Paul L. Caron

Monday, July 7, 2008

Johnston: Blame It on Rio: GE’s Brazilian Headache

David Cay Johnston has published Blame It on Rio: GE's Brazilian Headache, 50 Tax Notes In'l ___ (June 30, 2008).  Here is the summary:

In 2005 the new manager of a General Electric subsidiary in Brazil that made light bulbs and lighting equipment got a tip, the company says. It led to his discovering something curious in the company's records: Up to 64% of annual sales were recorded as going to wholesale distributors in lightly populated regions near the Amazon River.

Valter Moreira, the manager, noted in a report to his GE bosses in America that half of Brazilians live in urban states like São Paulo and Rio de Janeiro. So why would so many sales be made, at least on paper, to areas where few people lived? Moreira's report explained that urban Brazilian states charged the subsidiary a 19% VAT on its bulbs, switches, and fixtures, while the rural states charged just 7% or none at all.

In his PowerPoint presentation to GE executives in the United States, Moreira analyzed sales patterns by vendor and supposed location of the sale. His report cited "suspicious" invoices as "an indication of possible tax evasion" that saved GE either 12 cents or 19 cents on each dollar of sales. On $100 million of sales, that would be an extra $12 million to $19 million the company could use for all sorts of things, from lowering prices to gain market share, to funneling money to anyone from a corrupt purchasing agent to cronies of powerful politicians, or inflating the pay of its executives and sales agents.

All of these issues would come up internally in the months ahead, but would not be disclosed to American or Brazilian authorities or GE shareholders. Moreira's report noted that concerns about suspicious practices pointing toward tax evasion had been raised internally six years earlier, in 1999. His language suggests these practices were established long before then.

Yet GE, whose internal motto is "integrity always," had allowed the practices to continue and to grow, cutting them back only after Moreira came on board. The tax schemes and subsequent events are detailed in hundreds of pages of internal GE e-mails, memos, and legal opinions obtained by Tax Analysts. A lawyer for a participant in some of the events provided the documents on the condition that the source not be identified. The internal documents offer a rare and candid look at how, behind closed doors, GE executives, managers, and lawyers dealt with evidence of systematic tax cheating that flourished over many years.

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Brazil is notorious for its myriad variations of tax and business fraud ? how about the doctrine of vicarious liability...if that is the case, GE is also notorious for its acts of fraud.

Posted by: Tim | Jul 8, 2008 12:31:43 PM

Up to 64% of annual sales were recorded as going to wholesale distributors in lightly populated regions near the Amazon River.


Are these distributors subsidiaries of GE, or independent businesses?

If they're subsidiaries, yeah, it looks like GE did something wrong. If they're independent businesses, GE's hands are clean.

Posted by: rosignol | Jul 8, 2008 12:40:36 AM

As per normal, taxprof argues on behalf of that true underdog, the state. Now we all know that Brazil does nothing but good with the tax money it collects, and that the trees are made of sugar plums and gumdrops there...and that the skies are fleeced with cotton candy; however, is it not conceivable that a person might be so taken aback by rampant corruption, the bread and circuses, and taxation without representation that the only ethical option would be to fight such a regime, and withhold taxes however possible?

I'm no fan of GE, or any monolithic organization, but I'm even less a fan of the insane ideology that dictates a government is entitled to something simply because it is written thus in the law, democracy or no democracy. The test of law's goodness is not its popular support, but the degree to which it is consistent with a reasonable understanding; and the test of the reasonableness should rest on concinnity with nature.

We don't live in a world where the punishment of net productive activities meets any standard of reasonablness, and that explains why Brazil is a festering cesspool, along with the rest of the socialista states of South America.

Posted by: john schappert | Jul 7, 2008 5:17:18 PM

The problem would be if they say that they ARE dealing in less expensive regions when they really AREN'T.

Posted by: David R. Block | Jul 7, 2008 2:11:49 PM

Are you claiming that GE has an obligation to maximize tax revenue for Brazil? I hope not.

What I see from the story is that Brazil has made it expensive to do business in some regions, and not so expensive to do business in other regions. So GE conducts a good deal of business in the less expensive regions. If that's all that's going on, that's not fraud, it's economics.

Posted by: tom swift | Jul 7, 2008 12:58:24 PM

This sounds like what typically happens when governments discriminate in the application of taxes. Why would a Rio or Sao Paolo distributor order from GE when they could order from an outlying source with lower costs than what GE could provide? If Tax Prof doesn't understand how businesses react to discriminatory taxes he shouldn't have a blog.

Posted by: OregonJon | Jul 7, 2008 12:18:57 PM

Brazil is notorious for its myriad variations of tax and business fraud; its grasp of the rule of tax law is non-existent and graft is systemic. Put it on the list of unreliable tax schemes, along with China, Mexico and Russia. Please identify a US business which has NOT had a costly embezzlement or graft cum distribution problem dressed as a tax issue.

Posted by: dsquare | Jul 7, 2008 11:38:17 AM

So the lesson is to sell only in low-tax jurisdictions to distributors that do business in the high-tax areas. Let someone else have the headache and lower profits of doing business in Brazil.

Posted by: Some Guy | Jul 7, 2008 11:19:16 AM

Note that the people at the top of GE Brazil had to infer what was going on by an independent analysis of the sales data. People at the top of a large organization have to struggle constantly to understand the state of their own organization.

Of course, GE will not receive any kudos for uncovering and suppressing the practice. It will turn into a PR nightmare which will teach other companies to just keep quite and cover up these types of problems rather than do the right thing and correct them.

Posted by: Shannon Love | Jul 7, 2008 11:07:26 AM

It is not clear to me what is wrong here.

Was GE booking fake invoices to take advantage of the lower VAT? Or changing invoices to lie about the destination of the sales? If so, that is clearly fraud.

Or were GE's non-company owned distributors setting up legal entities in low VAT states to purchase equipment from GE? If so, what did GE do that was wrong?

Posted by: WJ | Jul 7, 2008 11:00:16 AM