Billions of dollars in tax revenues are lost to African governments each year, owing to illicit financial flows and tax avoidance, which impacts countries’ ability to provide services and support industrial development.

Trade & Industry Policy Strategies (TIPS) chairperson and Department of Trade, Industry and Competition industrial procurement chief director Dr Tebogo Makube explains that tax avoidance means legally reducing your taxable income, which has base erosion and profit-shifting affects as a consequence.

He adds that tax avoidance gets particularly complex to investigate and measure with multinational companies, with operations spanning many jurisdictions, including “tax haven” jurisdictions.

University of London School of Oriental & African Studies lecturer Jonathan Di John says tax speaks to State capacity, with governments using tax to finance public goods and social programmes. It can also be used as a strategic tool to promote development and incentivise production, particularly through tariffs.

He elaborates that there has been more emphasis in recent times on how efficiently and effectively governments are collecting tax and how tax links to production strategies over and above collection rates.

For example, Mauritius, through its export taxes on sugar, a major agricultural commodity in the country, has had several positive effects on State-society relations and has increased the productive capacity of the sugar sector.

Di John explains that Mauritius’ export tax on sugar has been an effective substitute for income taxes and has been generally progressive, as it shifted the burden of taxation onto the wealthier groups of society and land owners.

The tax has also been used by the State to finance research and development, as well as marketing of sugar, leading Mauritius to become one of the most efficient sugar producers globally.

Tax avoidance and tax evasion, the former of which is illegal in the form of concealing income, can impact negatively on development. Di John says tax incentives become ineffective if companies avoid paying tax in the first place. It also leads to a legitimacy problem if more people believe they can get away with tax avoidance, and leads to inefficacy of tax as an industrial policy.

Di John points out that most people with the ability to influence policy and taxation have increased independence from the State, including through tax avoidance measures and, therefore, do not use their influential ability to create better public institutions and better tax regimes.

However, Di John says that higher tax rates do not necessarily translate into high investment rates and, therefore, fixing tax avoidance will not necessarily be an effective industrial policy by default.

He elaborates that open capital markets and exit options discipline governments against appropriation of property, unsustainable macroeconomic policies and excessive taxation.

Di John argues that tax avoidance can be the result of ineffective industrial policy and investment climate, or vice versa. 

He adds that tax avoidance, and even tax evasion, is often tolerated by governments owing to the select few that benefit from the rent distribution system of a business or business activity. This is endemic to many African countries.

“Beneficiaries will expend significant effort and sources to prevent relevant institutions from destroying the rents associated with illicit financial flows,” he states.

TIPS economist Nishal Robb highlights that the misalignment, illegal or not, between where profits are declared and where underlying economic activity takes place, is fundamentally harmful to society, distorts markets and facilitates corruption.

He believes tax havens and offshore wealth results in secrecy, which has social consequences.

For example, a former platinum group metals mining company used to trade metals through a trading company based in Bermuda; however, the company paid no income tax, generated no branch profit tax and had no transfer pricing legislation bound to it.

The Bermuda-based subsidiary had no staff, no commercial rationale and it is believed that this subsidiary had an impact on fair dividend payments and wage negotiations.

By avoiding paying certain taxes, mining companies may dodge supporting more local beneficiation, Robb notes.

He stresses that South African subsidiaries of parent firms based in tax-haven jurisdictions often underreport their profits by as much as 80%.

Another tax avoidance problem observed by TIPS is that of foreign development finance institutions investing in South Africa, sometimes owing to incentives offered by government, and then avoid paying the full amount of taxes due.

This ushers in unfairness to local companies and erodes the tax base of the country.

The average tax-to-gross-domestic-product ratio in Africa is 16%, compared with the Organisation for Economic Cooperation and Development’s (OECD’s) average of 33.8%, indicating there is scope to increase tax collection in Africa, including through clamping down on illicit financial flows and tax avoidance.

One such initiative is the OECD’s outline for new tax rules, which many governments are developing implementation plans for. It allows, among others, a country to increase taxes on a multinational if another related entity in a different jurisdiction is being taxed below the 15% effective rate.

If multiple countries are applying a similar top-up tax, the taxable profit is divided based on the location of tangible assets and employees.

TIPS says the agreement represents a major change for tax competition and many countries will be rethinking their policies for multinationals; however, it is unclear when, or if, the agreement will be implemented.

*The experts spoke during a tax avoidance and implications seminar hosted by TIPS on September 9.