Ukraine Modigliani-Miller tax arbitrage

by on August 5, 2011 at 12:39 am in Law | Permalink

Today I received some tax saving wisdom from a taxi driver in Ukraine. He told me that people who import cars to Ukraine sometimes cut the car in two separate pieces and carry it through the customs this way. By doing this, they save a fortune on import tax. A car carried in two pieces is seen as spare parts and therefore is taxed at a much lower rate than a normal car.

When in Ukraine, the car is welded back into one piece. After that, it’s usually sold locally at a good price. I looked through forums and apparently this is a common practise in developing countries, particularly in post-Soviet states such as Ukraine.

The full story, with more pictures, is here.  For the pointer I thank Joe C.

Alexey August 5, 2011 at 12:50 am

It is also popular in Vladivostok, Russia with Japan cars.
They used just to disassemble cars and bring them through customs as parts, then assemble back. To prevent this, government imposed a 5000 USD flat fee tax for the car body, and now they cut the body in two to import as a scrap metal.

ron August 5, 2011 at 1:14 am

Isn’t this an example of the Laffer curve. If the taxes get too high you are better off doing silly stuff like this then paying the tax.

david August 5, 2011 at 1:25 am

No, it doesn’t say anything about whether the revenue from those who import their cars in one piece is higher or lower.

Andrew' August 5, 2011 at 8:02 am

Then why do they cut the cars? For fun?

S. O. August 5, 2011 at 10:06 am

The Laffer curve is about government revenue in terms of the rate of taxation, and in particular about the first derivative of this function.

Bill August 5, 2011 at 10:28 am

S.O.,
It’s not about government revenue. It’s about making the tariff so high that it is not ever collected, because the sole purpose of the tariff is to protect their domestic industry from international competition. You get the opportunity to buy a poorly built car at high price built by a company that faces no competition.

S. O. August 5, 2011 at 11:43 am

@Bill: The Laffer curve _is_ about government revenue, the tariff mentioned here is not. Hence, this whole topic – including your contribution – isn’t quite related to the Laffer curve, at least not in a direct way.

Veridical Driver August 5, 2011 at 12:03 pm

It is an example of the microeconomic workings of the laffer curve. If you can understand that people will cut a car in half in order to avoid taxation, then you can understand how higher tax rates produce less revenues.

Rahul August 5, 2011 at 1:20 am

Well it did have the effect of protecting local industry! Just not the one they wanted to protect……………….jk

david August 5, 2011 at 1:30 am

Note that this has negative effects on the safety of the car, since it saws the roll cage in two.

Eventually legislatures wise up to it, like they figured out why so many disassembled cars were moving across the border previously, and simply slap a tax on cars not built from scratch locally. But only after all the bribes from half-car importers run out…

david August 5, 2011 at 1:38 am

Ah… not “roll cage”. The rigid passenger cell. What’s the name, can’t recall it.

Rahul August 5, 2011 at 1:51 am

Doubt that’s a big item on peoples minds in Ukraine.

Finch August 5, 2011 at 9:32 am

“Unibody.”

Gunnar Tveiten August 5, 2011 at 2:19 am

The tax-code is stupid then. There’s no comprehensible reason to have a lower tax-rate on new parts than on a new complete car, since a car is just assembled parts anyway.

zbicyclist August 5, 2011 at 9:59 am

The original intent was probably as a form of luxury tax: only the rich would be buying new imported cars. The poorer would be repairing old cars, and would need parts.

Insert obligatory reference to “unintended consequences” here.

Tracy W August 5, 2011 at 3:32 am

This sort of thing showed up in NZ during the 1970s. Apparently some businessmen figured out they could buy TVs from a Japanese company, pay the Japanese company extra to buy them dissassembled (the NZ market makes for small orders), import the components to NZ, and reassemble them, and do better than just buying the TVs flat out because of the tarriff differential.
At least TVs don’t have the same safety problem.

Rahul August 5, 2011 at 3:42 am

One Indian entrepreneur regularly sent out old lab instruments ostensibly for repairs to a dummy firm Singapore. The instruments were worthless; but served as excellent conduits for duty free memory (RAM) chips on the way back.

William Sjostrom August 5, 2011 at 4:42 am

Back in the early 80s, when I worked for the Port of Seattle, they lobbied hard against a drop on the import duty on imported trucks, because the duty on imported parts was only about a tenth of the duty on trucks. They imported the bodies and the chassis, and had a nice business going bolting them together at one of their piers.

William Sjostrom August 5, 2011 at 4:46 am

This is not Modigliani-Miller. This is straight out of Yoram Barzel’s classic paper An Alternative Approach to the Analysis of Taxation in the December 1976 JPE.

k August 5, 2011 at 8:35 am

how so?

joshua the postlibertarian August 5, 2011 at 5:43 am

Hey don’t give the engineers working on those new CAFE standards any ideas!

James August 5, 2011 at 6:45 am

Volvo is running a promotion where buyers are flow to Sweden round trip, put up for a night, buy a new car there and able to bring back their new “used” car to the US (volvo pays for shipping too) at a much lower rate than if it were imported as a new car. Check out the link.
http://www.volvocars.com/us/sales-services/sales/volvo_overseas_delivery/pages/default.aspx

prognostication August 6, 2011 at 1:51 am

A friend just did this with a BMW.

Bob Knaus August 5, 2011 at 6:58 am

This was common in Jamaica in the 1980s. Difference on the duty was so large that it paid to have the two halves of the car air freighted from Miami on separate flights.

John Personna August 5, 2011 at 7:00 am

I’ve heard that the Lotus Super-7 was a “kit” for the same reason. And that a UK dealer did a “tune up” that put it together. Of course, the Super-7 is a pretty basic car – almost a kit when assembled.

Finch August 5, 2011 at 9:34 am

Being a “kit” also lets you get past numerous safety and emissions regulations.

Matthew C. August 5, 2011 at 7:35 am

This is the perfect example of why we are headed for a complete wipeout and reset.

We cannot afford to carry the burden of government when the rational economic decision is to saw cars in half and weld them back together again. Dig holes and fill them in again, indeed.

Arthur B. August 5, 2011 at 9:55 am
Rahul August 5, 2011 at 9:57 am

How long before a manufacturer makes an easy to cut-n-connect version?

Matthew August 5, 2011 at 10:02 am

This illustrates to me the importance of principles- rather than rules-based standards. Under a principles-based standard the customs agent says, “Looks like you’re importing a car in two pieces. Pay the full duty.” Under a rules-based standard he says, “I see. You have two spare parts. A spare front and spare back…” Principles-based standards are more challenging to design and administer. But worth the effort if it’s worth having a standard in the first place.

Veridical Driver August 5, 2011 at 12:08 pm

Principle based standards are also great for government corruption… as all it takes is a little bribe for the customs agent to decide in my favor.

Bill August 5, 2011 at 10:25 am

These exhorbitant tariffs are set up to protect domestic industries, not to raise money for the government.

Arthur B’s post about the US and what we did to coerce the Japanese to build plants here in the ’80′s is telling. Same with computer chips, for awhile.

Henry August 5, 2011 at 3:01 pm

In the 70′s this happened in Mexico with light aircraft. But the chopping only happened in paper, you made three or four different import applications (on different days): an engine, a pair of wings, a fuselage and a landing gear set. Once they were approved, didn’t make much difference if they were all delivered assembled.

I don’t think anybody ever paid the 13,000 USD tax on light single engine aircraft.

Andrew' August 5, 2011 at 5:08 pm

If you are going to do that to a Bimmer, you would be remiss not to go ahead and put in a hot tub.

Andrew Woburn August 6, 2011 at 1:20 am

I ran an export container loading service in Vancouver, Canada. We often loaded brand new minivans which were shipped to Hong Kong for disassembly before being shipped as parts to China where they were reassembled. I was told this involved process actually saved thousands per vehicle in duties.

aw August 7, 2011 at 9:17 am

This is common procedure at Mercedes Benz for exampled – disassembled cars are shipped in large quantities
to countries with these kinds of tariffs. I used to have a summer job in one Mercedes’ plants doing exactly that.

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