New reporting code for MNCs could save Africa $35b

East African countries expect to collect more revenue under a new code drawn, by the world’s richest economies to stop foreign multinationals from dodging taxes in host countries.

The new code — Base Erosion and Profit Shifting (BEPS) — adopted by G20 at its meeting in Turkey two weeks ago, seeks to seal loopholes in the global tax system that allow corporate profits to “evaporate” – that is – to be artificially shifted to low -or no-tax environments, where little, if any, of a company’s business takes place.

Through practices such as transfer pricing when buying goods and services from sister companies and inflating returns in low-or no-tax jurisdiction, multinationals are estimated to skim off more than $150 billion from tax collectors across the world.

Oxfam, the UK anti-poverty crusader, says about $18.5 trillion has been hidden by individuals and companies in tax havens in order to avoid paying taxes. A consortium of NGOs that included Kenya’s People Health Movement reported last year that Africa loses $35.3 billion annually in illicit financial flows to tax havens.

Transfer pricing refers to manipulation of prices at which goods change hands between parent companies, their subsidiaries, associate and related entities.

Deals that are mostly affected by transfer pricing include shareholder loans, where the interest rate may be higher than that obtaining in the parent’s market technical and management fees, royalties for intangible assets and prices for physical items like machinery and raw materials.

By inflating these prices, multinationals effectively increase the costs of operations for their entities in developing countries and reduce their book profit which is the basis for corporation tax. At the same time, the multinationals increase their earnings in lower tax jurisdictions, meaning they minimise the tax exposure iof the group to the detriment of their host countries.

There is now hope that the 15-point BEPS action plan will lead to a fairer global taxation system, especially when adopted by all countries, —a set back for the strategy of countries that had adopted low taxation as a basis for attracting foreign direct investment.

The plan that proposes that multinationals now adopt country by country reporting, bringing clarity to the at-arms-length principle and limits the extent to which treaties can be used to obviate tax payments.

“The transparency actions propose disclosure measures by multinationals of economic activities and taxes paid in each jurisdiction. These actions will persuade conglomerates to align their tax outcomes with value creation, as tax agencies will now have adequate information to identify any misalignment,” said Alice Muriithi, a manager with PwC Kenya’s tax practice.

The key plank of the code is that profit will be assigned to companies based on the level of activity in a country. Multinationals will henceforth be required to do country-by-country reporting, (unlike now when they make disclosures based on broader regions) bringing more transparency to their operations.

A company, the bulk of whose operations is in Kenya, for instance, cannot now declare a loss there and go on to declare a profit in a tax haven like Monaco or San Marino. “Regional revenue authorities are focusing on profit shifting across border through transfer pricing,” said Nikhil Hira, tax leader at Deloitte in Nairobi.

He said there were several tax audits going on across East Africa with regard to profit shifting to which the new rules would offer more objectivity when it comes to resolution.

US multinationals, had led a campaign against the new rules saying they would make compliance more expensive and force the disclosure of market sensitive information to revenue agencies that could release them to their rivals. Tax consultants, however, said the rules bind the revenue authorities to confidentiality.

Kenya, Morocco, Nigeria, Senegal and Tunisia were among the 14 developing countries that were involved in coming up with the new rules, which will come into force from January 2016. Developing countries that want to be in the first line of adoption will join in March next year.

The G20 working group that drew up the new guidelines, which will be domesticated into national laws, estimated that between four and 10 per cent of corporate tax revenue is lost through profit shifting but adding that the actual incidence could be greater.

Ms Muriithi said East African economies will be keen to implement the BEPS measures either through revisions in their double tax treaties or changes in the local legislation.

Last year, Kenya introduced a limitation-of-benefit clause in its taxation laws amid an outcry on how holding companies of local companies were being set up in Mauritius even before the double tax treaty comes into force.

During presentations to the working group, Kenya said it was losing taxes to multinationals through transfer of locally developed intellectual property to low-tax jurisdictions without compensation.

“A royalty is then charged on the Kenya entity. Some foreign companies structure their business activities to artificially avoid taxation,” Kenya officials said. KRA Director General John Njiraini did not responded to our queries with details.

On this, the BEPS action plan gives more guidance on how to look at the legal ownership of the financial and commercial entities and assignment of costs to determine how unrelated parties would handle a similar transaction.

Zambia, which said in 2012 it loses $2 billion annually to tax avoidance with mining companies being the chief culprits, told the working group, that multinationals were also structuring transactions to exploit favourable terms in a treaty, leading to loss of withholding tax.

The BEPS measures recognise abuse of tax havens and double tax treaties and one of the actions offers guidance on curbing abuse of treaties. “There are specific actions that will be carried out in 2016 to prevent or reduce the use of treaties as tax planning tools. 

Over 90 countries have indicated that they will take part in this initiative, which will look at the creation of taxable presences, treaty abuse and dispute resolution,” said Mr Hira.

The corporate tax losses could be more pronounced in countries like Burundi where one company contributes a fifth of tax collections and Rwanda and Nigeria, where multinationals contribute 70 per cent and 88 per cent of the tax base, respectively.

In Nigeria, crude oil companies were at pains to explain the local benefits from payments they had made to their parent companies in related-party transactions.

A survey done by the Organisation for Economic Co-operation and Development in Europe (OECD) found that management and technical service fees raised transfer pricing issues in a majority of developing countries. Colombia reported that a quarter of the related-party transactions involved parties in low-tax jurisdictions.

Vietnam reported that its efforts to contain transfer pricing were made difficult by lack of data on actual transacted prices between independent parties, which would indicate the extent to which multinationals overprice goods and services when selling to their local subsidiaries.