Corporate Tax Avoidance

EU takes on Corporate Tax Avoidance – Africa’s largest Financial drain

By Uzo Madu

Photo:Phillip Ingham under Creative Commons Licence 2.0

21 June 2016 – T
ax avoidance (legal) and tax evasion (illegal) costs the African continent anywhere from $30 to $60 billion a year with approximately 65% coming from legal practices, such as tax avoidance, according to the UN High-Level Panel on Illicit Financial Flows from Africa Report.

To give these figures some context, it is estimated that $20 billion a year in extra income is needed for Africa to ‘catch up’ with more economically developed regions. On top of this, approximately 28.9bn USD in aid was given to Sub-Saharan Africa in 2014, according to the OECD.

Corporate tax avoidance has been given the title of being Africa’s biggest financial drain and Europe’s role – flows of investment into developing countries via low-tax regimes, which have doubled in the past decade. With the bulk of these flows accounted for by just two EU countries, the Netherlands, and Luxembourg. Furthermore, the European multinationals account for a sizeable chunk of corporate activity, with the top 20 European multinationals having a combined market value of over $2.2 trillion.

What is the EU doing?

The EU is carrying out its own policy assault on corporate tax avoidance, the legal practice of minimising a tax bill. For example, by taking advantage of a loophole or exception to tax regulations, or interpreting tax rules in a way that lowers the tax liability, in stark contrast to the intention of the rules put in place. The most common forms of tax avoidance are shell corporations, tax havens (e.g. Luxembourg and the Netherlands in the EU or the Seychelles in Africa) and complicated tax-avoidance schemes to reduce their tax bill. A common thread is secrecy, which covers up many of these practices or makes it difficult to really assess with any specificity where profits are being made and what rate of tax if any is being paid. The whole world was given a glimpse of this reality when the biggest data leak in history – a weighty 11.5 million financial and legal records was disclosed from the Panama-based law firm, Mossack Fonseca, and exposed the secretive world of offshore companies, facilitating tax evasion and avoidance schemes around the world.

Tackling this secrecy is the purpose of one of the central EU proposals on tax avoidance, included in the wealth of proposals released in late January this year, is a revision of a previous directive on administrative cooperation, the proposal’s central premise is to adopt country-by-country reporting between Member States’ tax authorities on key tax-related information on multinational corporations operating within the EU. However, the absence of public disclosure falls short of what tax campaigners have said would be needed to shed light on the sophisticated tax-avoidance strategies. On the other hand, Wolfgang Schäuble, Germany’s finance minister, warned that the sharing of country-by-country data between national tax authorities should not lead to information being made public.

The rules proposed would require multinationals operating in the EU with global revenues of more than EUR 750 million a year to publish key information on where they make their profits and where they pay their tax in the EU and these companies would have to only publish an aggregate figure for total taxes paid outside the EU. Therefore, country-by-country reporting does not extend to those countries outside the EU, an issue that ex-South African President, Thabo Mbeki raised when he was in Brussels in April 2016, stating that “aggregated accounts have been used to hide the profits and not pay the taxes in the countries in which these companies are operating in the way that they should” and therefore he calls for the country-by-country approach to be global.

Another concern is the small scope of businesses subjected to the rules, the reporting system’s high threshold would exclude some 85-90°% of multinationals, according to research carried out by the OECD. The figure of €750 million is borrowed from the OECD’s Base Erosion and Profit Shifting (BEPS) project. The scope of companies covered plays a role in the effectiveness of these rules in the EU-Africa context, largely because in terms of greenfield investment – where a parent company builds its operations in a foreign country from the ground up, it is in fact western companies that are most active in Africa.

Western Europe accounted for more than half of all greenfield investment into Africa in 2014, with an estimated $47.6bn invested and the top 5 investing countries in Africa by capital expenditure, included three European countries (France, Greece, and Belgium) according to a Financial Times report.

Does a global problem not require a global solution?

In short, yes and the international forum in which these solutions have been discussed is the OECD. The OECD BEPS project has been the basis for the EU rules on country-by-country reporting and many other aspects of the EU’s proposals on tax-avoidance. The BEPS project includes minimum standards on country-by-country reporting and the template will require “multinational enterprises (MNEs) to provide annually and for each jurisdiction in which they do business, aggregate information relating to the global allocation of the MNE’s income and taxes paid together with certain indicators of the location of economic activity within the MNE group, as well as information about which entities do business in a particular jurisdiction and the business activities each entity engages in” according to OECD rules.

The threshold, as stated above is also set at 750 million EUR and the issue here is that whilst consultation was open to non-OECD countries during the decision-making process of these rules, non-OECD countries did not have a central role in the decision-making, which is a concern when we consider the gravity of deeper implications these rules have for African countries, for example, considering that the majority of the countries on the continent are developing and that the reliance on corporate tax revenue is significantly higher than other forms of tax revenue.Whilst non-OECD countries have now been brought into the fold, in terms of the implementation of these rules non-OECD countries have been invited to participate in the BEPS inclusive framework. This framework will open up the decision-making body of the OECD’s tax work to interested countries and jurisdictions in order to implement the BEPS project.

However, not being at the decision-making table when the very rules are being devised is a great disadvantage, since “if you’re not at the table, you’re on the menu.”The OECD situation is symptomatic of the marginalised role African interests tend to play in international forums where global governance rules are constructed (e.g the IMF and the World Bank) and therefore, the result is that African countries and in turn businesses end up being rule takers instead of rule makers.  Therefore, how can the continent ever intend to be prosperous from the global system when it is not drawing up the rules but instead implementing what has been prescribed by others.

Despite not being part of the global solutions, there are still many issues on the ground.

Despite EU and OECD activity, there is a clear issue with how the tax system is working on the ground, in many African countries. Not least because EU measures are only ever going to ensure that the tax usually avoided is collected within the EU’s internal market and because of the various issues which lie at the heart of effectively tackling tax avoidance so that avoided tax can be identified, but most importantly, it can be collected and invested into government spending on important public services, such as education, health, and infrastructure. But also that there is enforcement of rules on tax avoidance, enforcement that also results in these funds being repatriated back to the place it belongs.

The reasons for the losses on the ground are complex and numerous, there are structural issues in many African countries which are cross-cutting, for example, the difficulty of taxing the widespread informal economy, which contributes about 55% of Sub-Saharan Africa’s GDP and 80% of the labour force but also the limited capacity of fiscal administrations, the UN high-level panel on illicit financial flows found that only 3 African countries had internal revenue units that were equipped to deal with the most common form of tax-avoidance (transfer pricing). Secondly, the difficulty of taxing extractive industries, African continent hosts 20 of the most resource-rich countries in the world but yet it consistently struggles to achieve even a basic standard of living for its populations. Thirdly, the tax mix is imbalanced with an excessive reliance on a few types of tax to generate revenues, this means that some stakeholders are disproportionally represented in the tax base.Countries heavily reliant on a narrow set of taxes are putting their economies at risk because if a shock hits that source of tax, the country could see its public revenues collapse. For example, those countries heavily reliant on taxes on resources means revenues of these countries are closely linked to commodity prices and the price of crude oil in particular. In the current financial climate, this has been shown to be quite problematic for oil-rich nations, in particular, according to the AfDB. Therefore, a balanced tax base is considered to be more stable because it relies on a diversified set of taxes, with a mild burden on each type of taxpayer and each type of economic activity. A wide base also means a diversified range of stakeholders is active in the national political process, according to the UN. These African-owned shortcomings were also very much the focus of recommendations put forward by the UN High-Level Panel on Illicit Financial Flows, last year.

Where the EU stops and African governments must start. 

Whilst the EU is making attempts to overcome some of the catalysts of tax-avoidance, the efforts will only result in directly enriching EU countries, since the EU only has jurisdiction over collecting taxes within its own borders.

The real gains can only be made if fiscal administrations are strengthened on the continent and tax is collected and channeled to public services, public services such as education where only a fraction of the billions lost ($39 billion to be exact, according to ActionAid) is needed to send the global child population to school. Investment in public services by credible and accountable governments on the continent is one of the key ways in which real and lasting economic growth can be realised for the benefit of people.