Tax in Developing Countries: Increasing Resources for Development

TAX 32

Written evidence submitted by Christopher Lenon, Tax and Fiscal affairs Committee of the Business and Industry Advisory Committee to the OECD

Executive Summary

The role of taxation in transforming developing countries in the 21st century is a key challenge. Government civil society and business are all agreed on this. While transparency is a key enabler for developing country societies to ensure that government revenues are being spent on government services, the core issue to address is building the capacity of tax administrations in developing countries to manage tax policy, administration and collection. Aid budgets should have a key role to play in facilitating this (a role that to date has not been a priority) and donors should specify a target % of the aid budget which should be spent in this way, which significantly exceeds the current 0.7% average (source OECD).

Capacity building for tax administration/revenue institutions is the most important and fundamental infrastructure development for developing countries to move from aid to sustainable revenue to fund government expenditures. The transformation of lives in developing countries will not be achieved without these revenues.

Introduction

My name is Christopher Lenon, I am Chairman of the Tax and Fiscal affairs Committee of the Business and Industry Advisory Committee to the OECD (BIAC) and have held this role since April 2010. I am the lead business representative on the Tax and Development Taskforce established by the OECD in 2010 and participate in the subgroups on i) State building, Taxation and Aid , ii) Transfer Pricing and iii) Transparency. BIAC is working with OECD to establish a group of business experts in the field of transfer pricing to work within the OECD Capacity Building project for Developing Countries.

Prior to my current role I was Global Head of Tax for Rio Tinto plc based in London from 1993 to 2010. In that role, I managed the tax affairs of one of the largest global Mining companies. My experience of Tax in Developing Countries includes Brazil, Chile, South Africa, Namibia, Zimbabwe, Madagascar, Guinea, Indonesia, Malaysia,Mongolia and Papua New Guinea. I helped to develop the disclosure which Rio Tinto makes of its tax payments which developed from its participation in the Extractive Industries Transparency Initiative (EITI).

Given that the Committee is using Zambia as a case study, I should state that I have no direct experience of Zambia or the mining sector in Zambia. I have made some observations in my evidence from publically available information.

Comments

An important recent advance in the development agenda has been the insight that tax, and a functioning tax system, are understood as perhaps the key factor to support sustainable development rather than Aid. Current estimates indicate that 0.7% of Aid worldwide is spent on developing the capacity of tax administration revenue institutions in developing countries. Business has proposed that a higher target percentage of Aid should be spent in this way by all Aid donors (including the UK government and the EC). Business has an important and positive role to play in this sphere through technical assistance for capacity building, and through investment in developing countries.

Aid flows will continue to play a strong part in addressing these domestic challenges, but aid alone will not bring about the required changes that are needed to boost strong, sustainable and balanced growth in these countries. The required gearshift in development will only happen as a result of also mobilising the foreign and domestic private sectors in order to boost their investment in infrastructure, agriculture, and other economic sectors, and through developing countries reaping the some of the benefits of that growth through functioning tax systems.

The private sector can play an important role in capacity building and domestic resource mobilisation, as it relates to taxation. As a first step, there has to be a predictable and attractive enabling policy framework in place to inspire market confidence and to attract private sector investment which generates tax revenues for countries. This entails: rule of law; clear, predictable and transparent legislative frameworks; open competitive markets for trade and investment; fiscal transparency; human resources development; good governance; anti-corruption; fair competition policy; and so on – issues relating to taxation should be considered in this context as well as the broader policy context. Bringing together both public and private sectors, such as via public-private partnerships and leveraging aid for attracting private investment, will be essential in order to generate the necessary financing for development while reducing risks for investors.

Capacity building for tax administration/revenue institutions is the most important and fundamental infrastructure development for developing countries to move from aid to sustainable revenue to fund government expenditures. By creating an environment which fosters investment (at all levels) it enables countries to benefit from inbound investment, greater economic growth and local economic activity in the country. It is a basis to develop the public infrastructure and services and a social benefit system in a sustainable way. It is an important tool in the eradication of corruption by funding public service salaries on a sustainable basis, and facilitates the transformation from informal to formal economies.

Good governance is a prerequisite for successful capacity building for revenue institutions. Transparency and accountability must apply to governments and business alike. To help facilitate this, aid should be allocated to provide support for the infrastructure which is required to establish and maintain a modern tax administration. Based on UK experience, this includes the hardware and software that a tax administration needs and the training and salaries to staff an effective administration.

Development activities related to tax must include active engagement of developing countries in dialogue towards adoption and continued development of international tax standards by developing countries. Adoption of accepted international tax standards by developing countries will contribute to predictable and more certain investment environments and is an important part of capacity building for tax administrations.

As my comments above indicate, I believe that the link between taxation and development isfundamental, however, the inclusion in the terms of reference of an estimate of $160bn of annual tax revenues lost by developing countries due to alleged tax avoidance by multinational companies is unhelpful. Business does not recognise this figure and questions have been raised over both the analytical method and data used to arrive at this number , together with the definition of "developing countries".

I would also question the particular concern with "the extractive industries where payments to governments are often not disclosed and may not contribute to development or poverty reduction". Many multinationals (61 companies) are signatory to the EITI which was established in 2003 and have provided voluntary reporting of tax and wider economic contributions for a number of years. The International Council for Mining and Metals (ICMM) was established in 2001 to improve sustainable development performance in the mining and metals industry and has 21 mining and metal companies as members. Unfortunately, fewer countries have signed up to the EITI principles (11 countries of which Norway is the only OECD member, although the US and Australia have indicated they will sign .The UK is not a signatory). There are 23 "candidate countries" which include Zambia.

The criteria for full participation are:

Regular publication of all material oil, gas and mining payments by companies to governments ("payments") and all material revenues received by governments from oil, gas and mining companies ("revenues") to a wide audience in a publicly accessible, comprehensive and comprehensible manner.

Where such audits do not already exist, payments and revenues are the subject of a credible, independent audit, applying international auditing standards.

Payments and revenues are reconciled by a credible, independent administrator, applying international auditing standards and with publication of the administrator’s opinion regarding that reconciliation including discrepancies, should any be identified.

This approach is extended to all companies including state-owned enterprises.

Civil society is actively engaged as a participant in the design, monitoring and evaluation of this process and contributes towards public debate.

A public, financially sustainable work plan for all the above is developed by the host government, with assistance from the international financial institutions where required, including measurable targets, a timetable for implementation, and an assessment of potential capacity constraints.

The EITI is based on "the principle and practice of accountability by government to all citizens for the stewardship of revenue streams and public expenditure ". It is necessary to put in place a sensible assessment of the role of transparency/disclosure in driving development as it relates to international business taxation. Any standards must have a clear development objective, and should work towards one common global standard. The various initiatives for extractive industries should be tested and evaluated before consideration of whether any wider steps are appropriate. Transparency should be considered in the context of how it may contribute more to the integrity, efficiency and effectiveness of tax collection on the part of revenue authorities.

Turning to the issues identified:

How can DFID better support developing countries to improve revenue collection?

Tax policy must be adapted to the practical challenges of tax collection and administration. These challenges are best understood by Tax Administrations and the two best forms of support which can be provided are a) sharing the experience of HMRC and b) facilitating south-south cooperation between developing country tax administrations. DFID should be the enabler for this programme but HMRC should have the lead role in this programme given its expertise. As stated above, a greater percentage of the Aid budget (and not the HMRC budget) should be spent on this area. Private companies are willing to engage with tax administrations to promote practical improvements in tax collection.

How can DFID support developing countries to use the revenue base responsibly in order to improve service delivery and development outcomes?

The key challenge to the use of the revenue base is transparency in how government revenues are spent. A sub set of this is, of course, the eradication of corruption and in particular the diversion of government revenues for personal gain. The EITI provides for the disclosure of how government revenues are spent and this model of disclosure should be encouraged on a wider basis. Should the UK ( and other donors) make aid dependent on the disclosure of how government revenues are spent based on an international standard? Should the UK (and other donors) make aid dependent on countries signing up to the EITI within a specified timeframe?

Tax evasion and Avoidance in Developing countries by private individuals and companies

As I have stated above, the key enabler for a robust tax system in developing countries is a focus on the capacity building for tax administration and collection. The robustness of the tax system can be judged by how effective it is in taxing the country’s elite, the informal economy and companies. The taxation of all of these sectors are important in establishing that the tax system is robust and fair. Capacity building must include training and paying the personnel well and having the right hardware and software to support a modern tax administration.

How effective internatonal efforts to promote tax disclosure and transparency are likely to be?

I have described the EITI in some detail as this is the only operating system of disclosure of taxes. Both the SEC in the US and the European Commission have current proposals for transparency requirements. Business believes that the EITI should be used as the model for disclosure and that more countries should be encouraged to participate. The debate has moved on in the EU and US to whether mandatory rules for disclosure of payments to governments are necessary. A global standard could have advantages in creating a level playing field for the extractive industries. So where such rules are envisaged, we believe governments should work together to adopt a consistent comparable approach, which establishes disclosure requirements and thresholds that are proportionate.

Transparency should be judged in the context of how it may contribute more to the integrity, efficiency and effectiveness of tax collection on the part of revenue authorities. The priority objective should be capacity building for tax administrations and while transparency is important is should be an enabler supporting this objective not an aim in itself.

Capital flight and its implications for developing countries

Capital flight is largely associated with local elites in developing countries. The primary weapons in addressing capital flight are robust exchange of information treaties and procedures between developing countries and low tax jurisdictions. The OECD is working on this through a global forum. This is the right mechanism and future work should focus on increasing the coverage and operational effectiveness of the exchange of information.

Zambia and the Mining Industry

As I have stated above, I have no direct experience of either Zambia or the mining Industry in Zambia. It is worth understanding the history of the industry and what follows quotes from an EITI report.

"From the late 1960s to the early-1990s mining in Zambia was dominated by the State owned Zambia Consolidated Copper Mines (ZCCM). ZCCM was

established not only to ensure that the people of Zambia were the primary drivers of the main revenue earning industry in the country, but also to act as a parastatal organization which provided services significantly beyond that typically delivered by a major mining enterprise. At its height ZCCM provided – in addition to its core operations – hospitals, schools, housing, utilities (electricity and water), and funding for youth groups and sports teams. It was far more than just a company – it was the heart of the social and economic development of the Copperbelt Region.

Copper production has varied immensely over time – from a high of

750,000 tonnes of copper in 1973 to a low of 227,000 tonnes in 2000.

In 2010 a total of 720,000 tonnes of copper was produced. The international price of copper has fluctuated significantly over this period of time.

Under-investment and low copper prices eventually lead to a massive decline in production by the mid 1990s ZCCM became a loss making enterprise. Against this backdrop, as well as programs of broader economic reform and privatization, ZCCM was broken up and privatized in the late-1990s and early-2000s. At the time copper prices were extremely low, and the mines themselves in need of significant new investment. In order to attract investors the Government of Zambia (GRZ) negotiated a series of mine development agreements with what were (for investors) comparatively attractive levels of taxation, royalties, and conditions for depreciation of capital investment. The GRZ has maintained stakes in virtually all of the mines through ownership of 87% of the shares of ZCCM’s successor company – ZCCM Investment Holdings (ZCCM-IH), which is publicly listed in both Lusaka and London.

The ownership and levels of production of the mines currently producing in Zambia is

Chambishi Metals 10% ZCCM-IH

Chibuluma Mines 15% ZCCM-IH

Kansanshi Mines 20% ZCCM-IH

Konkola Copper Mines 49% ZCCM-IH

Luanshya Copper Mines 10% ZCCM-IH

Mopani Copper Mines 10% ZCCM-IH

NFC Africa Mining 15% ZCCM-IH

New foreign investors have shown significantly less interest in taking

responsibility for the non-core-business services which ZCCM provided to the

population. At the same time the GRZ has in some cases not been able to

adequately fill the gap in the provision of social services left by the break-up of

ZCCM.

Following significant investment in mines by new owners, as well as a more than quadrupling of copper prices, the Zambian mining industry is now – in terms of both the amount and value of production – booming.

In terms of transparency, ZCCM-IH stated that as a company quoted on the Lusaka and London stock exchanges, it is required to produced annual audited financial statements which are disclosed to numerous institutions (the Companies Registry, the Auditor General, the Securities and Exchange Commission, etc.), and thus access to this data was more a question of making the information held by these institutions more accessible, rather than a need to actually disclose the data. Other companies were barred by confidentiality clauses in their development agreements from disclosing the level of payments made to government. Many companies noted that their contracts were with the government, and thus they would only disclose information to the government – not to the general public. Some companies noted that as joint stock companies they would need permission from all of their board members (which in virtually all cases includes the Zambian

Government in the form of ZCCM-IH and MMMD) to disclose this kind of

information.

The result is increasing pressure on both companies and government to renegotiate the terms under which companies operate so that the people of Zambia are able to benefit from the boom."

Capacity building in tax policy, administration and compliance would be the key priority in addressing these issues.

Recommendations for Action

Aid Funding :The key priority is to build the capacity of tax administrations in Developing Countries. A higher target percentage of Aid should be spent on developing the capacity of tax administration revenue institutions in Developing Countries by all Aid donors (including the UK government and the EC).

How to facilitate: Tax policy must be adapted to the practical challenges of tax collection and administration. These challenges are best understood by Tax Administrations and the two best forms of support which can be provided are a) sharing the experience of HMRC and b) facilitating south-south cooperation between developing country tax administrations. DFID should be the enabler for this programme but HMRC should have the lead role given its expertise. A greater percentage of the Aid budget (and not the HMRC budget) should be spent on this area.

UK government support for EITI: The EITI provides a framework for shared transparency by Governments and Companies which is in place. The UK should support this initiative by:

a) Participating as a country

b) Considering making aid conditional on countries participating in EITI

Reducing capital flight : The UK should provide active support to the expansion of exchange of information treaties and processes between Developing and low tax jurisdictions to reduce capital flight opportunities.

February 2012