Tax in Developing Countries: Increasing Resources for Development

Written evidence submitted by Joseph H Guttentag

I commend the Committee for addressing such an important subject, and welcome the opportunity afforded me to make a presentation to this Committee.

Summary

While tax issues are extremely important, they cannot be considered in isolation from the many other factors affecting development. Would be assistance providers, whether NGOs, governments, international or regional organizations must realize the substantial difference in governance, administrative resources, sources of tax revenue, between developed and developing countries and between developed countries. The substantial revenue losses of developing countries often result from a combination of evasion and avoidance by local and foreign investors and lack of good governance and corruption in the host country. Blaming MNCs alone, however, can be counterproductive. While you focus on developing country revenue loss, you must enter this project knowing that our countries lose many billions of dollars of tax revenue for a variety of reasons. [1] I suggest that the UK focus on a most important reason for lost revenues and one which the UK and other countries and international organizations can do the most about in the short and medium term. I would place abusive transfer pricing at the top of the list to be dealt with by:

1. Requiring multinational corporations to provide publicly available detailed financial data concerning operations in the developing world broken down on a project by project basis; and

2. Entering into meaningful practical agreements with the developing world for the exchange of tax information as well as providing the requisite training on how to ask for and use all available information; and

3. Providing developing countries with the resources required to obtain tax inspectors with the necessary expertise to conduct tax audits of key operations.

International organizations should be encouraged to continue and expand their work in this and other areas to improve tax policy and administration. The UK should encourage the OECD with respect to its harmful tax competition and urge it to expand the project.

Introduction of Joseph H. Guttentag

I have spent over fifty years in both the private and public sector primarily in the field of international taxation, trade and investment. I practiced tax law in Washington, DC and Tokyo, and served as Chair of the Tax Committee of the US/Japan Chamber of Commerce, the international tax committees of the US Chamber of Commerce and the American Bar Association, Section on Taxation. While serving as Deputy Assistant Secretary for International Tax Affairs with the US Treasury, I served as Chair of the Committee on Fiscal Affairs of the OECD. I am presently working in a pro-bono capacity through the International Senior Lawyers Project for a sub-Saharan country. I was graduated from the Harvard Law School, cum laude, in 1953 where I served as an editor of the Harvard Law Review.

Recommendations for Improving Tax Systems and Revenues of Developing Countries

1. In a recent speech, George Soros in response to a question regarding the most important issues facing developing countries responded, "location and governance, and you can’t do anything about location." Taxation is one of the most important governmental functions and there cannot be a sound tax administration without a sound overall government. The development of a sound government I leave to others.

2. Transfer pricing in tax parlance generally refers to the prices charged for goods or services by one taxpayer to a related party. Abusive transfer pricing is the term used to denote establishment of a price, which is designed to inappropriately reduce or eliminate taxation. To combat such tax avoidance most governments require that for tax purposes, taxpayers be presumed to have dealt at "arms length" with related parties. Easily said, but in practice, terribly hard to administer. One expert estimates that the United States with one of the most efficient tax administrations in the world loses a minimum of US$28 billion a year from transfer pricing abuses. [2] Many tax experts believe a better system is required but it has yet to be found and agreed upon. [3] Developed world governments began to deal with transfer pricing issues about fifty years ago and developed policy and administrative techniques primarily through the OECD. [4] Much of the work of the OECD focused on the avoidance of double taxation, which could occur when countries disagreed on the allocation of income between their countries. Within the past few years the OECD, now consisting of 34 of the world’s major economies, has begun turning its attention to non-member countries, encouraging them to adopt OECD transfer pricing guidelines and to negotiate double tax agreements, which serve among other purposes to enable the avoidance of double taxation resulting from enforcement of transfer pricing rules. The OECD guidance posed difficulties for the developing countries, to some extent for countries such as the BRICS (Brazil, Russia, China and South Africa) but even more for countries of lesser development. These problems for the latter group included:

1. Lack of capacity to administer hundreds of pages of OECD transfer pricing guidelines;

2. Economies substantially different obviously than the OECD countries for which the guidelines were devised.

3. Double tax agreements which serve to reduce ability of such countries to impose their taxes without any offsetting benefit. Furthermore, many of the major investors in such countries invested through tax haven jurisdictions and therefore there could not be double taxation which the agreements were designed to avoid.

More recently, the OECD has begun to recognize these and many other issues

Which require training of tax officials as well as modification of transfer pricing

guidelines. For example, the OECD has been instrumental in the creation of a Tax and Development Task Force, the African Tax Administration Forum and is working towards the establishment in Africa of an International Tax Centre. It is essential that other international organizations with expertise in transfer pricing, in addition to the OECD, and including the United Nations, the IMF and the World Bank, cooperate in devising simplified and administrable means of handling transfer pricing issues around the world. If these efforts to bring the entire developing world into agreement with internationally accepted standard, some countries may go their own way, and some have already started in that direction. Such developments are threatening to both developed and developing countries and the possibility of double taxation could seriously interfere with desirable trade and investment opportunities. [5]

3. Obtaining and training tax policy makers and administrators is a long term project. We need to take advantage of new technologies such as "distance learning" techniques using the Internet. We need to better coordinate assistance in this area so that the UK and the many relevant international and regional agencies each know what the other is doing, taking advantage of particular skills, and avoid competition. Most importantly all of the agencies must realize that "one size" doesn’t fit all" and assistance must be tailored to the problems and abilities of the developing country. Furthermore, assistance must come, as I do as a lawyer with a developing country client, not bound to any other mission or objective other than doing what the client wants done but at the same time explaining fully the implications, counter indications and so forth of the steps to be taken.

4. I am focusing in this paper on the countries such as Zambia as the Committee is doing. I am not looking at very important tax issues of countries such as the BRICS. The issues facing these countries and their proposed solutions do sometimes pose problems for all of us dealing with Zambia and similarly situated countries.

5. A major problem of the developing world is actually collecting the taxes that are due, assuming that a sound tax system has been enacted. Substantial and sound assistance is obtainable from various donors to assist in the establishment of a sound tax system, training of staff and many other most helpful and useful work. But, when it comes to actually auditing taxpayers, there is very little help available. For various reasons, and all understandable, the regional and international organizations and foreign government donors are reluctant to provide funds to pay a tax auditor to sit across the table from a taxpayer, or at least a multinational corporate taxpayer. One reason is that it is difficult to find the auditing skill required to deal with the type of operation often involved. Another may be a concern, particularly by governments, with having their funds and other resources used to collect foreign taxes from their own resident multi-national corporations. As a result, the developing country is forced to rely on its out-gunned staff or use its limited funds to hire very expensive tax auditors often from one of the big four auditing firms. [6]

6. A major obstacle to the enforcement of tax obligations to both developed and developing countries is the ability of both individuals and companies to hide information relevant to their tax liability. Most of the developed countries primarily through the agency and effectiveness of the Committee on Fiscal Affairs of the OECD have entered into agreements providing for the exchange of tax information. The primary obstacle has been countries, which continue to maintain some form of secrecy, and these include OECD countries and tax haven countries, which even if they enter into agreements provide little practical information. [7] The ability of developing countries to obtain information particularly from countries, which are the ultimate residence of their foreign investor companies, is a key to effective tax enforcement. The OECD has developed a multi-national agreement for mutual tax assistance, which has recently been open to non-member countries. The OECD has made tax information exchange a key component of its harmful tax competition project targeting both member countries and tax havens.

7. Tax information exchange is often a two way beneficial street between developed countries. The developing world, whose tax revenues are often primarily from foreign investors, however, may have little in the way of information of value to the developed world. Foreign investors can often hide profits in low or no tax jurisdictions and therefore tax paid to the developing country from which they generate their profits becomes their major tax costs. By avoiding or minimizing such taxes they avoid or minimize their overall tax liability from such activities. [8] Developing countries must have access to tax information and the ability to use it effectively.

8. Developing country tax systems beginning with devising the nature and level of taxes, the drafting of legislation and regulatory and similar guidance, and the selection of and training of staff must be based on the economy, culture, resources and other attributes of the country. A tax system designed for a huge and diverse economy with millions of significant taxpayers such as in the UK is not at all suitable for a country, which may have only a few foreign investors in a few businesses responsible for the bulk of taxes. [9] For example, in such a country a dozen or so well trained tax inspectors may be sufficient to cover the bulk of the tax revenue while a much larger group with fewer skills and training may be highly suitable for the local small businesses constituting the balance of the economic activity.

9. In 1996, the OECD embarked on a project to deal with the problems of harmful tax competition. This has been one of the most important and difficult issues the OECD has had to deal with since its inception. At the present time, the project is focusing on the need for eliminating secrecy which inappropriately interferes with the ability of any country, developed or not, to assess and collect its taxes. These harmful tax practices whether engaged in developed or developing countries cause hundreds of billions of dollars of lost tax revenue on a global basis. The work of the OECD should be encouraged and expanded. [10]

February 7, 2012