ATAF Consultative Conference on New Rules of the Global Tax Agenda Johannesburg , South Africa 18 – 19 March 2014 AT

1. The African Tax Administration Forum (ATAF) ATAF Consultative Conference on New Rules of the Global Tax AgendaJohannesburg, South Africa18 – 19 March 2014ATAF INPUT Dr Nara Monkam ATAF: Director of Research

2. The African Tax Administration Forum (ATAF) CURRENT TAX ISSUES ON THE AFRICAN CONTINENT

3. Overview • Key risks and challenges facing African tax administrations from issues relating to global taxation • The granting of inappropriate and wasteful tax incentives • Ineffective natural resource taxation regimes • Profit shifting through cross border related party transactions (“controlled transactions”) • Challenges faced by African countries in effectively addressing the above risks • Putting in place the appropriate legislation and rules to effectively address these risks • Having access to the relevant information to i) identify the risk and ii) address the risk • Building the capacity within the tax administration to effectively implement the country’s legislation and rules and to effectively use the information obtained by the administration.

4. Introduction • African countries facing a wide range of challenges in the effective taxation of the different business segments of the economy • Taxation of the informal sector, small and medium enterprises (SMEs) and multinational enterprises (MNEs) are very different. • Important to develop a coherent evidence-based tax policy that balances revenue raising and robust governance with providing a climate to encourage business and economic growth.

5. Introduction • Focus of this presentation: risks and challenges to African countries in the effective taxation of MNEs. • Why MNEs? • Recent increased attention of mainstream media on corporate tax affairs • Recent scandals involving Amazon, Ikea, Google, Starbucks, Glencore, etc. • Spreading perception that MNEs dodge taxes all around the world • Wide range of issues that enable MNEs to avoid paying their fair share of tax and thus undermine efforts to tackle poverty and inequality, especially in developing countries.

6. Introduction • Why MNEs? • MNEs control an estimated 40% of global trade • MNEs contribute most to the domestic revenue • Rapid advances in technology, transportation and communication have given rise to a large number of MNEs which have the flexibility to place their enterprises and activities anywhere in the world.

7. Global Taxation: Key Risks and Challenges facing African Tax Administrations • The key risks: • African tax bases may be significantly eroded by: • 1. The granting of inappropriate and wasteful tax incentives • 2. Ineffective natural resource taxation regimes • 3. Profit shifting through cross border related party transactions (“controlled transactions”).

8. 1. Granting of Wasteful Tax Incentives • Significant evidence that many African countries grant incentives to large MNEs, primarily in the extractive industry, without undertaking a proper cost/benefit analysis, nor assessing whether the expected benefits from granting of the incentive have materialised. • Empirical evidence indicates there is significant revenue loss in developing countries through the granting of tax incentives. • Example: 6.13% of GDP in 2011 of revenue loss attributable to special tax provisions and exemptions in Ghana (Country review by the OECD Task Force Tax & Development).

9. 2. Ineffective Natural Resource Taxation Regimes • Many African countries are resource-rich • These resources are usually non-renewable resources • For decades, developing countries have suffered the consequences of an unfair and ineffective international tax system • Therefore critical that these countries obtain an appropriate share of the profits from the exploitation of their natural resources.

10. 2. Ineffective Natural Resource Taxation Regimes • Taxation of these natural resources is different to most other taxes: • It is essentially a means of splitting the profits from the exploitation of the natural resources between: • The country that owns the natural resource and, • The company (usually a MNE) that has the capacity to extract the mineral from the ground, refine it and sell it. • If the tax regime does not split the profits appropriately there may be a significant loss of revenue for the country.

11. 3. Profit Shifting Through Controlled Transactions • Risks from controlled transactions can be split into three broad categories: • Risks arising from large MNES with global operations • They are likely to be in the nature of tax avoidance, some of which might be sophisticated – e.g. involving complex but well documented, transfer pricing design. • The risk of illegal or fraudulent activity is relatively low. • Risks arising from medium or small MNEs perhaps based in the country or the region • Risks associated with more aggressive and poorly documented transfer pricing may be greater in these controlled transactions.

12. 3. Profit Shifting Through Controlled Transactions • Risks from controlled transactions can be split into three broad categories: • Risks emanating from owners/managers (including directors of private companies) of controlled companies in low tax jurisdictions. • There is evidence that business receipts due to individuals or smaller businesses may be diverted to privately owned companies in tax havens, with little or no justification or documentation. • Such practices may be closer to evasion than avoidance.

13. 3. Profit Shifting Through Controlled Transactions • Many African countries will face risks from all 3 categories: • However, greater risks may come from the 2nd and 3rd category, and they may be more significant than for many developed countries. • The approach to auditing these types of risks, and the skills and information needed, will be different from those in the first category. • This suggests that different approaches may be needed, perhaps supplemented by anti-avoidance measures.

14. Challenges Faced by African Countries in Addressing these Risks • A. Putting in place the appropriate legislation and rules to effectively address these risks • B. Having access to the relevant information to identify the risk and address the risk • C. Building the capacity within the tax administrationto: • effectively implement the country’s legislation and rules and, • effectively use the information obtained by the administration.

15. A. Legislation and Rules • 1. Tax incentives • Often granted by govtdepartments other than the tax administration or Ministry of Finance… • who are often not even aware that the incentives have been granted • Important to put in place appropriate transparency and governance procedures for the granting of tax incentives… • to ensure that all interested parties, including its citizens, are fully aware of the incentives being granted and why they are being granted.

16. A. Legislation and Rules • 1. Tax incentives • The inconsistencies in the granting of such incentives creates an uncertain and unclear investment climatein the country • It may cause legal difficulties particularly if the agreement contains a stabilisation clausethat guarantees no change in the tax that would be payable by the company under the Development Agreement.

17. A. Legislation and Rules • 2. Taxation of natural resources • Critical that African countries introduce rules for the taxation of natural resources that the tax administrations have the capacity to implement effectively. • There are a wide variety of natural resource taxation regimes in resource rich countries and these oftenchange on a frequent basis. • It is important that African countries share both experiences and best practices on the continent but also with other resource-rich countries on setting long term effective policies for the taxation of natural resources (collaborative approach).

18. A. Legislation and Rules • 3. International tax rules • Existing international tax rules have not kept pace with the changing business environment • They have weaknesses that create opportunities for MNEs to avoid taxes by: • Shifting their taxable profits out of the jurisdictions where those profits are created, into low or no tax regimes; • Making taxable profits disappear altogether; • This issue is being addressed through the OECD/G20 BEPS project.

19. A. Legislation and Rules • 3. International tax rules • It is essential that African countries facing issues related to BEPS take into account the specificities of their national, legal, and administrative frameworks. • In this respect, the OECD’s Task Force on Tax and Development has: • Recognised the need for international action and, • Acknowledged that developing countries must have a voice in the development of the work to address BEPS.

20. B. Access to Relevant Information • 1. Tax incentives • Sharing best practices and improved inter-government agency cooperation will assist African countries to ensure: • Tax incentives granted in the country are appropriate, • A consistent approach is taken to the granting of such incentives.

21. B. Access to Relevant Information • 2. Taxation of natural resources • Obtaining access to all relevant information on when and where natural minerals are being exported from a country is critical to enabling the tax administration to ensure compliance with its natural resource taxation regime. • It also needs accurate information on the quantity and quality of the exports. • Example: current project between Zambia and the Norway to introduce a state of the art IT system to record data regarding copper exports. • Data available on a real time basis to all govt. agencies enabling more effective monitoring of exports in terms of quantity and quality.

22. B. Access to Relevant Information • 3. International tax rules • Controlled transactions involve parties that are resident for tax purposes in different tax jurisdictions. • African tax administrations often experience significant difficulties in obtaining access to information relating to the non-resident party to the transaction. • This creates significant challenges in addressing issues such as transfer pricing where it is necessary to take into account the function performed by each of the parties to the transaction. • It is therefore critical that African countries resolve the issue of access to information regarding the non-resident party to the transaction.

23. B. Access to Relevant Information • 3. International tax rules • African taxpayers and tax administrations express concern regarding: • The availability and quality of financial data on transactions between unrelated parties that can be used for comparisons. • The availability and quality of information regarding the financial results of operations of comparable independent enterprises.

24. B. Access to Relevant Information • 3. International tax rules • Applying the arm’s length principle to review transfer prices set in transactions between associated enterprises often requires: • Acomparison to be made between these prices and the prices set in similar transactions between independent enterprises in similar circumstances. • Most African countries have transfer pricing rules that are based on the arm’s length principle and the lack of this data creates significant challenges for both taxpayer and tax administrations in African countries.

25. C. Capacity within African Tax Administrations • 1. Tax incentives • African tax administrations often not aware of which tax incentives have been granted and do not have the legal power to monitor adherence to the terms of the tax incentive agreement: • Due to a lack of transparency and appropriate governance procedures in the granting of tax incentives. • Where they do have that legal power they often lack the appropriate skills to audit adherence with the terms of the agreement.

26. C. Capacity within African Tax Administrations • 2. The taxation of natural resources • In most resource rich countries, specific taxation rules impose a royalty tax as a % of the value/price of the minerals at the specified point of transfer. • Some African tax administrations have reported difficulties in establishing eitherthe point of the transfer or the value/price that should be attributed to the mineral at the point of transfer. • In some cases they experience difficulties in ascertaining the quantity and quality of the minerals at the point of transfer.

27. C. Capacity within African Tax Administrations • 3. The taxation of controlled transactions • Auditing transfer pricing issues is complex and time-consuming, requiring the deployment of skilled auditors. • Many African countries lack the requisite skills and experience required to analyse these complex issues. • They lack the requisite skills and experience to face challenging issues relating to BEPS such as transfer pricing particularly when employed by well-advised MNEs.

28. C. Capacity within African Tax Administrations • 3. The taxation of controlled transactions • The approach to transfer pricing audits taken in many developed countries may not be transferable to some African countries. • The nature of transfer pricing is such that it is very rare to find definitive answers in transfer pricing audits and disputes. • This means that resolution of audit disputes often requires negotiation and compromise. • In some developing countries the legislation does not permit tax officials to enter into negotiations with taxpayers. • Even if allowed under the legislation at least some African countries are ill-equipped to carry out, and lack experience of, such negotiations.

29. Approaches Adopted by Some Developing Countries to Address the BEPS Issues • Withholding tax • Some developing countries have expressed concerns that… • Although many of the payments made by taxpayers in controlled transactions are subject to withholding taxes under the country’s domestic legislation… • The payments are being made to members of the MNE in a jurisdiction with which the payer country has a Tax Treaty that reduces the withholding tax to a lower or zero rate. • Countries are concerned that Treaties are being used inappropriately as the recipient of the payments are merely acting as a conduit and the payments are passed on by the recipient company to another member of the MNE who was the actual beneficiary of the payment.

30. Approaches Adopted by Some Developing Countries to Address the BEPS Issues • Withholding tax • Even where there is no abuse of the Treaty, some developing countries have expressed concerns about the loss of tax revenue due to the Treaty reducing the level of withholding tax in the payer country. • Developing countries tend to be net capital importers… • Therefore the reduction in withholding taxes on payments such as interest royalties and dividends reduces their tax revenues.

31. Approaches Adopted by Some Developing Countries to Address the BEPS Issues • Alternative approach: Apply withholding tax at approximately 20% to 25% on: • interest and items equivalent to interest (e.g. guarantee fees, repo charges, etc.), • royalties and other payments for use of intangible property, • payments to related parties for services (regardless of where service is performed) (Durst, 2013).

32. Approaches Adopted by Some Developing Countries to Address the BEPS Issues • Because bilateral income tax treaties often contain agreement to reduce or even eliminate withholding taxes: • It will not be problematic provided the treaty partner is not a tax haven and measures exist to prevent re-transfers of amounts received to tax havens. • Developing countries should enact statutes allowing treaty benefits only if taxpayer certifies that payments received will not be re-transferred. • Governments should avoid agreeing to waive withholding taxes in connection with mining concessions and similar government-taxpayer agreements (Durst, 2013).

33. Approaches Adopted by Some Developing Countries to Address the BEPS Issues • Benefits of Withholding tax: • Withholding taxes remove taxpayer incentive to strip income through deductible payments to tax-haven affiliates. • Of all potential remedies for base erosion from developing countries, withholding taxes easiest to administer. • Withholding taxes have long history; generally considered legitimate, albeit subject to criticism for departing from net-income model (Durst, 2013).

34. Approaches Adopted by Some Developing Countries to Address the BEPS Issues • The use of anti-avoidance or simplification measures: • A number of developing countries have developed simplification measures to improve the effectiveness and efficiency of their transfer pricing regimes. • They serve to prevent base erosion in high-risk transactions, especially in cases where there are challenges in applying transfer pricing rules due to capacity or information issues. • They improve the efficiency of the tax administration. • In both types of cases, these measures take a more mechanistic approach to the application of the arm’s length principle in comparison to the more traditional approach. • An example of this is the so-call “sixth method”.

35. Approaches Adopted by Some Developing Countries to Address the BEPS Issues • The “sixth method” • Increasingly prevalent particularly in developing countries in Latin America and Africa. • It provides for the mandatory use of publicly quoted commodity prices for certain transactions involving commodity products. • It is an attempt by resource rich countries to prevent base erosion through reduced sales prices for mineral and commodity products in controlled transactions. • This has the effect of preventing the shifting of commodity product related income to low-substance trading companies (usually located in low or no tax jurisdictions). • Depending on the country, a variety of exceptions and let-out clauses exist which are intended to have the effect of limiting the method to cases that are deemed potentially abusive.

36. Conclusions • The challenges facing Africa on erosion of its tax base are considerable, especially through: • The granting of wasteful tax incentives, • Ineffective taxation of natural resources and, • Profit shifting through controlled transactions. • It is primordial that developing countries and Africa in particular come together to create an African voice and influence new international tax rules.

37. Working Groups Questions • Developing an African response to the global tax agenda and the BEPS project: • COMMON QUESTION: • What should be the mechanisms / channels used to convey the African response and influence the development of new international tax rules? What contribution could be made by: • the international organisations (OECD; UN; IMF; WB; etc); • national authorities; • ATAF; • to support the implementation of effective measures to tackle the problems experienced by African / developing countries in dealing with the challenges posed by BEPS and the GTA?

38. Working Groups Questions • QUESTION GROUP 1: • What are the areas of greatest concern around the global tax agenda, including BEPS, and the potential risks they pose facing your country / tax administration? • LOCATION: PLENARY (ILANGA ROOM) • Chair:GHANA Rapporteur: BOTSWANA

39. Working Groups Questions • QUESTION GROUP 2: • What, in your opinion, should be the African approach / response to those issues concerning you on the global tax agenda? • LOCATION: 7TH FLOOR TRAINING ROOM • Chair: SOUTH AFRICA Rapporteur: SWAZILAND

40. Working Groups Questions • QUESTION GROUP 3: • Discuss the nexus between tax policy and tax administration in the context of: • Encouraging Foreign Direct Investment; • Maximising domestic revenues; and • Influencing the global tax agenda to benefit African / developing countries. • LOCATION: KHANYA 1 • Chair: NIGER Rapporteur: MAURITIUS

41. CONTACT DETAILS OF THE ATAF SECRETARIAT Dr Nara Monkam Director: Research