Tackling corporate tax dodging in a digital age is high on the political agenda as governments seek to protect the public purse. Launched this year, the Tax Justice Network’s Corporate Tax Haven Index outlines a comprehensive set of benchmarks that are relevant for countering illicit financial flows and multinational corporate tax avoidance in a digital economy.
In our new paper, ‘Corporate income taxation in a digital age: Africa in the Corporate Tax Haven Index 2019‘, we explore how African countries have responded to the challenge of tax avoidance in a digital economy and might be intentionally or unwittingly exacerbating profit-shifting activity and the race to the bottom in corporate taxation. The paper focuses on the nine African jurisdictions covered in the Corporate Tax Haven Index of 2019: Botswana, Gambia, Ghana, Kenya, Liberia, Mauritius, Tanzania, the Seychelles and South Africa.
The Corporate Tax Haven Index reveals that so far Africa is less engaged in a ruinous race to the bottom in corporate taxation than higher income regions. In comparison to countries in the Organisation for Economic Co-operation and Development (OECD) and the European Union, African nations have less aggressive treaty networks, have protected higher corporate income tax rates and have fewer loopholes and gaps in their taxation systems that can be exploited by companies for profit-shifting activity. Yet the research shows that African transparency and anti-avoidance measures are lagging behind.
The digital transformation of the global economy has shaken the foundations of the century-old international taxation system. Digital business models often rely on investment in intangible assets, especially intellectual property assets, such as algorithms and software that supports website and online platforms, which may be owned by a subsidiary of a multinational company or a third-party. Countries are exposed to base erosion and profit-shifting risks through the tax arrangements in different jurisdictions. Countries are also put at risk by preferential regimes for the tax treatment of intellectual property and the absence of rules limiting the deduction of royalty payments for intellectual property or intangibles between intra-group companies from the corporate income tax base.
Anti-avoidance measures can be improved to reduce the risk of base erosion and profit shifting in a digital economy. Robust controlled foreign company rules and withholding taxes on outbound dividends can act as a backstop for shifting untaxed profits to secrecy jurisdictions and zero tax havens. Deduction limitation rules could be introduced or strengthened to prevent multinationals from deducting interest, royalties and certain service payments from their tax base if paid to other members of the same multinational in other countries. The Rwandan example of limiting the deduction of outbound royalties is a case that warrants close examination by African peers. At the same time, African nations should withstand the false lure of introducing patent box regimes themselves, and consider appropriate reactions to countries that do, including Botswana, the Seychelles and Mauritius.
Beyond the domestic reform efforts, the Corporate Tax Haven Index underlines the important differences between members of the OECD and the European Union, and the African countries included in the sample. African nations are on average more exposed to tax avoidance risks than responsible for creating these risks compared to higher income regions. Therefore, African nations along with other developing regions need to remain alert and resolute in current negotiations under the Inclusive Framework of the OECD in determining the best approach to taxing the digital economy.
In these negotiations, unitary taxation with formulary apportionment has become the leading alternative to the arm’s length approach to taxing the digital, if not the entire economy. Indeed, the unitary approach is arguably the most promising alternative to replace the current global tax rules which have not kept up with the globalised or digitised economy and have resulted in vast profit-shifting and base erosion. Due to the arm’s length approach, there is massive misalignment between the location of multinational companies’ genuine economic activity and where their profits are declared for tax purposes. The unitary approach has the potential to vastly improve the taxing rights of African nations if the factors for apportioning profits of a multinational take into account not only sales and consumption, but also production and employment.
Earlier attempts to introduce unitary taxation, first at the League of Nations almost 100 years ago were thwarted. In the OECD Base Erosion and Profit Shifting project that commenced in 2013, this alternative was kept off the table by major actors insisting on applying and retaining the arm’s length principle. There is a risk that the interests of developing nations and the African continent might be undermined once again, especially since there are no African nation members in the OECD. If conflicts over the distribution of taxing rights should arise between OECD members and non-members, more inclusive fora, such as the Inclusive Framework on Base Erosion and Profit Shifting that involves 80 developing countries, may be relegated to footnotes or ignored. Therefore, African countries may consider if a convention to counter illicit financial flows at the globally representative United Nations could better serve their interests.
You can find summary reports and detailed technical reports here for countries included in the Corporate Tax Haven Index online.