An African proposal for reform of International Corporate Taxation and the Fight against Illicit Financial Flows

In this brief paper I try and make recommendations for a common stand that representatives from civil society from Africa should take on the fight against Illicit Financial Flows (IFF). It is envisaged that tackling IFF from Africa requires reform of international corporate taxation. This tax system has many loopholes, and Transnational Corporations (TNCs) have exploited them. Profit shifting, and transfer pricing remain the primary drivers of corporate tax practices that facilitate IFF. Yet, these practices have not been adequately dealt with at both the international and regional fora. Estimates from the African Development Bank reveal that IFF have resulted in corporate tax losses in excess of a trillion dollars from Africa since 1980.[1] The Tax Justice Network (TJN)[2] and the IMF’s Fiscal Affairs Department[3] estimate these losses at $500bn and $200bn respectively per annum. In 2015, the United Nations Economic Commission for Africa (UNECA) published its High-Level Panel Report on Illicit Financial Flows (HLP Report) in which it reported that Africa is losing more than $50 billion annually in IFFs. The Report asserted that this estimate may well fall short of reality because accurate data does not exist for all African countries, and these estimates often exclude some forms of IFFs that by nature are secret and cannot be properly estimated, such as proceeds of bribery and trafficking of drugs, people and firearms as well as corruption. In July 2018, at the High-Level Policy Dialogue on Development Planning in Africa the Head of Development Planning and Statistics at the Economic Commission for Africa reported that $100 billion a year is illegally earned, transferred, or used due to mis-invoicing. These Tax losses resulting from IFF have become too serious to neglect anymore.

A number of preventive solutions have been proposed at both the international and regional levels by governments, but they remain wanting in so far as the African continent is concerned. The latest of these proposed reforms are set out in the 2018 report on ‘A Roadmap to Improve Rules for Taxing Multinationals’ by the Independent Commission for the Reform of International Corporate Taxation (ICRICT).[4] ICRICT has identified profit shifting as the leading contributor of unprecedented levels of economic inequality in Africa and castigated the OECD’s Base Erosion and Profit Shifting project (BEPS) as failing on its mandate to ensure that profits are taxed where economic activities take place and value is created. ICRICT proposes a global formulary apportionment, coupled with a minimum corporate tax rate as the only effective way for all countries to collect a fair share of tax revenue from TNCs and avert a race to the bottom.

Other than ICRICT’s recent proposals, a number of international and regional law and policy reforms have also been identified by States as crucial to reducing and preventing IFF. These reforms are focused on transfer pricing, beneficial ownership, country by country reporting and the review of the international tax treaties. While these reforms are targeted to combat IFF through tax evasion and avoidance schemes employed by TNCs to increase the amount of their profits invested in relatively lightly taxed jurisdictions, they relegate the African experience to merely adopting the reform measures as policy initiatives without targeted and concrete proposals in detecting and preventing IFF and transitioning towards a convergence on unitary taxation as proposed by ICRICT. Certain accepted international corporate taxation measures such as thin capitalization rules, tax incentives, source and residence-based taxation, interest limitation and tax competition that TNCs use are being addressed under the BEPS project. However, this OECD reform proposal is patchy and does not address structural issues peculiar to African states and the measures it recommends are not adapted to African states interests and capacities.

The Tax Inspectors Without Borders, which is an OECD/UNDP joint initiative aims to help developing counties bolster domestic revenues by strengthening their tax audit capacities. This initiative seeks to facilitate the transfer of tax audit knowledge and skills by matching tax audit experts with local officials to work directly on current audits concerning international issues, and to share general audit practices. While the provision of technical assistance to developing countries is welcome and necessary, adequate care has not been taken to avoid conflicts of interest. For example, there have been concerns that some tax experts providing advice have previously assisted TNCs in negotiating problematic advance pricing agreements for them or assisted them in other ways to avoid tax payments in the African region.

At the United Nations summit for the adoption of the post-2015 development agenda, Member States adopted 17 Sustainable Development Goals, including two targets particularly relevant to IFF. Target 16.4 of the Goals commits States to “significantly reduce illicit financial and arms flows, strengthen the recovery and return of stolen assets and combat all forms of organized crime” by 2030. Under target 17.1, States agreed to strengthen domestic resource mobilization, including through international support to developing countries, to improve domestic capacity for tax and other revenue collection. However, the outcome on the post-2015 development agenda will only be of benefit to Africa if the full implementation of the Addis Ababa Action Agenda for the realization of the SDGs is achieved. The Addis Agenda calls for the elimination of IFF by combating tax evasion and corruption through strengthened national regulations and increased international cooperation. It also seeks to reduce tax avoidance by eliminating safe havens and improving disclosure practices and transparency in both source and destination countries. What remains lacking in the Agenda is the extent to which international cooperation is to aid in enhancing transparency on beneficial ownership, permanent establishments, base eroding payments, treaty negotiations, restructuring of supply-based chains and controlled subsidiaries in a continent that is unable to afford competent staff in the right numbers with the capacity to investigate these areas.

Further, the Group of Eight countries made a commitment at its 39th summit, in June 2013, to introduce automatic exchange of information by tax authorities across the world in order to fight the scourge of tax evasion; to change rules that let companies shift their profits across borders to avoid taxes; to assist developing countries with information and capacity to collect taxes owed to them; to introduce public country-by-country reporting for extractive companies; and to address the issue of misuse of shell companies to facilitate IFF.[5] In July 2014, OECD and the Group of 20 published a new global standard for automatic exchange of tax information, providing for the exchange of non-resident financial account information with the tax authorities in the account holder’s country of residence. As at 30 October 2015, 96 countries had committed themselves to implementing the standard to automatically exchange tax information by end of 2018.[6]

The OECD was also tasked by the Group of Eight and Group of 20 Finance Ministers with developing an Action Plan on BEPS, published in July 2013, containing 15 specific actions to address a range of issues relating to tax transparency, accountability and information exchange. The leaders called on OECD to develop a framework for monitoring the implementation of BEPS by 2016 and to encourage all countries and jurisdictions, including developing countries, to participate in it. While that project includes country-by-country reporting by transnational corporations as one of its action points, it requires that this information be provided only to the home tax authority of those corporations and not that it be made publicly available. Other countries will only be able to access that information through official treaty requests, which will make it more difficult for African countries tax authorities to access the information and will prevent public scrutiny.

Regional African measures have attempted to address these gaps in their reform proposals but still remain wanting. In Africa, in 2010 following a meeting of revenue authority officials, the African Tax Administrators Forum (ATAF) was created and their work includes facilitation of joint audits on cases of potential IFF from African states. They developed a model on information exchange between revenue authorities. In 2011, the African Commission on Human and Peoples’ Rights (ACHPR) passed a resolution stating that IFF was affecting the development of Africa and its ability to achieve human rights. Later in 2014, the Tana Forum of African Heads of State held their 3rd session on IFF and its effect on peace and security in Africa. In 2015 the African Union released the High-Level Panel Report on Illicit Financial Flows (the HLP Report) reflecting on the urgency in dealing with IFF.[7]

The HLP Report on IFF attempted to improve and strengthen the definition of IFF. The OECD and the Global Financial Index (GFI) both limit the definition of illicit financial flows to illegal actions. Those financial flows that are against the spirit of law or are just not criminalized in a particular country but as such are perceived as unacceptable are not covered. A much broader scope of IFF was proposed in the HLP Report which defines them as activities “that, while not strictly illegal in all cases, go against established rules and norms, including avoiding legal obligations to pay tax”.[8] It covers not only illegal actions but also those which are not explicitly forbidden by the statutes but are unacceptable in the light of unwritten rules, spirit of the law, or their purpose. This broad definition captures all financial flows even if they involve legal transactions. This definition must also be adopted at the international level since a higher proportion of IFF from Africa occurs as a result of legal transactions. The HLP Report called for a United Nations Declaration on the issue of IFFs from Africa and for concrete steps to be taken for the UN to adopt a unified policy instrument on IFF. This however has to date not taken place and there is no action from African states to draft either the declaration or a policy instrument to be taken forward to the United Nations as a result of a lack of agreement among the African states.

In February 2016 the HLP on IFF discussed its findings with UN Member States at a special briefing of the UN Economic and Social Council and stressed that Africa faces challenges in the areas of taxation, financial intelligence and IFF which require strong institutions to address and for which the UN is to build capacity.[9] The AU has also passed a special resolution on IFF where it asked UNECA, the African Development Bank and the Regional Economic Communities to submit annual reports on the progress of the counter measures to IFF.[10] In 2017, the Yaounde Declaration confirmed that the gaps in domestic legislation and administrative capacity in many African countries hampered their efforts to tackle IFF and this was compounded by the lack of transparency in international corporate tax matters. This has resulted in delays in the submission of the REC reports to the AU.

The AU resolution also called for the AU, UNECA and the African Capacity Building Foundation and other development partners to build capacities of AU Member States and institutions, particularly in contract negotiation, tax management, regulatory and legal frameworks, policies, money laundering, asset recovery and repatriation, and resource governance for effective and optimal management and governance of African natural resources. The resolution also reiterated that the issue of international co-operation on IFF be raised in the Post-2015 Development Agenda. This was done. However, African states have not moved the proposal to replace the UN expert committee on tax with a fully-fledged agency giving Africa an equal say in global tax rules and help them combat IFF. International corporate tax standards are still being developed behind closed doors at the OECD. In so far as Africa has its voice in reforming international corporate taxation the Addis Tax Initiative provides a dual approach; to improve tax rules for the benefit of all countries and train qualified inspectors in developing countries who will collect tax and offers a proposal for an intergovernmental expert committee[11] as part of the global architecture needed to fix the IFF challenges posed by TNCS in terms of their impact on development and inequality.

Despite these regional initiatives, the financial, technical, institutional and human capacity constraints in Africa, coupled with;

·      a lack of adequate supply of specialised technology and equipment for collecting, processing and storing specialised information on tax practices by TNCs,

·      lack of publicly available disaggregated financial information on TNCs,

·      restrictions on determining beneficial ownership,

·      lack of harmonized unitary taxation,

·      tax incentives, and

·      lack of clarity in the automatic exchange of information between resident and source states continue to facilitate IFF. Curbing IFF therefore, also requires a unified regional response.

There are various connections between IFF and their impact on development and inequality in Africa. First, IFF deprive African governments of resources required to achieve structural transformation, economic development and progressively realise human rights. Second, IFF exacerbates inequality. Tax evasion and avoidance by TNCs forces governments to raise revenue from other sources, including through regressive taxes, the burden of which falls hardest on the poor. TNCs adopt the OECD double taxation model that favours the Global North at the expense of the African economy in the taxation of profits and deprives Africa of taxes from income sourced domestically and from whence value is created. TNCs by their global nature are predominant movers of IFF by creating global wealth and value chains through which money is moved and made untraceable. The international corporate structure enables this movement within the parameters of the law though the use of definitions such as residence, subsidiaries, affiliates, beneficial ownership, debt servicing and permanent establishments. Legal concepts that are ambiguous and lacking in transparency.

Third, IFF perpetuates and aggravates extreme economic inequality, benefiting the rich at the expense of the poor. Inequality prevents millions of Africans from enjoying social and economic rights on a non-discriminatory basis, such as access to adequate housing, healthcare and food. Curbing IFF is therefore not only essential for achieving equality, but also for financing development in Africa. Thus, making progress on target 16.4 of the Sustainable Development Goals on reducing IFF will make an important contribution not only to achieve various other goals included in the Agenda 2030 for sustainable development, but also to the enjoyment of development and equality.

Finally, IFF also contributes to the build-up of debt crises since, in the face of missing revenues, African governments resort to external borrowing. Debt servicing reduces the amount of public resources available for development and achieving equality. TNCs focus their market in jurisdictions where the legal system is fragile such as in failed African states and states in conflict, as well as in countries that host financial centres that are self regulated with minimal supervision from the domestic capital markets to trace financial flows. TNCs also invest in states where their financial institutions are yet to comply with the Financial Action Task Force recommendations on tracing the source and flow of money. These weaknesses in the law contribute to the capital flight schemes employed by TNCs.

From the foregoing, it is apparent that various approaches to deal with IFF at both the international and regional levels exist but have to be improved and strengthened. The cross-border nature of international corporate tax avoidance means that action only at the national level cannot tackle the problem and can even lead to further problems. Tax competition, profit shifting, tax havens, lack of registries on beneficial ownership, digitalized customs data and global value chains can be addressed through the ICRICT proposal on unitary taxation as a first step towards accountability. Therefore, building on this proposal to boost African state’s collective stance against the problem of IFF under the current international corporate tax structure and to restore fairness in taxation ensuring stability for businesses and investors in the AU a common position towards pursuing a coordinated AU approach to reform international corporate taxation to combat IFF relying on ICRICTs proposal for unitary taxation under a formulary apportionment is necessary.

Under a unitary taxation model, African states will be able to tax a TNC as if it were engaged in a unified business as a single entity, requiring it to submit a single set of worldwide consolidated accounts in each country where it has a business presence, and then apportioning the overall global profit to the various countries according to a weighted formula reflecting its genuine economic presence in each country. Each African state in which the TNC has a presence sees the combined report and can then tax its portion of the global profits at its own rate. The question is how African states are to apply this model. The following list of demands will help manage the transition to unitary taxation:

1.     African states at the AU level to agree on a global minimum effective tax rate and work towards a common definition of the tax base – this would be problematic for African states initially to agree on a minimum effective rate for corporate tax - which worldwide appears to be converging around 25% but various African states have adopted much lower corporate rates and even more generous cuts to the tax base, and may be reluctant to give them up. Hence discussions at the AU level are necessary to come to common terms towards pushing for the UN Committee of Experts on International Cooperation in Tax Matters to be upgraded to an Intergovernmental Commission so that African states can pursue minimum effective tax rates within regional groupings en route towards global convergence.

2.     African states to introduce the requirement for TNCs to submit a combined report in each African state where they are subject to tax or have a presence. This should follow the country by country reporting of the taxes actually paid.

3.     African states to direct efforts within UNECA, HLP on IFF, Addis Agenda, Addis Tax Initiative and Tax Justice Network -Africa’s ‘Stop the Bleeding’ campaign to push for an African Declaration in support of ICRICT’s proposal on global formulary apportionment and taxation of TNCs where economic activities take place and value is created to counter the OECD stand on taxing TNCs under its residence principle.

4.     To use the Coalition for Dialogue on Africa (CoDA) and G77 platform to collaborate with the UN Expert Committee on Tax to push for the creation of an intergovernmental tax body under the auspices of the UN to lead the process of reforming international taxation instead of the OECD.

5.     AU to consider establishing a legal enforcement branch that pursues legal redress against TNCs for commercial tax evasion practices in order to recover the proceeds of IFF. 

6.     In the move to introduce a uniatry tax model for TNCs African states:

                        i.         To start sharing trade price data which would automatically expand the dataset against which African states can judge and identify abnormal pricing. This can be done in real time. African states can start a regional Open Government Guide on ‘following the money’ partnerships, to work with major trading partners in identifying abusive pricing happening at each end of the same transactions.[12] Starting such a process on a regional basis could be effective in reducing IFF.

                      ii.         To digitise the registry of companies. There should be a clear register of companies for tax purposes where domestically registered companies and their foreign related party data ought to be accessible. This is currently one of the biggest problems on the continent, forms are not filed, updated or if filed are misplaced. Current registries to be updated, triangulated with tax data, as well as stock exchange and even service-based data.

                     iii.         Each African state to establish transfer pricing (TP) laws. Currently only 9 African states have TP laws within their domestic frameworks. This means that whether or not there is a tax treaty in place on a cross-border tax issue, there is still no possibility of monitoring issues of TP without a clear legislative framework in place.[13] This law will empower African states to require TNCs operating in their countries to provide the revenue authority with a comprehensive report showing their disaggregated financial reporting on a country-by-country or subsidiary-by-subsidiary basis. African governments could also consider developing a format for this reporting that would be acceptable to multiple African revenue authorities.[14]

References

1.     Alex Cobham. 2014. The Impacts of Illicit Financial Flows on Peace and Security in Africa, Study for Tana High Level Forum on Security in Africa.

2.     Alex Cobham & Janský, P. 2018. Global distribution of revenue loss from corporate tax avoidance - Re-estimation and country results. Journal of International Development, Forthcoming. Ungated version: 3 http://www.europarl.europa.eu/legislative-train/theme-deeper-and-fairer-internal-market-with-a-strengthenedindustrial-base-taxation/file-quantification-of-the-scale-of-tax-evasion-and-avoidance 

3.     Allison Christians. 2014. Avoidance, Evasion, and Taxpayer Morality, 44 Wash. U. J. L. & Pol’y 039, http://openscholarship.wustl.edu/law_journal_law_policy/vol44/iss1/8.

4.     Alstadsaeter, A., Johannesen, N., & Zucman, G. (2017). Tax Evasion and Inequality. Working Paper. http://www.nielsjohannesen.net/wp-content/uploads/AJZ2017.pdf

5.     Arel-Bundock, Vincent. 2017. The Unintended Consequences of Bilateralism: Treaty Shopping and International Tax Policy. International Organization 71: 349–71.

6.     Attiya Waris. 2016. Measures being Undertaken by African Countries to Counter IFF: Unpacking the Mbeki Report. High Level Conference on Illicit Financial Flows: Inter Agency Cooperation and Good Tax Governance in Africa. Pretoria.

7.     Attiya Waris. 2017. How Kenya has Implemented and Adjusted to the Changes in International Transfer Pricing Regulations: 1920-2016. ICTD: Working Paper 69.

8.     Blankenburg, S. and M. Khan. 2012. Governance and Illicit Flows, in Reuter, P. (ed.) Draining development? Controlling flows of illicit funds from developing countries (Washington, D.C.: World Bank).

9.     Boyce and Ndikumana. 2012. Capital Flight from Sub Saharan Countries: Updated Estimates, 1970 – 2010. PERI Research Report.

10.   Cracea. 2013. OECD Actions to Counter Tax Evasion and Tax Avoidance: Base Erosion and Profit Shifting and the Proposed Action Plan, Aggressive Tax Planning Based on After-Tax Hedging and Automatic Exchange of Information as the New Standard, 53 Eur. Taxn. 11, Journals IBFD.

11.   Crivelli, E., de Mooij, R., & Keen, M. (2016). Base Erosion, Profit Shifting and Developing Countries. FinanzArchiv: Public Finance Analysis, 72(3), 268–301.

12.   Dev Kar and Joseph Spanjers. Illicit Financial Flows from Developing Countries: 2003-2012 (Washington: Global Financial Integrity, 2014).

13.   Global Financial Integrity. 2013. Explore the Data: Illicit Financial Flows from Developing Countries 2002-2011. How to Read the Report’s Findings (Washington, D.C.: GFI).

14.   Human Rights Council. 2016. Final study on illicit financial flows, human rights and the 2030 Agenda for Sustainable Development of the Independent Expert on the effects of foreign debt and other related international financial obligations of States on the full enjoyment of all human rights, particularly economic, social and cultural rights. Thirty First Session, A/HRC/31/61.

15.   Human Rights Council. 2018. The Right to Development and Illicit Financial Flows: Realising the Sustainable Development Goals and Financing for Development. Nineteenth Session. A/HRC/WG.2/19/CR.P.3

16.   ICRICT. 2018. A Roadmap to Improve Rules for Taxing Multinationals.  https://www.icrict.com/icrict-documents-a-fairer-future-for-global-taxation/

17.   Marc Herkenrath. 2014. Illicit Financial Flows and their Developmental Impacts: An Overview. International Development Policy.

18.   Mevel, Ofa and Karingi 2013. Quantifying illicit financial flows from Africa through trade mis-pricing and assessing their incidence on African economies. Africa Economic Conference.

19.   Morgan, Jamie. 2016. Corporation Tax as a Problem of MNC as Organizational Circuits: The Case for Unitary Taxation. The British Journal of Politics and International Relations 18: 463–81. 

20.   OECD. 2013. Measuring OECD responses to illicit financial flows (Paris: OECD).

21.   OECD. 2013. A Step Change in Tax Transparency. https://www.oecd.org/ctp/exchange-of-tax-information/taxtransparency_G8report.pdf

22.   OECD. 2013. Action Plan on Base Erosion and Profit Shifting. OECD Publishing. https://www.oecd.org/ctp/BEPSActionPlan.pdf

23.   Olbert, Marcel, and Christoph Spengel. 2017. International Taxation in the Digital Economy: Challenge Accepted? World Tax Journal 9: 3–46. Available online: https://www.ibfd.org/sites/ibfd.org/files/content/img/product/april_ppv_wtj_2017_01_int_4_international_taxation.pdf

24.   Open Government Partnership. 2016. Great Ideas for OGP Action Plans: Follow the Money. https://www.opengovpartnership.org/stories/great-ideas-ogp-action-plans-follow-money

25.   Outcome document of the Third International Conference on Financing for Development: Addis Ababa Action Agenda, July 15, 2015.

26.   Peter Sorenson. 2004. International Tax Coordination: Regionalism Versus Globalisation. Journal of Public Economics 88.  

27.   Peter Sorenson. 2003. International Tax Competition: A New Framework for Analysis. Economic Analysis and Policy 33: 179.

28.   Q. Reed and A. Fontana. 2011. Corruption and illicit financial flows. The limits and possibilities of current approaches, U4 Issue, January 2011 No 2.

29.   Report of the High Level Panel on Illicit Financial Flows from Africa commissioned by the AU/ECA Conference of Ministers of Finance, Planning and Economic Development, available online at. 

http://www.uneca.org/sites/default/files/publications/iff_main_report_26feb_en.pdf.

30.   UNCTAD, United Nations Conference on Trade and Development, World Investment Report 2015. Reforming International Investment Governance.

31.   UNECA. 2013. The State of Governance in Africa: The Dimension of Illicit Financial Flows as a Governance Challenge (Addis Ababa: UNECA).

32.   United Nations. 2015. Addis Ababa Action Agenda of the Third International Conference on Financing for Development. New York. http://www.un.org/esa/ffd/wp-content/uploads/2015/08/AAAA_Outcome.pdf

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[1] Alex Cobham. 2014. The Impacts of Illicit Financial Flows on Peace and Security in Africa, Study for Tana High Level Forum on Security in Africa.

[2] Alex Cobham, & Janský, P. 2018. Global distribution of revenue loss from corporate tax avoidance - Re-estimation and country results. Journal of International Development, Forthcoming. Ungated version: 3 http://www.europarl.europa.eu/legislative-train/theme-deeper-and-fairer-internal-market-with-a-strengthenedindustrial-base-taxation/file-quantification-of-the-scale-of-tax-evasion-and-avoidance

[3] Crivelli, E., de Mooij, R., & Keen, M. 2016. Base Erosion, Profit Shifting and Developing Countries. FinanzArchiv: Public Finance Analysis, 72(3), 268–301.

[4] https://www.icrict.com/icrict-documents-a-fairer-future-for-global-taxation/

[5]www.gov.uk/government/publications/g8-action-plan-principles-to-prevent-the-misuse-of-companies-and-legal-arrangements/g8-action-plan-principles-to-prevent-the-misuse-of-companies-and-legal-arrangements.

[6]www.oecd.org/newsroom/global-forum-on-tax-transparency-pushes-forward-international-co-operation-against-tax-evasion.htm.

[7] Report of the High-Level Panel on Illicit Financial Flows from Africa commissioned by the AU/ECA Conference of Ministers of Finance, Planning and Economic Development, page 85 available online at. 

http://www.uneca.org/sites/default/files/publications/iff_main_report_26feb_en.pdf.

[8] P. 23

[9] http://sdg.iisd.org/news/panel-addressing-illicit-financial-flows-could-help-finance-sdgs/

[10]Assembly Special Declaration on Illicit Financial Flows Doc. Assembly/AU/17(XXIV) http://summits.au.int/en/sites/default/files/Assembly%20AU%20Dec%20546%20-%20568%20%28XXIV%29%20_E.pdf at para 4.

[11]https://www.theguardian.com/global-development-professionals-network/2015/jul/15/addis-ababa-talks-risk-deadlock-over-un-agency-for-tax-ffd3-financing-for-development

[12]Open Government Partnership. 2016. Great Ideas for OGP Action Plans: Follow the Money. https://www.opengovpartnership.org/stories/great-ideas-ogp-action-plans-follow-money

[13] Attiya Waris. 2017. How Kenya has Implemented and Adjusted to the Changes in International Transfer Pricing Regulations: 1920-2016. ICTD: Working Paper 69.

[14] Attiya Waris. 2016. Measures being Undertaken by African Countries to Counter IFF: Unpacking the Mbeki Report. High Level Conference on Illicit Financial Flows: Inter Agency Cooperation and Good Tax Governance in Africa. Pretoria.