Visualising Uganda’s (and others’) tax treaties

Interesting news from Uganda, where the government announced in its latest budget that it has finished formulating its new tax treaty policy, and will be renegotiating treaties that don’t comply. Seatini and ActionAid Uganda will no doubt chalk this up as a success! The news report linked to above also states that the the government plans to amend the awkwardly-worded anti-treaty-shopping clause in its Income Tax Act, although there are clearly still doubts about its application. According to a report in Tax Notes International, there’s an ongoing mutual agreement procedure between the Netherlands and Uganda to try to settle the ongoing Zain capital gains case, which turns on the applicability of that clause. 105_screen_shot_2016_04_29_at_6_11_10_am

So this is good timing for my working paper with Jalia Kangave, based on a submission we made to the Ugandan government’s review, to have been published by the International Centre for Tax and Development.

Here’s a link to that paper on Researchgate

When writing that paper, I thought that Uganda had a pretty good record of tax treaty negotiations, but some new visualisations of the ActionAid Tax Treaties Dataset suggest otherwise. For these I am indebted to Zack Korman, and to tax twitter for introducing me to him. Below are some maps Zach has made using the ‘source index’ I developed for the dataset (read more about that here). Red means a residence-based treaty that gives fewer taxing rights to the developing country, while green means a source-based treaty that gives it more taxing rights.

This slideshow requires JavaScript.

Links to high-res versions of individual images: Uganda map, Uganda bar chart, Vietnam, Mauritius, UK, Nordics

Uganda’s treaties are pretty red, meaning that most of its treaties restrict its taxing rights much more than average. Looking at the breakdown of the index shows that Uganda has some above-average withholding tax provisions, but its treaties are quite a lot worse than average in other areas. The slide show also gives some other countries for comparison. Vietnam’s treaties are mostly green, while Asian countries have got better deals from Mauritius (an offshore financial centre, not a developing country, in this context) than African ones. The UK’s treaties are pretty red, while the Nordics are very interesting: diverse in content, but consistent among themselves, giving good deals to Kenya and Sri Lanka, and worse ones to Tanzania and Bangladesh. This suggests that more source-based treaties with Nordic countries have been up for grabs for tough-negotiating developing countries.

Below I’ve posted some of Zach’s animated maps, on which it’s easier (and interesting) to follow the developments at earlier stages. There’s lots to comment on, but mostly I just keep watching them. The technical service fees map, at the bottom, is especially interesting, as it shows how countries have changed attitudes over time: watch how Pakistan suddenly changes position in the mid 1980s, for example.

World2

Above: All treaties in the dataset (red=residence-based, green=source-based)


Asia

Above: Asia (red=residence-based, green=source-based)


Africa2

Above: Africa (red=residence-based, green=source-based)


Vietnam2

Above: Vietnam (red=residence-based, green=source-based)


UK2

Above: UK (red=residence-based, green=source-based)


Nordic2

Above: Nordic countries (red=residence-based, green=source-based)


Netherlands2

Above: Netherlands (red=residence-based, green=source-based)


Slow WHT

Above: Management, technical service and consultancy fees WHT (green=included, red=excluded)

 

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The Mopani saga and Zambia’s windfall tax: an alternative reading

In 2010, Zambian NGOs obtained a leaked copy of an audit report conducted for the Zambia Revenue Authority into Mopani Copper Mine, a subsidiary of the Swiss behemoth Glencore. I was working at ActionAid at the time, where we took an active interest in the case. The particular allegation concerning systematic transfer pricing abuse contained in the report was consistent with the experience of many tax authorities, so much so that many Latin American countries have a specific transfer pricing rule to combat it. And with the Grant Thornton imprimatur, it seemed like the perfect story. The company denied it, but then of course they would.

A group of NGOs filed a complaint with Swiss National Contact Point for the OECD Guidelines for Multinational Enterprises (not to be confused with the OECD Transfer Pricing Guidelines), triggering an investigation, but with the parties disputing the facts, there was no concrete outcome. The European Investment Bank, which had lent money to Mopani, conducted an investigation, but so far the findings have not been published. The whole thing feels frustratingly inconclusive.

So while I was in Zambia recently I thought I would look into the story. I have pieced together the account below from interviews with current and former government officials, and with tax advisers from the private sector. It is no doubt only one interpretation of the facts, given to me by stakeholders with their own interests to defend. But it is certainly an interesting one.

In the mid 2000s, as copper prices rose dramatically, the lack of tax revenue from copper mines started to become an issue in Zambia. So in 2008, the government decided to break the fiscal stability clauses in its agreements with mining companies, and enact new taxes.

Historical Copper Prices - Copper Price History Chart

There were two: the windfall tax was based on the value of copper extracted, and the variable profits tax was levied when profitability exceeded a certain amount. There’s an excellent paper by David Manley [pdf], who was in the Zambian finance ministry at the time, explaining all of this. The idea, so I was told, was to begin with a moderate tax on sales, and meanwhile to build capacity in the Zambia Revenue Authority to administer a variable profits tax.

Officials were frustrated, however, that the original proposal to levy the withholding tax at between five and 15 percent (depending on the price of the copper sold) was rejected by politicians, who instead set it at between 25 and 75 percent. This was politically unsustainable in a country where the mining industry is willing and able to lay off hundreds or thousands of unskilled workers in a standoff with the government, as it is doing now in a dispute over VAT refunds, and (so I was told by one researcher) powerful enough to manipulate the exchange rate.

“At the time the mines were in the development stage, and it would have killed them to tax on sales,” a former official told me. According to a tax adviser, “It was pushing the mines into a loss.” Manley is more understated:

The mining companies were upset by the unilateral revocation of the Development Agreements and some refused to pay the new taxes. The announcement was followed shortly after by the onset of the global financial crisis. Copper prices fell sharply and marginal mines started laying off workers.

In 2009, the government backed down, and the windfall tax was repealed. It is here that the Mopani audit comes into play. The ZRA, with support from Norwegian technical assistants, began to conduct (or rather commission) audits of all the mining companies. The purpose was to start enforcing the variable profits tax with a clear idea of the mines’ cost bases. This targeted approach would work well with limited tax authority capacity and only a few very large mines. As the Mopani audit report makes clear, the company wasn’t very cooperative with the audit. Here I paraphrase what a former official told me:

“It was a tactic.” It’s what you do in an audit if they are not supplying the information. There was a lot of missing information and so the report was written with the intention of giving it to the company and saying ‘either you provide the information, or we will tax you on this basis.’ So of course you take an aggressive position in the audit report to create an incentive for them to supply the information. Then it was leaked and it all exploded internationally. Over time, some information came and we settled with them. Of course it was lower than the amount in the audit.

According to this official’s version of events, the audit tells a tale of a company doing its best to frustrate a tax authority by obfuscating, but for that same reason it can’t be read as a final word on Mopani’s tax affairs.

As for taxing mining profits, it now seems that Zambia’s new government has given up on this altogether, opting instead for a much higher royalty rate – effectively a return to the windfall tax. The industry is unhappy. Worse still, “as audit firms we’ve been rendered useless,” a tax adviser said to me.

But one way to interpret this in the light of the Mopani audit is that, if firms make it difficult for developing countries to administer taxes on their net income, they risk being taxed on gross instead. Zambia has, after all, already raised withholding taxes on management and consultancy fees to 20 percent.

 

Time we scrutinised China’s tax treaty practice, too

Democracy in action: David Gauke at Monday's delegated legislation committee session

Democracy in action: David Gauke at Monday’s delegated legislation committee session

On Monday the UK parliament took a total of 17 minutes to scrutinise new tax treaties with Zambia, Iceland, Germany, Japan and Belgium. I’ve complained before about how paltry these debates tend to be, and was all set for another blog along those lines. There was, indeed, much to grumble about. No questions from the opposition about the UK’s renegotiated treaty with Zambia at all, a week after the IMF warned that developing countries should exercise “considerable caution” when entering into tax treaties.

Instead, Labour’s Shabana Mahmood asked how the UK’s treaty making priorities were set, and why there is no treaty with Brazil. The response from the Minister David Gauke was considerably less informative than what I’m sure Mahmood could have found out by asking, say, her colleague Stephen Timms, Gauke’s predecessor.

But something interesting did come up when Gauke was introducing the Zambia treaty. He noted that the withholding tax rates have been reduced in line with Zambia’s treaty with China. And indeed they have. It seems to be China, often regarded as the champion of source state taxation at the UN tax committee, which is responsible for the lower withholding tax rates. I’m going to explain here why I think both the UK and China have questions to answer about these treaties.

The UK-Zambia renegotiation: a missed opportunity

The UK-Zambia renegotiation looks like a ‘balanced package’, meaning that Zambia will have gained and lost in roughly equal measure. Looking at the treaty, I don’t think it can be seen as a win for Zambia.

What it lost was withholding tax rates. Zambian tax on dividends to British portfolio investors will be reduced under the new treaty from 15% to 5%, and tax on royalty payments for the use of British intellectual property will drop from 10% to 5%. This matches what’s in the 2010 Zambia-China treaty [pdf], so it looks like Britain was keen to keep its investors competitive relative to their Chinese competitors.

By way of context, Zambia’s non-treaty rates are much higher, 15% and 20% respectively. We can argue about the economic case for this level of withholding tax, but treaties are not just about rates, they’re about the right to raise rates. It will be five years before Zambia can re-examine these low withholding rates in its treaty with the UK.

What Zambia got in return for the reduced withholding tax rates was the UN concept of services permanent establishment, which will allow it to tax services provided within Zambia by British businesses or individuals. To do so, Zambia won’t need them to have a physical fixed base in Zambia, as it would have done before, but it will need them to be physically in Zambia, furnishing services, for at least 183 days in a given year.

(There are also some modernising changes, which may in practice benefit Zambia more than the UK. This includes simple anti-abuse wording such as the “beneficial owner” clause in the withholding tax articles and a “property rich companies” clause into the capital gains article. It also includes information exchange and assistance in recovery articles. These should be good for Zambia, if it takes advantage of them. The information exchange clause could, for example, allow Zambia to get hold of country-by-country reporting on British companies if that proposal is implemented by the OECD.)

But the overall picture, taking into account the lower withholding taxes, is of a treaty that is still much more disadvantageous to Zambia than one based on the UN model would have been. I’m not even sure it’s a better position than the OECD model. Since Zambia was not nearly as aggressive at negotiating after independence as, say, Kenya, it started this renegotiation from a lower base: already low withholding taxes, no taxing rights over British airlines, limited capital gains tax rights, and no right to tax management fees, to name a few examples.

In a context in which some countries are re-examining their tax treaties with developing countries, and organisations such as the IMF are calling into question the benefit of tax treaties on current terms, there would have been a strong case for the UK to seek not a balanced negotiation, but a reapportionment of taxing rights towards Zambia, in line with the UN model. It’s a real shame that the treaty slipped through parliament on Monday without anyone at least asking about this.

China is driving the falling withholding tax rates

This argument for a more pro-source taxation treaty between the UK and Zambia would be easier to make if the 2010 China-Zambia treaty had been more generous. But in fact the terms of the two treaties are near identical. On the face of it, it seems quite likely that Zambia has been bounced into this renegotiation to help keep British mining, agriculture and manufacturing companies more competitive in the face of competition from China. These companies will benefit from the lower withholding tax rates but are unlikely to be affected by the services permanent establishment quid pro quo.

The IMF report talked about “strategic spillovers” from tax policy, in which one country’s policy pushes other countries towards a response. I’m now starting to wonder if China’s negotiating stance might be having just such a strategic spillover, contributing to the decline in withholding tax rates in treaties also picked up by the IMF. Below you’ll see that China’s treaties with sub-Saharan countries have the lowest withholding taxes in a sample of countries investing into Africa.

Withholding taxes in treaties with sub-Saharan countries, 1973-2012

Withholding taxes in treaties with sub-Saharan countries, 1973-2012

China’s treaties are newer than other countries’, so what if this trend is just an artefact of the general decline? Not so if we look at just the last 20 years, where the story is much the same, with only Mauritius (which has several zero withholding tax treaties) having a more advantageous treaty network.

Withholding taxes in treaties with sub-Saharan countries, 1993-2012

Withholding taxes in treaties with sub-Saharan countries, 1993-2012

Let’s now test whether those three Chinese treaties in Africa are typical of China’s treaties more generally. This time we’re looking at all low-income countries. Not only is China the largest signatory of treaties with this group among my sample, it also emerges as one of the most demanding negotiators.

Withholding tax rates in treaties with low-income countries, 1993-2012

Withholding tax rates in treaties with low-income countries, 1993-2012

Withholding taxes are of course only one part of the source-residence balance in a tax treaty. I took a quick look at the China-Africa treaties, and – aside from the services permanent establishment.- there is no sign that they include pro-source provisions such as withholding taxes on management fees, or a “limited force of attraction”. It’s been well-documented that China favours expansive source taxation in its treaties with outward investors, while denying them to capital-importing developing countries.

The UK-Zambia treaty seems to be an example of a strategic interaction between two countries, one (the UK) with a longstanding investment base in Zambia, and the other (China) posing a threat to that investment. It’s all very well to criticise countries like the UK for not being more generous in negotiations with developing countries, but in doing so, critics should be careful not turn a blind eye to countries outside the OECD, who may even be the ones leading the race to the bottom.

Oxfam goes for the full Tanzi…but is that far enough?

“Revenue is the chief preoccupation of the state. Nay more it is the state”
– Edmund Burke

I spent the weekend with some old friends from the development sector. One of them, it now turns out, is working for a public relations consultancy. There was an awkward moment when I explained that I was working on international tax and my friend asked, with a sheepish grin, whether I was following BEPS. We were both following it from, well, different angles.

The most interesting moment in our conversation came when my friend mentioned clients’ fear of the ‘Margaret Hodge effect’. I can understand that, I thought. No company wants to see its executives thrown to the wolves in the Public Accounts Committee. But I had misunderstood.

“What my clients are concerned about,” said my friend, “is political interference in corporate tax policymaking.” I found this quite startling. Is it possible that businesses consider corporate tax policy to be a matter for private negotiations between them and the government, rather than the subject of public (and even parliamentary) debate as part of the government’s budgeting process?

The UK’s corporate tax regime has been dramatically overhauled over the last ten years, with a plummeting corporation tax rate and vast swathes of the multinational tax base exempted. This is a serious structural change in our tax system, yet there’s been barely a peep about it in public debate. And we continue to sign tax treaties, with only a cursory discussion in parliament each time. The public attention is only ever caught by the ex post impact of policy decisions in the tax returns of multinational firms. Hence why Pfizer’s bid for Astrazenica, and not the policy reforms that encouraged it, has been front page news.

I had this in mind as I read Oxfam’s new briefing paper on “Why corporate tax dodgers are not yet losing sleep over global tax reform” and Duncan Green’s blog post discussing it. Oxfam’s entry into the tax justice campaign has brought some fresh and interesting perspectives, and this is no exception. The paper argues that developing countries are unlikely to benefit from BEPS, for two main reasons:

Firstly, the business lobby currently has a disproportionate influence on the process, which it uses to protect its interests. Correcting the rules that allow the tax dodging practices of global giants like Google, Starbucks and others that lead to tax revenue losses in OECD countries will be difficult, given the size of the corporate lobby. But worse, perhaps, is that the interests of non-OECD/G20 countries are not represented at all in these negotiations.

It goes on to analyse the contributions to OECD consultations to demonstrate the overwhelming contribution from wealthy countries and business organisations. The paper calls for a three-pronged solution:

  1. Fully engaging non-G20/non-OECD countries in BEPS decision making
  2. Working towards a World Tax Authority to improve governance of international tax, along the lines proposed many years ago by Victor Tanzi.
  3. Widening the scope of the BEPS Action Plan to incorporate tax competition concerns, the redistribution of taxing rights, and reconsideration of the arm’s length principle

Oxfam, like other development NGOs, is keen to fix the problems it has observed with the OECD’s way of doing things. It is looking to change international institutional arrangements as a way of achieving this. The paper’s only real discussion about what happens at national level concerns “helping developing countries strengthen their fiscal administrations.”

This is all important stuff, but it’s missing something: a strategy to increase political engagement with corporate tax policymaking. International institutions can shape countries’ preferences and strategies, but the decisions they take (and maybe even the ways they work) are still products of the different positions taken by their member states. National politics matters.

If, as Oxfam argues, the business lobby has a disproportionate influence at the OECD, that influence won’t only be exerted at international level: it must also be applied inside the member states, who ultimately make the decisions at the OECD council. Is it wise to open up the source/residence debate within the BEPS process, as Oxfam proposes, when businesses favour reduced source state taxation? There is certainly a case for re-examining the political settlement at the heart of international tax institutions, but the outcome of such a process will surely follow the distribution of power among its participants.

If, as Oxfam also argues, developing countries are not participating in the decisionmaking, that isn’t just because the space for them is limited. It is also because they aren’t making the most of the opportunities available to them. Many of the UN tax committee’s most developing country-friendly initiatives in recent years have been led not by its developing country members but by members from OECD countries putting themselves in developing countries’ shoes, or by members from emerging economies whose interests do not always coincide with developing countries. That’s fine so long as international tax is a technical exercise, but an inclusive political process would cast these conflicts of interest in sharp relief.

Developing countries’ failure to take advantage of the opportunities that are already available to them can be seen in the tax treaties they have negotiated, comprehensively studied in an IBFD report for the UN tax committee [pdf]. Many significant clauses from the UN model treaty, which would confer on developing countries greater taxing rights, are absent from most of the tax treaties signed by developing countries. There are some examples in the chart below. I don’t know (yet) why developing countries often get such poor outcomes, but what happens in bilateral negotiations would surely occur in international negotiations too.

Use of UN model provisions in tax treaties between OECD and non-OECD countries

Source: IBFD for UN tax committee

Duncan Green situates the BEPS process in the later stages of the “Policy Funnel” (below), when “the technical content gets greater, and the chance to mobilize the public declines.” But corporate tax policy has been at that end of the funnel since the 1920s. The aim should be to drag it back towards a public debate.

The Policy Funnel (Source: From Poverty to Power)

The Policy Funnel (Source: From Poverty to Power)

What Oxfam is proposing would lead to an even larger technocratic tax community at international and national levels (a world tax organisation, and more tax authority capacity in developing countries). That may well be necessary. But what we need even more is for politicans and the public in each country to hold the technocrats to account. It seems to me that this can be done more effectively by beginning at the national level, looking at domestic tax rates, tax incentives, and tax treaties. Until that happens, I don’t think that the politicians of developing countries will pay enough attention to BEPS or anything of its ilk to get stuck into the politics and shift the centre of gravity of international corporate tax policy.

Tax-motivated illicit financial flows: A guide for development practitioners

January was a busy month and so this is my first blog of 2014. I didn’t intend for my comeback to be a self-promotion post, but that’s how the timing has worked out!

Last year I was pleased to be able to work with the U4 anti-corruption centre in Norway on an introductory briefing on illicit financial flows, which has just been published. U4’s main audience is people working for development agencies such as DFID or Norad, and so we wanted to briefly cover all the areas that such people might find it helpful to know about, without assuming any prior knowledge. We tried to offer up an even-handed summary of the different viewpoints, rather than coming down on one side or the other. I’m sure not everyone will think we achieved that even-handed balance, but you can’t please all of the people all of the time!

Also recently published is a short policy briefing by Mick Moore at the University of Sussex on the G8/G20 tax reform agenda and developing countries. He also picks two areas of priority for developing countries to address by themselves, outside these international processes: tax incentives and property taxes.

One point that both papers make is about the lack of coherence in developed countries’ tax policies. Mick says this:

experience suggests that the governments of the economically and financially powerful OECD countries will behave ambiguously. They find it relatively easy to close some international tax loopholes by pressuring jurisdictions that have little geo-political clout, like Ireland, Luxembourg, Switzerland, and tiny Caribbean tax havens. They are less likely to accept limits on their own capacities to attract investment and ultra-rich tax immigrants by granting tax ‘incentives’ of many kinds. Virtually all governments compete heavily for investors and investment, and are willing to forego quite a lot of their potential tax revenue in the process. While the British Prime Minister has been promoting the G8/G20 tax reforms, the UK Treasury has continued actively to develop new tax ‘incentives’, such as reduced corporate taxes on income attributable to intellectual innovation, to attract capital from abroad.

Whereas in the U4 paper we put the point as follows:

it would be paradoxical for a donor government to devote billions of dollars each year to overseas aid when much of this aid is plugging a revenue gap that could be closed through its own tax policies. In some instances, such as the negotiation of tax treaties with developing countries, this is a matter of adopting an enlightened approach to international tax that supports development priorities. In many other cases, however, developed and developing country governments have a shared interest in tackling illicit capital flight. The challenge is to develop sustainable, multilateral solutions that allow poorer countries to use taxation to raise public revenue for investment in economic development, to direct private wealth into productive investments, and to distribute the proceeds of growth fairly.

We’ll all think more about how to do this in the coming year, I hope!

Is tax treaty arbitration really a bad thing for developing countries?

I’m at the United Nations tax committee annual session this week, where I’ve learnt that I have to be careful what I write here, after a couple of posts from this blog were included in an input document [pdf]. Erk!

I’ve been taking the opportunity to discuss with delegates the recent article [£] by the chief of the UN committee’s secretariat, Michael Lennard, on the inclusion of arbitration in tax treaties with developing countries. Lennard begins from the concern that I’ve raised here too, which is that the BEPS Action Plan implies the use of a multilateral treaty to introduce mandatory arbitration clauses into existing tax treaties.

There are a number of potential problems with arbitration from a developing country perspective, which Lennard outlines, drawing on the experience of investment treaty arbitration. Briefly:

  • the cost of a full blown arbitration could be prohibitive for developing countries, forcing them to capitulate on some occasions, or alternatively stacking the process in favour of more wealthy countries who can afford the most skilled and experienced legal representatives.
  • Because transfer pricing expertise is limited in developing countries, it’s likely that most arbitrators themselves will come from developed countries, in which case their neutrality – or at least their sensitivity to the realities of developing country tax administration – might be questioned.
  • There is a range of concerns about the lack of transparency in arbitration outcomes, which is a problem for scrutiny (I’ve shared before a paper by Alison Christians on this topic), but could also mean that countries and lawyers only have their own experience to learn from, further biasing the arbitration process against developing countries to whom arbitration would be new.

Lennard also talks about a range of ways that arbitration might work better for developing countries. I’m just going to focus on one aspect of this, which is the ‘simplified procedure’ that is used in the UN model’s optional clause. (It’s also known as ‘baseball arbitration’, because it’s used in pay negotiations in the US baseball league).

Under the simplified procedure, the arbitrator doesn’t have to produce her own solution that tries to synthesise the concerns of the two sides. Instead she just chooses between one side’s position or the other.

Delegates I spoke to here said that the analogy with investment arbitration doesn’t hold when the simplified procedure is applied:

  • The costs are much lower, because there’s no need for lengthy meetings, the process demands much less time from the arbitrator, and – so one committee member said to me – you don’t need a lawyer to prepare written submissions.
  • The arbitration tends to move countries’ positions closer together, because it’s an all or nothing outcome, and a more conservative position might be more likely to succeed.
  • The democratic scrutiny point notwithstanding, transparency isn’t such a concern because the arbitrator is only permitted to choose one side, not to explain her reasoning – so there is very little to learn from past experience.

These discussions have certainly changed my thinking a bit, but I’m not sure that it is as clear-cut as those who favour arbitration suggest. In a judgement-based process, as opposed to a purely rules-based one, the quality of submissions is sure to affect the outcome. And it’s inevitable that an imbalance between countries in resources, expertise and experience will translate into an imbalanced outcome. Isn’t it?