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Big, powerful and ‘unprofitable’

Top 10% of foreign-owned firms in SA pay the least tax in the country.

Data from South African corporate tax returns for 2010 to 2014 has revealed that 10% of large multinationals doing business in the country reduced their taxable profit by 98%.

This much-needed research into the link between the size of a multinational enterprise and profit shifting was done by National Treasury director Hayley Reynolds and Ludvig Wier of the Department of Economics at the University of Copenhagen.

Their collaborative effort was done within the cumbersomely abbreviated UNU-WIDER SA-TIED project (the ‘United Nations University World Institute for Development Economics Research’ and the ‘Southern Africa – Towards Inclusive Economic Development’ programme).

The research has resulted in a paper called Big and ‘Unprofitable’: How 10% of multinational firms do 98% of profit shifting

As with all studies, the field had to be limited to the data that was available, that is, to companies directly owned by a parent based in a tax haven. Reynolds and Wier found that the biggest 10% of foreign-owned firms account for 98% of the total estimated tax loss.

The study did not include foreign-owned companies where the parent is not based in a tax haven. However, these enterprises can also use artificial methods to reduce taxable profits, such as moving intangible property to a tax haven, for which a royalty must be paid. Hence, the total tax loss caused by profit shifting is most probably underestimated in the study.

Although the most well-known profit shifting mechanism is transfer pricing, there are many other ways in which a company can artificially move profits to a tax haven where they are not taxed or are taxed at a much lower rate. For example, leveraged interest deductions, hybrid instruments (interest payments deducted for tax purposes but where the receipt in the other jurisdiction is treated as a non-taxable dividend), and an inflated charge for logistical services. Certain tax havens allow a notional interest deduction to be made against profits.

As treasury will no doubt be undertaking further such in-depth studies based on data obtained by the South African Revenue Service (Sars), it will have to ensure that Sars starts collecting the relevant data from tax returns.

Competitive distortions

The study found that tax havens not only enable tax avoidance for large multinationals, they also create competitive distortions between larger and smaller firms.

The Base Erosion and Profit Shifting (BEPS) process, a joint Organisation for Economic Co-operation and Development (OECD) and G20 initiative, resulted in a number of reports that gave best practice recommendations for neutralising profit shifting mechanisms, including hybrid mismatch arrangements and leveraged interest deductions. These reports were published in 2015. As interesting as this particular study is, treasury has much work to do to come to grips with those two reports that were published in 2015.

Unfortunately the best deterrent to profit shifting, whether through transfer pricing or another complex tax avoidance mechanism, is for Sars to have highly skilled teams of specialists supported by skilled auditors, who will not only timeously identify tax avoidance risks, but will be able to carry out an effective audit and obtain the relevant evidence to raise an assessment.

The problem with loopholes

Unfortunately, many complex tax avoidance mechanisms rely on a loophole in the law, or in differences between international laws. These are very difficult to identify, and even though they may be terribly aggressive, they are technically legal. As much as tax activists may argue that arbitraging a tax loophole is not within the spirit of the law, this argument is unlikely to be effective in a court case. Loopholes have to be timeously identified by skilled specialists within Sars, who can then recommend how legislation can be changed to neutralise them or render them obsolete.

Tax avoidance mechanisms that can be challenged with existing legislation must be identified, generally by scrutinising tax returns or collected data. The problem with a risk engine is that it can only identify what is known before the tax return for that particular year is finalised. At best it can be two years out of date.

If only Sars had enough audit staff to use the results of this study. To investigate, say, the largest 50 foreign-owned companies across various industries would require between 200 and 500 skilled Sars auditors, plus a solid base of legal support. A complex tax avoidance audit can take five years, and that is before the assessments are issued. Which is most probably why treasury is keen to find legislative solutions. But without a detailed understanding of what it is that they are trying to prevent, the solutions are unlikely to be effective.

We can expect our legislation to become more complex but less effective, the large multinationals to not give an iota, and for individuals to take the brunt of any tax shortfall in raised taxes.

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I really curson reading this.

And I dreaded reading it because it is alarmist nonsense. Firstly the study did not include foreign-owned companies in high paying tax jurisdictions like the UK, USA, Australia etc. Secondly the author refers to companies moving their intangible property to a tax haven. Therefore if Coca-Cola or LEGO move their trademarks to a tax haven, it becomes the problem of the USA and Denmark respectively because they loose out on royalty income and the tax on it. There is no loss to South Africa since we levy a withholding tax in any case. A SA company can’t move its IP to a tax haven and lease back because of Section 23I and exchange control rules so what’s the big deal? Thirdly, Reynolds and Wier refer to an ESTIMATED tax loss and therefore not a real one – nobody knows how big it really is. Finally, if we are so worried about money leaving SA to offshore head offices, why not introduce a withholding tax on management and technical services fees? It is very common all over Africa.

Unfortunately the corporate taxes and all the socialism taxes are stifling the economy and will continue to do so.The problem is, it’s about to get much worse.Show me one Socialist country that works (China is Socialist/Communist.)So they keep taxing the economy and the people, who are at wits end with their finances and what becomes of that, is a bit of a uproar from the PEOPLE. But South African’s are too nice and nice guys finish ____________ (fill in the blank.)Lower the corporate taxes and make everyone pay their fare share as well !!

http://blog.peerform.com/top-ten-most-socialist-countries-in-the-world/

Here is a list of 10 socialist countries.

Don’t be ridiculous. These are not socialist countries for most. Denmark, Sweden, Norway, Canada etc are market economies that have socialised medicine and other social welfare programmes. Socialism means a centrally planned economy such as Venezuela, North Korea and Cuba.

Let’s ask the Danish PM ? https://www.thelocal.dk/20151101/danish-pm-in-us-denmark-is-not-socialist

Consider the number of employees vs tax reduction to the fiscus ? If these Corporates are providing the necessary employment opportunities and are compliant in terms of the triple bottom line accounting we need to pause and look at the TAX issue objectively.
close the loopholes IF possible BUT not at the cost of sending off these Corporate to relocate elsewhere in Africa or wherever it’s Tax efficient for these Corporates.

There is a difference between tax avoidance and evasion. Every company and individual have the right to lessen their (high) tax burden. Enough taxes could be collected without having to increase the tax burden of companies and individuals, if the State and more specifically SOE`s and institutions like SARS were not captured. The squandering of tax payers` hard earned monies through corruption, greed, unethical behaviour as well as unauthorised, fruitless and wasteful expenditure could lead to a tax revolt by tax payers.

…the tax revolt is probably happening already: as in the article, foreign companies operating in SA, shift their (taxable) profit to the holding company’s tax-friendly jurisdiction.

Surely the solution is to make South Africa an attractive place to pay corporate taxes like the Swiss do in Zug or like Mauritius who have a super low corporate tax rate to create employment. When the level of tax is low, the effort and time spent on avoiding taxes declines.

The ANC gangsters simply want to earn a quick buck…it doesnt work like that. Global capital finds its way to its most attractive home and if tiny Mauritius can give us a bloody nose then that says a lot about the rubbish running our economy

SA needs a complete tax system overhaul – a restart from a clean sheet of paper.

Unfortunately, this will most certainly not voluntarily come from within the tax community – who have a vested interest in obtaining their income from a complex system that makes others dependent on their expertise.

Despite the complex tax technicalities, another great article Barbara!

It serves as a reminder that our SA income tax is becoming unattractively high!

Lower our corporate & individual tax rates (and reduce red tape / unnecessary business compliance), FDI will flow in to such an extent that the Govt will collect more tax from a ten times broader taxbase, at a lower rate. That will be a win-win for all.

As you correctly state, on SA’s current (narrow minded) path, Individuals will take more of the brunt in future tax collection. Luckily individuals have feet (and passports), with which they can vote 😉

The large multinationals do not give an iota? Emotive stuff, there Barbs, but irrelevant. Life is a game and we all participate. The secret to success is to know the rules of the game. If I lose 6-0, 6-7, 6-7 in tennis, I may have won more games than my opponent but I still lost as this is not what counts. It is sets that count (1-2). I cannot cry ‘foul’ like the democrats did winning the popular vote because that is not how it works.

In life the real power is economic. This is why academics and government bureaucrats despise industry. Investment capital is mobile and governments literally bid for this by showcasing their wares which include tax rates, skills, red tape and wage rates amongst other factors. Governments are not powerless to act against tax avoidance but the only effective weapons are carrots (incentives) not sticks. Many countries realise this but not the ANC. They will never get rid of transfer pricing or its allied avoidance schemes by ‘clamping down’. Investment in SA is minimal and currently confined principally to the mining sector due to favourable geology. The ANC could fix all this with a corporate tax rate of 18% but they would never do this as they cannot think laterally. At 18% corporate tax, the incentives will be to pay the tax in SA rather than the holding company country. There are of course many other ills to fix such as crime, education and defanging the labour unions. This is why it is critical to dump the ANC with extreme prejudice at the earliest opportunity.

Until tax systems are normalized around the world, the tax dodge games will continue. No deduction in country A if that item is not taxable income in country B and country B has a minimum tax rate. That, plus withholding taxes that are dealt with fairly in DTA such that the company does get a tax credit when earned. If a few tax havens hold out, then they will just get squeezed out of the banking system – no international clearing. 9/10 of the tax havens are in any event more about shielding illicit income, not paying less tax.

An easy start for SARS is groups with centralized global procurement through postbox operations in tax havens. That and royalties on trademarks and IP are never run from the actual HO.

One has to also take into account the devaluation of the Rand…that will offset 40% of their profitability alone! All is not what it seems – these companies have created jobs, supported us through SOE breakdowns, have absorbed and help us sustain our electricity supply, generated advertising revenue – have generated tax revenue for SARS in a million ways…let’s not be too critical because we still need them to hang around for a while and encourage their friends to open up here too.

Just pass a law stating that all companies MYST pay a demonstrabl minimum tax of 20%.

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