4.5.1 Double taxation treaties (DTTs)
These tax treaties, which are intended to eliminate double taxation, also pose significant risks of illicit financial outflows and domestic resource mobilization constraints. Many of the case-study countries have entered into bilateral taxation treaties that negatively impact their taxing rights in respect of different types of payments, such as service payments, commission payments, financial derivatives transactions, sales of shares or other transactions. This leads to tax base erosion and profit shifting, minimizes DRM capacity and significantly limits the legal framework enabling DRM.
Double taxation treaties negotiated in case-study countries are modelled after the OECD Model Taxation Convention and the United Nations Model Tax Convention. While both models are similar in many respects, the United Nations Model Tax Convention provides more taxing rights to developing countries as source countries.
4.5.2 Bilateral investment treaties
Another major constraint to policy space for domestic resource mobilization are the mushrooming bilateral investment and trade rules signed between African countries and key trade partners, including OECD and emerging countries. While bilateral investment treaties (BITs) remain unproven as decisive in influencing investment decisions, countries still continue to sign them at a rate of 50 per year (Adam, 2012). More than 400 BITs are operating in Africa.
With the goal to attract foreign direct investment, many countries have entered into BITs without a coherent, comprehensive strategy or space for promoting value addition.
197 Cobham et al (2014). Estimating Illicit Financial Flows of Capital via Trade Mispricing: A Forensic Analysis of Data on Switzerland, Center for Global Development
198 Kar, Dev and Sarah Frietas (2011). Illicit Financial Flows from Developing Countries over the Decade Ending 2009. Washington, DC: Global Financial Integrity
Most BITs lack a development orientation. National development policy has become secondary to the investor’s interests. The State-to-State agreements establish how governments handle investors from each other’s country, covering fair and equitable treatment, security, and compensation for expropriation etc. Based on an agreed equity in treatment principle, host countries may be prohibited from imposing performance requirements on multinational mining companies to encourage greater domestic content and value addition. For example, some developed countries go as far as seeking pre-establishment privileges for their investors, allowing them to enjoy preferential treatment even before they set up.
The extensive webs of outdated BITs are clearly misaligned with the goals of optimizing mineral revenues. The BITs include stabilization clauses, as well as generous tax provisions, which will likely become a bigger problem in the next boom. Despite the unproven potential of BITs to attract investment, more than 400 of them are operating in Africa199. Without forward-looking collective action at the continental level, tax holidays will take on a life of their own: in 1980, 40 per cent of sub-Saharan African countries offered tax holidays, while in 2005, 80 per cent did so.200 A study of 12 Western and Central African countries over the 1994-2006 period showed no relationship between tax holidays and investment.201 In fact, an IMF assessment of the Eastern Caribbean Monetary Union estimated that forfeited tax revenues as a result of tax incentives ranged between 9.5 per cent and 16 per cent of GDP per year202.
While many developing countries have taken steps to review their BITs, such initiatives remain limited in Africa. Only South Africa has undertaken a comprehensive review. In 2010, the government concluded a three-year review of its BITs to assess the role of foreign investment in South Africa, the levels of protection afforded to investment and the risks and benefits of BITs (Carim, 2013). According to the report, there was no conclusive link between BIT and Foreign Direct Investment (FDI) flows. In addition, some BIT terms violated the country’s constitution, existing BITs contained imprecise language and overall BITs constrained government from regulating in the public interest. South Africa has therefore taken encouraging steps. The government will refrain from entering into BITs unless there are compelling political or economic reasons to do so. In addition, it will terminate existing BITs and offer partners the possibility to re-negotiate BITs based on a new model. It will also develop a new Foreign Investment Act that is aligned with the constitution and clarifies typical BIT provisions under South African law, as well as establish an Investment Ministerial Committee to oversee this work. In fact, the country is revising its domestic laws to strengthen investor protection, the kinds of concerns provided in BITs. South Africa is also leading the SADC in designing a model BIT that is compatible with regional development.
199 Adam, G (2012). Bilateral Investment Treaties Coming Back to Bite, http://thisisafricaonline.com
200 Keen, M. and Mansour, M. (2009), Revenue Mobilization in Sub-Saharan Africa: Challenges from Globalization, IMF Working Paper, IMFWP/09/157, IMF Fiscal Affairs Department, Washington, DC, www.imf.org/external/pubs/ft/wp/2009/wp09157.pdf.
201 James, S. and Van Parys, S. (2010), The effectiveness of tax incentives in attracting investment: panel data evidence from the CFA Franc zone, International Tax and Public Finance, Vol. 17/4, pp 400-429.
202 Chai, J. and Goyal, R. (2008), Tax Concessions and Foreign Direct Investment in the Eastern Caribbean Currency Union. IMF Working Paper, IMF WP/08/257, IMF Western Hemisphere=Department, Washington, DC, www.imf.org/external/pubs/ft/wp/2008/wp08257.pdf.
5.1 Conclusions
Mineral wealth offers an opportunity for greater domestic revenue mobilization in countries.
Yet resource-rich Africa remains unable to take full advantage of the proceeds. Resource revenues as a share of overall taxes collected have increased, particularly during the recent boom in commodity prices. Surprisingly however, tax effort in resource-rich countries continues to remain below the African average—even when compared to their resource-scarce counterparts.
Taxation remains the most predictable instrument for mobilizing government revenues.
Structural transformation of resource-rich countries depends strongly on effective tax systems which are capable of reducing tax evasion, as well as avoidance. However, weak fiscal regimes along the mining value chain, interact in a vicious cycle with illicit and sophisticated tax-avoidance practices of mining companies. The outcome is often significant cross-border illicit financial flows, with resultant net negative impact on domestic resource mobilization efforts.
The impacts cut across socioeconomic and political fronts, through reduced mineral revenues, increased income inequality and depleted hard-currency reserves.
Illicit financial flow is a complex, multidimensional phenomenon. The report adopts the definition by the 2014 Conference of Ministers: “money illegally earned, transferred or used”.
The definition, which was also endorsed by the High Level Panel, brings together all relevant dimensions in a way that provides a consistent and relevant working definition for addressing IFFs. The working definition frames the outflows in terms of origin, motivation, method and destination.
Success requires collective and coordinated actions at the domestic and international levels.
Illicit financial flows represent a symptom of fundamental gaps in international tax governance.
Taxation of mineral resources continues to remain an act of sovereignty. However, national tax laws in most African countries have yet to keep pace with global corporations’ complex business models. A ‘broken’ international fiscal system creates opportunities for translating incentives for tax evasion in countries into cross-border illicit capital outflows. In fact, complex interactions of mineral regimes and international taxation, trade, investment, and finance create gaps and overlaps, with potentially damaging impacts on tax collection.
Strategic tax competition results in winners and losers. Low-tax jurisdictions or tax havens create cross-border tax arbitrage. Multinational companies take advantage of the loopholes to minimize their overall tax liability, artificially shifting their profits out of mineral-rich countries
Chapter 5
Conclusions and recommendations
to low-tax or no-tax locations, where there is little or no economic activity. The jurisdictions provide a legally backed veil of secrecy, making it harder to determine beneficiaries. The high level of secrecy is complemented by the ease with which companies and other legal entities can be registered or established offshore.
Most IFF practices occur in a grey area of the law: ‘legitimate tax planning’ and ‘tax evasion’.
While impacts are discernible, identifying, tracking and curbing IFF practices remains complex and challenging for tax administrators, particularly in resource-constrained settings. The risks are widespread and varied along the mining value chain. Every transaction in the chain presents a set of overlapping and discrete IFF practices. ranging from illegal and fraudulent activities to manipulative tax avoidance schemes by multinational corporations. These are compounded by political economy drivers, including corruption at the highest political levels in the mining industry.
Curbing multinational corporate tax avoidance remains a key development priority. African governments have collectively committed to tackle IFFs in key continental and global policy documents: The African Mining Vision, The African Union Agenda 2063, and The 2030 Agenda for Sustainable Development. Combatting IFFs effectively would raise development revenues for the countries of origin. Sustained and strategic efforts at strengthening institutions would seriously deter the incentive to move profits outside the country of origin. The task for many African countries is to develop mechanisms to detect IFF practices at all stages of the mining value chain, which are triggered by both internal and external players.
Good governance is at the heart of domestic resource mobilization. It entails the ability of governments to formulate and implement effective strategies, policies, laws and regulations for mobilizing optimal revenues from the mineral sector. It is about having a capacitated mineral tax administration to track, stop and repatriate illicit financial outflows. At a minimum, this involves reducing illicit financial flows and, at best, completely eliminating the development-inhibiting practices along the mining value chain.
Mineral-rich countries have made some progress, but challenges remain. While there is increasing awareness of DRM-damaging practices, there are still major gaps in policy, legislative and institutional frameworks. The case-study countries have formulated various regulations to combat some individual drivers associated with IFFs, including corruption, money laundering and tax evasion. However, no comprehensive working definition of illicit financial outflows exists in the mineral regimes of the countries studied. Consequently, the additional standalone actions were limited in their systemic impact.
Illicit financial practices are products of asymmetry of knowledge and power along the value chain. While case studies recognized the importance of geological information in their mining codes, integrating the investment and governance dimensions remain critical.