Goods for Processing / Toll Processing … a pragmatic approach

1. Goods for Processing / Toll Processing … a pragmatic approach • What is ‘toll processing’? • Why is toll processing used? • What is the problem? • How has ONS dealt with the issue? • Considerations for a longer-term solution

2. What is ‘toll processing’? • A form of outsourcing (also known as goods for processing) • Usually takes place across national borders • Often undertaken within a corporate group • Involves the transfer of goods without change of legal ownership • Involves the charging of a ‘toll’

3. Why do businesses use toll processing? Why? • Economic reasons – specialisation, economies of scale, access to global markets etc • Avoidance (or possible evasion) of tax liabilities Where? • Toll processing is commonly found within industries such as chemicals, pharmaceuticals, oil & gas, metals

4. Variations of Outsourcing (UK-HMRC definitions) • Licensed manufacturer – goods manufactured under a long-term licence. Manufacturer buys materials on own account and bears risks of selling finished products. • Contract manufacturer – manufacturer acts as agent, producing goods/components for the principal who guarantees to buy outputs. The agent bears risks of buying and stocking materials/components. • Toll Manufacturer – Principal buys the materials/components although these usually pass direct to the agent.Buying and selling risks lie with the principal. Termed ‘stripped risk manufacturers’

5. What is the problem? Businesses argue that: • The transactions are the provision of services rather than buying / selling of goods • No arm’s length transaction in goods has taken place (as no change of ownership occurs) • This leads to issues of statistical classification and measurement:

6. What is the problem? … statistical issues • Should transfer of goods be treated as a sale and subsequent purchase, or ignored? • If treated as a sale/purchase – should values be recorded on a net or gross basis? • If businesses cannot provide ‘gross’ data, which method(s) of estimation should statisticians use? • Possible misalignment of inputs and outputs if different services/goods classifications are used by respondents No clear guidance on the recording of toll processing activity has yet been produced, though work continues

7. Other issues for consideration Identifying: • Ownership/location of inventories • Location of capital expenditure • Location of labour costs • ‘Hidden’ turnover via recharging practices within a corporate group

8. How has the UK Office for National Statistics (ONS) dealt with the issue? Works on the assumptions that: • toll processing activity should be treated as manufacturing and • associated transfers of goods should be treated as arm’s-length transactions in goods, at full value • Adjustments should be made to statistical outputs, where necessary, to reflect this approach

9. How does the ONS approach operate? Where ONS identifies that a respondent has started to act as a toll processor, in order to ascertain the value of goods being transferred in and out, the adopted short-term solution, is:

10. ONS procedure – new toll processors Approach principal, if in sampling frame, formonthly turnover and price data relating to the agent If not possible Ask agent to supply monthly turnover and price data. If unavailable, request volume data, and estimate turnover data as price x volume (both collected from the agent) If not possible Ask agent for monthly price or turnover data to act as a proxy for factory gate prices and turnover If not possible

11. ONS procedure – new toll processors Ask agent for annual turnover data, or obtain this from annual financial statements. Alternatively, use Annual Business Survey data to calculate weights. Benchmark the imputed monthly data against this annual data If not possible Use an auxiliary variable as a proxy for sales data, e.g. work done recorded by PRODCOM survey. A number of approaches are possible to obtain a monthly path through annually benchmarked series. If not possible Impute agent’s weights, turnover and price data using normal imputation methods on the domestic producer prices, export and import prices

12. ONS procedure – Where a business has been a toll processor for some time Select agent (toll processor) into the survey sample in usual way and ask principal for turnover and price data relating to the toll processing activity If not possible As above, but use the annual turnover as the last turnover value collected or impute a last turnover value from the turnover provided by a company with a similar size and product

13. Summary of ONS short-term solution • Above procedures implemented in mid-2005 for a range of surveys • ‘Work done’ measured by PRODCOM used as auxiliary variable to update last weight calculated for toll processors in the output price index • Will investigate obtaining PRODCOM ‘work done’ data analysed by product type • ONS Business Register Unit continue to classify toll processors as manufacturers

14. ONS’s longer-term approach Four options identified: • Continue indefinitely with the short-term solution • Remove toll processors from manufacturing and possibly services surveys • Investigate new estimation methods and confirm/increase accuracy of existing estimation methods. Request Eurostat to clarify toll processing reporting but continue to treat as manufacturing until further advice received • Campaign for amendment of UK legislation to enable ONS to obtain correct/full data from businesses. Option 3 considered most realistic and was implemented in 2005.

15. Conclusion • ONS’s pragmatic approach is just one possible approach to the toll processing issue • ONS is interested in other approaches/suggestions and further discussions • The ONS approach has not yet fully considered all aspects (e.g. capital expenditure, inventories etc) • Obviously, a consistent approach internationally is the ideal and so clear international guidance on definition, treatment and measurement of toll processing activity is required