The 2015 Addis Ababa meeting on Financing for Development placed emphasis on the role of domestic resources in developing countries, yet ensuring those countries have a fair and equitable tax system is not mentioned in the United Nations’ Sustainable Development Goals. Development Finance looks at efforts by the UN and OECD to help governments recover tax, and asks what more can be done to make multinationals pay a fair contribution towards domestic resources.
Benjamin Franklin once said nothing in this world is certain except for death and taxes. This was when the Cayman Islands were a refuge for survivors of the Spanish Inquisition, rather than a haven for more than US$1.4 trillion in tax-sheltered assets.
How the global tax system should be made fairer, more transparent and more certain is a question few have answers to. Whether it should however is, by now, hard to deny. The Panama Papers, released on 3 April 2016, contained 1.5 million leaked documents of financial and attorney– client information for more than 214,488 offshore entities.
Mossack Fonseca, the Panamanian law firm whose services the papers exposed, helped its clients avoid taxes by creating shell corporations that could operate without direct legal liability. The front companies of multinationals and other parent firms were registered everywhere, from the British Virgin Islands to Uruguay, Malta to Wyoming.
One company in Uganda used Mossack Fonseca to avoid paying US$400 million in taxes after changing its address from one tax haven to another. The amount it saved equalled 1.4 trillion Ugandan Shilling, more than six and a half times the country’s budget for underfunded sectors that year.
The scandal represents an overwhelming problem for both rich and poor countries, which could explain why fairer tax doesn’t feature in the United Nation’s sustainable development goals (SDGs). Of the 17 goals the UN hopes to achieve by 2030, Peace, Justice and Strong Institutions (goal 16) can mean several things. It can mean fairer law courts and a more open press, but it can also mean better tax administrations that generate more domestic revenue for a country’s economy. In fact, an equitable and efficient tax system–at least in terms of multinational corporations–could be a development goal in itself.
An inspector calls
In a 2016 report, entitled Domestic Resource Mobilization and Taxation, the IMF and the World Bank argue that effective mobilisation of domestic resources will be critical to the fulfilment of the SDGs. This is backed up by a separate report published two years earlier by UNCTAD, which states that the US$4.5 trillion needed to the achieve the goals by 2030 is missing a chunk of around US$3 trillion. Multinational contributions are indispensable to filling the gap, yet make up only 23 percent of total corporate contributions in developing countries, and only 10 percent of total government revenues.
Two years before, the United Nations Development Programme (UNDP) and the Organisation for Economic Co-operation and Development (OECD) created Tax Inspectors Without Borders, a joint initiative to institutionalise better tax auditing capacity in partner countries.
The programme’s self-styled mission is to “complement the broader efforts of the international community to strengthen co-operation on tax matters and contribute to the domestic resource mobilisation efforts of developing countries”. Its clients are those countries’ governments. Heading up the programme is Kenyan national James Karanja who says its primary concern is with taxes owed to administrations by foreign multinationals.
“Developing countries face a situation where they don’t have the resources to recover tax from a wide range of players that operate in them,” says Karanja.
“If the system is going to be fair, all tax administrations across the world should have a fair amount of skill to be able to tap into tax revenues that can be achieved through the multinationals operating in their jurisdictions.”
Raising the audit bar
So far, Tax Inspectors Without Borders has reclaimed US$260 million in taxes owed by multinationals to their host administrations in developing regions. More than US$100 million – about 38 percent of the total – was recovered from tax audits in Zimbabwe alone last year. Auditors in Kenya are currently preparing a full review of tax records in Botswana, where much of what stands to be recovered is expected to come from large corporations deemed to have paid less than their fair share into the Botswanian economy.
Karanja explains the sequence of the programme. A tax expert ordinarily based in an OECD country is sent to a developing economy to work with a team of semi-trained auditors. The expert’s job is to do three things. One is to raise revenue. Another is to build capacity. The third task is slipperier, because it involves getting multinationals operating in that country to view their compliance as law. This, Karanja says, is something in which David and Goliath are easy to tell apart.
“There’s a lot of low-hanging fruit in the way companies like Google organise themselves in developing countries. The aim is to get those tax administrations engaged to a point where they’re more at par with the complexities of an international audit firm,” he says.
Part of what UNDP does with the programme is review a country’s political economy to identify the risks of sending in resources. Karanja says the main risk to doing tax audits in fragile economies is that governments that are anxious to protect their relationships with multinationals may draw the line at the first bill for a hundred billion dollars and withdraw from the programme.
“You don’t want to get to a place where you’re dealing with a firm and you’ve generated audit queries and assessments, but because of the capture of the political system by various companies, you find that the effort comes to naught,” he says.
In the year 2000, developing countries worldwide had generated around US$2 trillion in domestic revenue. By 2014, they had collectively raised more than US$6 trillion annually. Gail Hurley, senior advisor at UNDP, says the figures tend to reflect middle-income countries where tax auditing already works much better. She says many poorer countries are still being left behind.
“The reality is that you’re looking at these middle-income economies where the tax take is around 22 to 23 percent of GDP per annum, sometimes up to 25 percent.”
The proportion of tax taken as a percentage of GDP in sub-Saharan countries in Africa is meanwhile around 13 percent, 2 percent less than the average for low-income countries generally. According to Diana Noble, CEO of the UK’s development finance institution CDC, the tax take in Pakistan is 10 percent, while it is only 6 percent in Nigeria.
Noble says CDC has paid US$7 billion from its portfolio into local tax collections since 2014, based on an agreement with its investee companies.
“The best way to [generate tax revenue] is to grow successful, sustainable companies that will grow their contributions to local exchequers during our investment period, but also for decades to come,” she says.
Boosting those numbers is, according to Hurley, one of the most important ways for developing countries to eventually fund their own development efforts. UNDP also helps governments to understand the economic and social impact these efforts might have. For example, if a government opts to place the burden of taxation on society’s wealthiest, businesses may suffer, but if it rolls out a tax on consumption, this can have a negative impact on poor communities.
“I think its really important to situate initiatives like Tax Inspectors Without Borders within the broader issue of helping governments to think through what their taxation options are,” Hurley says.
There is another problem however. In a global tax system without borders, any poor country that asks a rich country with multinationals on its soil to send in tax inspectors exposes itself to manipulation. Exactly who benefits from the support may after all come down to which countries get to decide global tax policies. Negotiations of this kind typically involve finance ministers of the G20. Chad, Egypt, Kazakhstan and Laos are among developing countries called ‘guest nations’.
Eurodad, a network of NGOs in 16 European countries, reported last year on the conflicts of interest Tax Inspectors Without Borders reveals between G20 member nations and developing non-members. Tove Maria Ryding, Eurodad’s policy and advocacy manager for tax justice, explains how UK professional services firm PricewaterhouseCoopers was chosen to manage the programme’s pilot project with that decision being made by the UK government.
In another instance, Eurodad found tax inspectors from the Netherlands had been assigned to tax administrations in Ghana, a country where several major Dutch multinationals operate. Ryding does not put this down to a convenience of common language between parties.
“It’s clear that the European governments are very focused on promoting their own interests in developing countries,” she says.
Eurodad’s report also mentions that the Dutch government sees Tax Inspectors Without Borders as a concerted effort to “improve service levels and predictability for companies and investors in Ghana”.
“When these capacity building projects are started, are we doing it to help the developing countries, or are we actually doing it to help companies in our own countries do business in developing countries?” adds Ryding.
Karanja says Tax Inspectors Without Borders is not imposed on anybody; that it is essentially demand- driven, and engages countries that request help before getting those requests approved at the highest level of their tax administrations. These administrations must, he argues, show dedication to the programme in order for it to work. The power lies in the hands of heads of state rather than of multinationals, because they decide whether to initiate or terminate an audit. Karanja hopes more governments will back tax inspectors in an effort to minimise revenue losses and create a fairer system of tax.
“The risks will always be that governments and administrations change, but at least in the beginning, we want to ensure that when we go in we have a clear mandate to do what we’re doing, and that should a government at any point feel they want to pull out, that remains its sovereign right,” he says.
As development shifts from a model of grant and guarantee- based funding to one of impact investment, charges of conflicts of interest are likely to recur. What these ignore however is the pragmatism with which that shift is being made. At the World Economic Forum in Geneva this year, Swiss financial services company UBS released a report showing why it is mobilising private capital to align new investments with the SDGs. The report says its clients are seeking “impact investments or opportunities with a ‘dual bottom line’ of positive societal and financial returns”.
Many private investors do not yet know how to achieve this, but development finance institutions such as CDC and others are demonstrating the reality behind this type of investment. If Tax Inspectors Without Borders succeeds in its mission, the changing focus of some investors from pure profit to impactful returns will mean more small businesses, more jobs and exponentially fairer dues paid into developing economies by 2030.
Hurley identifies another issue in domestic tax collection by saying large corporate tax breaks are not only excessive, but aren’t always necessary to drive investment in developing countries.
“Some tax breaks offered to companies are too generous, and have lowered the amount of income some countries might have received through various forms of taxation from those investors over the short to medium term,” she says.
Nowhere in the fullness of time could Franklin have been more wrong about taxes and certainty. Upon returning from a trip to Gambia in 1943, another Franklin—the 32nd US president Franklin D Roosevelt— fumed that for every dollar the British had put into Gambia’s economy, they had taken out ten. Roosevelt was an advocate of fair tax, which he called “the dues that we pay for the privileges of membership in an organised society”. That was before tax planning went global, along with the scandals and public outcry. Everything that has happened since Roosevelt’s time however suggests developing countries are primed to use taxation to modernise economic development, starting with a strong fiscal and social state. Karanja thinks the need has never been greater anywhere in the world.
“If there’s one point of convergence between developed and developing countries on this issue, it is that we are all affected.”