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Why Africa Must be at Heart of Global Tax Reforms
Why Africa Must be at Heart of Global Tax Reforms
Illicit financial flows deprive Africa of billions of dollars each year, more than is received in overseas development aid or foreign direct investment combined.
By Kenneth Kazibwe
The UN High-level Panel on Illicit Financial Flows is charged with developing recommendations to end this flight of much-needed capital from Africa.
Multinational companies continue to engage in illicit financial flows, costing Africa $60bn in lost revenues per year
After two years of research and hearings in various African and developed countries, the final report from the panel, chaired by former South African president Thabo Mbeki, was presented at the AU Summit this week.
Illicit financial flows are commonly associated with criminal activity like drug dealing, smuggling or human trafficking. But according to the African Union panel, two-thirds of illicit movements involve multinationals and commercial transactions like corporate tax evasion and avoidance. Criminal activity and bribery make up 30 percent and five percent respectively.
The African Union has found that up to $60 billion is lost to Africa every year, and that the majority of that figure (and perhaps as much as two-thirds) is lost due to manipulation of commercial transactions rather than criminal activity or corruption.
That means that tax evasion and tax avoidance (e.g. using tax havens to shelter profits that would otherwise be taxed by African countries) are costing the continent up to $39 billion annually. Multinational companies are extracting resources or selling their goods and services in Africa while contributing little in the way of taxes.
They are depriving some of the world’s poorest countries of money vitally needed to pay for schools, hospitals and other essential services. When 30 million African children - about 20 percent of all eligible - are denied primary school education, it is clear that African countries need to gather all the resources they can.
The best way to achieve this- the one that allows the government to set the agenda and spend where it is most needed - is to mobilize domestic resources. Multinationals often defraud countries of tax revenue by using mechanisms like trade or transfer mispricing, or by exploiting tax treaties to stash their profits in places offering very low tax rates or harmful tax incentives. This is also unfair on smaller domestic businesses that are typically responsible for the majority of employment in Africa.
The Malabo summit of African Union leaders is a great opportunity to make real progress on domestic resource mobilisation. Reforming the international tax system and removing counter-productive tax incentives will lead to substantially increased budgets for African countries to finance the post-2015 agenda and pay for improved education, health care, and development initiatives.
East African Tax and Governance Network, Tax Justice Network Africa, AFRODAD and ActionAid, civil society organisations across Africa, are calling on the African Union and its member governments to review tax treaties which are one of the major routes by which tax avoidance takes place.
African Heads of State should look to renegotiate or, if necessary, to cancel the treaties to ensure that more money is available to help improve the lives of the majority of their citizens. African Heads of State should also review their tax incentives and cooperate at a regional level to develop a coordinated approach to tax competition.
Double taxation treaties
Multinational companies often use the global network of double taxation treaties or agreements to avoid or reduce the tax they need to pay.
There are perfectly legitimate reasons to have such agreements: citizens who earn their income in a country other than their home country should not have to pay tax twice. The same goes for companies. But double taxation treaties go well beyond stopping double taxation and such treaties between rich and poor countries or between poor countries and tax havens are usually bad deals for the majority of people in poor countries.
In many cases treaties to prevent double taxation are now facilitating non-taxation. Double taxation treaties usually reduce or eliminate source taxes (tax payable where the business takes place) and withholding taxes (tax payable as the money crosses borders), allowing the movement of finance to go ahead unchecked.
Multinational companies often take advantage of different double taxation treaties to shift profits from country to country to country, exploiting the treaties with the lowest withholding tax rates.
Routing financial flows through a number of different tax jurisdictions allows companies to avoid tax on cross-border transfers whether or not there is a bilateral treaty between the country in which the income is generated and the final destination country. This strategy, known as ‘treaty shopping’ is particularly problematic when it involves a tax haven, like Mauritius.
Mauritius and double taxation treaties
Tax havens are characterised by low tax rates, high levels of secrecy and extensive tax treaty networks. High levels of secrecy mean Mauritius is highly exposed to the risk of illicit transfers; its extensive treaty network increases exposure for other African countries too.
Fifty-six percent of foreign direct investment into Africa flows through Mauritius, which has signed double taxation treaties with 14 African countries and is in the process of negotiating another 11. Mauritius is well known for negotiating treaties that reduce or eliminate withholding taxes and that prevent its treaty partners from collecting capital gains tax.
In 2013, ActionAid uncovered a presentation prepared by the major international accountancy firm, Deloitte that illustrates how tax can be avoided in African countries by structuring business through Mauritius.
The presentation uses Chinese investment into Mozambique as an example, but can be applied in the case of many other African countries. If a Chinese company invests directly in Mozambique, standard tax treatment of international investments applies.
Profits from the Mozambique subsidiary are subject to a 20 percent withholding tax when they are remitted to the Chinese parent company as dividends. If the Mozambique company is sold to another investor, any capital gains is taxed at 32 percent.
In such a scenario the company could reduce withholding tax (WHT) paid when dividends are remitted from Mozambique from 20 percent to eight percent. It would also pay no capital gains tax if it sold the Mozambique subsidiary, because the treaty prevents Mozambique from charging capital gains.
There is no need for the company owners to actually live in Mauritius; many Mauritius-based companies, as with companies in many other tax havens, are little more than post boxes whose real ownership and control lies elsewhere.
ActionAid analysis of the new Nigeria-Mauritius double taxation treaty - which has been signed but is yet to be ratified by Nigeria - reveals that companies investing in Nigeria will be able to avoid tax by routing their investment through Mauritius as opposed to investing directly in Nigeria.
The Nigerian government was successful in negotiating some progressive terms in the treaty, including provisions to ensure that Nigeria can apply statutory tax rates to income not specifically referenced in the treaty and to prevent activities linked to the company’s Nigerian branch escaping the tax net.
But the treaty features reduced withholding tax rates and prevents Nigeria from applying capital gains tax to Nigerian shares sold by a Mauritius-based company 1 - the most common problematic provisions in treaties between Mauritius and African countries.Overall, the costs of the treaty appear to outweigh its benefits to Nigeria.
Weak multilateral action
The G20 mandated the OECD to tackle tax avoidance by multinationals through a process known as the ‘Base Erosion and Profit Shifting’ (BEPS) Action Plan. But the recently published proposals to address tax treaty abuse are over-complicated and restricted to technically complex measures which place the burden on the state to prove wrong-doing and risk tying up countries – particularly less-well-resourced countries – in endless legal disputes with multinationals.
The draft ignores simpler, more straightforward measures that less well-resourced countries could use to prevent treaty abuse, particularly treaty measures simply permitting the application of higher withholding taxes. The draft also fails to consider the potential for rebalancing taxing rights between treaty partners, a reform crucial for African countries .Renegotiating double taxation treaties.
However, governments do not have to wait for international processes to deliver; they can take action on problematic tax treaties themselves. Increasingly governments unhappy with the unfavourable arrangements are reconsidering their tax treaties with Mauritius. India has been trying, unsuccessfully, to renegotiate the capital gains clause in its treaty with Mauritius for years.
South Africa was recently successful in renegotiating its treaty with Mauritius, introducing 10 percent withholding tax on interest flows and allowing South Africa to collect capital gains tax on shares sold by a Mauritius-based company, neither of which was possible under the previous treaty.
Rwanda is also renegotiating its treaty with Mauritius, introducing 10 percent withholding tax on dividends, royalty and interest, and 12 percent for management fees, and allowing Rwanda to collect capital gains on shares sold by a Mauritius-based company. Rwanda's finance minister Claver Gatete said "We found that in terms of taxation, it was benefitting Mauritius more than ourselves".
The new treaty has been signed, but not yet ratified.
ActionAid researchers called upon African Heads of State to review their existing double taxation treaties and pay special attention to those with OECD countries and tax havens, and examine the scope for renegotiation or cancellation should the terms of the treaties facilitate illicit financial flows or give up too many taxation rights. They emphasised that African countries should be very cautious about signing any new double taxation agreements.
Transparency and public scrutiny is key and harmful and illicit tax incentives tax havens like Mauritius are not the only shelters for illicit financial flows.
Tax incentives provided by any domestic tax regime can also trigger the illicit movement of money from one country to another. Tax incentives are special tax deals given to a company to encourage it to invest. The most common and best-known is probably ‘tax holidays’ which exempt companies from tax (especially income tax)for a set period of time, often five or ten years.
At the moment, Nigeria does not apply capital gains tax to sales of shares, but this provision prevents the Nigerian parliament from doing so in the future if they change their mind. In recent years, there has been a proliferation of tax incentives across Africa purportedly to attract investment, including many harmful or illicit incentives. But there is a lot of evidence that tax incentives are not required to attract foreign investment in most African countries.
ActionAid estimates that US$138 billion is given away by governments in developing countries every year, just in corporate income tax exemptions. This is enough to put every primary school aged child in school, meet all the health-related Millennium Development Goals and leave enough money for the agriculture investment needed to end hunger.
In 2011, ActionAid published Rwandan government data showing that losses from tax incentives constituted a quarter of its potential tax revenue – over US$234 million. The Malawi Economic Justice Network estimates that from 2008-12 over US$300 million was lost through tax exemptions in Malawi, almost the same amount as the corporate income tax raised during that period.
“We consider discretionary incentives, tax holidays, free zones and stability agreements to be particularly harmful and should be avoided .Incentives are rarely subject to parliamentary or public scrutiny and often are granted by those without proper authority to do so,” reads part of ActionAid recent statement on illicit tax and financial outflows in Africa.
“This is particularly the case when a tax incentive prevents parliament or future parliaments from revising the favourable tax regime granted to a particular company or industry. Such tax incentives are clearly illicit and provide a tax-free shelter for illicit financial flows.
Recent European Court of Justice rulings show that many of these harmful tax incentives are considered illicit in the EU. We call on African Heads of State to cost their tax incentives and open them to parliamentary and public scrutiny. They should also cooperate at a regional level in order to counter tax competition.”