Executive summary

The failure to collect adequate levels of tax in developing countries is a major concern. Fear of corruption and absence of the rule of law are probably the biggest obstacles to effective tax administration in developing countries, along with lack of administrative expertise and/or lack of understanding of the broader international tax and reporting context in which multinationals operate. Measures to improve governance, strengthen the rule of law and develop expertise are at least as important to effective tax administration as any tax-specific measures.

We commend the UK Government’s existing support for capacity building of tax administrations in developing countries and would like to see its expansion made a priority.

In improving tax systems in developing countries, the key is to build simple and robust taxes. Developed countries should be cautious in imposing our own thoughts and standards: what is necessary and works well in highly developed countries may not be necessary nor work effectively elsewhere.

There is an absence of reliable estimates of the extent of transfer mispricing or of other abusive or illegal practices by business in developing countries. We would like to see more work done in this area using individual country and firm data.

Existing transfer pricing rules and international co-operation agreements are sufficient to enable a country’s tax authority to assess the correct level of taxation due in its territory, if it has the necessary expertise and capacity. Country-by-country reporting would create additional administrative costs for business without producing the benefits some anticipate.

Supporting developing countries to improve revenue collection

The CIOT agrees that failure to levy and collect tax in developing countries is a major concern. We note the finding that, as a result of insufficiently sophisticated tax administration structures and processes, many developing countries capture only 40 per cent of their tax potential, compared to around 90 per cent for industrialised countries such as the UK. [1] It is critically important that developing nations can maximise their tax revenues to break the cycle of dependency and poverty.

An effective tax collection structure requires:

· competent, knowledgeable tax administrators with sufficient capacity to carry out their work;

· well-managed and comprehensive tax record systems;

· tax laws which are transparent and command broad public support;

· collection mechanisms which are not disproportionately burdensome on taxpayers or tax collectors;

· levels of corruption kept to a low level;

· the rule of law, including independent mechanisms to resolve disputes between taxpayers and the authorities; and

· access for taxpayers to affordable, professional, independent tax advice.

The UK Government, through HM Revenue and Customs, HM Treasury and the Department for International Development, already provides capacity-building support for tax administrations in developing countries. This includes sending staff on secondment to developing countries as well as a range of techniques for spreading good practice. We are aware of the particular success of work to help Rwanda improve its tax administration. We pay tribute to this important and valuable work and would like to see its expansion made a priority. [1]

The need for a legal framework

Developing countries benefit from the establishment of legal frameworks to enable their tax administrations to work together. There is a particularly obvious need for African tax administrators to work together. We therefore welcome the formation of the African Tax Administration Forum (ATAF) in 2009 and the support the UK Government has given to it.

Anecdotal evidence from tax advisers suggests that corruption and the lack of effective rule of law may be the biggest obstacles to effective tax administration – and to wider economic progress – in developing countries. Perceived bribery and corruption are not only denying governments much-needed revenues and undermining faith in tax systems, they are also deterring potential inward investors from investing in such countries. The objection is less to the total cost of doing business than to the unethical behaviour required and above all the sheer uncertainty of the costs of doing business. As one CIOT member explained of his client who decided not to invest in a particular country: 'He was perfectly happy to pay the right rate of tax. He didn’t want to have to pay bribes and be left at the whim of local officials.' Measures to improve governance and strengthen the rule of law are at least as important to effective tax administration as any tax-specific measures.

Transfer pricing and paying taxes

We believe that internationally observed transfer pricing rules, based on the ‘arms length’ principle, are a substantial achievement for international co-operation under the auspices of the OECD and that they work in the interests of developing and developed countries alike. Properly applied, these rules should enable the correct amount of profits to be attributed to the activities of multinational companies in any country, developing or otherwise. Ensuring that international rules continue to operate in this area, and working to enable all countries to police them as robustly as possible, is an important way that the UK government can help developing countries.

Governments in developing countries can also increase their tax take by making it easier for people to pay taxes. We note the finding of the PwC/World Bank report, Paying Tax 2012, that: 'Paying taxes is easiest in high income economies, while only 22% of low income economies are in the first or second quartile for the overall ranking.'

Many countries could usefully reduce the frequency and variety of tax payments. We would encourage greater use of widely available technology for payment and collection of taxes in developing countries. We are aware that Botswana and Nigeria are working on systems to do this using mobile phones.

The place of the tax profession

A functioning tax advisory profession is an important part of an effective tax compliance regime. In developed countries such as the UK, professional tax advisers assist people in paying the right amount of tax and take a lot of the administrative work out of the hands of the tax authority. However, they depend on an efficient fiscal authority whose officials operate within the law and taxpayers who wish to comply with the law.

The CIOT, through its relations with tax institutes in other countries and through the International Tax Directors Forum, seeks to support the development of the independent tax advisory profession across the world, including in developing countries, so far as its resources allow.

Using the revenue base responsibly in order to improve service delivery and development outcomes

In general, we believe the UK and other developed countries should be cautious in imposing our own thoughts and standards on developing countries. The aim should be simple taxes that are understood and easy to comply with and police. Complex targeted incentives may well be counter-productive. VAT has considerable merits as a replacement for many-layered sales taxes and can be argued to have competitiveness advantages compared to direct taxes, but it imposes an administrative burden on businesses (as, indeed, do sales taxes). The prime objective must be a simple system to administer and collect.

Some argue that developing countries, which typically have relatively unsophisticated and under-resourced tax authorities, should aim to tax turnover rather than profits. This is on the basis that turnover is generally more accurately measured and reported, less easy to manipulate, and easier to verify during enquiries (though there are also accounting and broader international tax disadvantages to this approach).

Developing countries are also often generous – arguably more so than they need to be – when it comes to offering tax incentives to new businesses. For example, many offer extensive tax holidays, which are simultaneously open to abuse [1] and often not as appealing to multinational firms as they first appear [2] . It seems to us that there is little obvious link between the generosity of incentives offered and the value of new business attracted in to developing countries.

In terms of setting tax levels, there is clearly a balance to be struck between raising sufficient revenue to run public services and provide infrastructure on the one hand, and not driving away international investment by setting penal tax rates [1] . This is obviously a decision for the individual countries involved, but we note that there is increasing evidence that the governments of these countries, including Zambia, feel they are in a position of strength with regard to multinational companies, especially in the extractive industries sector, and are seeking to raise their tax take from this sector. [2]

Extent of tax evasion and avoidance in developing countries

Most of the debate around tax avoidance by multinational companies in developing countries has focused on possible abuse of transfer pricing – the rules governing movement of goods and services between the divisions of a multinational company and between companies in the same multinational group. Abuse of these rules can occur by the sale of goods and services from one part of the group to another at a price which is either inflated or deflated. By transferring goods and services to a subsidiary in a low-tax jurisdiction before their final sale, companies can reduce their tax liability and increase their profit. While there are rules against mispricing, this can be hard to prove, even for tax administrations in developed countries.

It is difficult to estimate reliably the extent of transfer mispricing or of other abusive or illegal practices by business. The figure of $160 billion of tax lost to developing countries from avoidance has been widely quoted. However, the analyses of trade mispricing which have produced this figure are at best highly questionable [1] . The first [2] was based on a ballpark estimate (based on anonymous interviews with company purchasing managers in developed countries) that seven per cent of trade is mispriced and the application of this figure to total trade volumes and tax rates for low and middle income countries. The vast majority of the loss from mispricing was attributed to middle income countries (a category which includes international trade giants such as China, Brazil and Russia) rather than low-income countries, who made up only one seventh of the total.

The second analysis [1] was more sophisticated and used US and EU trade data in an attempt to calculate the normal price range for products traded between countries, and estimate the amount of capital shifted by trades outside that range. Unfortunately this analysis also had a number of flaws, including comparing prices between very different types of goods (laptop components and nuclear power stations is perhaps the most eye-catching example). One conclusion was that the two biggest ‘losers’ to mispriced transfers into the UK are the US and Japan. Given their reputation as among the most aggressive transfer pricing jurisdictions, this lacks plausibility. [2]

A further difficulty with this analysis was that it dealt with all transfers, including those between unrelated parties, as well as those within a multinational group. While trade between related companies could conceivably be manipulated for tax purposes, the same is not true of trade between unrelated parties, though money laundering or other criminal activity such as bribery remain possibilities. Again, this points to the importance of building robust tax authorities and strengthening the rule of law generally in developing countries.

The absence of reliable estimates of the extent of tax losses to developing countries from evasion and avoidance is clearly a hindrance to work in this area. We share the conclusion of two economists from the Oxford University Centre for Business Taxation who have analysed the various studies in this area, that more work be done in this area using individual country and firm data. [1] With this in mind we welcome the decision of the Committee to focus its inquiry on Zambia.

Tax disclosure and transparency

Getting the right balance of information publication without imposing undue administrative burdens on business is important. The CIOT believes that existing transfer pricing rules and international co-operation are sufficient to enable a country’s tax authority to assess the correct level of taxation due in its territory. If this is not happening, we suggest the solution is to increase the resources available to the local tax authorities and ensure they are properly trained to use the information currently available. This would be more effective than imposing additional burdens and costs on multinational companies to produce more information that the authority is incapable of using.

We believe that Tax Information Exchange Agreements (TIEAs) are an effective and proportionate way of delivering the transparency, regulation and information exchange that is needed. Again there is a need to ensure the tax authority has the capacity to ask for the right information and use it. We also have some concerns around data security when it comes to exchanging sensitive financial information with countries which lack the UK’s safeguards. We encourage the UK Government to make the provision of such safeguards a part of its capacity building work.

One particular proposal which has been put forward is country-by-country reporting. While superficially appealing, our view is that country-by-country reporting would create a substantial additional administrative cost for business without producing any of the benefits that its supporters assume would arise. Requiring global companies to produce, and have audited, detailed profit and loss figures for every country in which they operate, would be expensive and time consuming (especially given that some jurisdictions do not oblige them to do so as a matter of course – and most do not require a company to separately identify social security contributions or irrecoverable VAT, for example). It would make company accounts, already overlong, even more unwieldy. Additionally, it is not possible to assess from accounting information whether taxes paid in a particular jurisdiction are "correct" – there are many legitimate reasons why taxes might seem low compared to profits, including reliefs, utilisation of losses and tax holidays.

In our view, the best way to tackle corruption and perceived transfer pricing abuses is to equip national tax authorities (especially in developing countries) with the necessary capacity and skills to design and police effective tax systems. This would include imposing disclosure requirements relevant to their tax systems, just as happens in developed jurisdictions.

The extractive industries sector is in some ways a special case. For this reason the Extractive Industries Transparency Initiative (EITI) is deserving of support, as an attempt to increase transparency over payments by companies to governments in resource-rich areas. We do not see the EITI as primarily a tax-related measure, although of course bribes and other corrupt payments are unlikely to be subject to tax so reducing corruption should lead to increases in tax revenue. We note, however, that the EITI’s coverage is patchy and concerns have been expressed that companies that have signed up to EITI principles may find themselves at a competitive disadvantage to those that have not. Once again, the long term solution has to be strengthening the rule of law, the capacity and expertise of the tax authority and improving democratic government accountability.

The Chartered Institute of Taxation

The Chartered Institute of Taxation (CIOT) is a charity and the leading professional body in the United Kingdom concerned solely with taxation. The CIOT’s primary purpose is to promote education and study of the administration and practice of taxation. One of the key aims is to achieve a better, more efficient, tax system for all affected by it – taxpayers, advisers and the authorities.

The CIOT’s comments and recommendations on tax issues are made solely in order to achieve its primary purpose: it is politically neutral in its work. The CIOT will seek to draw on its members’ experience in private practice, Government, commerce and industry and academia to argue and explain how public policy objectives (to the extent that these are clearly stated or can be discerned) can most effectively be achieved.

The CIOT’s 15,600 members have the practising title of ‘Chartered Tax Adviser’ and the designatory letters ‘CTA’.