Over the years, the UK property market has generated interest from foreign residents (i.e. people not resident in the UK) who continue to purchase properties in the UK for investment purposes or to occupy as holiday homes.
The trend is particularly common amongst wealthy Nigerians who very rarely seek professional advice on the tax implications of owning a UK property. The lack of advice may be indicative of the current state of the administration of the tax system and the resulting compliance requirements in Nigeria, but is no excuse for the level of ignorance shown in another country. Especially as such naivety may result in large sums of money paid as UK tax at death, despite not being UK resident.
The ownership of a UK property exposes non-UK residents to various UK taxes such as income tax, capital gains tax (CGT), inheritance tax (IHT) and Stamp Duty Land Tax (SDTL) as summarised below. During the process of acquiring the UK property, SDLT is usually paid to HM Revenue & Customs as advised by the solicitor dealing with the property conveyance. Tax planning advice that may help mitigate other taxes (as mentioned above) is not considered.
Income Tax
The net rental income received from a property situated in the UK is subject to UK income tax at rates determined by the ownership structure i.e. personally, via a company or an offshore structure. As a Non-Resident Landlord (NRL), rents will be received net of basic rate tax, which is deducted by the tenant or agent (acting for the owner of the property) except where approval has been obtained from HM Revenue & Customs to receive rent gross.
Capital gains tax
Non-UK residents are not subject to CGT on the gains made from the disposal of UK assets including properties situated in the UK. The same principles apply to offshore companies and overseas trusts. There are anti-avoidance regulations under section 10A of the Taxation of Chargeable Gains Act 1992 to prohibit UK residents from moving abroad to avoid UK CGT.
There is currently no statutory definition of residence in the UK, so specific advice is needed on the residence status.
Inheritance Tax
Liability to UK inheritance is determined by a person’s country of domicile and is normally due on all UK properties, no matter where the owner is resident. For UK domiciled individuals (regardless of resident’s status) IHT is levied on their worldwide assets, whilst non-UK domiciled individuals are exposed to IHT on UK assets only, such as a UK property.
The value of the assets above the Nil Rate Band (NRB) which is currently £325,000 is charged to IHT at 40%. There is an exemption for assets passing between spouses/civil partners but this can be limited in certain circumstances. If the donor (or deceased) client is UK domiciled but the recipient spouse is not, then the spouse exemption is limited to just £55,000.
Owning a UK property via an offshore company may help reduce the impact of IHT for individuals who are not UK domiciled. Provided the client does not become UK domiciled (or deemed domiciled) in the UK, their non-UK assets will be outside the scope of IHT.
Owning a UK property directly via an offshore trust can be expensive. There is now an immediate entry IHT charge whenever assets are put into a trust despite the resident status of the trust: the IHT charge would be calculated on the value of the UK situated property going into the trust.
The trustees will have additional IHT charges to pay on every tenth anniversary of the trust’s creation and whenever the UK assets come out of the trust.
Stamp duty
Many foreign residents are not aware of the additional tax due when buying a UK property. Stamp Duty Land Tax applies to all UK property purchases, irrespective of the residence of the purchaser. The rate of SDLT varies from 1% to 5% depending on the value of the property and is payable by the purchaser of the property.
There are some potential ways of reducing the SDLT charge, if the property is above £1 million but these can be viewed as being at the ‘robust’ end of tax planning!
Planning opportunities
If a company owns the UK property that the foreign resident wants to buy, the company shares instead of the actual property may be purchased and SDLT avoided.
Owning via a company can help reduce the exposure to IHT but appropriate planning may be required if there are plans to live in the property, in which case, direct ownership may be better. In addition, offshore companies must ensure their management and control stays outside the UK.
The ownership of a UK property via an offshore company may not be effective long term planning Whether a trust is right for an individual depends on a number of factors, including the tax position and succession plans. Offshore trusts could provide a suitable alternative. This type of structuring can be expensive to set up and run.
Conclusion
For non-residents, owning a UK investment property via an offshore company can help reduce the tax bill on the rental income and may help shelter the value of the property from IHT. There can also be SDLT savings by purchasing shares in a company that owns the property.
Being non-resident should mean the client doesn’t need to worry about CGT, unless they are only temporarily resident outside the UK. Non-resident companies and trusts should also be outside the scope of CGT, even on the sale of a UK situated property.
Where offshore companies own UK properties, there may be an issue on whether the company is trading in the UK property market which could result in UK corporation tax of about 21% of the profits made. HMRC clearance may be required for the CGT regime to apply.
There is no ‘right’ answer to how a non-resident should purchase UK property and much depends on their personal situation and intention. You should always seek advice from a tax specialist when buying a UK property.
Wednesday 21 April 2010
Tuesday 20 April 2010
UK Taxation - Becoming non-UK resident
Recent developments in the UK suggest that it is harder to become non-UK resident for tax purposes. Since UK taxes are normally due on worldwide income and gains made by UK residents, people living outside the UK may find that they have to pay UK taxes on foreign income and gains.
HM Revenue & Customs (HMRC) have won a series of test cases that show the "90 day rule" is not a reliable guide to UK residence. As a result, HMRC has recently updated its guidance to determine whether someone is non-UK resident and is looking far more closely at people who claim non-UK resident status.
One of the benefits of living or working abroad is that it can often mean you pay no UK taxes or at the least, less tax. Therefore, a summary of the current practice is provided below.
To become non-UK resident you need to be able to show that you have left the UK and settled abroad, making a clean break from the UK. When deciding on residence status, HMRC are likely to take into account social, economic and family ties and if your circumstances suggest that your family life is still rooted in the UK, they may take the view that you are still UK residence.
One crumb of comfort comes from working abroad. Provided a person physically leaves the UK to work abroad under a contract of employment for at least one UK tax year, and adheres to the 90-days rule, the non-UK residence status should be applicable under the right circumstances. In accordance with section 830 Income Taxes Act 2007, "living accommodation available in the United Kingdom for the individual's use" should be ignored when considering UK residence.
Despite a foreign employment contract, if a person's lifestyle suggests that he/she is away from the UK on a temporary basis, he/she may continue to be UK resident and the 90 day rule may be irrelevant.
HMRC’s approach to consider a person’s connection to the UK and looking for signs that they have severed all ties with the country when determining non-UK residence may be to stop people avoiding UK taxes by leaving the UK temporarily. But in the absence of a legal definition of “resident” in the UK, we will have to depend on an ever-expanding body of case law and HMRC guidelines to clarify the circumstances when a person can become non-UK resident.
These new guidelines came into effect on 6 April 2009 and are likely to affect individuals who may have moved abroad and still have ties with the UK. If HMRC’s view prevails unchallenged it may be virtually impossible for someone to become non-UK resident without taking the rest of their family with them, regardless of the disruption to other people’s careers or children’s education and social needs. This seems wrong on so many levels it is difficult to know where to begin.
The UK seems to be edging closer to the American system of taxing its passport-holding citizens regardless of where they live in the world. The European Court of Justice might have something to say about that one day. In the meantime, it has become more difficult to let clients know what they need to do to achieve or maintain their non-resident status. “Get out and never come back” just doesn’t sound like the sort of advice they’re looking for.
HM Revenue & Customs (HMRC) have won a series of test cases that show the "90 day rule" is not a reliable guide to UK residence. As a result, HMRC has recently updated its guidance to determine whether someone is non-UK resident and is looking far more closely at people who claim non-UK resident status.
One of the benefits of living or working abroad is that it can often mean you pay no UK taxes or at the least, less tax. Therefore, a summary of the current practice is provided below.
To become non-UK resident you need to be able to show that you have left the UK and settled abroad, making a clean break from the UK. When deciding on residence status, HMRC are likely to take into account social, economic and family ties and if your circumstances suggest that your family life is still rooted in the UK, they may take the view that you are still UK residence.
One crumb of comfort comes from working abroad. Provided a person physically leaves the UK to work abroad under a contract of employment for at least one UK tax year, and adheres to the 90-days rule, the non-UK residence status should be applicable under the right circumstances. In accordance with section 830 Income Taxes Act 2007, "living accommodation available in the United Kingdom for the individual's use" should be ignored when considering UK residence.
Despite a foreign employment contract, if a person's lifestyle suggests that he/she is away from the UK on a temporary basis, he/she may continue to be UK resident and the 90 day rule may be irrelevant.
HMRC’s approach to consider a person’s connection to the UK and looking for signs that they have severed all ties with the country when determining non-UK residence may be to stop people avoiding UK taxes by leaving the UK temporarily. But in the absence of a legal definition of “resident” in the UK, we will have to depend on an ever-expanding body of case law and HMRC guidelines to clarify the circumstances when a person can become non-UK resident.
These new guidelines came into effect on 6 April 2009 and are likely to affect individuals who may have moved abroad and still have ties with the UK. If HMRC’s view prevails unchallenged it may be virtually impossible for someone to become non-UK resident without taking the rest of their family with them, regardless of the disruption to other people’s careers or children’s education and social needs. This seems wrong on so many levels it is difficult to know where to begin.
The UK seems to be edging closer to the American system of taxing its passport-holding citizens regardless of where they live in the world. The European Court of Justice might have something to say about that one day. In the meantime, it has become more difficult to let clients know what they need to do to achieve or maintain their non-resident status. “Get out and never come back” just doesn’t sound like the sort of advice they’re looking for.
Wednesday 17 February 2010
Are African countries losing out on tax revenue?
The claim that poor countries lose $160 billion in tax from ‘transfer mispricing’ has been repeated endlessly. MIKE TRUMAN finds it hard to justify
KEY POINTS
• Two Christian Aid reports claim $160 billion tax lost.
• Raymond Baker’s 7% claim does not relate to TNCs.
• Problems of methodology in Simon Pak’s study.
• Real shortfall is homegrown tax evasion.
Nine months ago, outside the Park Lane Hilton on the night of the Taxation Awards, there was a small tongue-in-cheek ‘Alternative Tax Awards’ run by Christian Aid. They were publicising their ‘Big Tax Return’ campaign, and inviting people to petition the major accountancy firms to support country-by-country reporting, so that multinational firms would have to show publicly exactly how much profit they made in each country. This would prevent, Christian Aid said, the mispricing of goods and services within multinationals that led to ‘at least $160 billion’ of tax being lost by developing countries.
I subsequently took up an opportunity to debate the issue with John Christensen from Tax Justice Network, which was involved in the research behind it. I expected to find a lot that I agreed with. In fact, I ended up thinking that some very strident claims had been built on very little evidence. I’ve steered clear of covering it in Taxation so far because multinational taxation is not normally an area we cover. But the claim has been widely repeated as fact, and the issue has been in the pages of Tax Adviser recently, so I couldn’t resist having my own say.
There were two main reports in which Christian Aid laid out their case. The first was Death and Taxes published in March 2008, the second was False Profits published a year later in March 2009. Both reports are available on the Christian Aid website as pdf files.
Mister 7%
Death and Taxes calculates the tax lost to ‘false invoicing and abusive transfer pricing’, and then calculates how many deaths could have been prevented if developing countries had been able to collect and spend those taxes. It sets out its methodology for calculating the lives that could be saved in a closely worded appendix, using what appear to be sensible statistical methods. Christian Aid also explain what they mean by ‘false invoicing’ and ‘abusive transfer pricing’, which they more often refer to as ‘transfer mispricing’.
False invoicing is where a business either inflates the price invoiced on the goods they import to a developing country, or reduces the price invoiced on exports, in both cases for transactions with third parties.Transfer mispricing is where two related affiliates of the same trans-national company (TNC) similarly agree to overprice imports or under-price exports. In both false invoicing and transfer mispricing, the result is a reduced profit being declared in the developing country, and therefore a reduced tax take.
The problem is in the figures that they use. To get to the figure of tax lost, they need to know how much of the volume of trade is illicit capital movement caused by false invoicing and transfer mispricing. This is started as 7% of trade volumes. In other words, the true amount earned by the country in such trade is understated by 7%.
So where does this figure come from? It comes from some work by Raymond Baker, most recently set out in his book Capitalism’s Achilles Heel. He conducted 550 interviews in the early 1990s with officials from trading companies in eleven different countries, on conditions of anonymity. He said, ‘mispricing in order to generate kickbacks into foreign bank accounts was treated as a well-understood and normal part of transactions’, and drew his 7% estimate from this evidence.
Now, there are several criticisms that can be made of this with regard to false invoicing (transactions between third parties). The interviews are nearly 20 years old, they are necessarily secret so their suitability as a sample cannot be verified, and so on. But let’s accept for the sake of argument that this is a valid estimate of false invoicing. What does this say about the main target of Christian Aid’s campaign, transfer mispricing within TNCs? In my view, it says absolutely nothing about it. The whole point of the false invoice is to divert some of the value of the transaction into a bribe.
What TNC is going to sit back and accept that two of its subsidiaries should artificially alter prices so that they can generate a kickback for their employees? That’s not to say it won’t happen, but the TNC can be expected to have procedures in place to try and stop it. The alleged motive of the TNC is entirely different: tax evasion. Again, while that almost certainly happens, the figure for false invoicing will not tell you anything about its incidence.
Baker himself says that he has done no formal investigation in this area, he simply cites his own experience of seeing exaggerated intra-company pricing, which he says exceeds that in unconnected entities. It is, in other words, a guess, informed by personal experience.
Mister 25%
False Profits seems initially to back up the Raymond Baker figures. Although only covering trade between the EU/US and the rest of the world, the research looks at around 10 million records of trade data between 2005 and 2007. It categorises them by common trade classifications, and then estimates which are overpriced imports to developing countries and which are underpriced exports from developing countries.
Again, this is taken as showing the amount of profit illicitly moved from those countries, from which lost tax can be calculated. However, my eye was caught by a particular country’s figures. Part of the total that is being interpreted by Christian Aid as an illicit capital outflown was about 600,000 euros said to have been illicitly moved out of Andorra, presumably to avoid tax. Except that, of course, Andorra doesn’t have any direct taxes. Why would anyone want to reduce their Andorran profits, particularly for tax reasons? The problem, once again, is the methodology. What this study does is to put all the transactions for a particular classification, as recorded by the US and the EU trade data, in a line from the lowest to the highest.
It then says that anything in the bottom 25% is underpriced and anything in the top 25% is overpriced. It therefore follows that if there is any variation in price at all, this method will result in a quarter of the transactions being treated as priced too low and a quarter as priced too high.
I put these points by email to Professor Simon Pak, who carried out the research. On Andorra, he pointed out that there were other reasons why transactions might be mispriced apart from tax. This is true, although the main one I know of creates an artificially high price for Andorran tobacco exports (yes, Andorrans farm tobacco in their mountain hide-out. The reasons are complicated and probably best not enquired into too deeply). However, Christian Aid’s use of the research is all about tax paid by multinationals.
On the use of an inter-quartile range, Professor Pak pointed out that this was the measure used by the US tax authorities for transfer pricing. It is, but only once a truly comparable set of figures has been obtained. Even though these are the most detailed data available, they are still comparatively broad trade classifications.
They also cover the whole of a year. As the report itself says, right at the end, if prices are volatile this can legitimately cause wide variations from the interquartile limits. It cites crude oil as an example, where the spot price varied between $36 and $145 a barrel in 2008. And yet far more prominently, in the main body of the report, Christian Aid says:
‘In Nigeria, £501m was lost from its burgeoning mineral fuel and oil industry [in 2007] … What made that figure all the more surprising was that the previous year, only £145m was lost in that trade category.’
In fact, a rough piece of spreadsheet work that I did using some spot prices for Brent Crude shows that you would indeed expect the 2007 figure to be between three and four times higher than 2006 simply because more volatile prices create the impression of much greater under pricing.
The debate so far
In the space available I can only comment briefly on other contributions to the debate, but I would urge you to go and read them.
Bill Dodwell, in November’s Tax Adviser made many of the points that I have above, but also pointed out that False Profits calculated that the US and Japan were the two biggest ‘losers’ from transfer pricing, which as he says is simply not plausible, given their aggressive attitude towards it.
Dr David McNair, from Christian Aid, responded to Bill’s article in the January issue of Tax Adviser. He repeats the original assertions about Raymond Baker’s and Simon Pak’s work supporting each other, without addressing any of the problems above. He does address another problem raised by Bill, that if you are going to look at the capital outflows from one end of the price distribution you also have to look at the capital inflows from the other. Dr McNair says that netting the two off produces misleading results, because it makes Africa look like a net recipient of illicit inflows, which is ‘inconsistent with its continued dependence on bilateral aid’. Indeed it is, but doesn’t that also suggest that the methodology itself is simply wrong if it produces such an absurd conclusion?
Dr McNair also says that there was considerable discussion at a recent World Bank conference on illicit flows about the $160 billion figure, but that no alternative was offered and no compelling challenge made to it. Whatever was said at the conference, there certainly have been alternative figures put forward.
A study by the Oxford School of Business Studies in June 2009, carried out by Clemens Fuest and Nadine Riedel and available on the DFiD website, gives $160 billion as the highest estimate of the studies they considered, with $35 billion being the lowest (from an Oxfam study in 2000).
The case of Ghana
What the Oxford study suggests is that work should be done at a more detailed level, looking at the way tax avoidance and evasion is actually occurring in individual developing countries. Interestingly, a 2009 report produced jointly by Christian Aid and the Tax Justice Network does precisely that for Ghana. It is unable to produce any new data about tax evasion by TNCs, instead it reproduces the arguments from the previous two global reports and then applies those principles to Ghana. However, what it does do is to produce some very revealing data about where the tax revenues actually come from in Ghana. Individuals and companies make roughly equal contributions to the direct tax take in Ghana, each at just under 14% of total taxes collected. In developed countries, corporate tax generally raises much less than personal taxes. That suggests that it is personal tax which is undercollected, not corporate tax.
Within personal taxes, although the rate of collection by withholding taxes has increased significantly, the amount collected from the self-employed has not, and in 2007 was only 11% of total income taxation. The shadow economy in Ghana is estimated, the report says, at 38% of total economic activity, and over 80% of employees are in the informal sector. Presumably such businesses are not only avoiding direct tax on their own profits, they are also avoiding payroll withholding taxes and indirect taxes.
So who is actually paying tax in Ghana: their own and the taxes they have withheld? In general, it is the large companies, particularly the TNCs. While the report raises a question mark about companies involved in the extractive industries, it acknowledges that ‘relative to some parts of the economy, formal sector business actually contributes a reasonably large share of national revenue’.
Conclusion
So is country-by-country reporting, campaigned for by Christian Aid and the Tax Justice Network, really the answer? I don’t see that it is. I don’t necessarily oppose a limited version of it, perhaps concentrating on disclosing profits made in ‘secrecy’ jurisdictions, but I see no great benefit for Ghana in MegaCorp Inc having to itemise, allocate and audit its profits in a hundred different countries round the world.
Far more important, it seems to me, is the other part of the package now gaining traction with the Financial Secretary to the Treasury, Stephen Timms (though whether that will make any difference after 6 May is anyone’s guess). That is technical help for developing countries to put in more effective tax systems, and the sharing of information obtained from tax information exchange agreements.
TNCs make a nice bogeyman to blame for low tax revenues in the developing world, but the evidence suggests that the real problem is locally grown.
KEY POINTS
• Two Christian Aid reports claim $160 billion tax lost.
• Raymond Baker’s 7% claim does not relate to TNCs.
• Problems of methodology in Simon Pak’s study.
• Real shortfall is homegrown tax evasion.
Nine months ago, outside the Park Lane Hilton on the night of the Taxation Awards, there was a small tongue-in-cheek ‘Alternative Tax Awards’ run by Christian Aid. They were publicising their ‘Big Tax Return’ campaign, and inviting people to petition the major accountancy firms to support country-by-country reporting, so that multinational firms would have to show publicly exactly how much profit they made in each country. This would prevent, Christian Aid said, the mispricing of goods and services within multinationals that led to ‘at least $160 billion’ of tax being lost by developing countries.
I subsequently took up an opportunity to debate the issue with John Christensen from Tax Justice Network, which was involved in the research behind it. I expected to find a lot that I agreed with. In fact, I ended up thinking that some very strident claims had been built on very little evidence. I’ve steered clear of covering it in Taxation so far because multinational taxation is not normally an area we cover. But the claim has been widely repeated as fact, and the issue has been in the pages of Tax Adviser recently, so I couldn’t resist having my own say.
There were two main reports in which Christian Aid laid out their case. The first was Death and Taxes published in March 2008, the second was False Profits published a year later in March 2009. Both reports are available on the Christian Aid website as pdf files.
Mister 7%
Death and Taxes calculates the tax lost to ‘false invoicing and abusive transfer pricing’, and then calculates how many deaths could have been prevented if developing countries had been able to collect and spend those taxes. It sets out its methodology for calculating the lives that could be saved in a closely worded appendix, using what appear to be sensible statistical methods. Christian Aid also explain what they mean by ‘false invoicing’ and ‘abusive transfer pricing’, which they more often refer to as ‘transfer mispricing’.
False invoicing is where a business either inflates the price invoiced on the goods they import to a developing country, or reduces the price invoiced on exports, in both cases for transactions with third parties.Transfer mispricing is where two related affiliates of the same trans-national company (TNC) similarly agree to overprice imports or under-price exports. In both false invoicing and transfer mispricing, the result is a reduced profit being declared in the developing country, and therefore a reduced tax take.
The problem is in the figures that they use. To get to the figure of tax lost, they need to know how much of the volume of trade is illicit capital movement caused by false invoicing and transfer mispricing. This is started as 7% of trade volumes. In other words, the true amount earned by the country in such trade is understated by 7%.
So where does this figure come from? It comes from some work by Raymond Baker, most recently set out in his book Capitalism’s Achilles Heel. He conducted 550 interviews in the early 1990s with officials from trading companies in eleven different countries, on conditions of anonymity. He said, ‘mispricing in order to generate kickbacks into foreign bank accounts was treated as a well-understood and normal part of transactions’, and drew his 7% estimate from this evidence.
Now, there are several criticisms that can be made of this with regard to false invoicing (transactions between third parties). The interviews are nearly 20 years old, they are necessarily secret so their suitability as a sample cannot be verified, and so on. But let’s accept for the sake of argument that this is a valid estimate of false invoicing. What does this say about the main target of Christian Aid’s campaign, transfer mispricing within TNCs? In my view, it says absolutely nothing about it. The whole point of the false invoice is to divert some of the value of the transaction into a bribe.
What TNC is going to sit back and accept that two of its subsidiaries should artificially alter prices so that they can generate a kickback for their employees? That’s not to say it won’t happen, but the TNC can be expected to have procedures in place to try and stop it. The alleged motive of the TNC is entirely different: tax evasion. Again, while that almost certainly happens, the figure for false invoicing will not tell you anything about its incidence.
Baker himself says that he has done no formal investigation in this area, he simply cites his own experience of seeing exaggerated intra-company pricing, which he says exceeds that in unconnected entities. It is, in other words, a guess, informed by personal experience.
Mister 25%
False Profits seems initially to back up the Raymond Baker figures. Although only covering trade between the EU/US and the rest of the world, the research looks at around 10 million records of trade data between 2005 and 2007. It categorises them by common trade classifications, and then estimates which are overpriced imports to developing countries and which are underpriced exports from developing countries.
Again, this is taken as showing the amount of profit illicitly moved from those countries, from which lost tax can be calculated. However, my eye was caught by a particular country’s figures. Part of the total that is being interpreted by Christian Aid as an illicit capital outflown was about 600,000 euros said to have been illicitly moved out of Andorra, presumably to avoid tax. Except that, of course, Andorra doesn’t have any direct taxes. Why would anyone want to reduce their Andorran profits, particularly for tax reasons? The problem, once again, is the methodology. What this study does is to put all the transactions for a particular classification, as recorded by the US and the EU trade data, in a line from the lowest to the highest.
It then says that anything in the bottom 25% is underpriced and anything in the top 25% is overpriced. It therefore follows that if there is any variation in price at all, this method will result in a quarter of the transactions being treated as priced too low and a quarter as priced too high.
I put these points by email to Professor Simon Pak, who carried out the research. On Andorra, he pointed out that there were other reasons why transactions might be mispriced apart from tax. This is true, although the main one I know of creates an artificially high price for Andorran tobacco exports (yes, Andorrans farm tobacco in their mountain hide-out. The reasons are complicated and probably best not enquired into too deeply). However, Christian Aid’s use of the research is all about tax paid by multinationals.
On the use of an inter-quartile range, Professor Pak pointed out that this was the measure used by the US tax authorities for transfer pricing. It is, but only once a truly comparable set of figures has been obtained. Even though these are the most detailed data available, they are still comparatively broad trade classifications.
They also cover the whole of a year. As the report itself says, right at the end, if prices are volatile this can legitimately cause wide variations from the interquartile limits. It cites crude oil as an example, where the spot price varied between $36 and $145 a barrel in 2008. And yet far more prominently, in the main body of the report, Christian Aid says:
‘In Nigeria, £501m was lost from its burgeoning mineral fuel and oil industry [in 2007] … What made that figure all the more surprising was that the previous year, only £145m was lost in that trade category.’
In fact, a rough piece of spreadsheet work that I did using some spot prices for Brent Crude shows that you would indeed expect the 2007 figure to be between three and four times higher than 2006 simply because more volatile prices create the impression of much greater under pricing.
The debate so far
In the space available I can only comment briefly on other contributions to the debate, but I would urge you to go and read them.
Bill Dodwell, in November’s Tax Adviser made many of the points that I have above, but also pointed out that False Profits calculated that the US and Japan were the two biggest ‘losers’ from transfer pricing, which as he says is simply not plausible, given their aggressive attitude towards it.
Dr David McNair, from Christian Aid, responded to Bill’s article in the January issue of Tax Adviser. He repeats the original assertions about Raymond Baker’s and Simon Pak’s work supporting each other, without addressing any of the problems above. He does address another problem raised by Bill, that if you are going to look at the capital outflows from one end of the price distribution you also have to look at the capital inflows from the other. Dr McNair says that netting the two off produces misleading results, because it makes Africa look like a net recipient of illicit inflows, which is ‘inconsistent with its continued dependence on bilateral aid’. Indeed it is, but doesn’t that also suggest that the methodology itself is simply wrong if it produces such an absurd conclusion?
Dr McNair also says that there was considerable discussion at a recent World Bank conference on illicit flows about the $160 billion figure, but that no alternative was offered and no compelling challenge made to it. Whatever was said at the conference, there certainly have been alternative figures put forward.
A study by the Oxford School of Business Studies in June 2009, carried out by Clemens Fuest and Nadine Riedel and available on the DFiD website, gives $160 billion as the highest estimate of the studies they considered, with $35 billion being the lowest (from an Oxfam study in 2000).
The case of Ghana
What the Oxford study suggests is that work should be done at a more detailed level, looking at the way tax avoidance and evasion is actually occurring in individual developing countries. Interestingly, a 2009 report produced jointly by Christian Aid and the Tax Justice Network does precisely that for Ghana. It is unable to produce any new data about tax evasion by TNCs, instead it reproduces the arguments from the previous two global reports and then applies those principles to Ghana. However, what it does do is to produce some very revealing data about where the tax revenues actually come from in Ghana. Individuals and companies make roughly equal contributions to the direct tax take in Ghana, each at just under 14% of total taxes collected. In developed countries, corporate tax generally raises much less than personal taxes. That suggests that it is personal tax which is undercollected, not corporate tax.
Within personal taxes, although the rate of collection by withholding taxes has increased significantly, the amount collected from the self-employed has not, and in 2007 was only 11% of total income taxation. The shadow economy in Ghana is estimated, the report says, at 38% of total economic activity, and over 80% of employees are in the informal sector. Presumably such businesses are not only avoiding direct tax on their own profits, they are also avoiding payroll withholding taxes and indirect taxes.
So who is actually paying tax in Ghana: their own and the taxes they have withheld? In general, it is the large companies, particularly the TNCs. While the report raises a question mark about companies involved in the extractive industries, it acknowledges that ‘relative to some parts of the economy, formal sector business actually contributes a reasonably large share of national revenue’.
Conclusion
So is country-by-country reporting, campaigned for by Christian Aid and the Tax Justice Network, really the answer? I don’t see that it is. I don’t necessarily oppose a limited version of it, perhaps concentrating on disclosing profits made in ‘secrecy’ jurisdictions, but I see no great benefit for Ghana in MegaCorp Inc having to itemise, allocate and audit its profits in a hundred different countries round the world.
Far more important, it seems to me, is the other part of the package now gaining traction with the Financial Secretary to the Treasury, Stephen Timms (though whether that will make any difference after 6 May is anyone’s guess). That is technical help for developing countries to put in more effective tax systems, and the sharing of information obtained from tax information exchange agreements.
TNCs make a nice bogeyman to blame for low tax revenues in the developing world, but the evidence suggests that the real problem is locally grown.
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