Dirty deals and taxing truths: What do recent high-level commitments mean for tax and extractive industry transparency in developing countries?
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Following the usual pre-Summit wonk-up, G8 leaders gathered in Lough Erne last week. Amid burning issues of aid, trade and foreign policy, two topics were placed high on the agenda by the UK Presidency: combating tax evasion and avoidance, and transparency of governments and multinationals in extractive industries. Both are linked to the problem of illicit financial flows. Five years ago few advocated for tax justice. The push by advocacy groups and the pull of the purse-string made the issue attain global stardom faster than a pop idol. It now takes centre stage in the G8, EU and US political agendas. Tax evasion is, however, far more corrosive than pop music. Conservative estimates indicate losses of over $100 billion in tax revenues annually. Combating tax avoidance could not only provide resources that outstrip aid, but also bring benefits such as improved governance. So what did the G8 commit to in its communiqué and what are the implications for developing countries?
Undodgeable? The international tax system and the myth of voluntary complianceWithin the morass of tax terminology, the G8 wants to further the ‘tax and transparency for development’ agenda by calling for a multilateral system of automatic exchange of tax information (AEOI) and standardised reporting formats for multinational enterprises’ (MNEs) profits and taxes paid globally. They also want to ensure that both national and international tax rules prevent MNEs from artificially shifting profits to low-tax jurisdictions by supporting the Organisation for Economic Cooperation and Development’s (OECD) work on base erosion and profit shifting. Beyond this, and based on recommendations made by the Financial Action Task Force (which include identifying and monitoring high-risk jurisdictions for money laundering and terrorist financing), world leaders committed themselves to developing national action plans to prevent companies and legal arrangements being misused in order to evade taxes. Together, this rough sketch of a new international tax system is meant to make national tax administrations undodgeable. Not a bad effort by G8 standards, especially considering that tax experts have advocated for some of these measures for years. The OECD is mandated to design the rules and tools to put all this into practice - to monitor MNEs’ profits, including a thus-far elusive method for administering transfer pricing. They are liable to promote an international tax architecture geared towards ensuring compliance with internationally agreed standards. This can serve as a deterrent to certain forms of tax evasion. But an incomplete or misaligned multilateral tax system (which is likely to emerge) will leave countries hard-pressed to identify the owners of the funds and corporations, creating a tax haven patchwork. Clamping down on illicit financial flows may also end up hurting Western companies or interests to the benefit of Chinese or Russian firms. Both the US and the EU approach to transparency effectively prohibit companies that do not comply with particular transparency requirements from doing business in their jurisdictions. This reverse ‘not in my back yard’ effect should compel third countries to adopt similar legislation - it has so far not enticed emerging powers. An OECD-centric design of international tax measures is unlikely to find more appeal.
Trapped flies and spaghetti bowls - tax treaties with perverse effects for developing countriesEfforts to tackle tax evasion and improve corporate transparency recognise that international business has evolved. Alongside this, donors agencies hope to make these efforts worthwhile by supporting tax administrations in developing countries. The G8’s efforts in this regards however remain stuck in time. It commits to providing capacity building support for developing countries’ tax administrations to collect taxes and meet new global standards on information exchange . But only those developing countries seeking to join the OECD’s Global Forum on Transparency and Exchange of Information for Tax Purposes and the tax information exchange agreements it promotes. Tax experts agree that developing country should not volunteer to sign up to such tax treaties – they are considered a half-measure at best and incredibly damaging at worst. They include clauses and provisions that, by ambiguity or intent, enable vast outflows of funds by MNEs and strip countries of large amounts of income. Asking developing countries to sign up to these treaties in exchange for support to their tax administrations is like trapping flies with honey. Tax administrations should nonetheless be supported and developed, especially if they are not to suffer under the increased reporting requirements of AEOI (which can prove to be literally ‘too much information’ for developing countries’ administrations). Furthermore, developing countries need to be better placed in the renegotiations of the global spaghetti bowl of bi- and multilateral tax treaties expected in the coming years. But their governments should not only be able to negotiate effectively with other governments – international tax legislation facilitates but does not drive tax evasion or illicit flows. Countries do not need have tax treaties to do business with enterprises from other countries. It is more important for developing countries to be able to negotiate forcefully and competently with MNEs to take full advantage of the opportunities to tax their profits and rents from operation. Their objective should be to have simple, clear and unambiguous taxation requirements written into extractives contracts and investment agreements (like Botswana managed in handling the sale of De Beers to Anglo American).
Nitty gritty - cutting the teeth of trade, transparency and tax initiativesTransparency requirements are being ramped up for extractives industries with large illicit financial outflows. The US and the EU are putting legislation in place requiring multinational enterprises in extractives industries to report profits and taxes paid to the government of every country they operate in, on a project-by-project basis. Support is also welling up for the Extractive Industries Transparency Initiative (EITI), a voluntary standard requiring countries to report on corporate payments and government revenues from extractive industries. While the G8 endorses the EITI, five out of eight members are currently not participating in it. The initiative will grow teeth only when all developed countries housing multinational enterprises in extractives industries join and once developing countries with large extractives operations make the EITI standards a legal requirement (as Liberia has done). Nonetheless, these recent transparency breakthroughs could shine light on tax avoidance and the extent of the problem of transfer pricing. Despite some rough patches, it is important to remember that three interrelated issues – trade, transparency and tax (Cameron’s three T’s) - are finally together on one agenda at the global level and that the G8’s commitments consistently link these to developing countries. There’s hoping that the G20 will add further momentum to opening the tax floodgates in its July meetings. -- Florian Krätke is Research Assistant at ECDPM’s EU External Action Programme. This blog post features the author’s personal views and does not represent the view of ECDPM.