Transcript Document

Prof Annet W Oguttu
University of
South Africa
 Background:
 Previous heavy reliance on donor aid in Africa for economic growth & funding
government expenditure
 Limited donor budgets due global financial crisis
 Realisation to move to DRM from public & private sectors
 Public sector DRM - taxation, non-tax & other government revenue generation
 Ensures stable & predictable source of own revenue to facilitate long term fiscal planning
 Resources are allocated to priority sectors rather than donor constrained conditions
 Fosters government accountability
 Currently DRM in sub-Saharan Africa estimated to constitute 70% of
development finance with 30% filled by loans or Aid
Challenges facing DRM in Sub-Saharan Africa
 Very narrow tax bases across Africa
 Tax burden falls disproportionately on small formal sector of the economy
 Many African countries grant tax incentives to foreign investors to encourage FDI
 Distortions to resource allocation; sub-optimal investment decisions; harmful to long term growth
 Many African tax statues have various tax exemptions
 Costly in terms of forgone revenue
 Exemptions complicate tax systems - open doors to political interference & corruption
 Limited tax reporting
 low levels of tax education & general culture of non-tax compliance - low DRM
 Weak administrative capacity & inadequate resourcing of most tax administrations
 Lack of political will to insulate tax administration from political incursions - low DRM
Challenges facing DRM in Sub-Saharan
Africa cont.
 Many African countries levy high taxes; incomprehensive & complex tax legislation
 encourages tax evasion & avoidance - undermines collection
 High discretionary powers of tax officials
 leads pervasive corruption & lack of transparency; inhibit citizens’ willingness to comply with tax laws
 Main stumbling block to DRM in Africa is capital flight
 Global Financial Integrity: IFF the most damaging economic problem facing Africa
 No universally agreed definition of IFF
 money from illegal activities - tax evasion, organized crimes, customs fraud, money laundering, terrorist & bribery
 Some definitions include corporate tax avoidance schemes - base erosion and profit shifting - legal
 Tax & illicit capital flight from African: between $50billion & $80 billion per annum - revenue lost
exceeds aid
 Outflows from Sub-Saharan Africa growing – more than 20% per year
 Background
 International corporate taxation framework not kept pace with changing business environment impacts negatively on DTM in Africa
 Old business models - lower degree of economic integration across borders
 Modern business models - Global taxpayers; MNE value drivers - IP; information & communication technologies
 Result - encourages tax avoidance by MNE - to minimise global tax exposure
Exploitation of legal arbitrage opportunities & boundaries of acceptable tax planning;
Exploiting gaps in interaction of different tax systems - artificial reduction of taxable income
Shifting profits to low-tax jurisdictions where little or no economic activity is performed
Businesses integrate across borders - tax rules remain uncoordinated - technically legal structures devised to
take advantage of asymmetries in domestic & international tax rules
 What is at stake is the corporate income tax (CIT)
 CIT among OECD countries not high - average about 10% of total tax revenues
 CIT important source of revenue in Africa - average 29% - revenue from individuals & consumption taxes limited
 African countries have more at stake in an effective international tax system - their development depends on it
 Response: OECD 15 Point Action Plan - largely a developed country perspective
Some International corporate taxation principles that are
ineffective in enabling DRM
 Challenges posed to the bases of taxing income
 OECD BEPS Project: doesn’t cover taxing rights between residence & source countries
 This a fundamental BEPS issue - harmful tax competition & “race to the bottom”
 An effective tax system requires the right basis for taxing income: Two main bases:
 Territorial (source) – tax income derived from the territorial – most developing countries - easier to administer
 Worldwide (residence) – residents taxed on worldwide income – most developed countries - administrative
capacity to caste tax net worldwide
 Normally both bases applied in hybrid form - some countries lean towards territoriality, others towards worldwide
Historically countries’ tax policies generally territorial but had international dimension
Globalisation of trade – shift to worldwide systems to preserve tax bases – offshore investments
To lessen global tax exposure, taxpayers employ global tax avoidance strategies
Countries enact anti-avoidance legislation - taxpayers a step ahead - cycle
 Tax policy issue: Should countries’ resources be used to tax worldwide & prevent offshore tax
avoidance; or should resources be used to effectively tax domestic income & encourage
competiveness of domestic enterprises
 To remain competitive, reduce administrative costs, ensure simplicity - many developed countries (e.g Japan &
UK) have migrated to largely territorial systems
 27 of 34 OECD countries employ some form of territoriality system - ‘a pragmatic response to the practicalities in
a world where competition is fast moving and truly global.’
 African countries should place emphasis on strengthening source basis
International corporate taxation principles that are ineffective in
enabling DRM cont.
 The Permanent Establishment (PE) concept - crucial element of DTAs – article 5
 Fixed place of business through which enterprise's’ business is wholly or partly carried out
 Special rules for building & constructions cites
 Deemed PE - dependent agents
 Exclusions: preparatory & auxiliary activities
 Basic nexus to determine if country can tax business profits of foreign enterprise
 Foreign enterprises should create significant & substantial economic presence
 Article 7(1) - only profits attributable to PE taxed by source state
 Challenges of applying PE concept
MNE can artificially fragment operations among multiple group entities to qualify for PE exclusions
Manipulation of PE time limits
Non-residents service activities – consultants/engineers allege services of temporary nature
Challenges posed by digital economy
PE - physical presence as basis for taxation
Modern business models - MNE can transact in a without creating a taxable presence
Anonymous nature of e-commerce: tax compliance challenges; identification difficulties; verification of taxable
transactions; establishing a link between taxpayers & taxable transactions
 The PE issue concerning for developing countries
 Base erosion if foreign investors avoid PE status
 Yet its not in the interest of developed countries to expand PE concept
International corporate taxation principles that are
ineffective in enabling DRM cont.
 The arm’s length Principe (ALP) - to prevent transfer mispricing
 When conditions between two associated enterprises in their commercial/financial relations differ from
those between independent enterprises, any profits which would have accrued, but haven’t because
of those conditions, may be included in the profits of the enterprises and taxed
 Entities in MNE treated separately
Conceptual & practical difficulties in applying ALP
Requires matching comparable transactions between non-arm’s length entities & arm’s length entities
MNE transactions often not comparable to those between arm’s length parties
MNE do not operate as if their subsidiaries were separate enterprises
Requires taxpayers to comply with diverse documentation requirements
Challenges of treating PEs as fictitious separate legal entities
Difficulties of applying OECD Transfer Pricing methods
 Some African countries have transfer pricing legislation
Applying OECD Transfer Pricing Guidelines challenging for African countries
Difficult to find African comparables - few organised companies in any given sector; no African databases
European comparables used - these need to be adjusted to suit an emerging market business.
Gathering taxpayer information - absence of documentation requirements; inability to enforce existing ones
Capacity in tax administrations to process data & evaluate information - resource capacity & technical expertise
International corporate taxation principles
that are ineffective in enabling DRM cont.
 Thin capitalisation & other schemes for claiming excessive interest
 Thin capitalisation - tax avoidance scheme - company’s equity capital
small in comparison to its debt capital
 Debt – interest is deductible
 Equity – dividend distribution not deductible
 OECD recommends use of arm’s length principle
 If loan exceeds what would have been lent in arm’s length situation, lender is taken
to have an interest in the profitability of the enterprise and the loan.
 Any interest rate in excess of arm’s length amount, is taken to have been designed to
procure a share in the profits
 The challenges of applying the arm’s principle to transfer pricing also apply to thin
International corporate taxation principles
that are ineffective in enabling DRM cont.
 Beneficial ownership provision to curb treaty shopping
 Treaty shopping - use of DTAs by residents of non-treaty country to obtain treaty benefits
not supposed to be available to them
 Normally done by interposing a conduit company in one of the contracting states
 OECD counteracting measures:
 Use of domestic law provisions
 Specific treaty provisions
 Beneficial ownership - used in most African treaties - art 10, 11 & 12 OECD MTC
Denies treaty benefits unless beneficial owner is resident of one of the contracting states
However internationally - lack of clarity on meaning of “beneficial ownership”
Challenges posed by international case developments - Velcro Canada ; Prevost Car
2014 OECD MTC - OECD acknowledged limits of beneficial ownership - it doesn’t deal with other cases of
treaty shopping - should not restrict application of other approaches
 BEPS Action Plan 6: Use of LOB clause; Principle purpose test; preamble of treaties – not intended for nontaxation
 In many African countries curbing treaty shopping has not received much attention
 Tax treaty negotiations do not fully take treaty shopping into account
 Yet African tax officials often deal with multinational companies involved in treaty shopping –often via Mauritius
Netherlands, Luxemburg & Switzerland
 Background
 OECD - BEPS project “marks a turning point in the history of international co-operation
on taxation”
But: fundamental international tax reform not dealt with
Basic principles of international tax system not re-examined
Focus - strengthen tax avoidance legislation to be effective for modern business models
To remain competitive some OECD countries reluctant to strengthen these laws
No clear global solutions to address fundamental issues
 Developing countries have for long called for international corporate tax reform
 BEPS Agenda not drawn up with developing countries - does not address their immediate
 Most Actions to benefit developing countries in the long term – with economic & capacity
 BEPS project doesn’t explore certain practical measures more suitable for developing countries
Specific Recommendations for Reform of the International
Corporate Tax System Rules and Institutional Framework
 Strengthen source taxation by enhancing withholding taxes (WHT)
 Practical way to enhance source taxation - not addressed in OECD Action Plan
 Many developing countries impose WHT on interest, dividends & royalties paid to nonresidents
 Alleviates difficulties in collecting tax from non-residents
 Resident appointed as non-resident’s agent – obliged to withhold % of tax from payments to
 Failure to comply - personal liability imposed on resident agent
 MNEs find WHT a major loss of revenue - flat rate on gross income
 DTAs can reduce WHT
 Treaty negotiations:
 Developed countries - gross tax wipes out profits – impacts on importation of capital &
 Developing countries have to fight for WHT in DTA negotiations
 Pressure to reduce WHT rates to zero/near zero or to give up their right to tax these payments
 Developing countries also contribute to the earning of this income – WHT should be used to
strengthened source taxation
Specific Recommendations for Reform of the International
Corporate Tax System Rules and Institutional Framework
 Positions on attribution of Profits to PEs: Denial of notional internal payments
 Art 7(1) OECD MTC
 Foreign enterprise only taxable in source state if PE created
 Only profits attributable to PE may be taxed
 Art 7(2) - OECD authorised approach for attributing profits to PEs
 Functionally separate entity - internal dealings of PE recognised without regard to the actual profits of the
enterprise of which the PE is a part
 Allows deductions for notional internal payments that exceed expenses actually incurred
Non-actual management expenses, notional interest & royalties from head office may be charged on the PE
Notional payments for financial services on internal loans & derivatives involving PEs
 Differs from approach in UN MTC & 2008 version of OECD MTC
 Single entity approach - only actual income & expenses of PE allocated
 Developing countries very sceptical about adopting OECD approach
 MNEs often avoid PE taxes - claiming deductions of fees charged to headquarter office
 Disallowance of notional head office expenses should be maintained to preserve source tax bases
Specific Recommendations for Reform of the International Corporate
Tax System Rules and Institutional Framework cont.
 A practical way to deal with transfer pricing: Unitary taxation (UT) with
formulary appointment (FA)
 OECD BEPS rejects radical switch to FA- advocates ALP approach
 Commentators suggest unitary taxation - treats related parties as part of a single enterprise
 FA: MNE taxed on global income - each country’s tax depends on fraction of economic activity therein
 Addresses economic reality of MNEs - highly integrated with operations in different regions
 Fixed formula for profit attribution - administrable
 Objections to FA
Requires countries to agree on a fixed formula
Relies heavily on access to foreign-based information
Profits attributed to each member may differ from income in its books of account
Difficult to apply with respect to intangibles
 The case for FA: overcomes the challenges of ALP
Art 7(4) 2008 version OECD MTC permitted customarily use of apportionment formulae
Some OECD TP methods (profit splits) entail apportionment of profits
APAs often use FA
Developing countries lack data bases for comparables: FA - clearer & easier to administer
Access to foreign-based information – addressed in UN Transfer Pricing Manual & BEPS Action plan 13
Varied use of FA: American Federal States; Brazil - varying approaches not good for international trade
OECD should developing guidance on FA - Convergence between ALP & FA needed
With potential strength of FA, its varied use, ALP problems - FA important in international tax
Specific Recommendations for Reform of the International Corporate
Tax System Rules and Institutional Framework cont.
 Practical way to deal with excessive deductions of fees: An article on income
from technical services in tax treaties
 MNE keep claiming deductions for various management, technical & service fees
 Little or no tax paid in source countries – allegations of making losses year after year
 Profits shifted to low tax jurisdiction while taxes are minimized in source state
 Response – treaties with articles on services, management & technical fees - deviating
from OECD & UN MTC
 Services, management & technical fees generally defined as payments of any kind to any
person, other than an employee of the person making the payments, in consideration for any
services of a managerial, technical or consultancy nature, rendered in a contracting state
 Fees may be taxed in resident state but also in source if beneficial owner is a resident of other
state - fee not to exceed a certain percentage
 Examples: Royalty & service fees - Ghana’s treaties with Germany & Netherlands; Technical
fees – Uganda’s treaties with South Africa, Mauritius & UK; Management fees – Ghana’s treaties
with Italy & Belgium; US-India treaty
No standard way of drafting these articles - creates uncertainties
 OECD countries oppose such article – prefer PE taxation under art 5 and 7 or “fixed base” – UN
 2012: UN proposed new article on technical services - allows country to tax service provider
even if no physical presence is created
Specific Recommendations for Reform of the International Corporate
Tax System Rules and Institutional Framework cont.
 Develop Guidelines on granting tax incentives (TI)
 TIs considered a tool for encouraging FDI – However:
 TI distort resource allocation, lead to sub-optimal investment decisions; harmful to long term growth
 TI not primary determinant of investment decisions
 Internationally not much guidance on granting TI
 Treaty context – some guidance on tax sparing provisions between developing & developed countries
 To prevent elimination or reduction of TI offered to foreign investor by his residence country – credit method
 Developed countries allow residents to retain TI – tax is spared
 However: tax sparing can lead to tax abuse (e.g. transfer pricing, round tripping and treaty shopping)
Inevitably results in the direct loss of revenue for the foregone tax
Developing countries have to make concessions to obtain tax sparing
 1998 OECD Report on Tax Sparing - recommendations on tax sparing
Tax incentive should be defined precisely - no open-ended tax sparing
Set maximum tax rate for the tax sparing credit
Inclusion of anti-abuse clauses
Time limitations or sunset clauses
Restrictions to business income not passive income
 Guidelines on TI should be developed – building on the above on tax sparing
 2015: G20, IMF, OECD, UN & World Bank to work jointly on options for efficient & effective use of TI for