by Maria José Romero
A four-day workshop in Buenos Aires, Argentina, last week highlighted serious challenges faced by developing countries trying to mobilise their own resources for development. The event, organised by Latindadd, gathered more than forty delegates, from Latin American civil society organisations, the US, Europe and Africa to academics and regional tax administrators to discuss how transfer pricing mechanisms and double taxation agreements undermine the possibility for developing countries to collect taxes in an equitable manner. The event was also an opportunity to expose specific examples of the negative impact that illicit financial flows have on developing countries and to evaluate concrete policy proposals.
Trade mispricing and illicit flows
Christian Aid estimates suggest that in Sub-Saharan African countries almost $ 27 billion was shifted illicitly between 2005 and 2007, as a result of mispriced trade with European Union members and the United States. The figures increase to $ 95 billion in Latin America during the same period. If tax had been levied on this capital, an additional $ 4.34 billion could have been collected in Sub-Saharan Africa and an additional $ 31 billion in Latin America. According to Global Financial Integrity, trade mispricing accounted for an average of 54.7% of cumulative illicit flows from developing countries over the period 2000-2008, between $ 397 billion and $ 443 billion.
Civil society representatives and tax administrators present at the event agreed that the victims of trade mispricing are mainly developing countries, where the revenue authorities have neither the expertise nor the resources to monitor or prove what is happening.
MNCs have a lot of resources and can, often following the advice of the big four accounting firms, set up complex tax planning schemes and use tax havens to minimise tax payments. Lack of transparency in financial reporting make it incredibly difficult for ill-equipped tax authorities in developing countries to work out what tax is due to them, because companies are not obliged to report the profits they make in each country where they operate.
Regarding international standards, there was broad consensus about the problems posed by OECD guidelines on transfer pricing, which recommend the application of the “arm's length principle” for the valuation of cross-border transactions between associated companies, requiring market prices in their intra-group trading. These guidelines are becoming increasingly difficult and complex to administer and enforce, as transfer pricing today typically involves huge and expensive databases and high-level expertise to handle. Participants discussed the case of Brazil, which allows taxpayer to mathematically determine and prove its pricing benchmark without having to go through a search for comparables, as a concrete alternative to the OECD arm’s length principle. However, much more evidence is needed to find a way that works effectively for all developing countries.
In order to illustrate the modus operandi and the impact of these activities, in my presentation I highlighted the findings of ActionAid research, which reveals how SABMiller, the world’s second biggest brewer, uses transfer pricing to siphon profits out of subsidiaries in developing countries, depriving those governments of significant amounts of tax. It was also useful to point out the case of Glencore in Zambia, where an independent tax audit revealed that its Zambian subsidiary, Mopani Copper Mine, artificially increased its costs and sold its commodities far below marked prices in order to siphon its profits to Glencore International, registered in the tax attractive Canton of Zug, Switzerland.
A net of double taxation treaties: in favour of whom?
Developing countries also face great challenges when they negotiate investment contracts and Double Taxation Agreements (DTAs), which all too often include tax-related conditions that curtail the possibility of developing countries collecting taxes in a fair and equitable manner. Aiming at analysing the development implications of DTAs, participants discussed in the first place the links between DTAs and foreign direct investment (FDI).
DTAs are signed to avoid double taxation in two different jurisdictions, in other words, to redistribute taxing rights from host to residence states. But in practice, these treaties lead to a loss of tax revenues in developing countries in favour of developed countries. A crucial question is whether that loss is compensated by an increase in FDI and the corresponding corporate income taxes.
Other relevant questions were also posed, namely, whether DTAs are necessary to avoid double taxation and whether they are a useful tool to enforce tax compliance by exchanging meaningful tax information. In terms of examples, I mentioned the case of the Netherlands to illustrate the effect of treaty shopping on developing countries and Afrodad representative talked about the implications of the DTA between South Africa and China. At the end of the discussion the use of these treaties from a development perspective remained unclear. Instead, participants were clear about the need for increasing awareness about this issue among civil society organisations and like-minded decision makers.
Some proposals from civil society
It was the need for greater financial transparency and recent developments at EU level which I picked up in my presentation during the panel on proposals from civil society organisations. Country-by-country reporting was seen as an important tool to enhance the quality of comparable data which would, in turn, help developing country tax administrations and civil society groups to raise red flags regarding potential abuse worthy of further investigation.
It is also important to know who is behind the money, which in practical terms would mean stronger beneficial ownership requirements under the Anti-Money Laundering directive that is being reviewed at EU level, so that illegal money flows are harder to transfer or invest in EU assets.
In Latin America participants called on the Union of South American Countries (UNASUR) and other regional bodies to work towards transparency and regional cooperation in tax matters arguing that it is crucial to address transfer pricing practices and the treaty architecture in an effective way.