Tax and International Financial Architecture

Taxation is increasingly recognised in the global discourse on development financing as the most reliable and sustainable source to finance economic development and help poor countries overcome the poverty trap. The centrality of taxation to development is further underlined in the Outcome document of the Third Financing for Development Conference (FfD3) which clearly outlines the importance of Domestic Resource Mobilisation (DRM) in raising development finance and in the context Sustainable development Goals (SDGs). This comes after a global realisation that resourcing was one of the biggest challenges of the MDGs. With the relative decline of Official Development Assistance, the post 2015 SDG agenda looks to domestic resource mobilisation as well as other internal innovative financing options which came out clearly at the discussions at the FfD3 conference. However, a global system that is as flawed as it currently is undermines African countries’ efforts to secure their own resources which would in turn contribute to their development.

The issue of securing a nation’s taxing rights doesn’t stop at the country’s borders. We live in a world where financial systems and frameworks are interdependent and relatively complex with very few and poor regulatory systems. This has been further demonstrated by the Panama Papers leaks which begin to show both these complexities and their magnitude with the revelation of a system of secrecy jurisdictions that allows for the outflow of capital from developing countries. It is widely accepted that the current

Photo credit: Trenchard/ Panos

Photo credit: Trenchard/ Panos

international financial architecture of global rules that determine the flow of capital between nations is flawed and not fit for purpose. The current weak international regulations encourage aggressive tax evasion and tax avoidance especially by Multinational corporations operating in Africa and its wealthy elites. It is also responsible for the illicit outflow of resources from Africa amounting to over USD 50 billion a year according the report by the High Level Panel on Illicit flows from Africa. Little is known of the real owners behind companies and the push for international efforts to reform the tax rules are yet to yield any tangible results.

The most recent Organisation for Economic Cooperation and Development (OECD) led Base erosion Profit shifting (BEPS) project is one such effort to redesign international tax Rules to protect the tax bases of both developed and developing countries.  The BEPS project has however been criticised for being a First World- led initiative which failed to effectively involve and include the  concerns and priorities of poor developing countries. Systemic problems also remain in the BEPs process particularly on monitoring the risks of tax avoidance by companies for instance on the treatment of tax havens. However African models are emerging most notably from the African Tax Administration Forum (ATAF). These models take African realities and contexts into consideration and need to be promoted for ratification and adoption. It is against this backdrop that there is an increased demand for a new more democratically representative global tax governance structure.

Key terms to know:

  • African Tax Administration Forum (ATAF)– Launched in 2009, this body brings together 25 African tax administration bodies. Its mission is to mobilise domestic resources more effectively and increase the accountability of African states to African citizens while actively promoting an improvement in tax administration through sharing experiences, benchmarking and peer reviewing best practices.
  • Base erosion and profit shifting (BEPS)– According to the OECD (2013), base erosion and profit shifting refers to “tax planning strategies that exploit gaps and mismatches in tax rules to make profits ‘disappear’ for tax purposes or to shift profits to locations where there is little or no real activity but the taxes are low resulting in little or no overall corporate tax being paid.” The base erosion and profit shifting project coordinated by the OECD, mandated by the G20 countries, seeks to reform international tax standards that have become open to exploitation by multinational firms.
  • Beneficial owner– The real (natural) person(s) or group of people who ultimately owns, control(s) and benefit(s) from a corporation, trust, or account, or on whose behalf a transaction is being conducted. The Financial Transparency Coalition (FTC), including many NGOs such as Oxfam and TJN, advocates that beneficial ownership information be collected and made publicly accessible. Transparency of beneficial ownership is one of the five FTC recommendations.
  • Country-by-country reporting– A proposed form of financial reporting in which multinational corporations report certain financial data—such as sales, profits, losses, number of employees, taxes paid and tax obligations—for each country in which they operate (including in each tax haven); so that citizens and authorities can see what the corporations are doing in their countries. Currently, consolidated financial statements are the norm.
  • Automatic information exchange – this is a proposed standard of international tax co-operation between tax administrations that required governments to collect data from financial institutions on income, gains and property paid to individuals, corporations, trusts and other incorporated entities that are non-resident is the country. This data should then be automatically provided to the government’s tax authorities where the non-resident entity is located, that is, the headquarter country for companies and often country of nationality for individuals.
  • Illicit financial flows (IFFs)-Money that is illegally earned, transferred or utilized. These funds typically originate from three sources: commercial tax evasion, trade misinvoicing and abusive transfer pricing; criminal activities, including the drug trade, human trafficking, illegal arms dealing, and smuggling of contraband; and bribery and theft by corrupt government officials.
  • Trade Misinvoicing –This is the term used to describe both transfer pricing abuse between related parties, and false invoicing between unrelated parties.
  • Transfer pricing – This refers to the price of transactions occurring between related companies, in particular companies within the same multinational group.
  • Secrecy jurisdiction– Secrecy jurisdictions are cities, states or countries whose laws intentionally allow banking or financial information to be kept private under all or all but few circumstances. Such jurisdictions may create a legal structure specifically for the use of non-residents. The originators of illicit financial flows may need to prevent the authorities in the country of origin from identifying them (e. g. if the money is the proceeds of tax evasion), in which case the flow will be directed to a secrecy jurisdiction thus undermining the legislation of the other jurisdiction in question. Because those directing IFFs seek out low taxes and secrecy, many tax havens are also secrecy jurisdictions, but the concepts are not identical.
  • Tax havens– Jurisdictions whose legal regime is exploited by non-residents to minimise the amount of taxes they should pay where that perform a substantial economic activity, that is, avoid or evade taxes. A tax haven usually has low or zero tax rates on accounts held or transactions by foreign persons or corporations.This is in combination with one or more other factors, including the lack of effective exchange of tax information with other countries, lack of transparency in the tax system, non-disclosure of the corporate structure of legal entities or the ownership of assets or rights and no requirement to have substantial economic activities in the jurisdiction to qualify for tax residence. Tax havens are the main channel for laundering the proceeds of tax evasion and routing funds to avoid taxes. Also see Secrecy jurisdictions.
  • International tax governance. International policy frameworks, institutions and mechanisms for promoting international cooperation on tax.
  • Tax treaties– Formally known as tax conventions or multilateral agreements on income and capital, bilateral tax treaties between countries were originally referred to as double taxation treaties. By concluding them, countries reach a negotiated settlement that restricts their source and residence taxation rights in a compatible manner, alleviating double taxation and allocating taxing rights between the parties. Treaties also harmonize the definitions in countries’ tax codes, provide mutual agreement procedures that can be invoked if there are outstanding instances of double taxation and establish a framework for mutual assistance in enforcement. A treaty between a developing country and a country from which it receives investment will shift the balance of taxing rights away from the developing country. Such treaty provisions create opportunities for treaty shopping by foreign investors.
  • Transfer pricing is the setting of the price for goods and services sold between controlled (or related) legal entities within an enterprise. For example, if a subsidiary company sells goods to a parent mining company, the cost of those goods paid by the parent to the subsidiary is the transfer price. Most times, extractive industry MNCs employ transfer (mis)pricing to understate their profits and thus their tax liabilities in the countries where they make their wealth. As the international operations of MNCs grow in developing countries especially in Africa, the issue of effective transfer pricing regulation has become more pressing for them. Given the more limited skills and resources of such countries in the field of transfer pricing, it becomes increasingly important to consider to what extent international investment agreements including mining contracts can address this imbalance through, for example, increased transparency, information sharing, co-operation and technical assistance provisions, thereby ensuring that developing countries derive full benefits from FDI without exposure to a potentially harmful diversion of revenues through transfer pricing practices.
About TJNA

The Tax Justice Network-Africa (TJN-A) is a Pan-African initiative and a member of the Global Alliance for Tax Justice. Launched in January 2007 during the World Social Forum (WSF) held in Nairobi, TJN-A promotes socially- just, accountable and progressive taxation systems in Africa. It advocates for tax policies with pro-poor outcomes and tax systems that curb public resource leakages and enhance domestic resource mobilisation.

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