The emergence of ‘frontier economies’ in Sub-Saharan Africa, which are essentially characterised by financial markets that have developed rapidly in the past two decades, has placed enormous developmental demands on these growing economies. Since sustained gross domestic product (GDP) growth serves as an indicator for investors to buy into a country, potential institutional investors tend to seek out growth prospects that are driven by technological catch-up trends, young populations, and significant output gaps. For African countries, this calls for strategic investment that will facilitate trade and support the growing private sector as new industries emerge.⁽²⁾ In an effort to respond to these growing demands, African economies have tended to adopt policies that encourage foreign direct investment (FDI), a trend that has been at the centre of regional and international debates on economic growth and sustainable development.

The African Development Bank (AfDB) and other major financial institutions, including the International Monetary Fund (IMF) and the World Bank have been spearheading initiatives across the continent to diversify African economies mainly through public-private partnerships. These initiatives are aimed at developing the secondary and tertiary sectors, as poor infrastructure, low human capital levels and poor service industries impose hidden costs on business and offset the advantages of youth and low wages in labour-intensive manufacturing and projects requiring reliable telecommunications infrastructure and a skilled labour force thus, deterring potential foreign direct investment. However, many of the deals that have led to a surge in foreign investment have often been coupled with questionable conditions and demands made by investors on African governments. Offshore centres that typically channel FDI flows require African nations to sign investor protection and promotion agreements (IPPAs). Essentially these IPPAs are designed to minimise the risk of nationalisation by ensuring fair compensation and arbitration. But they also serve as taxation avoidance agreements which reduce the tax bill that companies pay, and, in some cases, permit companies to pay taxes in the country of legal residence, usually a low-tax jurisdiction such as Luxembourg, rather than in the country where the physical operations are based.⁽³⁾

With growing interest in tax policies and practices pertaining to tax evasion and tax avoidance, prompted by regulatory efforts taken in response to the global economic downturn, Africa is also doing its part in combating the loss of millions by African nations to big business investing and operating in Africa. This discussion paper provides an overview of tax avoidance and evasion in Africa by exploring recent developments in the fight against illicit financial outflows across the continent.

Special tax regimes for FDI

A longstanding argument that has been made to justify the massive losses of African economies resulting from wide-ranging tax breaks has centred on FDI. This argument posits that the scramble for FDI by African countries has led to intense competition to attract investors. In this competitive environment, African governments tend to look beyond the use of conventional methods of attracting investment, such as reforming property rights legislation or private sector development and other typical concerns raised in the popular World Bank ‘Doing Business Index’ (which ranks countries according to the ease with which a private entity can start and operate a business in a country), and instead favour the use of more aggressive tactics for securing investment.⁽⁴⁾ One such method is through a country’s tax regime. It has been established in international economic trends that countries that impose heavier corporate tax or capital gains taxes are likely to observe outflows of savings to countries employing lower tax rates on capital.⁽⁵⁾ Nonetheless, empirical data shows that there is no obvious link between FDI flows into a country and a country’s tax policy.⁽⁶⁾

The risks associated with macroeconomic policies that rely on the use of tax to increase FDI can be easily observed in many mineral-rich economies in Sub-Saharan Africa. In the scramble for FDI, many African governments find themselves pushed into instituting ‘competitive’ tax regimes for high-risk capital. In many cases, the laws established to attract investors lead to lower royalties, corporate taxes, fuel levies and windfall and other taxes not stipulated in the law.⁽⁷⁾ Since multinational enterprises are well known for their ability to obtain favourable tax treatment in developing economies, countries become more vulnerable to experiencing greater losses to tax avoidance when they experiment with a wide variety of incentives in different sectors. In 2012, the AfDB estimated that losses due to tax incentives and exemptions in Uganda, for example, amounted to at least 2% of GDP.⁽⁸⁾

Getting the bigger picture: Illicit financial outflows from Africa

A 2013 report by the AfDB and Global Finance Integrity (GFI) shows that, contrary to popular belief, Africa is in fact a net creditor to the world and not a net debtor. Measured in terms of net transfers adjusted for inflation, the net transfers of financial resources directed from Africa to the rest of the world were estimated at between US$ 597 billion and US$ 1.4 trillion over the period of 1980-2009. Illicit transfers over the same period increased within a range of US$ 1.22 to US$ 1.35 trillion.⁽⁹⁾ The latest available data shows that global corporate tax evasion accounted for 60-65% of the global total for illicit financial flows, well above the global proceeds generated through criminal activities and corruption, which accounted for 30-35% and 3% respectively. While the proceeds of commercial tax evasion have not yet been calculated for Africa, GFI maintains that similar approximate percentages ranging in the same order of magnitude can be projected for Africa.⁽¹⁰⁾

The Organisation for Economic Cooperation and Development (OECD) defines tax evasion in broad terms as efforts taken by the individual and corporate entity to facilitate illegal arrangement where tax liability is hidden or ignored. Thus it may entail taxpayers deliberately misrepresenting or concealing the true state of their affairs to tax authorities, or reducing tax liability through illegal means. Tax avoidance, on the other hand, essentially refers to efforts taken by taxpayers to arrange their tax affairs in such a manner that will facilitate a reduction of their tax liability. While these arrangements could strictly be legal, the nature of tax avoidance is such that it is usually in contradiction with the intent of the law it purports to follow. For instance, there are many activities that corporations tend to engage in that are referred to as avoidance but could easily be classified as evasion.⁽¹¹⁾ Jane Gravelle, Senior Specialist in Economic Policy at the Congressional Research Centre in the United States, cites transfer pricing as one such activity employed by corporations, whereby firms charge low prices for sale to low-tax affiliates but pay high prices for purchase from them. If these prices are set at an artificial level, then this activity can viewed as a case of evasion, but evidence for establishing pricing is all but unavailable.⁽¹²⁾

In 2013, ActionAid, a United-Kingdom-based nongovernmental organisation released a report ⁽¹³⁾ on capital flight and tax evasion ploys by international big business investing and operating in Africa that generated a lot of attention from policymakers. The report implicates auditing and consultancy services group Deloitte, citing it advises companies on how to avoid paying tax on their African investments and operations. For example, the report shows how Deloitte provides companies wanting to invest in Mozambique with details on how they can achieve a 60% reduction in tax payments and a 100% reduction in capital gains tax by investing through Mauritius, which has over the years become a reputed tax haven and offshore jurisdiction. Like many other tax havens, Mauritius has no taxes on offshore companies and offshore bank accounts. The jurisdiction provides individuals and corporations confidentiality and privacy that are further facilitated by laws which allow flexibility. With a global ranking of 19, the Republic of Mauritius was the least transparent country in Sub-Saharan Africa in the 2013 Financial Secrecy Index (FSI) by the Tax Justice Network. The only other African country that appears in the top 50 FSI global ranking and tailing the island nation at 36th position in the index is South Africa. The Financial Secrecy Index ranks jurisdictions according to their secrecy and the scale of their activities. Very broadly, the index serves as an indicator for assessing global financial secrecy, tax havens or secrecy jurisdictions, and illicit financial flows.⁽¹⁴⁾

The issue of tax havens has generated a lot of interest recently, triggered by reports of some of the largest multinational companies from different sectors, such as Google, Starbucks and Barclays operating in Africa and elsewhere, dodging tax by using tax havens. While there seems to be no consensus on the precise definition of a tax haven, the OECD has established a list of features for defining tax havens, which are: no or low taxes, lack of effective exchange of information, lack of transparency and no requirement of substantial activity.⁽¹⁵⁾ From this definition, one can easily describe tax havens as parallel economies that provide rich individuals and self-serving multinational enterprises with sanctuaries that protect them from financial regulations while shielding their identities.

For the first time ever, the OECD compiled an initial list of tax havens across the world in the 2000. The list categorised countries according to geographic locations, and featured advanced and emerging economies, from Switzerland and Luxembourg to Mauritius. Following major uproar from countries protesting that the blacklist compromised their country’s image and reputation, the OECD published a blacklist in which countries that had agreed to come forward with information were omitted. Of the 35 countries that were included in the revised global blacklist for tax havens, only three were African: Liberia, Seychelles and Mauritius.⁽¹⁶⁾ One of the largest lists of tax havens blacklists, which featured countries and cities, was compiled by the Tax Justice Network (TJN). The TJN list extended the OECD list for Africa by adding Sao Tome e Principe, Somalia and South Africa and Melilla ⁽¹⁷⁾ to the list.⁽¹⁸⁾ A 2012 report by the Tax Justice Network-Africa and ActionAid⁽¹⁹⁾ identifies Kenya as the next potential location for a tax haven in Africa. According to the report, the Government of Kenya has been providing a wide range of tax incentives to big business in an effort to attract FDI into the economy. When the report was first released in 2012, Kenya was losing approximately US$ 1.1 billion annually from tax incentives and exemption. The policy in the corporate tax regime relating to Kenya’s Export Processing Zone, which grants corporations a 10-year tax holiday and tax exemptions on import duties on machinery, input and raw materials, is a particular cause for concern.⁽²⁰⁾

Tax incentives impose significant structural macroeconomic and social risks. Extensive tax incentives lead to substantial losses of current and future tax revenue. While industrial and trade business operations generally rely heavily on public infrastructure such as roads, energy and water supply for instance, the burden of paying for infrastructure maintenance and services delivery by government ends up falling on the taxpayer. With high unemployment rates and large informal sectors, African governments struggle to collect sufficient taxes, undermining the state’s capacity to provide basic services such as healthcare and education. Furthermore tax incentives can potentially exacerbate corruption and lead to rent-seeking.

Moreover, Africa has also been reported to be a net provider of resources to the world with net resource transfers (NRT) ranging from US$ 597 billion and US$ 1.4 trillion depending on the definition used for measuring these transfers. Illicit financial flows (IFFs), which include those from tax evasion, were identified as the main driving force behind the net drain of resources from Africa of US$ 1.2 - 1.3 trillion on an inflation-adjusted basis.⁽²¹⁾ As Africa lags further behind in establishing modern financial systems and tax regimes that match international standards, IFFs grew at a much faster pace over the period 1980-2009 than net recorded transfers. In terms of the volume of illicit financial flows, Nigeria, Egypt, and South Africa led the regional outflows.⁽²²⁾

Taking bold steps against tax evasion and avoidance

Recently, the OECD and the G-20 industrialised nations embarked on several actions aimed primarily at tackling tax evasion, explicitly targeting tax havens at the global level. The actions are summed up in three initiatives, which are being spearheaded by the OECD:⁽²³⁾

• The Global Forum on Transparency and Exchange of Information for Tax Purposes, which is reportedly moving swiftly and will be publishing unambiguous ratings for fifty jurisdictions.
• The OECD‘s work on Base Erosion and Profit Shifting (BEPS) has established an action plan for further work in the organisation’s effort “to bring international tax rules into the 21st century.”
• Together with the G-20 countries, the OECD is developing a global model for automatic exchange of information as the new standard, and plans to have this work completed by the end of 2014.

Regionally, African leaders have also taken serious steps in the fight against tax evasion and avoidance that will enhance tax policy and systems at the national and local level. Established in 2011, The African Tax Administration Forum (ATAF) was created to promote and facilitate mutual cooperation between African tax administrators.⁽²⁴⁾ Following a three-day meeting in July 2012 in Pretoria, South Africa, 21 African countries (out of the 36 member-states that make up the African Tax Administration Forum) reached a consensus on the text of an African Agreement on Mutual Assistance on Tax (AFAT). The AFAT set precedence for a legal basis from which administrators can provide assistance to one another in tax collection and other tax matters. More specifically, the assistance involves the exchange of tax information within and between countries.⁽²⁵⁾ With the AFAT, signatory member-states aim to modernise their national tax policy and law in order to respond more efficiently to the rapidly changing global economic and financial environment. The treaty, which marks the biggest of its kind on the continent, originated in response to an ActionAid report on SABMiller’s tax policies. In the report, SABMiller, the second biggest brewer in the world and number one in Africa, is accused of costing Africa an estimated US$ 33 million annually and having about 65 tax havens across the globe.⁽²⁶⁾

Indeed, the cross-national nature of tax evasion and avoidance makes it difficult for countries to identify violators or spot the loopholes in their national tax law and policy. Thus, by sharing information between countries, the AFAT is aimed at consolidating details of tax systems and taxpayers’ data to make it easier for tax authorities to identify and follow up on incidents of foul play. However, there still seems to be no clarity, firstly on how long it will take to implement this system. It is well known that Sub-Saharan African countries vary greatly in GDP size, political stability and government capacity, and that many countries suffer from weak institutions, lack of skilled labour and resources. Secondly, it has not been established exactly what information regarding taxpayers’ data and tax systems between countries will be exchanged between governments and what information will be made public. For instance, in order to build a comprehensive system, in addition to sharing information about their national tax policy and law, it would be useful if countries also revealed how much they receive from a specific company in taxes.

With the ATAF in place, the United Nations Economic Commission for Africa (UNECA) announced the establishment of a High Level Panel on Illicit Financial Flows on 18 February 2012, to examine what it referred to as “the debilitating problem of illicit financial outflows from Africa.”⁽²⁷⁾ At the sixth meeting of the panel, which took place Accra on 3 December 2013, the members of the High Level Panel conducted a regional consultation with key stake-holders on the project across West and Central Africa including Executive, Legislature, Judiciary and key civil society and private sector representatives.⁽²⁸⁾ The Panel will act as an Africa-led knowledge hub on illicit flows in African countries; its role is to assess how these illicit flows affect development and governance, and to provide policy recommendations. In the pilot project, the Panel is conducting studies on illicit financial outflows from Africa in seven countries, namely Algeria, Democratic Republic of Congo, Kenya, Liberia, Mozambique, Nigeria and South Africa, in preparation for a comprehensive report which will contain the recommendations of the Panel.

The efforts of the High Level Panel on Illicit Financial Flows coupled with the AFAT approach to curb tax evasion and avoidance in Africa have borrowed largely from the policy approach that is being implemented by the European Commission and the Unites States Government. While the institutional capacity issues cited earlier cannot be dismissed in the consolidation of tax policy and tax data in Africa, there seems to be almost no other viable alternative for addressing the problem. The carrot and stick method for instance, which proposes assessing transactions of illicit funds and targeting financial institutions and legal personnel that advise and oversee illicit flows, presents a range of challenges for governments pertaining to international business practice and the market attractiveness of countries, among others. Thus, although this method appears to be the most straightforward and logical course of action, the OECD has established that because the international financial system is not only driven by market behaviour, but also largely by policymakers, transparency is key for exposing failures in policies and economic models that are implemented by policymakers, making the information exchange an important step in the fight against tax evasion and avoidance.⁽²⁹⁾

Concluding remarks

Tax evasion and avoidance, and the use of offshore tax havens by big business operating in African countries and the accompanying illicit financial flows from the continent are pervasive. Moreover, tax evasion and avoidance have had a devastating impact on African development and economic growth. Illicit financial flows of this nature particularly, dry up funds and overburden the taxpayer and encourage public sector corruption. In addition, the notion that tax breaks encourage FDI flows should be abandoned because it is impossible for a state to economically and sustainably continue to support the arrival of new business and investment, even in strategic sectors, without collecting adequate tax revenues from those investors and businesses.

Disproportionately burdening citizens with the responsibility of providing revenue for public services highlights the inherent unfairness of tax regimes that pander to big business. Although citizens benefit widely from government services, big businesses would not be able to operate without adequate and efficient infrastructure and services such as electricity and water supply, so citizens are essentially paying for businesses to make profits, which are often taken out of the countries in which they were generated. Another issue, that is perhaps more immediate to the average tax-paying citizen is that in most countries in Africa and elsewhere the tax system is such that it is easier for tax authorities to efficiently monitor and prosecute the ordinary low- to medium-income taxpayer for infractions such as tax evasion, but fail to exert such force on the wealthy and on multinationals manipulating the system.

There is very little empirical data that elucidates the role of financial intermediaries in tax evasion and avoidance in Africa. In this regard, as African leaders enforce measures to strengthen the fight against tax evasion and avoidance on the continent, revising the treatment of these financial intermediaries, which essentially act as the service providers to tax evaders, should be prioritised in regional efforts to curb tax evasion. African governments have indeed shown great commitment to curbing tax evasion and avoidance on the continent because it is only through streamlined international tax cooperation and the formalisation of the economy that developing countries stand a chance against multinational giants, and the gulf between the actual and potential revenues that African countries receive can be closed.

Written by Refiloe M. Joala ⁽¹⁾

NOTES:

(1)Refiloe, M. Joala. is a Research Associate with CAI with a particular interest in development economics. Contact Refiloe through Consultancy Africa Intelligence's Africa Watch unit ( africa.watch@consultancyafrica.com). Edited by Nicky Berg.
(2) Nellor, D.C.L., ‘The Rise of Africa’s “Frontier” Markets’, Finance & Development, September 2008, http://www.imf.org.
(3) Blas, J., ‘Offshore centres race to seal Africa investment tax deals’, The Financial Times, 19 August 2013, http://www.ft.com.
(4) Perkins, D.H., Radelet, S. and Lindauer, D.I., (eds.), 2006. Economics of development. W.W. Norton: New York.
(5) Stapper, M., ‘Tax regimes in emerging Africa: Can corporate tax rates boost FDI in sub-Sahara Africa?’, African Studies Centre Working paper 88, 2010, https://openaccess.leidenuniv.nl.
(6)Ibid.
(7)Curtis, S., ‘The role of transparent and fair taxation in converting Africa’s mineral wealth into development’, Private Sector and Development, January 2011, http://www.proparco.fr.
(8) ‘Tax competition in East Africa: A race to the bottom? Tax incentives and revenue losses in Uganda’, Tax Justice Network and Africa Action Aid International, April 2012, http://www.actionaid.org.
(9) Kar, D., et al., ‘Illicit financial flows and the problem of net resource transfers from Africa: 1980-2009’, A joint report from Global Financial Integrity and the African Development Bank, 2013, http://africanetresources.gfintegrity.org.
(10) Cartwright-Smith, D. and Kar, D. 2009. ‘International financial integrity, illicit financial flows from Africa: Hidden resource for development’, International Financial Integrity, http://www.gfintegrity.org.
(11) ‘Centre for Tax Policy and Administration - Glossary of tax terms’, OECD, http://www.oecd.org.
(12) Gravelle, J.C, ‘Tax havens: International tax avoidance and evasion’, Congressional Research Service, 23 January 2013, https://www.fas.org.
(13) ‘Deloitte advised big business on how to avoid tax in some of the poorest countries in Africa’, ActionAid, 2013, http://www.actionaid.org.
(14) ‘Financial Secrecy Index - 2013 results’, Tax Justice Network, http://www.financialsecrecyindex.com.
(15) Gravelle, J.C, ‘Tax havens: International tax avoidance and evasion’, Congressional Research Service, 23 January 2013, https://www.fas.org.
(16) ‘Towards global tax cooperation’, Organization for Economic Development and Cooperation (OECD), 2000, http://www.oecd.org.
(17) The Spanish city of Melilla, an exclave on the north coast of Africa sharing a border with Morocco, was also included in the Africa section because countries are listed geographically.
(18) ‘Tax us if you can: A true story of global failure’, Tax Justice Network briefing paper, September 2005,http://www.taxjustice.net.
(19) Curtis, M., et al., ‘Tax competition in East Africa: A race to the bottom? Tax incentives and revenue losses in’, Tax Justice Network-Africa and ActionAid International, May 2012, http://taxjusticeafrica.net
(20) Ibid.
(21) Ibid.
(22) Ibid.
(23) ‘OECD Secretary General report to the G-20 leaders’, OECD, September 2013, http://www.oecd.org.
(24) African Tax Administration Forum website, http://www.ataftax.net.
(25) ‘Twenty one African countries finalise mutual assistance agreement in collecting taxes’, African Tax Association Forum press release’, 2 August 2012, http://content.ataftax.org.
(26)‘Campaign – The SABMiller guide to tax dodging’, ActionAid, 2010, http://www.actionaid.org.uk.
(27)‘The High Level Panel on Illicit Financial Flows meets in Lusaka’, United Nations Economic Commission for Africa, 19 June 2013, http://www.uneca.org.
(28) ‘High Level Panel on Illicit Financial Flows from Africa Regional Consultation for West and Central Africa’, UN Economic Commission for Africa, December 2013, http://www.uneca.org.
(29) Ibid.