Hosted by ITIC, in cooperation the Common Market for Eastern and Southern Africa (COMESA) and the Commonwealth Association of Tax Administrators (CATA), over 60 tax officials, leading academic specialists and private-sector representatives from 18 countries convened in Cape Town on 15-17 November 2016 for the Eighth Africa Tax Dialogue to discuss the balance between domestic revenue mobilization and enhancing the investment climate.
His Excellency Dr. Mikhisa Kituyi, Secretary General of the United Nations Conference on Trade and Development (UNCTAD), delivered a spirited opening address on “The Role of Business Investment to Deliver on the Post-2015 Development Agenda.” Dr. Kituyi, who has an extensive background as an elected official, an academic, and a holder of high government office, pointedly remarked that “smart tax reform is critical to mobilizing resources for the 2030 agenda,” a theme that reverberated throughout the discussions of the Dialogue.
The Dialogue also featured keynote remarks from the Honorable Kipyego Cheluget, Assistant Secretary General of COMESA, Mr. Duncan Onduru, Executive Director of CATA, and the Honorable Judge Dennis Davis, Chair of South Africa’s Davis Tax Committee. Commenting on the high-level participation in this year’s meeting, ITIC President Dan Witt noted: “This reinforces that taxation, and especially tax administration, has taken on a new level of urgency as a key instrument in achieving the sustainable development goals.”
Major Observations and Findings
Regional Economic Outlook
The main features of the sub-Saharan economies are the dominance of commodity-based economies, narrow tax bases, huge informal sectors, weak government and market institutions, high exposure to external shocks, low competitiveness, and a shortage of skills and capital. Recently, there has been a sharp decline in commodity prices, tighter financing conditions, and a severe drought in southern and eastern Africa. The long-term way forward for governments should not be one of “command and control,” but one of “enable and facilitate.” It is important that countries more actively increase the quality and efficiency of public investment, continue efforts to mobilize domestic resources, and pursue economic diversification. Tax systems can play an important role in achieving these objectives.
The Davis Tax Committee – Where Are We and What Lies Ahead?
The Davis Tax Committee was installed in 2013 by the South African Minister of Finance Pravin Gordhan to inquire into the role of the tax system in supporting the objectives of inclusive growth, employment creation, development and fiscal sustainability. Considerable progress has been made with the publication of various final reports on macro analysis, small and medium-sized businesses and estate duty. Further, interim reports have been tabled for public comment on BEPS, mining and carbon taxation. While South Africa’s tax system compares favorably with those of many developed and emerging economies, the pace of globalization, the modest growth after the 2008-09 recession and significant social challenges (such as persistent unemployment, poverty and inequality) point toward the need to review what role the tax system can play in addressing these new challenges. All in all, an excellent and formidable work program is being executed which should have a lasting impact on society.
Taxing Corporations – BEPs and International Aspects
The traditional form of taxing corporations is under review in the wake of globalization and capital market innovation. This review should be guided by neutrality and tax sovereignty considerations. Traditionally, corporate tax has been a tax on the return to equity (e.g. profits), but the increased ease with which equity can be substituted by debt has led to calls to tax equity and debt income jointly at the corporate level. Doing so, however, means that the rate of return that makes an investment worthwhile is being taxed, implying less investment and possibly economic growth. Accordingly, proposals have been made to tax economic rents only by, for instance, permitting an allowance for corporate equity.
The revenue loss due to Base Erosion and Profit Shifting (BEPS) for low-income countries is estimated at 1-2% of GDP. In 2013, the OECD committed itself to “delivering a global and comprehensive action plan based on in-depth analysis… to provide concrete solutions to realign international standards with the current global business environment.” To date, however, there has been no fundamental rethink of international tax rules and no comprehensive plan to deal with base erosion. In fact, there has been much “tinkering around the edges.” Source taxation is important for developing countries because what they lose through base erosion is not made up by greater residence taxation. There is no agreement yet on EBITDA in the OECD. Some progress has been made on the information side through agreement on country-by-country reporting, but more progress is necessary on adequate access to information and effective dispute resolution.
Models for the taxation of retirement savings are:
- TTE: contribution taxed, fund income taxed, pay-outs exempt;
- EET: contributions exempt, fund income exempt, and pay-outs taxed; and
- EEE: contribution, fund income and pay-outs all exempt.
Variations are also possible. EET is the most commonly used model in OECD and EU countries. Developing countries should be aware that tax concessions for retirement savings can be very costly to the budget, as evidenced by the Australian experience. The EET system is recommended for employer-provided retirement schemes, but a ceiling should be imposed on tax deductible contributions; benefits should be transferable to another employer (the portability issue), and the tax treatment of pension income should be dealt with in double taxation agreements.
South Africa reformed the tax treatment of retirement savings in 2015. Contribution requirements have been simplified, while employers’ contributions are now considered a fringe benefit for the employee. The current system can be characterized as an EET model; it could be improved by regular inflation increases on fixed amounts of tax and a capital gains tax exemption for the disposal of discretionary assets if proceeds are put into a recognized retirement income vehicle. The government should also resist re-introducing prescribed assets investments for retirement funds or any taxes on the fund build-up. The risk of not having enough capital to retire or staying retired should not be ignored. Overall, South Africa’s system for retirement savings meets most international criteria for a good system.
In South Africa, only half of the country’s formally employed workers belong to an employer-sponsored retirement fund. Of greater concern is that 86% of the formally employed earn less than the current income tax threshold, which means they receive no tax benefit for participating in retirement savings vehicles. This indicates that a broader set of tools to address inadequate savings should be made available, such as incentives, mandates and nudges.
Taxation of Mining, Oil and Gas
Many countries are reviewing their fiscal regimes for natural resources, particularly through the IMF’s technical assistance programs. The three main fiscal regimes (sometimes blended) are (1) contractual production sharing contracts; (2) tax and royalty instruments; and (3) state participation. The recommended regimes for the mining and petroleum sectors consist of a flat rate royalty; a ring-fenced corporation tax for all sectors without immediate expensing of investments; and some form of cash flow tax to capture above-normal returns. Evaluation is essential, tax administration critical, and transparency in resource management crucial. Details of good natural resource policies can be found in various IMF handbooks (see South African Extractive Industry Fiscal Regimes and United Kingdom Fiscal Transparency Evaluation).
To create the greatest overall value from a country’s resources, the regime should be equitable to governments and investors – aligning their mutual interests through the life of projects. The tax regime should ensure that the government receives an appropriate share of the benefit realized from its resources, but this should not distort investment decisions, enable long-term planning, allow for changing economic conditions, be competitive, and administratively simple with an effective dispute resolution mechanism.
South Africa has one of the most modern VATs in the world, with a broad base and a single rate (mainly based on the New Zealand example). Exceptionally, 19 basic food items and illuminating paraffin are zero-rated, while exemptions are limited to non-fee related financial services, education, residential rental accommodation, and public transport. South Africa’s 2007 study on the VAT treatment of merit goods concluded that efficiency and simplicity considerations should dominate VAT design. Equity objectives should be pursued through the income tax and the social benefit system. South Africa could consider a marginally higher VAT rate, but this should not be considered if more zero rating is seen as a trade-off.
In reforming African VAT systems, much can be learned from European experience:
- Limit the number of exemptions which distort input choices and penalize outsourcing;
- Beware of rate differentiation, which tends to be of greater benefit to the rich than the poor;
- Provide for a high threshold, remembering that 90% of the VAT is collected from 10% of all taxpayers;
- Coordinate VATs in regional economic communities, but continue to base it on the destination principle; and
- Target enforcement controls on fraud-prone taxpayers.
The overall lesson is that African countries should not do what Europeans did, but examine VATs in countries, such as New Zealand and South Africa, which have broad-based VATs (with very few exemptions), impose a single rate, and have a sizable threshold.
SADC Excise Tax Guidelines
Excise tax cooperation in the Southern African Development Community (SADC) is a challenge as member state systems vary widely, including French and Portuguese applications. In 2010, after carrying out a study into the illicit trade in alcohol and tobacco products, the tax subcommittee agreed to drop the development of a model excise tax law in favor of guidelines as a regional framework to implement the SADC Protocol on Finance and Investment (FIP). The Guidelines are not binding on the member states but are a good benchmark to facilitate cooperation and coordination. A list of standardized excise tax rates for tobacco, alcohol and fuel will be published, while common definitions and classifications will be developed for exemptions, rebates and reliefs. Excise taxes are viewed as appropriate externality-correcting instruments. Specific rates are favored and excise tax administrations should be harmonized.
Marginal Effective Tax Rates (METRs)
The marginal effective tax rate (METR) is a measure of the tax burden on incremental investments for a profit maximizing firm and determines the scale of a project: a high METR means less investment. By contrast, the average effective tax rate (AETR) measures the average tax burden on overall investment and is an important determinant for the location of foreign direct investment. METRs should take account of deprecation, credits and allowances, tax incentives, other taxes, as well as the statutory tax rate. METRs can be calculated for different types of capital, in different sectors, in different countries; differences between METRs are then an indication of the distortions of the tax system. While METRs are a valuable summary measure of the tax system, they capture only formal tax rules, not actual practice.
VAT Compliance Gap
The scope for VAT revenue mobilization (without raising rates) can be defined as the sum of the policy gap (exemptions and lower-than-standard rates) and the compliance gap (the difference between actual collections and collections with full compliance under existing rules and regulations). Both are captured in the VAT’s collection efficiency (C-efficiency) ratio, calculated as actual VAT revenue over potential revenue. Identifying the gaps helps indicate necessary policy and administrative actions. Following the IMF’s work on South Africa’s VAT gap, other countries should be encouraged to undertake similar analyses of their VAT’s C-efficiency.
Taxation of E-commerce
Under OECD rules, source countries have the right to tax business profits provided there is a sufficient economic presence (permanent establishment or PE) in the jurisdiction to support the taxing right. PE can be avoided by digital businesses which can derive substantial profits from dealing with customers through a “digital” presence (website) rather than a physical presence. Under BEPS, rules have been developed to attribute profits to a significant (digital) presence but they do not go to the core of the digital business model developed to avoid the PE-status. Taking exception, Australia and the UK have moved forward independently to deal with arrangements to avoid a PE. Similar problems are encountered under VAT.
Climate change is a major negative externality confronting humanity, but its consequences are not always visible and its effects cut across borders and regions. Accordingly, the urgency to act is not always a priority for many countries. Fortunately, the 2015 Paris Agreement (signed by nearly all countries around the world) is a significant step forward, but dealing with the consequences of climate change requires a multi-disciplinary approach. Effective coordination and cooperation between government departments within a country is important, as is consultation with all stakeholders. The intensive and often destructive lobby efforts of vested interest groups should not be underestimated. Much is to be said for using the price mechanism rather than a regulatory or command-and-control approach to curtail harmful emissions. This implies the implementation of well-designed ecotaxes and/or emissions trading schemes – a country-specific and political decision. In the end, some form of combination of instruments seems feasible.