It's strategy, not under-invoicing

Last week the automobile market was stirred with the news about FBR's investigation on the potential under invoicing by one player. This not the first time FBR is probing an automobile player on tax/duty evasion. Nothing is being said by the FBR officials on the current issue; but it has been all over the media. Let's try to delve in what is happening; and what potentially could be the issue.

MG HS was launched in Pakistan with a massive fanfare. The local partner claims that it has booked over 6,000 units. Already, 687 units are being imported, and another 800 plus units will be docked this month. The company claims that it will start domestic production by June 2021 to reap the benefits of the Automotive Policy 2016-21, and will sell around 12,000 MG HS units - CBU (imported) and CKD (locally assembled) combined in 2021.

The retail price is Rs5.5 million (~US$34,000) and the imported cost (including freight) is at US$11,632. The news report said that in Australia, the car is sold at US$27,000 and based on that, its pre-tax price should be around US$22,000. Well, to give it perspective, the selling price in Pakistan is over US$34,000 and its imported price is US$11,632. This shows one cannot compare the prices in one jurisdiction to the other without having full information of duties and taxes in both places.

Technically, under-invoicing happens when the importer (in Pakistan) shows lower prices at import stage versus the price at export stage (in China). If the price is the same, the case has no merits. FBR must be doing its due diligence, and if there is any sign of under-invoicing, it will be in the news.

Here, the attempt is to find the case based on pricing and strategy. The tax and duty structure is standard for such capacity cars imports, and based on that, MG HS local company is making gross margin of Rs500,000-600,000 on a car. That is pretty much in line with industry norms. For example, import price for Toyota Rush is at US$12,897 and is selling at Rs5.8 million (~US$36,000). The gross margins are similar to what MG HS is making.

This implies that the MG local company is not seeking any economic rent. Hence, the chances of under-invoicing are slim. If the car was being imported at US$22,000, the breakeven gross margins would have been at a price of Rs8.8-9 million. The car is being sold at Rs5.5 million. The breakeven gross margins for MG at its selling price is US$13,325. In that case, all the admin, operational, finance, marketing and other expenses would have been borne by the company. The local company, however, is just making normal profits - as per industry norms.

Having said that, the price the parent company (SAIC) is selling to the local MG company (51% owned by SAIC) seems to be less than what is being sold in other jurisdictions. The numbers show that the parent is probably selling at cost (or even loss) to the local company where parent has majority shareholding.

It is a strategy, not under-invoicing, to capture the market. The strategy is to sell CBUs (at loss or cost) to have strong footing in the market before starting to assemble in Pakistan. It is to sell CBUs at a price which will be appropriate for CKD assembling (the duty structure for CKD is less - and at further discount for new entrants in Automotive 2016-21 policy). There is nothing wrong in it.

If any government investigation is required, it would be on dumping of the MG HS cars in Pakistan. When producers in one country sell products in other countries at lower prices, compared to the prices they sell in their own or a third country, the case of applying anti-dumping duty makes sense to protect local industry from harm. For example, there are jurisdictions where anti-dumping duties on cement sales from Pakistan are applied.

That is the case for domestic producers to make to the National Tariff Commission (NTC) and ultimately, the NTC to decide. However, SAIC sold over 6 million automobile units around the globe in 2019; selling a few of thousands of one variant (right now, 687 units) at a discount to Pakistan is not a big number to make a strong case of anti-dumping.

Some fear that MG may not start production in Pakistan and will continue selling CBU units, and will disappear from the market sooner or later. In that case, the strategy would not make sense at all. Why would the parent company bleed to pass on the benefit to the consumers, if it does not have a long term horizon? And if the company exists prematurely, it will be at a loss.

The duty structure in Pakistan is to incentivize local assembling. The additional benefit of local assembling is for new entrants in the policy expiring in June 2021. Many new entrants (such as Kia and Hyundai) didn't sell one unit as CBU for cars they are assembling in Pakistan. The reason is, if they do so, local or parent company will make loss at the prices local assembled units are being sold.

Their strategy is different from MG's. MG is getting low price from China and passing on the benefit to consumers. In the process, there is a loss for the parent company and the government of Pakistan (in terms of taxes). In the past, Japanese companies had an opposite strategy. These companies would buy parts (CKD) from trading arms of parent company usually at a premium to what parts can be bought from open market. In that case, parent companies make more money and the government fetches higher taxes and duties. In such cases, consumer is at a loss.

Now FBR is peeping into the auto industry. It's better to look from a broader lens. The main idea should be to promote auto assembling in Pakistan and to have affordable choices for consumers.

Copyright Business Recorder, 2021