The latest in a series of roundtables was held in Cape Town on 25 March which looked at the challenges in the global tax system, specifically in relation to corporation tax and whether the current system is fit for purpose in 21st century Africa. The attendees at the roundtable included clients from a number of different sectors, tax authority and revenue services, representatives of professional bodies, and academics.
It was agreed that the international tax system did need updating to take account of modern business practices and, for Africa, building on the significant economic presence concept could be a way forward. However, creating effective tax regimes required “an African solution to African problems” given the diverse and unique challenges on the continent. The need to address difficulties with existing transfer pricing rules – especially in the extractive sector - and to ensure tax incentives were properly focused were highlighted. There was a strong theme of needing to address the lack of trust between business and tax authorities through increased transparency, capacity building and better legislation and enforcement. And there was some discussion about the need to deepen and widen the tax base generally by making more effective VAT regimes, using property taxes, collecting income tax from richer members of society and addressing the informal economy.
Increasing tax revenue goes wider than improving the corporation tax system and stopping avoidance by multinational enterprises (MNEs) - important though that is - and involves widening and deepening the tax base generally, tackling the informal economy and increasing revenue authority capacity
The group spent some time trying to define the problems from a tax perspective both globally and locally within Africa. It was commented that – going back to the post-independence period in the 1960/70s - many African countries had relied on income from natural resources. Deflation of their currencies meant that revenues fell in real terms which made them dependent on international aid and inward investment. It is only comparatively recently that the emphasis has shifted to strengthening domestic resource mobilisation.
Due to their historical development, many African countries did not have developed tax systems and lack capacity within the tax authorities.
It was acknowledged that African countries are generally reliant on ‘source’ taxation. The difficulty of applying transfer pricing rules was noted and it was thought countries were vulnerable to tax competition, particularly between themselves over the giving of tax holidays. There is a concern that many African countries give incentives to attract inward investment which are unnecessary, poorly targeted and costly. However, it was noted that in the long term incentives can be beneficial in generating employment and tax receipts but they need to be properly targeted and measured. It was also suggested that some governments were concerned about raising tax on the corporate sector for fear of driving away investment. One attendee referred to the estimates contained in the Report of the High Level Panel on Illicit Financial Flows from Africa, chaired by Thabo Mbeki, which estimated that Africa loses $50bn per year through illicit financial flows1. While others pointed out that this figure refers to much wider issues than tax avoidance (eg evasion, corruption and other criminal activity) it was agreed that there were other estimates showing significant revenue losses – for example the IMF reckons that $200bn is lost to all non-OECD countries annually2.
Nevertheless, it was agreed that the issues were much broader than the corporate tax system or avoidance by MNEs. Many SMEs do not pay tax, and there is a significant informal economy in Africa. Corruption is also a problem. Many countries rely heavily on customs duties and corporation tax while property taxes are under-utilised and income tax on the middle and upper class are often low or not properly collected.
Part of the problem stems from inadequate laws or misapplication: Investors require tax certainty
There was general agreement in the room that global investors need tax certainty. That requires laws which are transparent, relatively straight forward to implement and consistently applied. Tax authorities should be facilitating conversations with taxpayers in real time and during transactions so that the outcome of the tax treatment is known. It was noted that in reality the way laws, and tax treaties, were applied was sometimes inconsistent with the legislation and tax disputes could run for over 10 years. Many times different government departments work in silos which produces sub-optimal laws. Furthermore, MNEs would not invest if they thought were seen as “cash cows”.
There is a need for more transparency on all sides and greater investment in tax capacity leading to greater trust between tax authorities and taxpayers
There were many comments relating to lack of trust between taxpayers and tax authorities. There was a feeling that many revenue authorities mistrust MNEs and believe they hold all the information and power; while conversely many MNEs think that tax administrations hold the power and act arbitrarily. One attendee referred to a situation where a tax authority raised an assessment for $millions and as soon as it was contested offered to reduce it to $thousands.
On the other hand, some tax administrations felt that some MNEs were not transparent or forthcoming with their financial information while some had even refused to provide information and tried to pay tax based on a deemed basis.
Some business delegates were concerned that the tax authorities’ main focus is on multinationals and therefore they feel penalised. More than one delegate made the point that if you are not a listed company, in some countries tax paying almost becomes elective because of a lack of requirement for audited accounts. It was suggested that focussing more on a wider base of taxpayers, including individuals, and having more transparent systems in place - perhaps through the use of technology - could improve voluntary compliance.
One tax authority representative made a plea for the Big 4 to help companies become more transparent in tax matters.
It was also agreed that moving towards a cooperative compliance approach could be beneficial for all. But this would require more investment in tax authorities. One attendee noted that, at a previous company, they had requested the tax authority to carry out annual audits but were told it was not possible.
Out of the three proposals being discussed at the OECD concerning the tax challenges of the digitalisation of the economy, it was felt that building on the significant economic presence concept could be a way forward
There was general agreement that market jurisdictions need to be compensated more. It was pointed out that you could have the “best” technology, but it is worthless without a market. One delegate noted, for example, that 90% of mobile phones in Africa are made elsewhere and imported; but Africa plays a large part in making the market for these phones due to the number of users across the 55 countries. Furthermore, the way business is developing it is not necessary to have physical or human presence – for example there is now technology allowing driverless truck in the extractive industries or automated milking of cows.
Another delegate pointed out that the OECD proposals currently assume that we can identify clearly where value is created which is not necessarily the case. Probably there is an over emphasis on value creation. Furthermore, the discussion can focus too much on certain business models – such as those that are heavily reliant on using customer data – rather than concentrating on the bigger picture of how business is developing, how supply chains are becoming more global, and the possibility to do business remotely.
There was general agreement that focusing only on user participation was not the way forward. There was merit in the significant economic presence approach but one tax authority delegated noted it could be hard to track small companies and know once a taxable threshold had been reached. Nevertheless it was pointed out that when MNEs go into a developing country often they have a relatively dominant position. One business representative noted that as long as the rules on what creates a taxable threshold were clear, they would be able to apply them.
It was queried whether the marketing intangibles or significant presence concept required profits to be allocated on a consolidated basis. Given the global nature of supply chains there was some comments that taxing on a separate entity basis many not make much sense anymore and maybe more consideration should be given to formulary apportionment. However, it was noted that a way would need to be found for splitting loses.
Finally it was noted that it was necessary to look at a range of tax instruments to create a comprehensive, adequate, tax regime – this included for example using royalties in the mining sector, indirect taxes such as VAT or customs duty and personal income tax. There is an argument that too much attention is paid to corporate profit tax and not enough to other types.
There was some support for a minimum tax but concern that it would have to be implemented carefully so as not to negatively impact appropriate tax incentives or investment structure
It was noted that a minimum tax could help prevent a race to the bottom on corporation tax rates. But on the other hand, unless carefully implemented, it could undermine tax incentives which were legitimate and did not constitute harmful tax practices. It was thought such incentives should be permitted.
One delegate noted that at a recent Global Infrastructure Conference in Berlin it was clear that there is no shortage of capital to invest in infrastructure projects but there is a shortage of suitable projects and concerns about how tax changes could impact legitimate structures. For example, unless there were appropriate carve outs a minimum tax rule could adversely impact exempt entities like pension and sovereign wealth funds and so reduce investment from these sources.
It was also agreed that a minimum tax rule could create significant complications and one delegate suggested it may be better to introduce a blunter but simpler rule which simply restricted certain deductible payments rather than looking at the effective rate of tax borne on the corresponding receipts.
There is a need for capacity building around treaties and for some treaties to be updated. The delegates were divided on the introduction of binding mandatory arbitration
It was thought that double taxation is problem, even with intra-African trade, and especially in relation to services. Many African countries do not have many or any treaties – especially with other African countries and many with developed countries are out of date. Several of the tax authority delegates thought African countries were losing revenue to developed countries and there needed to be improved training so authorities new better how to apply and negotiate treaties.
It was noted though that a tax treaty is only needed between countries where trade actually exists and in some parts of Africa – such as between the French speaking countries – there are multilateral agreements.
While some tax authority delegates indicated binding mandatory arbitration would be problematic, the business representative would favoured its introduction. It was also noted that generally there are too many open tax cases.
The inclusive framework is working and has been a useful mechanism for giving developing countries a voice
There was recognition in the room that the UN takes responsibility for developing countries but that it is the OECD that currently has capacity to move forward with addressing issues. The two groups need meet half way. The Inclusive Framework has been successful and given developing countries a voice even if it is not perfect. One delegate suggested that the Platform for Collaboration on Tax with IMF and World Bank as well as the OECD and UN may be able to play a role in ensuring all countries felt adequately represented.
There was agreement that it was necessary to widen and deepen the tax base outside corporation tax but it would require a range of measures. There may be possibilities to better implement VAT but presumptive turnover taxes on the smallest business were not considered to be very effective
VAT could be a low hanging fruit if implemented properly as it is easier to administer than corporation tax or income tax, especially where there is a large informal economy. VAT could therefore widen the tax base quite considerably. VAT is regressive of itself but what matters is the overall mix of taxes and also expenditure – which can make the system as a whole progressive. Nevertheless, it was expressed that current VAT systems have not proved to be as beneficial as originally thought because, for example, they are only applied in major cities or selectively on certain goods and services. It was noted that South America has been more successful due to the use of technology to collect and enforce VAT.
It was noted that in designing tax systems, consideration should be given to the informal economy and the fact that many businesses do not keep documentation or produce financial statements. The Kenyan idea of introducing a turnover tax at a very low rate on the smallest businesses instead of a profits tax was raised. However, there does not seem to have been a significant adoption of the regime and it was noted that presumptive taxes can result in a lot of work for little revenue. One delegate said that presumptive taxes had not worked well in South Africa.
The table was in strong agreement that no single tax can give what is needed but instead a mix of taxes tailored to the situation of a particular country is required.
by Chris Morgan
Chris became Head of Tax Policy for KPMG UK in 2011. In this role he was a regular commentator in the press, as well as on radio and TV, led discussions on various representations with HMRC/HMT. In 2014 Chris spearheaded KPMG UK’s Responsible Tax for the Common Good initiative. In September 2016 Chris took on the role of Head of...