Wednesday was a taxing day for developing economies hoping to attract investment from the United Kingdom and grow domestic resources.
Parliament approved a tax treaty Wednesday with Senegal that will allow U.K. companies to pay a fraction of the developing country’s standard tax rate. The goal of the treaty is to promote foreign direct investment between the two countries, which currently exchange less than $3 million in annual investments.
According to the International Monetary Fund, such treaties have “mixed” results, and whether they actually increase investment over the long-term remains difficult to measure.
What can be measured, however, according to nongovernmental organizations ActionAid and Christian Aid, is the increased limitations on Senegal — and the dozens of other countries party to similar treaties — to collect tax from one of the richest countries in the world.
And the U.K. is among the harshest in negotiating lower tax rates with developing countries, Toby Quantrill, principle economic justice adviser at Christian Aid, told Devex.
“The trend globally has been more towards using treaties that favor developing countries over developed countries — while the U.K. has not followed that trend,” he said. “We still tend to favor ourselves when signing treaties with developing countries.”
Experts warn that the effects of the treaties are often long-term, if not permanent, regardless of whether a country’s financial circumstances change.
“Because the treaties can’t be revisited without going through a big negotiation process, they will bind any future Senegalese government,” Charlie Matthews, tax advocacy adviser at ActionAid told Devex. “If new natural resources were to be discovered, or if the situation was to change, the government will continue to be bound by these clauses they’re signing now.”
The big picture
The IMF estimates that developing countries miss out on $200 billion annually due to tax avoidance on current — not potential — investments by multinational corporations. This means that if multinationals already working in developing countries were to begin paying standard tax rates by the book — comparable to what local and regional businesses pay — those struggling economies would gain access to $200 billion in domestic resources. This, Matthews said, “could pay for an awful lot of nurses.”
“When one developing country agrees to lower tax rates on multinationals, other developing countries feel pressure to do the same, and we’re now witnessing this race to the bottom as poor countries compete to give multinationals the biggest discount,” Matthews said.
The good news? Some international bodies are cracking down on corporations and governments engaging in treaties and under-the-table agreements to aggressively lower tax rates.
The bad news? Only rich countries are benefiting from the crackdown, for the time being. The European Commission ruled against Fiat and Starbucks on Wednesday, revealing the companies were offered unfair deals by the Netherlands and Luxembourg for reduced tax rates in exchange for investment. The companies will be forced to pay the standard tax rate and will likely also pay significant fines, according to an EU Commission press release.
In order for this landmark decision “to truly have a global effect,” Natalia Alonso, deputy director of advocacy and campaigns at Oxfam International told Devex, “we need more investigations into tax rulings and other ways in which tax advantages are granted and more debate on this within and among countries,”
“Tax dodging in all forms results in significant loss of potential public finance which could fund national development,” she said. “When there are insufficient funds, other actors need to plug the gaps.”
While developing countries are less likely to budget for investigations or renegotiations, ActionAid’s Matthews pointed out that what’s good for the goose may eventually be good for the gander. Such rulings, while insulated from the “race to the bottom” still taking place across the developing world, could trickle down.
“When an EU member state reduces its tax rate — for example if Germany does, then the Netherlands feels like they have to, then France — this eventually lands at the door of developing countries, who end up under pressure to reduce their tax rate in order to stay competitive,” Matthews said.
And developing countries — who, according to a report by Christian Aid, rely on international corporate tax revenues far more than OECD countries as a portion of gross domestic product — are then obliged to give advantages to the richest countries. In the case of Senegal, domestic and regional businesses pay a standard rate, and more than 50 percent of the population remain below the poverty line.
The rocky road to accountability
When negotiating treaties with developing countries, the U.K. and other developed countries use a template created by the OECD. ActionAid’s Quantrill pointed out that while the terms change for every treaty, on the whole the OECD template favors the developed country and leaves the developing country more vulnerable.
“The U.N. put forth a model treaty for countries to use, and it’s not clear why the U.K. doesn’t use it, particularly when dealing with a country that lacks the same OECD protections,” he said.
Matthews added that the OECD model is much more restrictive on what developing countries can charge multinational companies, and “takes away their agency to make decisions about their own tax system.”
Asked why the U.K. government doesn’t use the U.N. treaty, a spokesman from Her Majesty’s Revenue and Customs Department told Devex the Senegal treaty actually reflects many of the elements of the U.N. template, arguing that “the two models are substantially similar.”
The OECD is making strides to be more inclusive. It’s final report for the Base-Erosion and Profit-Shifting project, or BEPS, released last week, claims to offer a more balanced approach with protections for developing countries, and “represents the results of a major and unparalleled effort by OECD and G-20 countries working together on an equal footing with the participation of an increasing number of developing countries,” according to the report’s explanatory statement.
Another solution, Matthews and Quantrill agreed, would be the establishment of an international tax body, where both developed and developing countries could convene to decide on universal tax protections.
“The current treaties used provide an upper limit on tax rates. One thing an international tax body positioned at the U.N. could do is propose a floor limit, which would relieve the pressure on developing countries to keep slashing tax rates,” said Matthews.
By failing to live up to their obligations, developed countries are 'doing harm'
In a conversation with Devex in Addis Ababa, Ethiopia, Nobel Prize-winning economist Joseph Stiglitz had some harsh words for developed countries and explained how poor tax practices are hurting development in poor countries.
At the third International Financing for Development Conference in Addis Ababa, Ethiopia, in September, nongovernmental organizations were pushing hard for an international tax body, but no agreement was reached. Many countries, including the U.K., voted against establishing an international tax body at the U.N.
Asked why the U.K. voted no, Secretary of State for International Development Justine Greening, responded to members of the U.K. International Development Committee at a hearing in August: “There is already a tax body in place, which has tax experts from a variety of countries … The real issue is that you need to get G-7 countries to agree that this is an issue that needs to be faced and then commit to taking the sorts of steps that we are doing, on transparency and beneficial ownership, so that there is the right structure in place.”
Added Greening: “That was, from our perspective as the U.K., the problem … We just did not feel that the U.N. tax committee upgrading was particularly going to do that at all.”
Asked whether the U.K. Department for International Development was involved in assessing how tax treaties will affect development outcomes in countries, the HMRC representative told Devex that “it is for each country to assess for itself the trade-off between retaining all its taxing rights and possibly limiting those rights in order to attract foreign investment.”
“When Senegal approached us regarding a [double taxation agreement] we were happy to oblige,” he said, adding that developing countries have good reasons to enter a tax treaty — such as a positive effect on foreign direct investment and certainty for potential investors.
Read more international development news online, and subscribe to The Development Newswire to receive the latest from the world’s leading donors and decision-makers — emailed to you FREE every business day.
