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Tax is an issue of fundamental importance for development. If developing countries are to escape from aid dependency, and from poverty more broadly, it is imperative that their revenue authorities are able to collect taxes effectively. The effectiveness of tax collection can be enhanced in a number of ways, including:
- with respect to the extractive industries, a heavier focus on taxing volumes of extraction or turnover (as opposed to taxing profits), since turnover-based taxation is more difficult to avoid or evade;
- improved collection of personal income taxation, VAT and local property taxation.
Underpinning all this is an urgent need to provide incentives for hitherto unregistered enterprises to join the formal (i.e. taxpaying) sector. Again, there are a variety of ways of doing this. Whilst neither this Committee nor the Department for International Development (DFID) seeks to prescribe policy to developing country governments, DFID should support developing country governments as they attempt to resolve these issues. DFID should also support a broader dialogue around tax policymaking in developing countries.
The capacity of developing country governments to collect tax is not, of course, conditioned solely by the policies which they themselves adopt. On the contrary, global-level regulatory issues play a major role. Requiring tax authorities to exchange information automatically with their counterparts in other countries would constitute a strong deterrent against cross-border tax evasion, whilst requiring corporations to report their financial information on a country-by-country basis would enable irregularities to be more readily detected. In the immediate future, the Government should enact unilateral legislation to achieve both these objectives: in the former case, the relevant section of the US Foreign Account Tax Compliance Act may serve as a model. In the medium term, the Government should also use its influence in international fora to persuade other countries to enact similar measures.
One of the principal forms of cross-border tax evasion is 'transfer pricing abuse.' This occurs when a large corporation (i.e. one with multiple divisions) engages in intra-corporation transactions at non-market rates, with a view to 'transferring' its profits into countries where they will be taxed less heavily (tax havens). The scale of such abuses is disputed, and profits are also transferred for reasons unrelated to tax avoidance, but it is nevertheless a significant problem. To help developing country revenue authorities to detect this, DFID should stress—in its dealings with these revenue authorities—the importance of requiring 'related party transactions' (i.e. transactions taking place within the same corporation) to be declared on annual tax returns.
Since there is a risk that its revised Controlled Foreign Companies rules will encourage the transferring of profits into tax havens, the Government should conduct an analysis of the likely financial impact on developing countries. Depending on the outcome of this analysis, it should consider dropping its proposals. More broadly, the Government should be required to assess any new primary or secondary UK tax legislation against its likely impact on revenue-raising in developing countries, and should designate a DFID ministerial responsibility for the development impact of tax and fiscal policy.
The Extractive Industries Transparency Initiative (EITI), founded in 2002 by the UK Government, is an excellent tool for identifying corruption. However, if the Government hopes to persuade more developing countries to take part, it must be willing to lead by example by becoming an EITI candidate itself. Additionally, we recommend that the Government support a further broadening of EITI in the coming years, under which participating companies and governments be required to publish the contracts which exist between them. Such transparency would allow any contracts which are patently unfair to be identified as such.
DFID provides technical assistance to national revenue authorities in developing countries, as well as providing funding for technical assistance delivered by HM Revenue & Customs (HMRC). Much of this work has been greatly successful: DFID's work in Rwanda is just one example. We recommend that DFID scale up its technical assistance work with developing country revenue authorities. HMRC should also be provided with additional funding to enable it to do likewise.
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