The Tale of 16 Brothers: RH Logging Subsidiaries in PNG

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With the PNG Forestry Association saying PNG will loose K1 billion in revenues with increased taxes, I decided to re-read a report published by the Oakland Institute, a California-based policy think tank that conducted detailed report on PNG logging companies in 2016, and 2018. This two reports show that logging companies in PNG engage in illegal logging, tax evasion and financial misreporting, costing PNG millions of Kina in lost revenue of more than US$100 million (K4 million). This blog will focus on the Oakland Institute Report 2018 findings relating to the 16 subsidiaries of HR Company engaged in logging alone (16 brothers is a reference to the 16 subsidiaries, not necessarily 16 humans).

Summary is as follows

• HR subsidiaries keep reporting losses every year, but keep increasing their exports every year
• There is possibility that RH logging companies misreport their real financial loss to avoid paying taxes
• PNG Forestry Association was so wrong in 2017, so you should therefore not believe them now when they say PNG will loose K1 billion

Financial Misreporting (intentionally?)

The Oakland Institute Report reveals a pattern of possible financial misreporting and tax evasion by logging companies – and its getting worse. The financial records of 16 subsidiaries of PNG’s largest log exporter, the Rimbunan Hijau (RH) Group, show that these companies declare little to no profit! Between 2000 and 2016, all together, the 16 companies have declared losses of K776 million (US$277 million) from their operations, compared to a profit of K53 million (US$18.5 million).These companies therefore declare losing 15 dollars for each dollar of profit they make. 

Several subsidiaries have declared little or no profits for the entirety of their operations. RH subsidiary Niugini International Co. Ltd., for example, has declared zero profits and K126 million (US$44 million) in losses over the past 17 years, while more recently established operations such as Gilford Ltd, Sinar Tiasa, and Sinaran Papua have each declared more than K50 million (US$18 million) in losses. 

The Oakland Report observes “…. It is hard to comprehend how these companies continue to operate despite such significant financial losses…. the more these companies harvest and export timber, the more money they lose…” 

Even for non-accountants, you see the accounting blunder: If you make more loss after increasing exports, why increase exports every year? Shouldn’t it make sense to reduce exports instead? What is the incentive for increased logging and increased exports if you are making loss? 

What is the motivation for declaring loss?

Its something called the Future Income Tax Benefit (FITB).“Under PNG tax law, when a company incurs a negative operating income, it does not have to pay the 30 percent income tax on its profits and is able to carry forward the loss for 20 years.The ability to carry a tax loss forward allows the company to accumulate tax credits from the government and apply these future income tax benefit (FITB) credits from prior years to reduce the amount of taxable income in following years.” The Oakland Institute Report (2018).

Because these companies have worked at an overwhelming loss over the past 17 years, most of them have never paid any income tax and instead, have accumulated a vast pool of “Future Income Tax Benefit” (FITB), which can be used to pay income taxes in future profitable years. The total FITB incurred by RH subsidiaries totaled US$32.6 million in 2011, and nearly doubled to US$58.8 million in 2016, five years of record losses. Because the FITB can be rolled forward and used to offset income taxes in profitable years, it is likely that these companies will never pay any income tax. 

How can you misreport losses?

There are several methods companies use to intentionally misreport their financial status (due to lack on publicly available data, it is not possible to establish how exactly RH provides this contradictory accounting, but the following are some of the ways in which you can do that). One is called transfer pricing. You can undervalue the price of logs that are sold and exported.

For instance, Company A and Company B are subsidiaries of the same company, lets say “Bau Group of Companies”. Company B, as a buyer pays a lower price than the real cost of the timber under an arrangement with the seller, Company A. However, since they both belong to the same company, Company A actually does not loose any money. Company A can declare loss in the country it is operating from, but that money can be recovered by Company B making excessive profits from buying cheap logs, and manufacturing and selling at premium prices. 

Another way is, Company A buys logging equipment and machinery from Company C. Both Company A and Company C are subsidiaries of the Bau Group of Companies. Company C artificially increases the price of the equipment so that it is very expensive. Company A buys the equipment nevertheless, but it is not making a loss. The money is going back to Bau Group of Companies via Company C. This way Company A’s expenses end up greater than its revenue, allowing the Company A to declare an operational loss for the year. Company A then can justify not paying corporate income tax under PNG laws, when in fact the group as a whole is making a excessive profits…!

Of the 60 or so companies in PNG identified as being owned or controlled by the Tiong family, which owns the RH Group, over 30 companies engage in logging and agribusiness in operations ranging from timber processing and distribution to the repair of heavy machinery and oil palm production. The Report notes that a “significant amount of RH subsidiaries’ operational expenses are spent on activities, goods, and services offered by their sister companies, leading to a situation in which transfer pricing could easily occur.” Also, according to the Report, “Data from 2000 to 2016 reveals that PNG’s export prices were US$92 less than world average for log prices .” Basically, PNG logs were sold less than the world price. 

Why you should not listen to PNG Forestry Association

The government realized this almost cheating behaviour, and introduced progressive tax rate on exported logs in 2017. The progressive tax system allows you to charge different tax rates to different timber species, with rate increasing with the value of timber. The new system resulted in a four percent increase in the average tax rate paid by exporters on the value of exported timber, from 27 percent to 31 percent in 2017.

The Minister of Forests Douglas Tomuriesa and the logging industry, especially Mr Bob Tate of the Papua New Guinea Forest Industries Association (PNGFIA) argued that the tax increase, combined with a falling demand for tropical timber affect the revenues of the companies and by extension, the nation.

According to Tate’s statement in November 2017, the impact of this policy is already being felt: “This year, raising the tax rate resulted in the Government collecting K32 million less in tax revenue than last year. Further tax increases may result in revenues – and landowner royalties – falling to zero, and to thousands more jobs disappearing.”

However, if you compare the export data from before and after the introduction of the progressive tax in 2017, you get a different result. There was in fact a six percent jump in duties paid from K293 million (US$103 million) in 2016 to K310 million (US$109 million) in 2017. The tax rate increase generated an additional K17 million (US$6 million). More interesting fact is that, this increase in revenues was achieved as exports of logs were reduced. Log exports dropped from 3.6 million cubic meters in 2016 to 3.3 million cubic meters in 2017). PNG earned more revenues for less logs. Exports did pick up again after that. So what this shows is that, the Minister and PNGFIA’s predictions were wrong.

Now, with the increase imposed on Log Export Levy tax by the Government from 35% to 59%. The Forest Industry Association reckons it will lose over K1 billion if the industry shuts down operations due to the increase. The same Association, and even the same guy is making this claims. Well here is a trade-off:

You can go into downstream processing as per the direction of the government, or continue to export raw logs, evade taxes, misreport financials, and be forced to pay 59% tax. It not too much, it about time PNG gets its lost revenue for more than 20 years.

Illegally granted Special Agriculture and Business Leases (SABLs)

The increase in log exports by PNG in recent years is largely the result of illegally-granted Special Agriculture and Business Leases (SABLs),which have added 5.5 million hectares of land to the ten million hectares already under active logging concession. As a result, PNG has surpassed Malaysia as the largest exporter of tropical timber in 2011. Despite PNG being a major timber exporter, the forestry sector contributes a mere three percent to PNG’s total export earnings. To date no decisive action has been taken to stop illegal logging or return land to traditional owners. 

In January 2020, company hired policeman went into Foru, lower Musa in Popondetta, and assaulted local land owners who refused to let a logging company from trespassing through their land to log in the virgin forest of the lower Musa Plateau. Oro Governor Gary Juffa has since then stopped the logging after consultation with landowners pending verification of how the loggers attained the license to cut time in the area. 

This is just one example. Elsewhere in PNG, loggers act with impunity. Tax evasion is a norm. Illegal practice has become normal. And when the government directs the companies to go into downstream processing, they claim loss of billons of Kina for PNG. There is already massive loss of billions. If you have not read the Oakland Institute Report titled “The Great Heist: Tax Evasion & Illegal Logging in Papua New Guinea”, you should read it.