Tax in Developing Countries: Increasing Resources for Development

Written evidence submitted by The Centre for Trade Policy and Development (Zambia)

The Centre for Trade Policy and Development’s role and engagement with tax issues:

1. The Centre for Trade Policy and Development (CTPD) is a non-profit making, membership based trade policy think tank which aims to promote equitable, pro-poor trade policies and practices, based in Lusaka, Zambia. CTPD provides analytical research, capacity building and facilitation services in trade and investment sectors to civil society, local private sector, small scale producer groups and government. 

2. We are grateful for the opportunity to contribute towards this important investigation by the International Development Select Committee. CTPD have been engaged on tax related issues 5 years. Our aim is to ensure that the people of Zambia receive tangible benefits for the trade undertaken within the country. Our programme of work in this area promotes accountable and responsive economic governance, particularly in participatory policy reform in addition to investing in the poor as well as the exploitation of natural resources and utilization of public revenue. Through this work CTPD desires to contribute to the affected communities increasing their demand for equitable benefits from exploitation of natural resources.

3. CTPD have been particularly active in relation to issues of mining taxation. Alongside partners from other civil society organisations, we have been actively campaigning for a windfall tax on the mining companies. CTPD have also been very involved with tax issues relating to the Mopani mine, majority owned by the FTSE listed Glencore group. A pilot audit report commissioned by the Zambia Revenue Authority (ZRA) that was subsequently leaked to the Zambian press suggested systematic tax evasion by the company. CTPD has campaigned vigorously to ensure that Mopani pays all the taxes it owes to the ZRA, and was one of five organisations to submit an OECD complaint on this topic to the Swiss and Canadian national contact points.

4. CTPD is a partner of several international NGOs, including ActionAid and Christian Aid. We have also assisted ActionAid in their investigations into the Zambian tax affairs of SABMiller, providing in depth analysis of the implications of the Zambian corporation tax system for multinational companies.

5. In August 2011, CTPD launched the Zambian Tax Platform. The main aim of the initiative is to increase stakeholder engagement and public debate around tax issues in a simplified manner, so as to add value and influence the policy process in Zambia. The Tax Platform also links to other similar networks both locally and internationally. The Platform seeks to link civil society, business and government officials to promote effective tax policy making in Zambia.

Tax and development in Zambia

6. In Zambia, two thirds of the population live below the poverty line. Average life expectancy is 46 and just £15 is spent on each school pupil a year. At the same time, Zambia has recently been officially classified as a middle income country and the country is rich in mineral deposits. It is clear that tax policies, both of the Zambian government, but also of the wider international community, are vital to deliver long term prosperity to the people of Zambia.

7. Taxation has several important functions, including: raising revenue for spending on agreed national and local development plans; influencing the economic behaviour of companies and individuals; and encouraging tax-paying citizens to hold their governments accountable. Combined with economic growth, taxation can help developing countries like Zambia deliver social and economic development and reduce aid dependency.

8. In its 2010 country report on Zambia [1] , the IMF stressed the need for enhanced revenue mobilization, especially from the mining sector. The IMF calculated that Zambia’s revenues and grants total 19.7% of gross domestic product (GDP) in 2009 and its expenditure 22.4%, leaving a gap of 2.7% of GDP to be bridged by financing. Mining taxes total 1% of GDP (this is projected to rise to 2% by 2010, but the gap will still stand at 1.6%). Furthermore, Zambia’s capital spending is low compared to neighbouring countries, and this should rise.

Figure 1: Total revenue and financing for the 2010 budget

Figure 2: Tax revenues in the 2010 budget

Tax and mining companies

9. Zambia’s large mineral reserves are its richest natural endowment. Copper mining is the main source of foreign exchange earnings and an essential part of the country’s developmental plans.

10. There are many ways to tax mining, but these are some of the main ones:

a. Royalties – payable as a percentage of the market value of minerals. These are the principal way governments extract an economic rent for allowing a mineral to be dug out of the ground and removed from the country.

b. Income taxes – employees in the mining sector, like other workers, pay a proportion of the salary in tax through Pay As You Earn (PAYE). When applied to companies, income tax is usually called company tax or corporate tax, and it takes a percentage of the taxable income (i.e. the profit) of the mining companies.

c. Other corporate citizenship taxes will also apply to mining companies in the course of their work, such as customs duty on goods imported into the country, or VAT on goods bought locally. These are sometimes the subject of remissions (exemptions or deductions), as has been the case in Zambia.

d. Companies are often charged withholding taxes on interest, management and consultancy fees, dividends, rent, commissions and payments to non-resident contractors, although these may be the subject of remissions.

e. Export taxes – export taxes can be applied to exports of raw materials as an incentive for further in-country refining and processing

f. Supplementary taxes – such as a windfall tax or a variable profit tax: a higher tax rate sometimes applied to the profits that ensue from a sudden windfall gain. In Zambia a windfall tax was applied to revenues rather than profits – see below. Many countries have imposed varieties of windfall tax, most commonly to oil, but in some cases to mining.

11. Existing empirical evidence continue to show that in spite of the relative importance of the mining sector to the country its contribution to the GDP as well as to promoting inter sector linkages is relatively small. This is due to the detachment of mining from Zambia’s social and economic activities.

12. Zambia’s mining tax regime is strongly focused on attracting foreign investment through low rates and an assortment of incentives. But this needs to be balanced with the urgent need to raise more revenue from mining in order to invest in infrastructure and the country’s economic development. The optimal balance between these two objectives has not yet been struck.

13. The Zambian Revenue Authority has a particular problem effectively administering variable corporate profits tax. It’s a widely held view in Zambia that many large companies effectively chose the amount of corporation tax they wish to pay. Zambia’s most recent EITI disclosures (for 2008, disclosed in 2011) illustrate this: of 16 extractive companies operating in Zambia, only seven reported paying any corporation tax. The total tax paid by these seven companies was 443 billion kwacha (£54 million), which is small compared to the size of the country’s mining sector. In part, this is due to a lack of capacity within the ZRA, but more fundamentally it is a result of the difficulty the ZRA has in enforcing transfer pricing rules.

14. A report by PWC Zambia [2] states that "In Zambia transfer pricing legislation exists. Section 97A of the Income Tax Act introduces the arm’s length principle.… The enforcement of the legislation by the ZRA has however not been as aggressive as expected." Transfer pricing legislation is extremely complex for developing countries to enforce effectively as revenue officials lack access to the necessary information. Much of the country’s mining activities are structured to minimise taxes, for example as branches of companies registered in tax havens.

15. The revenue-based windfall tax, repealed in 2009, is a simpler way to tax windfalls than the existing variable profit tax, which has not yet delivered any revenue. Had it remained in force, the windfall tax could have contributed many hundreds of billions of kwacha to government coffers. Given the limited capacity of the Zambian authorities to assess mining companies’ claims on profitability levels, the windfall tax should be re-introduced, at least until such a time that Zambia is able to administer a profits based tax effectively.

16. Public discontent concerning the lack of revenue generated through mining taxation is fuelled by the secrecy of government relations with mining companies. This needs to be resolved by greater public dialogue on key tax issues. Greater transparency, which assured citizens that companies were making a fair contribution and not shifting profits into tax havens would help to resolve this issue.

17. It is also important to remember that developing the mining sector implies more than attracting foreign investment. The structural transformation of the production side of the economy, including diversification, requires government investment, which requires revenue. In the long-term view, mining copper is not an end in itself, but a means to becoming a more advanced economy.

Example: Grant Thornton’s Pilot Audit Report on Mopani Copper Mines

18. Mopani is the second biggest copper and cobalt producer in Zambia. It operates the Mufulira mine, which is the largest underground mine in Africa and employs 10,000 people.

19. 73% of the company is owned by Glencore, the Swiss based commodities trader, which has recently floated on the London stock exchange. Ownership is via a string of holding companies in well-known tax havens including the British Virgin Islands, Bermuda and ultimately Switzerland. The government of Zambia holds 10%, with the remainder owned by a Canadian company, First Quantum Minerals.

20. A pilot audit report [1] , commissioned by the Zambian government and carried out by Grant Thornton and Econ Poyry, examined mining activities from 2006 to 2008. A draft of the report, described by the Zambian Revenue Authority as which the Zambian Revenue Authority has described as "confidential, preliminary and incomplete" was leaked to the Zambian press in February 2011. Glencore has argued that the report "contains fundamental factual errors" and refuted its conclusions.

21. The auditors found that Mopani Copper Mine "resisted the pilot audit at every stage". The company’s book keeping was incomplete, several legally required documents were lacking and the general ledger analysis showed several loopholes and couldn’t be matched with the trial balance.

22. The report accuses Mopani of selling copper to Glencore in Switzerland at below market price – contravening OECD rules on arms-length pricing and effectively shifting profits from Zambia to Switzerland.

23. According to the report, Mopani hedged its copper sale prices, but "the hedging pattern of Mopani is more equal to moving taxable revenue out of the country than true hedging." Glencore’s freight charges were based on fixed fees to Rotterdam, even when the actual shipments were made to closer ports, artificially increasing shipping costs.

24. The auditors also found what they described as an inexplicable doubling in the operational costs of the company from 2005-7. The mine is loss-making, and Mopani has paid no corporation tax since it purchased the mine from the government over ten years ago.

25. Calculations by ActionAid based on the figures within the audit report suggest that the practices outlined in the report, if correct, would have cost the Zambian government up to £76 million a year in lost corporation tax. That’s more than the £59 million a year the UK government gives Zambia in aid. In addition, the Zambian government would be losing out on dividend payments relating to its 10% share in the company. ActionAid estimates that this would be as much as £30 million a year.

26. In response, Glencore has argued that this was an interim pilot audit and that the rise in costs is a result of Mopani processing copper mined by third parties. However, the audit states that third party transactions were incorporated into its analysis, and that "Mopani have used every opportunity available to hamper the progress of the audit".

27. The auditors stated that "the Mopani cost structure cannot be trusted to represent the true nature of the costs of the Mopani mining operation." Their conclusion was "The pilot audit has shown that there is a high need for a determined effort at collecting the taxes that are assessed under the laws implemented by the Zambian parliament."

28. CTPD has worked closely with communities living near the mine in Mufulira, which have long suffered from the environmental impact of the operations. Sulphur dioxide emissions in the area continue to exceed safe levels. Sulphuric acid used in the mining process has also leached into the water table, with majors incidents in 2005 and 2008.

29. We continue to press the government to resolve the situation, ensuring that Mopani Copper Mines pays the full amount of overdue taxes.

Tax and other multinational companies

30. While mining remains the key export industry for Zambia, there are also significant problems with the taxation of multinationals and large businesses in other sectors of the economy.

31. CTPD advised ActionAid on the Zambian tax affairs of SABMiller. The final analysis in ActionAid’s ‘Calling Time’ [3] report showed that SABMiller avoids an estimated £1.6m in corporation tax in Zambia each year. The company achieves this by making significant payments to subsidiary companies in Switzerland & the Netherlands for management & royalty fees. These fees were 36% of operating profit in 2009.

32. In its response, SABMiller’s Zambian subsidiary (Zambia Breweries) claimed it is regularly audited by the ZRA. This suggests that current international tax rules don’t work for developing countries like Zambia, and that the ZRA has been unable to effectively audit multinational companies like SABMiller. In the meantime, Zambia’s Auditor General, however, has confirmed that it is investigating the allegations.

33. Ultimately, building public faith in the corporate tax regime requires an end to the culture of secrecy around taxation and more communication with civil society and companies. A more effective tax system requires more transparency and information.

Recommendations:

34. DfID should continue to support capacity building for the ZRA.

The ZRA now has more mining accountants than before and a dedicated Mining Tax Unit supported by the Norwegians via NORAD. Audits of some mining companies have taken place for the first time in 2010. The ZRA needs to receive continued support from the Government and donors, including earmarked funding to ensure that strategic improvements are made in the medium to long term. The Ministry of Mines also needs support – its engineering expertise is vital if Zambia is to audit and control mining policy effectively. There also needs to be a better relationship between the institutions involved – the ZRA and respective ministries for mines and finance – so that policy and resources are managed coherently.

35. The UK government should involve African countries in international processes with regard to tax cooperation.

Much of the current progress on tax cooperation has been pushed through the OECD, of which countries like Zambia are not members. A more equitable solution would be to pursue this agenda through the UN, where every state has an equal voice.

36. The UK government should support international progress towards a country-by-country reporting mechanism of key financial information for all multinational companies.

This would provide both ZRA officials and civil society with the necessary information to monitor whether multinational companies are paying their fair share of tax in countries like Zambia, or if significant profits are being shifted into tax havens.

37. The UK government should support developing countries in their efforts to secure multilateral and bilateral tax information exchange treaties, particularly with tax havens.

38. DfID should assist in building the capacity of civil society to monitor hold government and companies accountable for their tax policies and practices.

February 2012