While sub-Saharan African (SSA) countries have made some progress in collecting more taxes domestically in the last 20 years, international tax issues remain a significant concern for these and other developing countries, reflecting aggressive tax planning by multinational enterprises (MNEs) and the international initiatives designed by G20-OCED countries in response. Drawing on a new CGD paper on international taxation and developing countries, we argue here that the time has come for SSA countries, and developing countries in general, to take unilateral action—as many developed countries have—to protect their tax base. They should continue participating in multilateral forums where these issues are discussed but be wary about giving priority to minimum standards stressed at the G20-OECD forum. They should also consider using regional forums to discuss international tax issues, pursue developing-country focused solutions, and discuss tax competition
Sub-Saharan Africa and international taxation
In the past two decades, SSA countries have made progress in collecting more taxes domestically, as reflected by an increase in the average tax-to-GDP ratio by around 2 percentage points of GDP since 2000. This is comparable to the progress made by Asia during this period. Revenues from corporate income taxes have remained resilient at about one-fifth of the average tax take. If these revenues were to fade away and not grow with expanding national output, SSA countries would struggle even more to meet their social and infrastructure needs, especially because their options for raising additional domestic resources are limited in the short term.
When it comes to corporate taxes, MNEs are able to exploit weaknesses in the current international tax framework to reduce their tax liabilities. These strategies usually aim to shift income to low tax jurisdictions and away from higher tax jurisdictions, and/or to shift tax deductions so they can be claimed in higher taxed jurisdictions rather than in low tax jurisdictions. While MNE tax planning is not new, the revelations on the small amount of tax paid by large MNEs, such as Google, Amazon and Apple, and details of widespread tax avoidance identified in disclosures, such as the Panama papers, has forced governments into action.
Both developed and developing countries are challenged by MNE activities, but low-income SSA countries are particularly vulnerable because of their weak capacity to administer international tax rules and audit and monitor MNE’s activities.
Multilateral and unilateral response
The response to aggressive tax planning by MNEs has been both multilateral and unilateral. The most notable multilateral response is the G20-OECD Base Erosion and Profit Shifting (BEPS) project, which began in 2013 and resulted in 2015 in a package of 15 proposed measures known as “BEPS Actions.” Some countries, notably advanced, are progressively adopting these Actions, although work is ongoing on some Actions, in particular those addressing the challenges of the digital economy. This later work, commonly referred to as “BEPS 2.0.” In addition, the EU has sought to address aggressive tax planning within its jurisdiction through its anti-tax avoidance directive.
Despite these multilateral actions, some advanced countries have acted unilaterally to address aggressive tax planning by MNEs. These unilateral actions include diverted profits taxes (introduced in Australia and the UK), digital services taxes (introduced in France and Italy), and various international tax measures in the 2017 US Tax Cuts and Jobs Act.
Advanced countries have taken the lead in the G20-OECD forum in addressing concerns with the international tax system. Developing countries have been less engaged, at least in the initial stages, even though they face similar problems with aggressive tax planning. Many of the international tax reform initiatives are designed by, and for, developed countries, and may be too complex or not practical for a developing country, particularly in SSA. The OECD has taken steps to better include developing countries by establishing the Inclusive Framework on BEPS (IF), which counts over 135 member countries. Still, the IF is implementing Actions designed by developed countries, including minimum standards that are not necessarily a priority for SSA developing countries.
What should countries in SSA do?
The dilemma for developing countries in SSA is how to respond to these international tax challenges, including the range of international tax initiatives. Countries want MNE investments and the benefits those investments bring, but they also need tax revenue to meet their fiscal needs, including financing the Sustainable Development Goals. SSA countries struggle with collecting taxes from domestic businesses, let alone MNEs. There are a number of reasons why developing countries in SSA face difficulties in addressing aggressive tax planning. One is that laws may lack adequate international tax provisions; when these provisions are present, there is not a clear understanding of how they work or can be applied (for example, transfer pricing rules). A second issue is that these countries may have few double tax treaties and those in place may not favor developing countries. SSA countries often also have weak tax administrations, with a lack of capacity to monitor and challenge MNEs.
There are several strategies that SSA countries can adopt as a priority to address international tax challenges, rather than focusing on the minimum standards as stressed under G20-OECD BEPs. These strategies include:
Legislating simple and comprehensive international tax rules in domestic laws (including transfer pricing rules);
Imposing a limit on interest deductions, as overpayment of interest to related parties is one of the simplest means to shift profits;
Imposing withholding taxes on payments to non-residents. These should be set at a rate of 10 to 15 percent and cover dividends, interest, rent, royalties, management fees and technical service fees, and the withholding taxes should not be significantly reduced under double tax treaties; and
Exercising caution about entering into new double tax treaties, at least until countries have a clear tax treaty policy that protects their revenue base.
These countries could further expand the range of reforms to include:
Limiting overall deductions for other non-interest payments between related parties (e.g., management fees). This would ensure that the amount paid to a related party is reasonable;
Introducing a simple minimum corporate income tax, to address potential tax avoidance. In this regard, it is preferable to keep the tax simple, such as applying a low tax rate on turnover or the value of assets. It would only apply if the tax liability under the standard income tax is less than the minimum tax;
Reconsidering tax holidays and income tax exemptions and using alternative incentives targeted at the actual investment to attract foreign direct investment; and
Taxing gains on offshore indirect transfers of interests. These gains arise where immovable property (such as real estate or petroleum or mining rights) in a country is sold indirectly through the sale of shares in an offshore holding company that beneficially owns the underlying asset.
To implement this strategy, SSA countries should make use of technical assistance from international organizations and bilateral donors. The IMF, World Bank, and OCED have developed a joint Platform for Collaboration on Tax for providing support to developing countries in addressing tax challenges. There are many bilateral donors who are also interested in providing technical assistance on international tax issues, given their objective to encourage revenue mobilization. The most suitable technical assistance provider for a country will depend on the nature of the assistance sought.
It would also be beneficial for developing countries to use their existing regional forums (e.g., African Tax Administration Forum in SSA, Pacific Island Tax Administrators Association in Oceania, Centro Interamericano de Administrationes Tributarias in Central America) to discuss international tax issues and potential responses that are appropriate for the countries in the region. For example, in regions with smaller countries, it may be possible to have regional transfer pricing audits. The regional forums can also be used to address regional tax competition.
A final word: While international tax issues are important for developing countries, they should not distract governments from addressing often more pressing domestic tax needs, such as ensuring the VAT works properly and is administered effectively, and income tax is being paid by domestic residents. Addressing these issues is likely to raise more revenue than just resolving the international tax issues.