Africa will have to rebuild its economies post the Covid-19 pandemic, and efficient fiscal policies will be vital in ensuring that revenue is not lost through aggressive tax avoidance schemes, illicit financial flows and the inability to tax business operations provided by offshore digitised multinationals.
According to the African Tax Administration Forum (ATAF), corporate income tax represents a higher share of tax revenues and GDP in developing countries than in rich countries.
Tax levies are also higher – on average 16% of total tax revenue, compared to 9% in Organisation for Economic Co-operation and Development (OECD) countries.
Global tax reform
July 1 saw 130 countries and jurisdictions sign a statement agreeing with the Inclusive Framework two-pillar plan to reform international taxation rules and ensure that multinational enterprises pay a fair share of tax wherever they operate. These countries represent more than 90% of global GDP.
The two-pillar plan had been developed by the OECD and its members over the last decade. ATAF, with 38 member countries, had been invited to participate, and to strengthen the participation of Africa in the process.
ATAF views the work being carried out by the OECD and the Inclusive Framework on the Pillar One and Pillar Two rules to be of vital importance to African countries.
Pillar One will ensure a fairer distribution of profits and taxing rights among countries in regard to large multinationals, including digital companies. It would reallocate taxing rights to the markets where they carry out business activities and earn profits without having a physical presence in those markets.
Pillar Two introduces a 15% global minimum corporate tax rate.
The biggest tax overhaul in 100 years
After nearly a decade, it is a big deal that some 130 countries have agreed to the Inclusive Framework. But who will lose, and who will gain?
When powerful countries are driving (or curtailing) proposed reform, how strong is Africa’s voice?
Africa is resource-rich, and most African countries struggle with an imbalance in the allocation of taxing rights between source and residence countries.
African countries are also in need of foreign direct investment, which can be a disadvantage when negotiating or renegotiating a double taxation treaty.
For nearly a hundred years, countries have levied taxes based on the location of a business. However, with the digitisation of the economy, companies are able to sell digital services into countries where they have no physical presence.
When the OECD published the blueprint of the Inclusive Framework, ATAF published a press release stating that it “welcomes the achievement of this new milestone as, in our view, a global consensus on the tax challenges arising from the digitalisation of the economy is of paramount importance as now more than ever, cooperation and multilateralism are required in developing solutions that will assist all countries in rebuilding their economies in a post-Covid-19 environment”.
ATAF’s comments on Pillar One rules
The Pillar One Rules incorporate some of ATAF’s suggestions, but more needs to be done to address the imbalance in the allocation of taxing rights between source and residence countries.
In partnership with the African Union, ATAF is calling upon the Inclusive Framework to undertake further work on the tax allocation issue.
ATAF also notes that the profit allocation, namely that 20% of the residual profit can be reallocated to countries where the multinational operated and earned profits, but only where that multinational has a minimum profit margin of 10%, “appears to lead to only a low level of profit reallocation, in particular, to smaller markets jurisdictions”.
ATAF is of the view that many digital businesses have no taxable nexus presence in a market jurisdiction, and therefore none of the routine profit will be allocated to that jurisdiction.
“This does not seem like an equitable outcome,” it says.
The Inclusive Framework provides an allocation between 20% and 30% of residual profit, in excess of a 10% minimum profit margin, to market jurisdictions. ATAF would prefer to see at least 35% of residual profit being allocated to market jurisdictions.
The Inclusive Framework proposed an elective binding dispute resolution mechanism to solve any issues, and ATAF managed to get agreement that any binding arbitration would be consensual, as dispute resolution is a demanding and complex process.
ATAF’s comments on Pillar Two rules
ATAF anticipates that the Pillar Two rules will help stem illicit financial flows out of Africa by multinational enterprises through artificial profit shifting. It also welcomes a minimum effective tax rate, but would prefer this to be 20% and not the agreed 15%.
Developed countries opposed ATAF’s proposal for a source-based rule – such as the so-called Undertaxed Payments Rule (UTPR) or Subject to Tax Rule (STTR) – to be applied in priority to the so-called Income Inclusion Rule (IIR).
The STTR can be included in bilateral tax treaties with Inclusive Framework members that apply nominal corporate income tax rates below the STTR minimum rate.
ATAF called for the STTR to be broad in scope to cover payments of interest, royalties, all service payments, and capital gains. However, the Inclusive Framework agreed that the STTR will cover interest, royalties, and a defined set of payments.
ATAF notes that its members have found that service payments are a notable profit shifting risk.
Restoring stability to the international tax system
ATAF holds the view that the work of the Inclusive Framework will restore stability to the international tax system.
African countries have been introducing new measures to curtail aggressive transfer pricing schemes by multinational enterprises. Mining regimes will be strengthened and tax incentives will be evaluated.
The Pillar One and Pillar Two rules will enable African countries to claw back some tax on highly digitalised businesses. The development of global tax rules is a key part of the tax policy considerations for Africa in the post-Covid era.
More work needs to be done to ensure a more equitable tax allocation and to stem illicit financial flows from Africa. ATAF notes that developed countries should not exert political pressure on developing countries if an equitable outcome is to be attained.
Compromises have been made. Extractives and financial services have been excluded.
Countries that had already introduced digital services taxation, such as the UK and France, have agreed to dispense with these.
ATAF executive secretary Logan Wort says the carve-out for financial services was contentious, but at least a compromise was reached on mandatory binding arbitration (that countries would participate in binding dispute resolution on consensual basis). Wort also notes that even though 130 countries agreed with the Inclusive Framework plan, some agreed with reservations.