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

3  Global level tax policy

33. The ability of developing countries to collect taxes is determined not only by their own governments' policies, but also by policies and initiatives launched beyond their borders, either by individual developed countries, or at intergovernmental level. This section examines several such policies and initiatives, and makes recommendations to the Government: both on measures it could enact unilaterally, and on measures which need to be taken at intergovernmental level, and which it should advocate.

Automatic exchange of information

34. Capital flight from developing countries—the process by which assets are removed from a developing country and stored overseas—is a serious problem for developing countries. As DFID rightly highlights in its written evidence, capital flight does not necessarily imply illegality; it may simply represent a rational economic decision to invest assets overseas.[50] However, capital flight may also occur as a result of tax evasion. Global Financial Integrity estimates that illicit capital flight from developing countries totals over $1 trillion per year.[51]

35. In this context, if the tax authorities of a developing country wish to investigate possible tax evasion by one of its citizens or corporations, they may need to obtain information pertaining to the offshore activities of the relevant citizen or corporation from the tax authorities of the relevant offshore jurisdiction—most likely a tax haven. Until recently, the only way for developing country authorities to do this was by making a formal request via a bilateral agreement with the relevant jurisdiction.[52] Bilateral agreements take one of two forms:

·  Tax Information Exchange Agreements (TIEAs), and

·  Double Taxation Treaties (DTTs): the principal purpose of DTTs is to prevent the same item of income being taxed in two separate jurisdictions. As a part of this, however, DTTs make (limited) provision for exchange of information.[53]

Making such requests constitutes a high and sometimes unaffordable administrative burden for the tax authorities concerned.[54]

36. Since 2009, developing countries have had another option: by joining the Convention on Mutual Administrative Assistance in Tax Matters (a multilateral treaty for the exchange of information), the need for bilateral treaties is removed. (The Convention originally dates from 1988, but until 2009 was open only to Council of Europe and OECD members.)[55] However, developing countries still have to go through a relatively complex process in order to join the Convention.[56] Additionally, even under the Convention, the need to make a formal request—and the consequent administrative burden—still stands, unless two particular signatories to their convention sign an additional agreement to the contrary.[57]

37. Under the US Foreign Account Tax Compliance Act (FATCA), by contrast, information is exchanged automatically, rather than just on request. If a US citizen or corporation (subject to certain exemptions) holds an account with a financial institution outside of the US, this financial institution is required to provide an annual report to the US authorities, covering information including the account balances, gross deposits and gross withdrawals.[58]

38. There are no similar rules in place for non-US citizens or corporations. The EU Savings Directive is currently the closest equivalent to FATCA in the EU: if any EU resident holds an account in a member state other than his / her country of residence, there is a requirement for the tax authorities of his / her country of residence to be notified of any interest paid on this account. (Austria and Luxembourg are currently exempt from this obligation for a 'transitional period.) However, unlike FATCA, which applies to tax authorities outside of the US, the EU Savings Directive does not apply to tax authorities outside of the EU.[59]

39. It has thus been argued by organisations ranging from Christian Aid to Glencore, the global commodities trader, that a system of automatic information exchange should be implemented more widely (rather than just in the US).[60] In its written evidence, the Tax Justice Network argues that:

    automatic exchange has clear advantages over the 'on request' approach mentioned above in so far as it has a stronger deterrent effect—and will therefore work faster to shape a culture of tax compliance—and it is vastly easier and cheaper to implement.[61]

In his oral evidence to us, Tim Scott, Global Head of Tax at Glencore, stated that "I think this [automatic exchange of information] is a good idea, and something that we would have no problem with."[62]

40. Whilst the Government claims to support automatic exchange of information in principle, it has expressed some concerns about the possible burden on businesses and financial institutions, and around taxpayer confidentiality.[63] The Exchequer Secretary to the Treasury, Mr David Gauke MP, also suggested that the UK should wait for an international consensus to emerge rather than acting unilaterally, since the UK has "less of a tradition of extraterritorial impositions" than the US.[64] In respect of the possible burden on businesses, meanwhile, the Government's concerns appear to be unwarranted: large businesses such as Glencore and brewing giant SABMiller have no opposition to the policy.[65]

41. The capacity of a developing country tax authority to obtain information on the offshore activities of its citizens or corporations (i.e. information from foreign tax authorities) is critical to its ability to curtail illicit capital flight. Their capacity to obtain such information could be greatly enhanced by legislative measures: the US Foreign Account Tax Compliance Act (FATCA) is a welcome start, but it only affects US citizens or corporations. We recommend that the Government introduce legislation similar to the relevant section of the US Foreign Account Tax Compliance Act (FATCA), requiring tax authorities automatically to exchange information relating to UK citizens or corporations. The Government should also use its influence (via the OECD Tax and Development Task Force, and similar avenues) to persuade other governments to follow suit.

Tackling transfer pricing abuse

42. In order to maximise the proportion of their profit occurring in tax havens, and to minimise that occurring in high-tax jurisdictions, corporations which form part of a corporate group may engage in transactions with other corporations in the same group. For example, in a group which includes corporations in Luxembourg and Ghana, transactions may be conducted between the corporations with the sole aim of maximising the taxable profits of the Luxembourg division, whilst reducing those of its Ghanaian counterpart. The potential for corporations to reduce their tax bills in this way is vast—60% of world trade is intra-group,[66] and large corporations are generally able to hire the most skilled accountants to facilitate such 'tax planning.'[67] According to ActionAid estimates,

    payments to Switzerland, the Netherlands and Mauritius from SABMiller's subsidiaries in Africa and India resulted in a total tax loss to governments in those countries of £20 million, enough to put 250,000 children in school, and equivalent in Africa to almost one-fifth of the company's estimated tax bill.[68]

43. Under present OECD rules, this practice is not in principle illegal, and of course corporations frequently transfer profits for reasons unrelated to tax. For example, the commonly accepted way for a business to reward shareholders is through declaring a reasonable dividend, but sometimes local rules make it very difficult to declare a dividend. In these cases, businesses may look for other solutions—such as profit shifting or unjustified management fees. We believe that the acceptable and transparent method for businesses to reward shareholders is through the declaration and payment of reasonable dividends. Host countries can contribute to this by establishing straightforward taxation regimes for dividends. We therefore suggest that DFID's work for revenue authorities includes technical support in this area, where appropriate.

44. Under present OECD rules, the price charged in intra-group transactions must be the same as that which would have been charged if the goods / services had been sold externally, i.e. at 'arm's length.[69]' However, a number of NGOs have campaigned vigorously for these rules to be made more stringent: Christian Aid claims that there are "substantial questions on both the practicality and applicability"[70] of the present rules. One of the suggestions is a system of 'formulary apportionment,' whereby a corporation's taxable profits would be allocated based on the proportions of total property, payroll or sales in each country.[71] Given the current lack of support for such legislation within the OECD,[72] however, we do not consider formulary apportionment to be a workable option at present—unlike certain other areas of legislation discussed in this report, transfer pricing legislation by definition requires international agreement in order to be effective.

45. However, it is claimed that even the present OECD rules are often broken, with intra-group transactions taking place at non-market rates. This is what we mean by 'transfer pricing abuse'—a form of tax evasion. Global Financial Integrity claims that Zambia lost over $4billion (an amount similar to its total external debt) during the period 2003-09 due to transfer pricing abuse.[73] A report by PwC Zambia 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.[74]

46. Corporations from which we took evidence, including SABMiller and Glencore, assured us that their intra-group transactions took place at 'arm's length' prices—and hence complied with the OECD guidelines.[75] Rio Tinto suggested to us that corporations should be required to demonstrate their compliance by publishing information on intra-group transactions on their annual tax returns in developing countries, as is already the case in many developed countries.[76] Graham Mackay, the Chief Executive of SABMiller, claimed that his business did not seek to minimise tax through intra-group transactions at all: in other words, that it eschewed even those methods which the OECD guidelines permitted.[77] However, in its subsequent submission of written evidence to the Committee, ActionAid casts some doubt on this assertion, claiming that:

    '... SABMiller states in its written evidence that it has centralised the administration of its intellectual property management and its management services. In doing so, it has moved many of the higher-value activities of its business out of developing countries and into low-tax jurisdictions (on paper, the Netherlands and Switzerland). Regardless of the motivation for this centralisation, it not only affects the global distribution of SABMiller's tax liability, but also the extent to which its investments result in positive spillovers such as knowledge transfers and economic linkages in the local economy.'[78]

47. In its written evidence, the CBI told us that businesses had made "a number of offers" to engage with HMRC and explain the approach they take to transfer pricing issues.[79]

48. 'Transfer pricing abuse'—corporations selling goods or services at non-market rates to other corporations in the same corporate group—can seriously undermine developing countries' capacity to collect the taxes they are due. OECD rules prohibit this practice, but it is often difficult to detect when these rules are breached. To help developing country revenue authorities to tackle transfer pricing abuse, 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.

49. In order to understand the perspective of multinational businesses on transfer pricing issues, HMRC should meet the CBI to discuss the issue. HMRC should also seek the views of trade unions and civil society organisations. HMRC should report back to the Committee before the end of 2012 to advise us of the outcome of these discussions.

Implications of UK Finance Bill 2012

50. In the 2012 Finance Bill, the Government proposed a relaxation of its anti-tax haven laws: the so-called 'Controlled Foreign Companies' (CFC) rules. If the Bill is approved as it currently stands, the newly relaxed legislation will apply to accounting periods beginning on or after 1 January 2013.[80]

51. Under the current system, prior to these revisions coming into force, if a UK-owned corporation reports profits in jurisdictions with lower corporate tax rates than the UK, (such as by transacting with its own subsidiaries to shift its profits from developing countries into low-tax jurisdictions) the UK Government is able to impose an extra tax charge on the corporation to 'make up the difference.' Profits shifted from developing countries into tax havens, therefore, would still incur tax at UK rates: this may disincentivise such profit-shifting.[81]

52. Under the new system, the UK will only be able to impose this extra levy if the profits in question have been shifted from the UK. Profits shifted from developing countries into tax havens, therefore, will incur tax at the tax haven rate, rather than at the UK rate—so the incentive to shift profits into tax havens will be significantly higher.[82] A number of NGOs are campaigning vigorously against this legislative change. As an example, ActionAid states its concern that:

    the proposals will eliminate a significant deterrent that discourages UK-based companies from shifting profits from developing countries to tax havens. We estimate that the reforms may cost developing countries as much as £4 billion.[83]

53. The Exchequer Secretary to the Treasury told us that he did not accept the £4 billion estimate; however, he did not deny that there would be a cost to developing countries. He stressed that the objective of the CFC rules was to protect UK tax revenues, not those of developing countries.[84] Given that through DFID the Government is also seeking to support revenue collection in developing countries, such a comment indicates a lack of joined-up thinking between Departments.

54. In a recent joint report by the IMF, OECD, UN and World Bank, it was argued that where domestic policy reforms were likely to impact on revenue flows to developing countries, a 'spillover analysis' should be conducted to ascertain the magnitude of such impacts.[85] In the case of the revision to CFC rules, such an analysis has not been conducted.[86]

55. If approved, the newly-relaxed Controlled Foreign Companies (CFC) rules, proposed in the 2012 Finance Bill and due to come into force in January 2013, will incentivise multinational corporations to shift profits into tax havens. This is likely to have a significant detrimental impact on the tax revenues of developing countries. As a matter of urgency, the Government should conduct or commission an analysis of the likely financial impact of the revised Controlled Foreign Companies rules on developing countries. Depending on the results of this analysis, the Government should consider whether to drop its proposals.

56. The Government should designate a DFID ministerial responsibility for the development impact of tax and fiscal policy. Furthermore there should be an administrative or legislative requirement for the government to assess new primary and secondary UK tax legislation against its likely impact on poverty reduction and revenue-raising in developing countries, and to publish that assessment alongside the draft legislation.

Role of Extractive Industries Transparency Initiative (EITI)

57. The Extractive Industries Transparency Initiative (EITI) was established in 2002 by the then UK Government, with the aim of combating corruption in the extractive industries. The EITI is governed by a Board, whose membership includes governments, corporations and civil society organisations. It is currently chaired by the Rt Hon Clare Short.[87]

58. The principle underlying the EITI is that governments disclose the amounts they receive from corporations in the extractive sectors (including payments of taxes, signature bonuses and royalties), whilst corporations operating in participating countries make a corresponding disclosure of the payments they make to the government. An 'EITI report' for the relevant country is then published, which reconciles the amounts paid by corporations with the amounts received by the government.[88] Any discrepancy between the two amounts may indicate revenues falling into the hands of corrupt officials.

59. There are two stages of EITI accreditation: EITI candidate status, and EITI compliant status. To achieve EITI candidate status, a country must comply with five specific sign-up requirements. To achieve EITI compliant status, a country must complete its first EITI report within 18 months,[89] as well as fulfilling various other criteria pertaining to independent verification within two-and-a-half years.[90] EITI compliant countries are re-assessed every five years to ensure continuing compliance.[91]

60. Despite its involvement in founding EITI, the UK has not yet sought EITI candidacy itself.[92] The Parliamentary Under-Secretary of State argued that the UK was not sufficiently resource-rich to warrant participation.[93] However, whilst the UK extractive sector is not as large as it once was, we believe it remains significant enough to warrant EITI participation: as at April 2012, mining and quarrying constitutes approximately 16.4% of total UK production.[94]Table 4: countries currently participating in EITI
Countries with EITI 'compliant' status Countries with EITI 'candidate' status
Azerbaijan Afghanistan
Central African Republic Albania
Ghana Burkina Faso
Kyrgyz RepublicCameroon
Liberia Chad
MaliCote d'Ivoire
Mauritania Democratic Republic of the Congo
Niger Guatemala
Norway Indonesia
Timor-Leste Kazakhstan
Yemen (suspended)Madagascar (suspended)
Republic of the Congo
Sierra Leone
Trinidad & Tobago

Data source: EITI website. In addition, several other countries - including the US - have indicated their intention to become EITI candidate countries.

61. However, EITI has a number of weaknesses. Given that figures are published on an absolute basis (rather than as a percentage of the relevant country's GDP, or as a percentage of mining industry profits in the relevant country), it is difficult to draw international comparisons. Additionally, EITI does not require the publication of contracts between mining companies and governments: it has been suggested by the 'Publish What You Pay' campaign that such publication would help to expose any contracts which are patently disadvantageous to the country concerned.[95] Examples might include those contracts signed by the Zambian Government in 2000.[96]

62. The Extractive Industries Transparency Initiative (EITI), founded in 2002 by the UK Government, has had a promising first decade. The process of creating an 'EITI report,' which reconciles what corporations say they pay (in taxes, royalties and signature bonuses) with what governments say they receive, is of great help in identifying possible corruption. Whilst the UK extractive sector is not as large as it once was, it remains significant enough to warrant EITI participation. If the Government genuinely hopes to encourage more developing countries to sign up for EITI, it must be willing to lead by example. Given that the UK was involved in founding the Extractive Industries Transparency Initiative (EITI), we feel that it should now become an EITI candidate itself. Additionally, the UK should encourage EITI to broaden its scope: EITI should require participating corporations and governments to publish the contracts which exist between them, and should also require the publication of percentage figures in addition to absolute figures.

Country-by-country reporting

63. At present, international accounting standards do not require corporations to present financial information on a country-by-country basis:[97] such information can be presented on an aggregate basis. Many have advocated the implementation, by the International Accounting Standards Board (IASB), of a standard requiring country-by-country reporting.[98] Christian Aid argues that:

    The potential for the private sector to drive development is vast, as DFID has recognised, but this can only provide real benefits for those living in poverty if the returns from the private sector are shared. Therefore, there is a clear need as DFID increasingly promotes private sector led development to also promote mechanisms by which the contribution of the private sector to development can be more effectively assessed, such as a Country-by-Country reporting standard.[99]

64. More specifically, the European Network on Debt and Development (Eurodad) suggest that multinational corporations should be required to present the following items of information for each country in which they operate:

·  the names of all the companies they own in each country;

·  their financial performance in each country;

·  their tax liability in each country;

·  details of the cost price and carrying value of physical fixed assets in each country, and

·  details of gross and net assets for each country.[100]

65. The Parliamentary Under-Secretary of State for International Development assured us that he supported the passage of EU legislation requiring some degree of country-by-country reporting, but was unwilling to introduce such measures unilaterally if agreement within the EU was not reached, for fear of damaging the UKs competitiveness..[101] Evidence we received suggest that—if country-by-country reporting were to be mandated—the extra costs for businesses would be very modest.[102] Mining companies such as Rio Tinto and Glencore do not oppose the measure (indeed, Rio Tinto already report much financial information on a country-by-country basis voluntarily),[103] whilst the Chair of the OECD's Business and Industry Advisory Committee is also broadly supportive.[104]

66. Requiring multinational corporations to report financial information on a country-by-country basis would constitute both a means of detecting tax avoidance and evasion, and a conspicuous deterrent. Given that corporations such as Rio Tinto already report financial information on a country-by-country basis voluntarily, we anticipate that others could follow suit at minimal inconvenience. Irrespective of whether EU-level agreement is reached, the Government should enact legislation requiring each UK-based multinational corporation to report its financial information on a country-by-country basis. Such information should include the names of all companies belonging to it and trading in each country, its financial performance in each country, its tax liability in each country, the cost and net book value of its fixed assets in each country, and details of its gross and net assets in each country. Additionally, the UK should continue to support the progress of similar legislation at EU level.

50   Ev 98 Back

51   Ev w26 Back

52   Ev 124-125; "Convention on Mutual Administrative Assistance in Tax Matters", OECD, July 2012, Error! Bookmark not defined. Back

53   Tax Information Exchange Agreements, Draft Tax Justice Network Briefing Paper, April 2009, Error! Bookmark not defined.  Back

54   Ev 75 Back

55   "Convention on Mutual Administrative Assistance in Tax Matters", OECD, July 2012, Error! Bookmark not defined.  Back

56   Convention on Mutual Administrative Assistance in Tax Matters, OECD briefing paper,17 April 2012,Error! Bookmark not defined. Back

57   Convention on Mutual Administrative Assistance in Tax Matters, full text, last amended 1 June 2011,Error! Bookmark not defined. Back

58   Foreign Account Tax Compliance Act (FATCA): Proposed Treasury Regulations §1.1471 - §1.1474, as published by PwC, February 2012, Error! Bookmark not defined. - see section 1.1471-4(d)(3)(ii-iii) Back

59   "EU Savings Tax Rules and Savings Agreements with Third Countries: frequently asked questions", European Union press release MEMO/12/353, 15 May 2012 Back

60   Ev 75; Ev 122-125; Ev w28; Q 22; Q 89 Back

61   Ev 124 Back

62   Q 89 Back

63   Q 223 Back

64   Q 224 Back

65   Q 89; Q 91 Back

66   Transfer Pricing Service: Unravelling the Opportunities and Risks, Deloitte, 2009, Error! Bookmark not defined.  Back

67   Ev 91 Back

68   Ev 58 Back

69   Ev w9 Back

70   Ev 75 Back

71   Calling Time: why SABMiller should stop dodging taxes in Africa, ActionAid report, 29 November 2010, Error! Bookmark not defined.  Back

72   Q 213 Back

73   Ev w27 Back

74   Ev 81 Back

75   Q 99; Q 100 Back

76   Ev w76 Back

77   Q 101 Back

78   Ev 72 Back

79   Ev w7 Back

80   Finance Bill, Schedule 20 [Bill 1 (2012-13)] Back

81   "The problem with a new tax loophole", ActionAid, Error! Bookmark not defined.  Back

82   "The problem with a new tax loophole", ActionAid, Error! Bookmark not defined. Back

83   Ev 61 Back

84   Q 207 Back

85   Supporting the Development of More Effective Tax Systems: a report to the G-20 Development Working Group by the IMF, OECD, UN and World Bank, 2011, Error! Bookmark not defined.  Back

86   Ev 60-61 Back

87   Ev 121 Back

88   Ev 121 Back

89   EITI Factsheet 01, Extractive Industries Transparency Initiative, Error! Bookmark not defined. Back

90   "EITI countries", Extractive Industries Transparency Initiative, Error! Bookmark not defined. Back

91   "Nigeria: EITI", Extractive Industries Transparency Initiative, Error! Bookmark not defined. Back

92   Ev 120-121 Back

93   Q 190 Back

94   Index of Production, April 2012, ONS Statistical Bulletin, 12 June 2012, Error! Bookmark not defined.  Back

95   "Objectives", Publish What You Pay, Error! Bookmark not defined. Back

96   In most countries, including Zambia, minerals are deemed to be the property of the government, until such point as a mining company buys 'prospecting rights' - i.e. the right to search for, and claim ownership of, mineral deposits. See Paul Collier, The Plundered Planet (London, 2010), p 51-52; and Robert F. Conrad, Zambia's Mineral Fiscal Regime, in Adam, Collier & Gondwe (eds.), Zambia: Policies for Prosperity (Oxford, forthcoming). Back

97   Ev w28 Back

98   Ev w28; Ev w68 Back

99   Ev 76 Back

100   Exposing the lost billions: How financial transparency by multinationals on a country by country basis can aid development. Eurodad report, November 2011, Error! Bookmark not defined.  Back

101   Q 196 Back

102   Q 130 Back

103   Ev w75; Q 90 Back

104   Q 91 Back

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© Parliamentary copyright 2012
Prepared 23 August 2012