Taxing to Develop: International Taxation Challenges for Africa

18 April 2019 | Minutes

Developing countries need to work together on international tax cooperation - Oxfam


Vitor Gaspar, Director, Fiscal Affairs Department, IMF
Ceyla Pazarbasioglu, Vice President for Equitable Growth, Finance and Institutions, World Bank Group
Michael Keen, Deputy Director, Fiscal Affairs Department, IMF
Mary Baine, Director Tax Programmes, African Tax Administration Forum
Jan Loeprick, senior economist, World Bank Group
Susana Ruiz Rodriguez, Global lead on Tax Justice, Oxfam International
Alexandra Readhead, Technical Advisor to the Intergovernmental Forum on Mining (IGF)

Opening Remarks:

Vitor Gaspar: First, taxation is fundamental for development. Tax is the means that enables the state to deliver on inclusive and sustainable growth. Second, the IMF has been working on issues of international tax cooperation for a long time. International spillovers are particularly important for low-income countries (LICS) and hence, international tax cooperation is important for development. Third, we are at a point that is extremely important for international tax cooperation. We have the opportunity to shape the way forward for international corporate tax cooperation that hopefully will prove robust to technological change and globalisation. This process is important to the world, but particularly for LICs. Finally, there is some urgency in making progress in state tax capacity and coordination. It is incumbent on us to work together, in particular the IMF and World Bank.

Black-listing is viewed as bullying on the part of the EUMary Baine, ATAF

Ceyla Pazarbasioglu: Domestic revenue mobilisation, financing the Sustainable Development Goals (SDGs), and how to think about new challenges such as digital taxation are on top of these Spring Meetings agenda. What is the critical question for us, and what we heard echoed at the G20, is how to join up efforts. Countries are bombarded by International Finance Institutions (IFIs) and bilateral donors, providers of technical assistance (TA), but it is important that, given the lack of capacity they face, we work together and make sure we have a joined up approach. We have been providing IDA countries with assistance on domestic revenue mobilisation. These efforts are in the billions of dollars in terms of support. Linked to this discussion on tax is debt and debt transparency, and how do we look at both sides of the fiscal coin? While digital tax also came up in every single meeting, at the G20 meetings there is not a consensus on it yet and it will take some time to reach a consensus.

Corporate Taxation in the Global Economy, with a Focus on the Issues for Developing Countries

Mick Keen: The international corporate tax system is under unprecedented stress. The G20/OECD project on Base Erosion and Profit Shifting (BEPS) has made significant progress in international tax cooperation, addressing some major weak points in the century-old architecture. But vulnerabilities remain. Limitations of the arm’s-length principle—under which transactions between related parties are to be priced as if they were between independent entities—and reliance on notions of physical presence of the taxpayer to establish a legal basis to impose income tax have allowed apparently profitable firms to pay little tax. Tax competition remains largely unaddressed. And concerns with the allocation of taxing rights across countries continue. Recent unilateral measures, moreover, jeopardise such cooperation as has been achieved.

The IMF has published a paper that reviews alternative directions for progress. The call for taxation “where value is created” has proved an inadequate basis for real progress. There now seems quite widespread agreement that fundamental change to current norms is needed—but no agreement, as yet, on its best form.

Key concerns are to better address both profit shifting and tax competition—and ensure full recognition of the interests of emerging and developing countries. Low income countries (LICs) are especially exposed to profit shifting and tax competition (and have limited alternatives for raising revenue) and their limited capacity is now stretched further by increased complexity. For them, securing the tax base on inward investment is key.

Alternative international tax architectures differ not only in their economic properties, but in how far they depart from current norms and the degree of cooperation they require. No scheme is without difficulty, but there are clear opportunities for improvement:

  • Minimum taxes on outbound investment can offer significant though incomplete protection against profit shifting and tax competition and generate positive spillovers for other jurisdictions (other than those with low tax regimes). Minimum taxes on inbound investment can be especially appealing for LICs. These schemes have the merit of being readily designed to complement current norms. But there is a tradeoff between ease of administration and risk of such bluntness as to potentially jeopardise investment. Further, distortions remain (through for instance the relocation of parent companies) and underlying weaknesses of the system are patched rather than fixed. While minimum taxation has advantages over current arrangements, it is not clear that it alone would prove a robust long-term solution.
  • Further from current practice, but addressing current weaknesses more fully, schemes of residual profit allocation (RPA)—broadly, allocating a normal return to source countries, and sharing the residual on a formulaic basis. Such schemes can substantially reduce profit shifting, as would other unitary approaches, while retaining the familiarity of the arm’s length principle for straightforward cases. But much depends on the way in which residual profits are allocated: tax competition is more limited the greater the weight placed on allocation by the destination of sales (or similar criterion), given the relative immobility of final consumers. The residual profit allocation approach sets the scene for constructive discussion of the allocation of taxing rights in relation to some part of international corporate profits, though securing agreement on such apportionment will be difficult.
  • Some allocation of taxing rights to destination countries features in many proposals, including some residual profit allocation schemes: this is the most effective way to address tax competition and profit shifting. Among such schemes— and most remote from the current debate among policy makers—border adjusted taxes—combining value-added tax (VAT)-like treatment of trade with a wage subsidy—face potential World Trade Organisation issues (because border adjustability resulting in imports and exports being taxed differentially is not currently permitted for (direct) corporate taxes) and may amplify refund problems that arise under the VAT; and unilateral adoption could have significant adverse spillover effects. They remain, nonetheless, the most complete solution to tax competition and profit shifting. To the extent that erosion of the corporate tax leads to increased reliance on the VAT moderated by a desire to keep labor taxes low, the default outcome in the absence of more deliberate reform may be implicit but imperfect taxation of this kind. The economic impact and administrability of these schemes requires further analysis—especially for emerging and developing countries. Even for advanced economies, little is known, for instance, about the nature and extent of residual profits. Data and research gaps for low income countries remain substantial. Some improvements can be achieved unilaterally or regionally, but more fundamental solutions require stronger institutions for global cooperation. Addressing the distinct concerns of developing countries is critical, as is making full use of the differing comparative advantages and mandates of relevant international organisations.

Mary Baine: Key international corporate tax challenges in the African landscape.

  1. Developing technical and other administrative capabilities to address base erosion.
    1. The importance of corporate tax in Africa; Corporate Income Tax (CIT) revenues make up 15 per cent of total revenues in Africa. Does this mean CIT is not a priority area? No. The question to ask is rather whether the contribution is too low due to BEPS and or tax incentives or other factors.
  2. Developing effective legal regimes in Africa to address base erosion.
    1. Challenges of BEPS in Africa:
      1. Weak domestic legislation
      2. Tax treaties that do not have the appropriate tax allocation rights between source and residence taxation and are susceptible to abuse.
      3. Limited exchange of information networks which starves African tax administrations of the vital information they need to address base erosion and stem illicit financial flows.
      4. Limited capacity within tax administrations.
      5. Excessive tax incentives. Example, we found very high investment deductions in some countries, with some offering 100 per cent exemption for bringing in certain technologies or expertise.
    2. Taxing the digital economy in Africa:
      1. The digitalisation of the economy presents tax challenges and opportunities for Africa.
      2. The tax challenges may lead to fundamental changes to the international tax rules, including changing the allocation of taxing rights between residence and source jurisdictions.
  3. ATAF is part of the global debate on international cooperation on corporate tax.
    1. ATAF is part of the debate in many fora, including the OECD.
    2. ATAF supports its African members on this issue
    3. ATAF develops technical notes on this issue
    4. ATAF participates in global standard setting to give the African perspective and make proposals
    5. ATAF is working with key African bodies
  4. ATAF advice on tax incentives
    1. ATAF advises on base erosion
    2. Results from the studies suggest that tax incentives are not the main driver for Foreign Direct Investment (FDI) in Africa
    3. ATAF has created this awareness through a Technical Note to members.
  5. The EU blacklisting story and the ATAF response.
    1. ATAF is concerned about the EU listing of African countries on its list on non-cooperative tax jurisdictions. It is the unfairness of the process we really object to, and it often causes severe distress to countries placed on them.
      1. The list does not provide a fair picture as countries such as Namibia do no provide fertile grounds for tax avoidance.
      2. The listing is viewed as bullying on the part of the EU, as joining these international bodies and instruments is voluntary for developing countries.
    2. ATAF is providing technical assistance to members on the list helping them to:
      1. Understand the commitments made to the EU
      2. Meet the commitments in a manner that meets the country’s own priorities whilst ensuring they are completely removed from the list of countries.

Susana Ruiz Rodriguez: Reforming the international tax corporation architecture

The new tax paradigm:  Corporates are paying less while burdens are shifting to families through Personal Income Tax (PIT), payroll taxes, and taxes on goods and services. We are glad to hear here at Spring Meetings and from other speakers that tax is seen as being crucial to the achievement of the SDGS. However, it is just as important to ask, ‘who is contributing?’, as to ask whether we are collecting more revenues. We are seeing the contributions of large corporates to tax revenues decrease by 14 or 15 per cent, while the burdens to families increases by 30 per cent. To us, we need to take into account how we increase tax revenues and who contributes.

A phantom economy: Eight major pass-through economies host more than 85 per cent of global investment in special purpose entities, often set-up only for tax reasons. These are growing fast. More and more growth that is being created is going to those jurisdictions, taking money away in particular from developing countries. As we were talking about blacklists earlier, none of these pass-through economies are part of European blacklists. We need to ask ourselves what we are doing if countries like Namibia are being identified on tax blacklists, while we are not able to address these very low tax jurisdictions. These countries represent a huge risk to many developing countries.

New business model, same old problems: The time has come for real solutions. Many of the same old problems remain after BEPS. BEPS has not been successful in looking at the problems of the present and future. It was just set up to address the problems of the past. For example, tax challenges of digitalisation are not limited to specific business sectors, but existing problems are exacerbated by digitalisation. The implementation of BEPS has left room for profit shifting and increased tax competition for real investment. We have a unique and important opportunity now to look to the future. The current system and BEPS was designed to address the past. The more we have been looking at how to address this, the more we see that countries are choosing to attract FDI through tax competition. What we are seeing is that we have been trying to solve only part of the problem, but that this approach actually is exacerbating a new problem. Trying to look only at the individual pieces will not be helpful.

Developing countries need to work together on international tax cooperation – Oxfam

It is therefore now a unique time for a historic reform, that has to include two components. Implementing one without the other will not be sufficient. Shifting taxing rights has to go together with minimum tax (TBEP IIR). It will not make sense when we have a historic opportunity to only tackle part of the problem. The whole solution means that even if we shift taxing rights, it will mean nothing if we still tax at very low levels. Employment will be a crucial element in terms of taxing rights. Developing countries need to act together and be united to work together. It is complicated because developing countries are diverse and can have different interests, but it is acting together that will bring the solution, perhaps best exemplified by this illustration (to the right). We cannot afford to again go through solutions that only address part of the problem.

Alexandra Readhead: Unresolved issues, corporation taxation in the natural resource sector.

Extractives are different when it comes to international corporate taxation. The most obvious issue is that we are dealing with a finite source that is location-specific. Citizens are thus right to be concerned about whether they are receiving their fair share of these resources, because when they are gone they will not be able to benefit from them anymore.

There is a risk that because they are different, they are left out of tax reforms. Yet, it is precisely what makes this sector different that demands more, not less, attention on profit shifting. We cannot offer proper solution to LICs without looking at the resource sector. LICs really rely on resource taxes, averaging 17.5 per cent of total government revenues in those countries.

Yet, still, profit-shifting persists. While it is difficult to have a global estimate, it is reasonable to assume that the extractive sector accounts for a large chunk of profit shifting. Current rules are too complex. For example, in the case of one transfer pricing dispute in Australia, the dispute fees equalled 45 per cent of Sierra Leone’s entire budget for its tax administration. There is tax competition, despite dealing with a location-specific resource. We have looked at the number of mining tax incentives over time in 21 countries. Looking at these incentives over the last 10 years we see there are 12 newly signed contracts, and 2 newly enacted laws, that include corporate tax holidays.

Corporate tax reform proposals applied to mineral sector – IGF

So, can reforms apply to this industry? To provide an overview we have designed this traffic-light assessment (above) of alternatives. For instance, the destination-based approach is unlikely to work for the extractives sector. While source-based tax might compensate some of those losses, it is still unlikely it will be very successful. What might be more feasible for the extractive industries is formula apportionment. There would be a lot of issues to resolve but it could work. But perhaps the best solution for this sector would be the ‘minimum tax on inbound’ combined with a greater use of benchmarks prices – option.

What type of source-based tax would be most appropriate for the extractives sector? – IGF

If these more ambitious reforms do not take place and source-based tax continues, then what type would be most appropriate for this sector? Again, we have designed this colour-coded guide on different options (above), with ‘fixed fee’ and ‘paid equity’ options making most sense.

In summary, resource taxation has to be part of the conversation. Source-based taxes that are robust to BEPS should be prioritised, and some reform proposals could apply, with modifications.

Jan Loeprick: To get back to the initial presentation and what we have heard, on where we are and future proposals. It is clear that when we think of LICS and priorities, you certainly need to look at matching tools to capacity. And we need to think about the political economy of reform implementation and decision-making.

If you look at Africa, there are major implementation gaps, even with the current rules. Clearly there is an important question on why that is. The IMF toolkit on transfer pricing offered some solutions to implementation, but, as mentioned, was very long and perhaps difficult to use in practice. In theory we have made the case, in practice we have failed to implement. We have done some work in TA to address this, but we have not seen this all the way through and many of these proposals have not seen the light of day. Policy makers are afraid to be the first mover.

We should hope for an inclusive framework discussion that includes the interests of the wider constituencies. Like how to make country-by-country reporting easier for African countries to do and use. It is key to understand that profit shifting has continued due to gaps in the rules and a mismatch between rules and the current environment. You end up with a lot of room for discretion and judgement by design.

While the administrative side is quite critical to get right, there are many small solutions for those. To tax competition, I agree that self-inflicted base erosion is a big concern. On the treaty body argument, what comes out of TA on this is that we should think of tax treaties like other areas where TA is needed, especially outlier treaties, as they tend to come with a very high cost.

Two concerns around BEPS: One, implementation is not trivial, and two, it can divert attention from looking at treaty policy more generally. Minimum taxes can be a very useful tool, but perhaps also think about more targeted rules. I still think there is merit in thinking more simply about the formulaic method for developing countries.

Which brings me to future directions. I agree that we need to think about balance between unilateral measures and reaching a consensus, and we are facing a very ambitious timeline to reach consensus. In that context it would be hard to justify holding back unilateral measures. In the short term, we need to very quickly move to provide parameters of the overall design.


(only in part)

Q – Tove Ryding (Eurodad): Thank you for the new IMF report. It says that while all countries are invited to participate in BEPS implementation on equal footing, it acknowledges that LICS were not on equal footing when BEPS was adopted. To get a seat at the table, developing countries had to accept the decisions already made. Meanwhile, we continue to hear the constant call of the G77 for a UN negotiation of tax standards that is open for everyone on an equal footing. Where does the IMF stand on such a UN-led process?

A – Mick Keen: Please take another question, I need time to think about that one.

Q – Chris Morgan (KPMG): One thing that has not been touched on is trust. There is a lack of trust on both sides, between companies and tax authorities. We had companies saying that tax authorities have all the power and can unilaterally make the rules, while tax authorities often have no way of knowing what companies are telling them is accurate. Between companies and tax authorities, how do we overcome a lack of trust, because at the end of the day they are all in the same boat.

Q: A lot of large companies pay 1 to 2 per cent of their revenues of tax, although the nominal tax rate is about 30 per cent. Do you think we should consider a tax on gross profits?

A – Mick Keen: On the UN question, we all know it is a charged issue. We are keen on multilateralism and it can be achieved in a manner of ways, at the regional or global level. We are not particularly invested in one mechanism or the other. One of thee reasons we did the Platform for Collaboration on Tax is to bring in more groups, bring in the standard setting and analytics of the IMF and the Bank. We are admirative of all efforts to promote multilateralism, and as the IMF are keen to support that.

A – Mary Baine: On the trust question, the issue of trust has been put on the table. In our opinion, both examples that you gave are quite valid. They emanate from a lack of tax certainty, meaning that weak tax laws lead to profit shifting.