Multinationals operating in Africa: the tax dimension

February 19, 2013

Over the last decade, Africa has experienced unprecedented growth, and it is expected to begin to match the growth rates seen in the BRICS markets.

This article was first published in the Ernst & Young Global Tax Policy and Controversy Briefing, Issue 11, December 2012 (pdf, 4.26 MB)

This outstanding economic performance has been accompanied by political reform. For example, 2011 saw a record 28 nationwide elections, most of which were fair and peaceful. And the Arab Spring has spread democracy in the Middle East and North Africa (MENA) region.

The Freedom House political freedom index, which measures political rights and civil liberties, now classifies almost one-fifth of the continent as “free,” two-fifths as being “partly free” and two-fifths as “not free.” Although corruption remains a problem in many African countries, there are exceptions, such as Botswana and Mauritius, and the overall business environment.

In fact, the World Bank “Doing Business” indicators show that, in 2011, one-third of the economies that had experienced improvements were African. Large multinational companies (MNCs) now recognize that Africa could be the next economic frontier.

We have seen an inflow of both foreign direct investment (FDI) and portfolio investment into Africa, not just from OECD countries but also from other emerging economies, particularly China, Brazil and India. This inflow of investment is creating jobs, bringing new technologies, making domestic markets more competitive and generally contributing to rising living standards, disposable income and increasingly sophisticated tastes throughout the continent.

Africa’s population today totals more than one billion people, with combined consumer spending approaching US$1 trillion. And a sizable number of households are expected to move into a higher income band over the next 10 years.

For example, in Ghana less than one-quarter of households had an income of more than US$5,000 in 2010. By 2020, more than one-third of households will enjoy an income above US$5,000. In Nigeria, 2020 will see nearly 56% of households enjoy an income in excess of US$5,000, up from 45% in 2010.

The tax dimension

As more capital flows into Africa, the nations involved want to make sure that any profits made are taxed accordingly and that the tax base is not eroded by tax abuse. But for many tax directors, operating in Africa can be a painful experience; because they are dealing with such rapid growth in inbound investment, these emerging countries tend to experience large volumes of tax policy and tax administration change as they develop the laws and processes to secure what they feel are the right levels of tax revenues from those capital flows and transactions.

This is particularly prevalent in the complex area of transfer pricing, a concept that is experiencing significant global change. It can take many years for a tax regime unaccustomed to policing cross-border commerce to mature, so some key nations rely on existing legislation and processes that globetrotting taxpayers may view as unsophisticated, complex and, without doubt, culturally different.

But as emerging market countries become more confident in their own right, they are increasingly challenging commonly applied international standards.

Striking the right balance

Africa is no different in this regard; it is not easy for African governments to achieve the right balance between providing a business-friendly tax environment for investors while making sure that when foreign investors come into their countries, they pay a fair share of the tax burden. Around the world, many tax administrations — supported by collaborative efforts within the OECD — have accepted that securing high levels of tax compliance requires not only robust enforcement but also improved taxpayer service.

They have therefore developed more sophisticated risk management tools, a greater willingness to group taxpayers into high- and low-risk groups and a “lighter touch” audit approach to those classified as low-risk. Indeed, many tax administrations are actively increasing levels of commercial awareness and industry specialization, and many auditors now have a better awareness of how business operates.

These changes, taken together, take the form of what the OECD currently calls an “enhanced relationship” approach to tax compliance — in other words, cooperative compliance. This more open, transparent approach is typically accompanied by new pre-filing resolution programs and more robust domestic dispute settlement procedures.

“An enhanced relationship between a revenue authority and taxpayers is obviously beneficial to both parties” says Mr. Oupa Magashula, the South Africa Revenue Service Commissioner and Chairperson of the African Tax Administration Forum (ATAF), the grouping of tax commissioners, senior tax administrators and tax policymakers from 28 African countries.

“It can and should lead to greater certainty and greater understanding of each party’s position. In this regard, the South African Revenue Service (SARS) was the first revenue administration in the world to enter into an accord with its banking industry, followed by Her Majesty’s Revenue and Customs (HMRC). This has resulted in a stronger relationship between SARS and the South African banking industry, but also in greater Magashula.”

But such an enhanced relationship is compliance, said Commissioner unachievable when the underlying fundamentals to support it are missing, Commissioner Magashula explains. “There is not, however, always a fair and balanced approach to such ‘enhanced relationships,’” he says.

“Frequently, corporations and industries appear to want to use such enhanced relationships for their own gain, but are less keen to accept the point of view of the revenue authority. In this regard, our experience has been sometimes that corporations seek a great deal of transparency, openness and clarity from the revenue authority, but are a lot less eager to show the same level of trust, openness and honesty with their information”.

“Relationships between revenue authorities and taxpayers are like any other relationship — they must be equitable and both parties’ point of view should be taken into account. That doesn’t mean that the parties will not disagree on occasion. But in a strong and healthy relationship, these disagreements can be overcome through honest and open dialogue.”

Africa does not need to follow the same path of confrontation and conflict that characterizes the relationship between tax authorities and taxpayers in many OECD countries; there are better ways of structuring and managing this relationship. As Commissioner Magashula says, it is not easy, and it is a challenge to overcome a lack of trust.

But the idea of a relationship that builds on openness and transparency is one that both tax administration and business would benefit from, especially in the complex area of transfer pricing. This balance must be found if Africa is to continue its stellar development and reap the ensuing rewards.

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