The craft of tax avoidance
There are suggestions in the pipeline to trim the amount of taxes companies can legally evade, but they are not going to aid developing countries any time soon unless the entire tax system is overhauled, and tax treaties amended.
Webber Wentzel tax partner Michael Honiball says one of the biggest problems with the current tax system is that it universally requires profit to be booked against intellectual property (IP).
In countries such as the United States (US), IP can legally be moved to countries such as Ireland, which offers an immense saving on tax — 12.5% compared to 35% in the US.
South Africa is not subject to this problem as foreign exchange laws mean IP cannot be moved to more advantageous countries, such as Mauritius, notes Honiball. He says this situation is problematic because it means tax is not paid where the sale is made, and many countries in Europe are racing to the bottom to cut taxes and lure in companies who they hope create jobs.
While fixing this problem is possible, it will take a long time because it will require tax treaties being reworked and every country changing its law so that profits are booked where sales are made, says Honiball.
In addition, countries that offer low tax rates should be forced to hike them, or other countries drop their rates.
These are issues that the Organisation for Economic Co-operation and Development (OECD) — the creator of the current tax system — is trying to fix. However, Honiball notes that its 2013 Action Plan on Base Erosion and Profit Shifting (BEPS) is meeting resistance from rich countries, which are not likely to back down from their positions.
Jens Brodbeck, executive at ENSafrica"s tax department, explains the BEPS project, ongoing since the G20 leaders” meeting in 2012, has identified transfer pricing as one of the major areas of concern, when it comes to the reasons for reduced tax revenues, stemming from tax planning by multinational enterprises aimed at eroding the tax base through the shifting of profits to locations where they are subject to a more favourable tax treatment.
Transfer pricing is not illegal, but commodities moved between companies” different entities — in different countries — need to be priced at what is called the “arms” length rule”. This dictates that the products are moved at the same price as they would be if they were sold to an independent company.
Deborah Tickle, director of international corporate tax at KPMG, says transfer pricing legislation assists countries to make sure they collect the taxes on cross border transactions. It is usually based on a model, the most common being that created by the OECD.
“It is important to remember that the result of correct transfer pricing should be fairness to the country in which the multinational is operating and fairness to the multinational enterprise. Thus, the objective of global legislation going forward is to ensure no double non-taxation and no double taxation.”
More transparency needed
Oxfam notes the tax gap for developing countries — the amount of unpaid tax liability — is estimated to come in at $104-billion every year, a figure that includes profits shifted in and out of tax havens.
Governments in these countries then give away an estimated $138-billion each year in statutory corporate income tax exemptions, the body adds. These losses combined could pay twice over the $120-billion needed to meet the Millennium Development Goals related to poverty, education and health, it says.
Edward Harris, head of communications at the Africa Progress Panel, says that abuse of tax regimes is an issue that requires global action. He recommends building the capacity of African countries to identify and to tackle tax avoidance and evasion issues, more transparent accounting by multinational corporations, including country-by-country reporting, as well as automatic tax information exchange.
Harris maintains the key issue is asymmetry of information. “A key solution would be to build tax administration capacity. But every country around the world struggles with transfer and trade misplacing.”
However, says Honiball, the world is likely to end up with half a solution as the wealthy nations will only appear to back down. Among mooted measures to cut back on tax leakage are country-by-country reporting and automatic information transfer.
Honiball says that country-by-country reporting would, if it comes into effect, stop countries consolidating regions, and instead tell regulators what each country has earned.
This, he says, will allow for comparisons of a company"s profits and gross profit margins between countries and profit anomalies can highlight red flags, which can then be investigated further.
Automatic transfer would also help with information, because tax authorities would push information to their counterparts without being asked for it, says Honiball. This would negate the need for a tax regulator to be suspicious before asking a counterpart to submit data.
Currently, companies need to ask for information, a system that has been in place for 60 years. Tickle explains that tax treaties and exchange of information agreements assist revenue authorities to find information about what taxpayers are doing in other countries to ensure they are not acting to the disadvantage of the requesting country.
Tickle says the OECD also provides a commonly used tax treaty model, and treaties assist where a group is taxed, to its detriment, in one country at one price and in another at a different price, because different revenue authorities have different beliefs about what the arm"s length price is.
Keith Nichols, managing director of Africa at Thomson Reuters, says avoiding double taxation is an important issue of fairness, and is also needed to make sure that foreign trade and investment are not discouraged.
However, neither of the two proposals would resolve the situation whereby companies legally use the current tax regime to trim their tax bills, says Honiball. He says before they would aid those countries that are losing out, the entire system needs to fundamentally change.
Oxfam"s recently-released briefing paper, Business Among Friends, notes that the OECD"s consultations on country-by-country reporting (CBCR) have not been met with open arms by big business.
Consultations opened at the end of last year and almost 87% of the non-state contributions have come from the business sector, none from developing countries” tax authorities, and the remaining 13% include contributions from NGOs (eight, including Oxfam), academics (seven), experts related to tax administrations (two) and one trade union, it says.
“More striking, of 135 contributions in total, only five come from developing countries; 130 come from rich countries with a large proportion (43%) coming from the UK and the US. Unsurprisingly, the business sector is almost all opposed to the proposal.”
Oxfam notes only 6% of the private sector supported CBCR, and only two contributions were in favour of making this information public to improve accountability.
The OECD has since announced, after the consultation process, critical reporting requirements will be dropped, including reporting on transactions relating to royalties, interests and service fees (at the centre of a number of profit shifting scandals), and that data will not be made public.
“Private companies are, of course, entitled to put forward their views in this open and transparent process, but because representation is unbalanced it is likely to lead to a biased outcome.”
Honiball adds that these proposals will add greatly to companies” administrative burdens.
This article is part of a series on the effects of monetary instruments on developing countries, in partnership with Oxfam.