House of Commons - Tax in Developing Countries: Increasing Resources for Development

Tax in Developing Countries: Increasing Resources for Development - International Development Committee Contents

2 Country-level tax policy

Forms of taxation

7. The appropriateness of a tax policy will always depend upon the precise circumstances of the country concerned; determining the tax policies of developing countries is a matter for the governments of the relevant countries. Nevertheless, if we are to assess DFID's work on tax collection, we must begin by understanding the tax regimes of the countries in which it works. Table 3 sets out the respective importance of different forms of taxation in various Sub-Saharan African countries in 2008:Table 3: forms of taxation (% of GDP)

Botswana Namibia Nigeria South Africa Zambia

Total revenues (including non-tax revenues) 35.1 31.8 12.3 26.9 18.6

of which: revenues from extractive industries 13.8 3.2 10.3 data not available 1.4[8]

Total tax revenues 21.6 29.4 12.3 26.3 17.5

of which: income tax 7.9 10.1 0.8 16.0 8.5

of which: VAT and sales tax 3.6 5.9 0.2 7.2 4.0

Source: IMF Article IV Reports. The figures from extractive industries revenues include revenue sources such as mineral royalties, which are regarded as non-tax revenues. These figures have been derived from IMF taxation data, and may be underestimates.

The remainder of this section aims to set out the advantages and disadvantages of each major form of taxation, drawing heavily on our case study of Zambia.

NON-CORPORATE TAXATION

Personal income taxation

8. In his oral evidence to us, Dr Jonathan Di John reported that "in countries that do collect a lot of income tax, most comes from the PAYE system, so salaried workers contribute the vast majority of personal income tax".[9] We understood him to be implying that High Net Worth Individuals (HNWIs), who are often self-employed, may be relatively under-taxed). In the case of Zambia, however, Dr Di John acknowledged that "Zambia is one of the better tax collectors in sub-Saharan Africa: its tax collection is 17% or 18% of GDP, and it collects, relatively, a fair amount of personal and corporate income tax, especially personal income tax."[10]

If developing countries are to improve their collection of tax revenues, it is imperative that elites within those countries pay the correct amounts in personal income taxation, and—critically—are seen to do so.

VAT

9. VAT is the principal form of indirect taxation—i.e. taxation levied on consumption rather than on income. Certain NGOs have raised concerns surrounding its allegedly regressive nature.[11] As an example, Christian Aid argued that VAT "can be very regressive in terms of putting high cost on very low income earners."[12] Christian Aid do, however, recognise that this problem can be resolved by exempting key items from VAT (or 'charging VAT at zero rate' on such items)[13]. Moreover, as highlighted by Professor Mick Moore, Professorial Fellow at the Institute of Development Studies:

Local taxation

10. In its written evidence, the International Centre for Tax and Development (ICTD) argues that—whilst there has been considerable progress in building the capacity of national tax authorities—there has been relatively limited focus on taxation at regional and local levels. It claims that this represents a missed opportunity to enhance the autonomy and decision-making power of local authorities, and to make them more accountable to the public.[15] Additionally, in many countries including Zambia, local government is increasingly responsible for the delivery of services, but lacks adequate resources to meet these responsibilities.[16]

11. Local property taxation not only provides a valuable source of revenues for local governments; it also requires the development of land registries. Land registries lead to improvements in the security of property rights,[17] and enable people to use property as security against loans: the Committee was particularly impressed with DFID's work on land registries in during its visit to Rwanda in 2011. The Department told us that the UK Land Registry had signed up to iFUSE,[18] a scheme facility under which UK public bodies provide technical assistance to their developing country counterparts:[19] we warmly welcome this development.

12. During our visit to Zambia, we were told that Mopani Copper Mines, which is majority owned by Glencore, was in dispute with the Municipal Council of Mufulira in respect of its local property tax bill. It was clear that the company's relationship with the local community had been damaged by the dispute, and we hope it can be resolved swiftly.

13. In many developing countries, there is considerable room for improvement in the collection of non-corporate taxation. Given its usefulness in promoting land registries, an increased focus on local property taxation is likely to be especially fruitful. DFID should seek to support the national revenue authorities of developing countries as they attempt to improve the collection of personal income taxes, VAT and local property taxes. DFID should also encourage and support programmes that engage civil society and trade organisations, academics, journalists and parliamentarians in the tax policymaking process.

CORPORATE TAXATION

14. Corporate taxation represents an important source of government revenues. In setting their corporate taxation policies, governments must seek to strike a balance between the need to raise sufficient revenues, and the need to attract investment. Bearing this in mind, governments must decide on their preferred corporate tax rate, and must also decide whether to offer any tax incentives. Tax incentives divide opinion: some focus on their adverse impact in terms of tax revenues foregone,[20] whilst many businesses consider them as a useful incentive to invest.[21]

15. Whilst tax incentives can be useful if applied appropriately, arbitrary tax exemptions are generally damaging. Professor Mick Moore suggested to us that in many African countries, revenue authorities granted tax exemptions worth around 5% of GDP, which may be up to one-third of total tax revenues.[22] ICTD told us that 'tax holidays' for new companies were often manipulated, citing the example of existing hotel / tourism companies which 're-constitute' under a new name so as to ensure their continuing eligibility.[23]

16. Our case study of Zambia allows us to explore these issues in more detail. Prior to 1997, the Zambian mining sector was nationalised, with the mines operated by the state-owned Zambia Consolidated Copper Mines (ZCCM).[24] Between 1997 and 2004, the mines were privatised[25] (though ZCCM Investment Holdings, the successor company to ZCCM, is 87% state-owned and retains a minority shareholding in the mines).[26]

17. It is clear that private investment in the mining industry has brought many benefits to Zambia. We visited two mines in Zambia, one run by Mopani Copper Mines and one run by Konkola Copper Mines. Mopani Copper Mines employs 8 300 people, with another 8 000 contractors working on site. In a country where the national minimum wage is US$81 per month, even the most junior of Mopani employees earns US$508 per month.[27] We were informed that both companies also operated schools and healthcare facilities.

18. However, whether the mining industry contributes an appropriate level of tax revenues is less clear. At privatisation a highly business-friendly tax regime was implemented.[28] During a meeting held at the Zambian Ministry of Finance, we were told that 'Development Agreements,' including preferential tax terms, had been signed—initially with two mining companies, and subsequently with several more. By 2004, we were told, those mining companies which did not have development agreements had become resentful of those which did. The Government thus decided to 'level the playing field' by extending the same tax incentives to all mining companies.

19. By 2008, as Figure 1 indicates, the copper price had risen to an all-time high:

Figure 1: Copper prices

Data source: IMF data. Refers to LME spot price for copper (grade A cathode), CIF Eiropean ports.

Thus the profitability of the mining industry had increased. However, as a result of the tax arrangements it had made, the Government gained very little in terms of corporate tax revenues: copper exports stood at $2 billion per annum, yet tax revenues from these were only $30 million: an effective tax rate of 1.5%. Paul Collier has highlighted that according to World Bank estimates, if the Zambian tax regime had been akin to that of Chile (the other major copper exporter), tax revenues from the industry in 2008 would have been closer to $800 million.[29] We note that Chile is a more mature economy than Zambia, but this example still demonstrates the potential for Zambia to increase the amount of tax it collects from the industry.

20. In 2008, the Government abolished the Development Agreements,[30] and introduced a new tax regime. As well as introducing a new variable profits tax, this regime focused much more heavily on turnover-based taxation, i.e. taxing turnover rather than profits. Whilst turnover-based taxation may be perceived as less progressive than profit-based taxation, we were told during our visit that the former is much easier to collect (more difficult to avoid or evade). This is because profits can be shifted into low-tax jurisdictions (as discussed elsewhere in this report), whereas turnover cannot. In the case of the copper industry, turnover is relatively simple to verify, e.g. by multiplying the price of the raw material (as per the London Metals Exchange, or LME) by the quantity produced—though systems must be in place to ensure that physical quantities can be accurately measured.[31] In the case of minerals whose price is not listed on the London Metals Exchange, of course, verifying turnover poses a greater challenge.

21. The 2008 tax regime expanded turnover-based taxation in two principal ways:

· It introduced a windfall tax, rates of which were to be determined by the LME copper price. (Indeed the tax did not apply at all if the copper price was below $2.50 per pound.)[32]

· It increased the mineral royalty rate from 0.6% to 3%.[33] (The mineral royalty is calculated as a simple percentage of total turnover, with the LME price used to verify turnover as explained above.)

22. The windfall tax, however, was considered by the mining companies to be overly punitive: some claimed that they were under no obligation to pay, citing a 'fiscal stability clause' in the now-abolished Development Agreements.[34] Ultimately the windfall tax was abolished in 2009;[35] the mining companies who had disputed its legality finally paid their arrears in 2011.[36]The unpopularity of the windfall tax amongst mining companies, and its consequent failure, was attributed largely to flaws in its design: the thresholds should have been set higher, whilst the amounts paid should have been deducted from companies' taxable profits before the regular corporate tax was charged.[37]

23. During our visit, we were told that—following a change of government in September 2011—the new Patriotic Front (PF) Government had come under considerable pressure to re-instate the windfall tax. Thus far it has resisted; it has, however, increased the mineral royalty rate from 3% to 6%.[38]

24. Our case study of Zambia thus provides an insight into the thorny issues which surround corporate taxation. We recognise that turnover-based taxation is a blunt instrument, and in countries where the revenue authority has sufficient capacity to enforce a profit-based taxation regime, turnover-based taxes should not be used. However, for many revenue authorities with lower levels of capacity, imposing a turnover-based tax may be the only reliable method of collecting corporate taxes. In these circumstances, turnover-based taxes are most valuable.

25. For reasons of transparency, it is highly desirable for corporations' annual audited accounts to be made readily available to citizens and civil society organisations in the countries in which those corporations operate. In the case of Zambia, accounts are—in theory—available to the public on request, for a fee of around $4. However, there is some disagreement as to whether this happens in practice. For example, whilst Mopani Copper Mines assured us that its accounts had been made available in accordance with regulations,[39] ActionAid tells us that it and its partner organisations have been unable to access the accounts.[40] Thus there appears to be something of a bottleneck. We urge DFID to stress—in its dealings with the national revenue authorities of developing countries—the importance of making corporate accounts available to the public. In Zambia, to test the allegations that the process is not working at present, DFID should request access to the accounts of some of Zambia's main corporations, using channels available to the ordinary Zambian citizen. In its response to this report, the Government should notify us of the outcome of these requests.

26. The Government should encourage the OECD and other standard-setting fora to require the filing of public statutory accounts in all jurisdictions. The Treasury should also press Crown Dependencies to meet these standards.

Broadening the tax base

27. In many developing countries, informal economic activity—i.e. economic activity which falls outside the tax 'net'—is extremely widespread. In 2009, for example, Senegal had a working population of 5 million, yet 4.5 million of these were in the informal sector—either operating as sole traders and not registered for tax, or employed in unregistered enterprises, which pay no tax on their profits and whose employees pay no tax on their wages. Data from 2008 indicates a broadly similar situation in Benin, Cameroon and Ethiopia.[41] The large size of the informal sector has gender implications: a recent study of non-agricultural sectors in three Least Developed Countries (LDCs) in Africa countries found that the female working population was employed almost entirely in the informal sector.[42]

28. In the case of Zambia, the working population stood at 5.2 million in 2008, with the vast majority (4.7 million) in the informal sector. As well as constituting the lion's share of the economy, the informal sector was found to be growing more quickly than the formal sector.[43]

29. The level of formalisation within particular economies is determined by a number of factors. Of principal importance is the strength of the legal system: traders and enterprises which have faith in the legal system are significantly more likely to enter the formal economy than those which do not. The degree to which traders and enterprises have confidence in their governments to make effective use of tax revenues is also a factor.[44]

30. Developing country governments might employ various strategies to bring unregistered traders and enterprises into the tax base. As an example, they might seek to offer incentives—such as distribution and marketing assistance, or micro-credit schemes—in return for registration.[45] In some cases a purely financial incentive might be offered: the Parliamentary Under-Secretary of State for International Development, Mr Stephen O'Brien MP, told us that this approach had worked well in Sri Lanka.[46] In Zambia, meanwhile, the Government is currently considering a different approach, namely to require all unregistered enterprises to pay for a 'business licence' at a flat rate.[47] Additionally, governments can incentivise traders and enterprises to register by charging VAT at a relatively high rate.[48] This incentivises registration because as well as charging VAT on their sales—registered businesses are able to reclaim the VAT they pay on their purchases.[49]

31. In countries where the level of economic activity is extremely limited, the cost and administrative burden of broadening the tax base might outweigh the benefit. In most countries, however, the benefits will be enough to warrant such initiatives.

32. In many of the countries in which DFID works, informal economic activity—i.e. economic activity which falls outside the tax 'net'—is extremely widespread. Formalising the economies of developing countries would have significant implications, both in terms of increased tax revenues and in terms of governance: those who operate in the formal economy are much more likely to hold their governments to account. To encourage unregistered traders and enterprises to enter the formal economy, developing country governments might offer a variety of incentives: examples include distribution and marketing assistance, micro-credit schemes, or purely financial incentives. DFID should support the governments of developing countries as they seek to incentivise hitherto unregistered enterprises to join the formal, taxpaying economy.

8 IMF projections indicate that - by 2012 - revenue from extractive industries will have increased to 4.0% of GDP. Back

9 Q 54 Back

10 Q 56 Back

11 Ev 58; Ev 78 Back

12 Q 5 Back

13 Ev 78 Back

14 Q 41 Back

15 Ev 91 Back

16 Taxation, Resource Mobilisation and State Performance, Crisis States Research Centre Working Paper no. 84 (Jonathan DiJohn, November 2010, Error! Bookmark not defined. Back

17 Q 51 Back

18 Q 184 Back

19 Ev 93 Back