo became a ‘drain’ as the digital business expanded and its costs grew. In-vestments in Kobo fuelled the ballooning of Indigo’s Q2 losses from $4.6 million in 2010

to $40.4 million in 2011. Retailers often en-ter both the e-book and e-reader or tablet markets together in a bid to lock consum-ers to their devices and stimulate demand for e-books from their respective stores. Be-cause of this strategy, any traditional print publisher or retailer’s entry into e-books en-tails heavy investments in not only publish-ing technology, but also constant efforts to develop readers of improved features and specifications, as well as aggressive market-ing campaigns to raise the profile of their readers and e-book stores in the face of exist-ing heavyweights like Amazon. Without the extensive market reach that leading players like Amazon have, companies like B&N and Indigo would struggle to fund these con-tinuous investments to stay in the game.

The crushing weight of tabletsIn entering the e-reader market to cap-ture e-book sales, print retailers also face threats from the more sophisticated tablets segment. Tech market researcher IHS iSup-pli estimates that shipments of dedicated e-readers are expected to slide following their peak in 2011. By 2015, iSuppli fore-casts less than 8 million units of e-read-ers to be shipped worldwide, down from

Source: IHS iSuppli Research 2012


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1 http://www.reuters.com/article/2013/02/14/us-barnesnoble-nook-idUSBRE91D04120130214


the 2011 high of 23 million units. At the same time, iSuppli expects worldwide tablet ship-ments to increase steadily from 64 million units in 2011 to over 280 million units in 2015.

How can we reconcile these trends with large positive growth rates in e-book demand? Pew Research Center finds that consumers are just increasingly likely to read e-books on tablets rather than e-readers. This can be explained by the increasing attractiveness of tablets over e-readers. Tablets are not only becoming more affordable, but are also being introduced at more price points and with different specifica-tions to meet demands of customers with dif-ferent price elasticities. Consider, for instance, how tablets range from pricier branded iPads, to cheaper Kindle Fire tablets at the lower end of the price range. As multi-use tablets offer more value-for-money over e-readers to consum-ers, Tom Mainelli, IDC’s tablet research direc-tor, even claims that e-readers ‘will eventually become a niche product’ (Trachtenberg, Wall Street Journal, 2013) and most e-book custom-ers will eventually read their purchases through tablets. To compete with tablet manufactur-ers, traditional print retailers and perhaps even publishers would have to scale a steep learning curve in technology and quickly build (or ac-quire) capabilities to develop and manufacture sophisticated devices at competitive prices.

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This presents traditional print play-ers’ with additional barriers to entering a market of new growth opportunities.

ConclusionWhile the e-book market has been described by some impressive growth rates, perhaps a future of completely paperless books will not become reality until much later. For now, print and e-books have yet to become adequately close substitutes, and this buys traditional print publishers and retailers some time as they undertake the necessary investments to transition into an increasingly digital literary publishing and retail sector. We can also per-haps look forward to increasing interaction be-tween the consumer technology and literary industries as traditional players in print look to climb the technology ladder and capture any future opportunities remaining in e-books.

Source: IHS iSuppli Research 2011

2 http://online.wsj.com/article/SB10001424127887323874204578219834160573010.html

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Ever since the Chinese economic reform initiated in 1978, China has been attracting attention worldwide as a rapidly rising eco-nomic power; with overall growth averaging a robust 7% to 8% for more than a decade.

The 2008 financial crisis has further em-phasised China’s remarkable success story. As the West continues to struggle with the impact of the financial crisis, China con-tinues to boast healthy GDP growth, low inflation and low unemployment rate, be-coming the main driver behind the global economy. Moreover, China’s currency ---RMB stood out as one of the currencies that barely influenced by this financial crisis.

Table 1 shows the GDP, Inflation and Un-employment rate for the major coun-tries in the world in the year 2008.

Nation GDP Inflation Unemployment

China 9.74% 6.43% 4%

UK 0.99% 3.78% 5.40%

USA 1.57% 4.22% 5.62%

Russia 7% 14.03% 5.90%

Saudi 5.85% 11.45% 13%

South Africa

3.83% 11.78% 23.20%

Iceland 0.30% 7.93% 2.20%

India 7.93% 7.93% 7.80%

Japan 0.69% 1.57% 4.05%Table1

Additionally, over the past few years, China has become the turn-to country for govern-ments that are struggling with debt. In Au-gust 2011, the Italian government turned to cash-rich China in the hope that Beijing will rescue it from financial crisis by making significant purchases of Italian bonds and investments in strategic companies. In Oc-tober 2011, French president, Mr. Sarkozy’s office put out a statement saying he spoke with his counterpart in China, Mr. Hu to inform him of the euro-zone rescue pack-age, and that the leaders also discussed the priorities for next week’s Group of 20 sum-mits in Cannes. Many has expressed sur-prise towards China’s willingness in lending out funds to troubled states, including the World Bank Group President Zoellick, who commented: “It showed weakness. Also, the average per capita income in China is about $5,000 a year. In Europe, it is close to $40,000 a year. So it would be hard for Chinese leaders to explain to their people why China is bailing out Europe when they still have about one-eighth the income.”

Nevertheless. It remains clear China has not only established itself as the sec-ond largest economies in the world, but also as one that can contribute to and influence the world’s economy.


CHINA’S FINANCIAL MARKET: PEACEFUL OCEAN OR DYNAMIC VOLCANO? BY YE XIAOLI

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China’s secrets behind its stable market

So what is the secret behind Chi-na’s resilience in weathering the big-gest crisis since the Great Depression?

To start with, compared with western coun-tries, there are fewer legal derivatives in Chi-na. A lesson learnt from the 2008 financial crisis was that more derivatives mean more leverage and thus more risk. Additionally, compared with other Asian countries with few derivatives, China enjoys a more dynam-ic market since the 1978 Reform and Open-ness, and the dynamic market has helped to transfer the risk. Table: Various Industries in China and other Asian countries. Futher-more, China is too diversified to break down.

Secondly, while it may have formed the ba-sis of the conflict between the Chinese and western political systems, the government’s regulation played an important factor in ensuring China’s stability during the crisis. On one hand, state-owned assets can be directly manipulated by the government, and in this case, be used to rescue com-mercial institutes. Compared to the tedious procedures that western countries have to go through in order to decide whether or not they should bail out troubled commer-cial institutes, the control that the Chinese government has gave China a lot advantage in rescuing firms that were going under. Although state-owned assets in China has long been criticised for discouraging fair competition with the private sector, their dominance has ensured that China was insulated from financial disasters caused by the bankruptcy of ‘too big to fail’ pri-vate companies, such as Lehman Brothers.

Will China’s reputation as enjoying a stable market be stable?

While China has enjoyed a lot from its unpar-alled development, both in real economy and finance, China is now putting increas-ing amount of emphasis on the develop-ment and openness of its finance market. The advantages of having various kinds of derivatives have been advertised in China, from increasing liquidity, decreasing risk to balancing input and output. Additionally, in the seminar “China’s financial innovations in the face of financial crisis”, experts stressed that financial instruments should not be the scapegoat for the 2008 financial crises (Yu-ansheng Ding); and the problem is with the financial system but not the financial instru-ment (Yaling Tan). Moreover, the previous years have already witness a huge boom in financial derivative in China’s markets.

Nevertheless, with China’s lack of experience and the complex and turbulent financial environment, it remains to be seen wheth-er the financial derivatives would work as well as the government hopes it would.

Secondly, even without the predicted boom of financial derivatives, China’s present mar-ket is not that stable as it appears to be. For one thing, the unrealized foams in the real estate market are at risk of bursting.

Furthermore, the unhealthy financial plat-form for the local government, especially rural ones is like a ticking bomb waiting to explode.


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Last but not least, the non-receivable debts of the four state-owned banks might one day be big enough to restrict govern-ment’s ability to influence the market.

It is a tough time for China

With so many factors at play, and high ex-pectations from citizens of China and the world, it is fair to say that China is now go-ing through tough times as well. If han-dled properly, China can compose a new chapter of its own for the world’s financial system. However, if mishandled, China might just follow the footsteps of western countries into the same old tragic road.


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Alfonso, Analyst, Equities

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Tax avoidance has been a popular debate in recent years. Its impacts upon the economy are tremendous: the UK’s exchequer lost £32bn in tax revenue in 2010-2011 and the US government are looking for ways to close the $150bn gap in tax revenue annually. These losses have resulted in increased cut in government spending which aggravates the economic woes, created by the 2008 fi-nancial crisis. Moreover, such losses would mean someone else has to pay the bill, fur-ther hurting consumption and investment.

Given such devastating consequences, it is important to first look at the causes of tax avoidance, which are essentially a result of an era of globalisation and the rise of tax havens. After having identified such causes, this article would introduce Transfer Pric-ing as a tool to facilitate tax avoidance for corporations, including manipulations in intra-group transactions and creation of shell companies. In the end, solutions to tackle this phenomenon are also discussed.

19| the analystFundamentals

TRANSFER PRICING AND TAX AVOIDANCEBY VINH NGUYEN QUANG

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Losses in tax revenue are the result of in-creased austerity in the developed econo-mies. Essentially, during booming period, government would be likely to increase spending, thus allowing job creations and increase in consumption and invest-ment. However, running such stimulus pro-grammes will result in a wider deficit if it is not financed by tax revenues. Thus, in the case of an economic crisis, drastically cut-ting government spending seems to be an obvious solution. Such measure is called austerity and without doubt, it would hurt the economy. A prominent example for such explanation is the UK. The nation has recent-ly discovered that its 9 key IT suppliers, in-cluding the UK leading IT and management consulting firm - Accenture, have paid less than 1% in tax out of £62bn revenue. Such losses, coupled with a public debt of over 80% in GDP, have prompted George Osborn to announce the duration of austerity until 2008 in his Autumn Statement, adding fur-ther to the deteriorating job market where unemployment rate has jumped from 5.1% in 2008 to 7.8% (graph) in 2012. Effectively, UK’s credit rating has been downgraded in the early of 2013 from AAA to AA1, damp-ening the prospect of a British recovery.

In addition, tax avoidance of MNEs would mean that someone else has to pay the tax bill to avoid more painful cut in the government budget. In effect, other tax payers, especially the middle income class who are most vul-nerable during the crisis, will be likely to face an increase in tax. A prominent example is the United States. Although the fear of the so-called Fiscal Cliff has disappeared, which means income tax will not rise for the major-ity of Americans, federal tax has increased, which will damage the wage earners. Such decision is an effect of the inability of the US government to repatriate $150bn losses in tax revenues annually from its biggest

MNEs such as Google and Starbucks. The de-crease in purchasing power, resulting from the rise in federal tax would reduce con-sumption and investment, thus the capa-bility of the US to revive economic growth. Overall, the consequences of tax avoidance are extremely damaging to the economy: losses in tax revenue contribute to spark a wrong direction in government’s fiscal poli-cy which further decreases the chance of an economic growth. Given these consequenc-es, it is essential to investigate the causes of tax avoidance. In other words, what are the incentives for corporations to partici-pate excessively in tax avoidance schemes?

Increase in the complexity of intra-group transactions is one of the causes of active engagement in tax avoidance schemes by Multinational Enterprises (MNEs). Such com-plexity has been created by the globalised economy where capital, money, labour are constantly circulating around the world. In the pre-crisis period, foreign direct invest-ment has increased from $779 billion in 2005 to $1.9 trillion in 2007, especially in the emerging economies. China has recorded a dramatic increase in FDI from $17bn in 2007 to $60.1bn in 2011 (OECD). A more opened economy allows MNEs to settle their op-erations abroad, which benefits from a re-duction in corporation tax rate. In order to bypass tax rate charged at home, complex accounting techniques have been adopted, which, in many cases, are crafted by the Big 4 (Deloitte, Ernst & Young, KPMG and PwC).

Companies from the developed econo-mies tend to face high corporation tax rates (chart) in their home country. To avoid pay-ing a high tax rate, companies have been known to establish subsidiaries or move to areas with much lower tax rates – tax havens, also known as offshore financial centres (OFC). OFC potentially consists of around

20 | the analystFundamentals

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50-60 low-tax jurisdictions, which have much lower rates, according to the Econo-mist’s Special Report on Tax Avoidance. These so-called tax havens provide financial services for non-resident firms while giving firms the opportunity to take advantage of the jurisdiction’s tax structure. In effect, MNEs shift their operations abroad to ben-efit from substantial reduction in tax pay-ment. One of the methods in which MNEs avoid high tax payment is Transfer Pricing.

Using transfer pricing to avoid tax bills is a common practice among group companies such as Starbucks or Google. Because these firms have many subsidiaries, many that are their suppliers or distributors, these sub-sidiaries can charge their main operation with high input price in order to increase the costs in operations in their home coun-try, thus drastically reduce the operational profit there. Effectively, operations in low-tax jurisdictions will hold most of the com-pany’s taxable profit. UK Starbucks, a sus-pected culprit in this practise, has miserably failed to reveal their record of taxable profit for 14 out of the last 15 years when taken to court in November 2012. The case also extends to intellectual properties such as patents. A prominent example comes from the world leading management consulting firm Accenture. Accenture relies heavily on their intellectual properties such as IT pat-ens which the firm holds in Ireland where tax rate is 12.5 % (chart) (Unsafe offshore Financial Times analysis). The UK operation will have to pay a fee or royalty for the use of this intellectual property, thus reducing UK profit but increasing profit in Ireland’s operations. Moreover, it is hard to evalu-ate the monetary value of these intellec-tual properties, the Ireland operation who holds these assets can thus impose higher price for Accenture UK operation, thus mini-mise the company tax bills in the UK, which entitles to a tax rate of more than 20%.

Country Corporation Tax Rate

UK 24USA 39France 33.33Germany 29.8Ireland 12.5Switzerland 13

However, big MNEs are not alone in engag-ing in tax avoidance .Many small and me-dium sized companies are also known to avoid paying high tax by seeking a permis-sion to open a shell-company in the low-tax jurisdictions without having to invest heav-ily there. Here, the notion of Onshore Finan-cial Centres is introduced. An example could be the USA. Since different states in the USA have discretion in determining corporation tax rate, tax havens such as Delaware is the country’s giant in incorporating shell-com-panies. Offering a tax rate of only 8.7% with leading services in secrecy and business registration, Delaware have profited from an average incorporation growth of 7% a year with 945,000 active entities. Companies which set up their shells in Delaware or other jurisdictions can benefit from transfer pric-ing with low cooperation tax rate and other services that hide their tax bills and other related documents from being revealed by their home country’s tax administrations.

OECD report has suggested some impor-tant steps to enhance the transfer pricing practices. It outlines a better process of identifying serious transfer pricing exploi-tations and suggestions for transfer-pricing expertise development. Initially, developing as well as developed economies have strug-gled to identify the appropriate transfer pricing cases given their complexity. Before, different countries had different methods to


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identify transfer pricing violations, such as routinely selecting a few transfer pricing cases every few years or selecting cases on the basis of their gross value of cross-border transactions; ie the higher the val-ue, the more likely that the transactions are the result of transfer pricing. However, these two methods have enabled many MNEs to easily avoid tax bills. A better solu-tion would be to build up a sophisticated method that incorporates different criteria. But, this led to another problem as tax ad-ministrations often struggle to find the rel-evant documentation to discern whether the MNE engages in serious tax avoidance. It must be acknowledged that transfer pric-ing is a fact-based issue, thus, an inability to obtain sufficient documents will lead to poor result. Thus, building up relation-ship with MNEs is an important step for tax authority to acquire these documents.

In addition, transfer pricing knowledge and expertise is in shortage. Firstly, developing economies are found to have a lack of com-petencies in transfer pricing, thus they are vulnerable to MNEs taking advantage of it. Tax administrations from developed econo-mies should work with the ones from de-veloping economies. This transfer of knowl-edge and skills would be an important step for global cooperation in tackling tax avoid-ance. Secondly, accusing an MNE to avoid tax just because the firm reveals high losses is certainly unjustified. A comprehensive knowledge of the firm’s industry by the tax administration is crucial in preventing such false accusations from taking place.. Hence, cooperation between the tax team of the firm with tax administrations is essential to establish required industrial knowledge, al-lowing better cooperation and more accu-rate identification of transfer pricing cases.

OECD represents an important global in-stitution in promoting international coop-eration in tackling tax avoidance. However, countries also have the incentives to sup-port such cooperation, due to the damage of tax avoidance upon their economies. The European Parliament, along with its recent announcement of putting a curb in bankers’ bonuses, has announced that banks may need to reveal their profits and tax details in the countries where they operate. Such a rule would enable tax authorities to acquire the relevant facts to identify which banks have engaged in serious tax avoidance. Overall, as the Eurozone crisis is showing no sign of recovery, the global economy is slowing down, thus it is unsurprising that MNEs will be the targets for tax reforms. This will require an international cooperation amongst countries, from high-tax to low-tax jurisdictions. Promotion of transparency is crucial for the acquirement of relevant data and information, which in fact char-acterises the complexity of transfer pricing.

Tax avoidance has a huge impact upon the economy. When a crisis struck, insufficient tax revenue would lead to austerity initia-tives which further dampen the struggling economy. Economic growth will be limited as government spending is drastically cut. Furthermore, someone else would have to pay such gap in government’s budget. Middle-income class will thus be hit hard by potential increase in income tax rate. Given these impacts on the economy, im-proving tax practices, expertise and skills are essential to tackle the so-called Trans-fer Pricing, a popular accounting tech-nique used by firms and their advisers to manipulate the tax bills. Furthermore, in-ternational cooperation is essentially cru-cial because Transfer Pricing deals with tax administrations from different countries.


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One of the key reasons for the recent boom and development in the Brazilian Venture Capital industry is the number of invest-ments made in the technology sector. Four main factors drive the success of technolo-gy-related venture capital in Brazil. These are the focus on education, the entrepre-neurial culture, the flood of foreign capital and the role of the Brazilian government.

Out of all the regions that have been devel-oping and focusing on technology in Brazil, Campinas has become the most organized and successful in the country in terms of en-trepreneurship. This success has in part been dependent on the universities and centres for development that have been set up in the region. Until the 1970s Campinas had very few industries and an economy based

on agriculture and commerce. However, with the foundation of UNICAMP (University of Campinas), referred to as Brazil’s answer to MIT, a number of high-tech firms began to establish their industrial plants and R&D labs nearby. Currently, the region is home to companies such as IBM, Samsung, Mo-torola, Dell, 3M, and Huawei among others.

Today, the region has a vibrant high-tech university driven environment and is home to multiple universities like UNI-CAMP, the Pontificial Catholic University of Campinas (PUCCAMP), and the Cen-tro Universitario Salesiano de São Paulo (UNISAL), all of which continue to supply the region with well-trained engineers and scientists. In fact, according to the Times Higher Education World University


Source: GVcepe Database – Getulio Vargas Foundation

THE BOOM OF BRAZILIAN VENTURE CAPITALBY FERNANDO FERNANDEZ AND CAN KARAPENCE

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Rankings UNICAMP is the 177th best univer-sity in the world and the 2nd best in Latin America after the University of São Paulo1. The university is well known for its high quality research, its engineering programs, and above all the number one computer sci-ence program in Brazil. Furthermore, in ad-dition to all the universities, Campinas is the home of various research centers such as the Center for Research and Development in Telecommunications, the National Labo-ratory of Synchrotron Light, and the Renato Archer Research Institute, among others2. In addition, the region has developed multi-ple industrial parks and incubators for high tech companies. Clearly, Campinas has felt the impact of a successful education system that continues to provide a supply of well-trained engineers, so it should come as no surprise that the Brazilian Silicon Valle y is being developed in this region in particular.

The universities, R&D centres, and corpora-tions are there, but what about the intangi-bles? What about the entrepreneurial cul-ture that has been so instrumental to the success Silicon Valley? A look at some of the trends in entrepreneurship in Brazil sug-gests the country’s efforts to boost its cul-ture of innovation have been very success-ful. According to data gathered by Endeavor Brazil, an organization working to promote high-growth entrepreneurship in the coun-try, young businesses play a crucial role in the future of the Brazilian economy. Cur-rently, small and medium size enterprises are responsible for 96% of the jobs in Brazil and comprise 98% of all companies in the country3. Furthermore, according to the di-rector of the Brazilian Micro-Enterprise and Small Business Support Service, Luis Carlos Barboza, the increase in new companies is related to the growing entrepreneurial spirit of Brazilians. Another statistic that helps to

support this claim is the fact that the num-ber of participants in Brazil’s Global Entre-preneurship Week increased from 1.5 mil-lion people in 2008 to 5.3 million in 2009, a 3.7 million people increase in just one year, and attendance has continued to increase year after year. In addition, numerous Brazil-ian entrepreneurs like Bedy Yang have been organizing multiple startup events and con-ferences in order to create an environment that will enable Brazilian entrepreneurs to discuss, meet, and at the same time thrive and create even more successful start-ups.

The Brazilian internet culture is particularly strong, so much so that not all have access to the web but those who do spend an average of 70 hours a month online, which is more than anywhere else in the world4. Addition-ally, the growth of the web has transformed Brazilian society as a whole since now most services are also delivered online. Today it is not uncommon to do banking online, buy tickets, or even interact with the govern-ment via the web. Brazil has an enormous population and the internet is becoming a major player in the everyday lives of Brazil-ians, opening many opportunities for entre-preneurs to create start-ups to meet custom-er’s needs. The internet boom and the surge in Brazilian start-ups has made entrepre-neurship more accepted as a viable career and past and present success stories make this an even more attractive career path.

However, there is still one big obstacle left to overcome: the fear of failure. While Bra-zilians are feeling more and more comfort-able with taking risks, start-up failure is still a taboo that needs to be tackled. According to Fabio Seixas, a successful entrepreneur with over 16 years of experience in Internet start-ups, the problem is that “the Brazil-ian culture doesn’t value failure as a learn-ing tool.” One of the main reasons has to


1 World University Rankings. <http://www.timeshighereducation.co.uk/hybrid.asp?typeCode=144>2 Brazilian Silicon Valley. ENotes. <http://www.enotes.com/topic/Brazilian_Silicon_Valley>3 Ortmans, Jonathan. Brazil’s Entrepreneurship Boom. <http://www.entrepreneurship.org/en/resource-center/brazils-entrepreneurship-boom.aspx>4 Gregory, Mark. Brazil entrepreneurs thrive on the web.BBC.<http://news.bbc.co.uk/2/hi/8559334.stm>

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do with education. Entrepreneurship is a relatively novel concept in Brazil and uni-versities have only fostered entrepreneur-ship in the country for a few years. Never-theless, as the start-up ecosystem grows and the entrepreneurship culture becomes stronger with the help of incubators and accelerators, Brazilians will understand the importance of failing and learning from past mistakes and to be more open about it.

Thankfully for Brazilians, this is an area in which they have not been having many problems considering the fact that Brazil has a booming economy and capital is flooding its shores. Foreign investment now not only concentrates on capital markets but also in private equity and venture capital. Accord-ing to the Latin American Private Equity and Venture Capital Association firms investing in Latin America reached a historic record of US$10.3 billion in 2011, an increase of 27% from the previous year’s record of US$8.1 billion. Interestingly, Brazil dedicated funds captured US$8.1 of the total capital commit-ted, which is more than 50% of the total in-vestment pool . However, this should come as no surprise given the fact that Brazil’s economy, now the sixth largest in the world, has been posting surprising growth num-bers. This growth has been possible due to various factors that include abundant natu-ral resources, stable government policies, a sophisticated banking sector, a rapidly growing middle class (now almost 50% of the more than 190 million people that live in Brazil), and also a surge in real estate and in-frastructure development to prepare for the 2014 FIFA World Cup and 2016 Olympics.

In the start-up scene, capital has also be-come more readily available. Marcelo Mar-zola, the 33 year old co-founder of suc-cessful Brazilian start-up Predicta.net is the perfect example of how hot the Bra-zilian economy has become. “Ten years

ago, when I launched my business, get-ting start-up capital was impossible. At the time, I called 20 banks, venture capital and private equity firms, and everyone turned me down” he says. But now, after raising over US$15 million from DFJ FIR Capital he mentions, “there are signs that the equity-capital market for entrepreneurs is igniting.” Today there are about nine major players in the Brazilian venture capital business in-cluding Antera, Confrapar, DFJ FIR Capital, Monashees Capital and Status Capital, but slowly American venture capital firms such as Accel Partners have been also trying to tap into the Brazilian start-up market. Now firms are investing in all stages of start-ups and financing is not only coming from tra-ditional venture capital firms but also from High Net Worth individuals and other in-stitutional investors that see the value in investing in the growing Brazilian start-up scene. While in purely nominal terms invest-ment in start-ups is a fraction compared to what is invested in the United States it is surprising to see the rate of growth and the availability of capital in the Brazilian start-up market that is coming not only from Brazil itself but also from international sources.

With regards to government assistance, the government has noticed the importance of the internet and entrepreneurship, and has injected a lot of money and energy into the technology sector. A significant project was the creation of SEBRAE, the Brazilian Ser-vice of Support for Micro and Small Enter-prises, which is an organization established by the government to “create small to me-dium businesses, and establish professional networks that support the growth of these enterprises ”. In addition, in August last year, the then Minister of Science, Technology and Innovation of Brazil Aloizo Mercadente announced a US$2.2 billion initiative to in-vest in 75,000 science and technology schol-arships by the end of 2014. Furthermore, the


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government has also introduced a string of incentives such as the ‘Lei do Bem’ (Good Law) to offer tax incentives in order to lure businesses that focus on technological in-novation into the country . Another no-table project is ‘Primeira Empresa Inova-dora’ (First Innovative Enterprise) which is a venture conceived and implemented by FINEP, the financing agency of the Ministry of Science and Technology which has al-ready invested over US$100 million in over 1300 companies. FINEP has also launched another project to support start-ups called PRIME, which will give around US$ 65,000 to start-ups focused on innovation . Clearly, the Brazilian government has tak-en an interest in entrepreneurship and has been implementing multiple pro-en-trepreneurship policies whose results can be clearly seen today. While government intervention is not the only thing needed to create a healthy and successful entre-preneurial ecosystem it is extremely ben-eficial to the population to have a govern-ment that focuses on innovation and job creation through start-ups and entrepre-neurial spirit since it encourages people to take risks and pursue their own ventures.


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29Inside Analysis | the analyst

A massive programme of investment in Thailand’s infrastructure, designed to en-hance international connectivity and com-petitiveness, is set to be implemented this year amid a renewed commitment to invest-ment and regional development.

The government is lining up 55 projects worth Bt2.27trn ($76.27bn) to be executed by 2020, with Bt100bn ($3.36bn) allocated in the 2013 fiscal year, the local press report-ed on January 18. The projects come under the government’s long-term development plan, but are being accelerated due to new commitments to investment and regional development, including liberalisation in neighbouring Myanmar, and the roll-out of the ASEAN Economic Community (AEC). The AEC has set a goal of regional economic in-tegration, with the focus on creating a com-petitive single market integrated both inter-nally and within the global economy.

“The infrastructure development projects are designed to make Thailand the true centre stage of ASEAN,” said Chadchart Sit-tipunt, the minister of transport. “Under this plan, Bangkok will no longer singly repre-sent Thailand. Major cities will gain greater prominence, thanks to the AEC, which will […] extend regional connectivity.”

The Ministry of Finance is expected to pre-sent a plan to Cabinet to borrow Bt2.2bn ($73.91m). If given the green light, 64% of

Thailand: Transportation InvestmentBy: Oxford Business Group

this figure will be allocated to 31 railway projects, 24% to 13 road schemes, 7% to seven water transport projects and 5% to four air transportation development ven-tures. The aim of the investments is to im-prove Thailand’s connectivity with its ASEAN neighbours, boost trade, lower transporta-tion costs, ease existing bottlenecks, and support the growth of the crucial tourism sector. By developing alternatives to road transport, Thailand also hopes to lower its carbon emissions.

Thailand lies at the heart of South-east Asia, a region which has enjoyed strong econom-ic growth in recent years, and has recovered from the global economic crisis consider-ably more quickly than countries in Europe and North America. As well as the AEC, Thai-land is a participant in a number of other regional bodies intended to support growth and integration, including the Bay of Bengal Initiative for Multi-Sectoral Technical and Economic Cooperation and the Ayeyawady-Chao Phraya-Mekong Economic Coopera-tion Strategy.

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30 Inside Analysis | the analyst

Important transportation corridors that are likely to be the focus of infrastructure in-vestment include the Southern Economic Corridor (from Bangkok to Phnom Penh in Cambodia and Ho Chi Minh City in Vietnam) and the North-South Economic Corridor (linking Thailand with Laos, Myanmar and China, and terminating in the Chinese city of Kunming).

Chandchart said that he aimed to increase the use of railways from a 12% share of the transport sector to 40%, and four high-speed rail projects worth Bt900bn ($30.24bn) will be among the first to be rolled out under the plans. However, the government is not only committing money, it is also looking to restructure the State Railway of Thailand (SRT) to improve services and increase ad-ministrative capacity.

Investments in airports will take some of the pressure off Bangkok’s Suvarnabhumi Airport, which currently accounts for 72% of airport arrivals, said Chadchart, who sug-gested that the airport at Mae Sot, a trading centre on the Myanmar border, could be de-veloped.

While the transportation plans are certainly capital-intensive, the minister said financing would be available through 3% government bonds as well as other revenue streams, and that the economic benefits of transport development would pay off the cost in the longer term. There should also be consider-able scope for private investors as well as contractors, as public-private partnerships are expected to account for 14% of the total spent; this proportion could increase, thus lowering the burden on the public purse.

Foreign investors are expected to play a leading role, and Japanese Prime Minister Shinzō Abe has reportedly already expressed interest in Japanese firms’ participating in tenders, particularly for the upcoming high-speed rail projects. Chinese officials have shown strong interest in the rail links to Chi-ang Mai and Nong Khai, as they will eventu-ally connect to the Chinese network.

With such large investments planned, Thai-land has shown a commitment not only to overhauling its own transportation infra-structure but to greater connectivity in the region. However, for the AEC to succeed, new railways and roads need to be part-nered with a renewed commitment to freer trade and economic liberalisation, including lowering tariff and non-tariff barriers and legislation restricting foreign investment. Thailand has one of the more liberal econo-mies in the region, but across ASEAN, there is still some way to go before the ideal of an integrated economy open to globalised world markets is achieved.

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