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Developing Countries’ Search for a Post-Pandemic Tax Path

Posted on June 8, 2020

Forget a new deal, or even a green new deal, to pull governments out of the global economic downturn caused by the COVID-19 pandemic. Instead, some development economists like Jayati Ghosh, chair of the Centre for Economic Studies and Planning at the Jawaharlal Nehru University in New Delhi, are envisioning a global “multicolored” new deal that touches on broad aspects of socioeconomic life, including workers’ rights, to generate recovery from the pandemic.

Ghosh, speaking at a May 28 conference organized by the Financial Transparency Coalition, the Independent Commission for Reform of International Corporate Taxation, and others, acknowledged that such an idea may not be supported by the political environment. But she and other panelists urged governments to think creatively about how they can respond to economic pressures and find ways to derive sustainable revenue.

Across the board, governments find themselves at a crossroads. Will they pursue multilateral cooperation as they address the pandemic and try to raise more revenue, or will they enact unilateral measures and go it alone? The conference, Health vs. Wealth: Tax and Transparency in the Age of COVID-19, particularly focused on this issue as it applies to developing and emerging countries.

The general message is that any interim responses, including tax responses, should advance the core message that developing countries need greater taxing rights, according to Wayne Swan, former treasurer and deputy prime minister of Australia. He believes that governments are in the best position over the last 40 years to reform the global system and argue for more progressive taxation.

“How you raise tax is just as important as how much you raise,” Swan said, speaking at the conference.

Corporate Taxation

For Logan Wort, executive secretary of the African Tax Administration Forum, African economic responses to the COVID-19 pandemic need to look past interventions from the World Bank and IMF, both of which have made available billions of dollars in emergency financing. But looking past cannot be done without considering how to generate revenue sustainability and how to determine the proper allocation of taxing rights for fair revenue collection and payments, he said. The COVID-19 pandemic has shined a spotlight on the absence of fair taxing rights in developing countries, African countries in particular, that have faced difficulty financing economic responses to the pandemic and have had to turn to outside resources for help.

Wort expressed concern with the OECD’s unified approach, which seeks to develop a new taxing right over the digital economy, and a minimum corporate tax rate, by the end of 2020, although the African Tax Administration Forum has said it generally supports the OECD’s initiative. But Wort said he fears that developing countries are being left out of the decision-making process, even though 25 African countries are participants.

“The pace at which this takes place and the forum in which this takes place, the G-20, is leaving a lot of countries behind, even smaller European countries behind,” Wort said. “One can see the huge risks to developing countries and African countries in particular.”

Rajat Bansal, joint secretary for foreign tax and tax research for the Indian Department of Revenue, agreed. He added that developing countries and the world in general missed the bus on allocation issues when the OECD launched its base erosion and profit-shifting project.

But on a more domestic level, developing country revenue authorities need to look at sectors that have performed well during the pandemic or have not been hit hard. Wort cited digital services, telecom, and food and beverages as examples.

“The taxes will come from areas that African countries have not looked at and in some cases have been unwilling to look at,” Wort said. These include taxation of high-net-worth individuals and a fresh look at the possibility of reversing, cutting back, or stopping altogether incentives like tax holidays and special economic zones. But in the immediate term, Wort says closing loopholes and enhancing current taxes will likely be more productive. Beyond that, he maintained that any sort of long-term revenue strategy for developing countries must consider digital taxation.

Within Africa, Nigeria and Kenya are early adopters of unilateral digital tax legislation. Nigeria published a legislative order establishing a new significant economic presence standard for nonresident companies that make over NGN 25 million (about $64,000) in annual income from providing several kinds of digital services in the country:

  • streaming and downloading services;

  • online data transmission; and

  • online intermediation services.

The provision also applies to foreign companies that provide technical, professional, management, or consultancy work in the country and receive payment from Nigerian residents.

In its Finance Bill 2020, Kenya proposed a 1.5 percent digital services tax on services provided in Kenya though digital marketplaces. In addition, the country plans to assess VAT on services provided in digital marketplaces.

A related issue for Bansal is how capital gains taxation can be used to generate more revenue for developing countries. He pointed out that software royalty taxes, which are linked to software copyrights, could collect more revenue for source countries if linked to software intellectual content instead.

Getting Foreign Companies to Stay

Part of Algeria’s economic recovery strategy is inducing foreign service providers to open offices and put down roots in the country.

Offshore foreign service providers operating in Algeria may face increased withholding tax rates under the country’s economic recovery strategy. In mid-May the Algerian Cabinet approved a draft finance bill that seeks to raise the withholding tax on foreign service providers operating in the country from 24 percent to 30 percent. The government hopes the increase will induce foreign service providers to change structures and open offices in Algeria.

A similar idea is swirling around in India. In late April, a group of over 50 Indian Revenue Service officials released a report called Fiscal Options and Response to COVID-19 Epidemic, filled with suggestions on tax measures the country could implement. Chief among them is increased taxation of foreign companies.

They suggest that the government increase a surcharge imposed on so-called higher-income foreign companies that have branch offices or permanent establishments in India.

“The said surcharge has not been revised for some time now, and with companies operating in India and deriving profits through their PEs, it is time that a flourishing market like India with its huge prospects flexes its customer-base muscle,” the report said.

That said, the report is not an official document of the Indian Ministry of Finance or Central Board of Direct Taxes, and does not reflect their views, according to the country’s Income Tax Department.

Treaty Revisions

Tax Inspectors Without Borders, a collaboration between the OECD and United Nations Development Program, is considering how taxation beyond the pandemic may look for developing countries. Tax treaty negotiation technical assistance is part of the strategy. Treaty negotiation work has been on the organization’s agenda but Tax Inspectors Without Borders expects it will become more important in the immediate future.

The issue played out last year in Kenya, which in March 2019 lost a constitutional challenge over its double tax agreement with Mauritius. Tax Justice Network Africa, which filed the lawsuit, argued that the terms of the arrangement could enable Kenyan companies to avoid tax by routing their investments through Mauritian shell companies. The organization ultimately challenged the law on constitutional grounds, alleging that the Kenyan government failed to properly ratify the arrangement. Kenya’s High Court sided with Tax Justice Network Africa and voided the DTA. The decision could have ripple effects for other African countries and their DTAs with alleged haven states like Mauritius, according to the network. Both countries have since signed a new treaty.

India was a trailblazer in this area, amending its treaty with Mauritius in May 2016. Both countries signed a protocol giving India greater rights over how Indian assets are taxed in the hands of Mauritian investors.

The Indo-Mauritian concern was over tax treatment of capital gains — Mauritius does not tax capital gains, but the treaty gave Mauritius control over capital gains taxation involving Indian assets. Mauritius-based companies selling Indian shares did not pay capital gains taxes on their profits, and Indian authorities felt the scheme encouraged taxpayers to route their investments through Mauritius. This was important because at the time, Mauritius generated the largest percentage of foreign direct investment into India, roughly 34 percent. The protocol eased investors into the tax change and allowed India to tax Mauritian investors at half of the going capital gains rate on investments acquired during a two-year period ending March 31, 2019. After that, the full tax rate applied.

The change also affected India’s treaty with Singapore, which under its article 6 explicitly provided the same capital gains tax rights as those allowed in the Mauritius treaty. In December 2016 India and Singapore signed a protocol amending the treaty to provide for the same capital gains treatment with Singapore as in its updated Mauritius treaty.

Early this year, Senegal announced that it too had terminated its treaty with Mauritius and has a new one pending.

Over the past few years, the Netherlands has been revisiting its treaties with developing countries on a rolling basis. In 2013 the country announced it would renegotiate tax treaties with 23 developing countries and would add new antiabuse provisions to all the agreements.

Dutch lawmakers are taking a deeper look at their developing country treaties and plan to restructure dozens to give treaty partners greater taxing rights, particularly in cases in which interest, royalty, or dividend payments originate from those countries.

“Since these countries often have little other tax revenue, it is particularly important that they can levy enough tax on the income generated by activities and investments there,” the Dutch government said in a May 29 release.

Part of the plan is that the Netherlands will incorporate a new “source state tax” in its treaties with 47 developing countries. The tax would target payments issued to Dutch tax residents for technical services carried out in those source countries. Generally, the Netherlands taxes those payments, but the new measure would divide the taxing right with the source state.

Solidarity and Wealth Taxes

Will we see an increase in wealth taxation following the pandemic? It’s too early to tell — net wealth tax discussions have historically been big on words but short on implementation because of the myriad difficulties in designing them. Administrability issues, taxpayer compliance, information security issues, and valuation issues loom large. In the OECD, only four countries maintain net wealth taxes: Norway, Spain, Switzerland, and Colombia, which joined the OECD in April. But the task is not impossible — Argentina and Uruguay also maintain net wealth taxes.

In recent weeks, some countries have either introduced or are discussing various measures to raise taxes on the wealthy via one-off solidarity taxes or net wealth taxes. Algeria has been considering a wealth tax in earnest since 2017 but is now seizing on its recent economic downturn to introduce a progressive wealth tax. The measure, which was released in the government’s draft finance bill, would institute a sliding tax beginning with 0.15 percent on assets worth at least DZD 100 million (about $776,000) and would top off at a 1 percent on assets worth DZD 450 million or more. Algeria currently imposes a 0.1 percent tax on assets exceeding DZD 100 million.

In Peru, lawmakers want to impose a solidarity tax and the idea has backing from President Martín Vizcarra, who has made it clear that he wants to implement such a measure. India dismantled its net wealth tax in 2016 after the administrative costs became higher than the tax revenue it collected, but there are arguments that the government should revive it.

South Africa is also considering a one-off wealth tax after years of research. In 2013 the government created the Davis Tax Committee to investigate the country’s tax system, its progressivity, and how it could be improved. Three years later, the minister of finance expanded that mandate to net wealth taxes and asked the committee to determine whether such a tax is needed, and if there are any potential implementation constraints.

The committee said that a net wealth tax may be viable, but that more work needs to be done to determine how it can be designed to fit the country’s needs. The committee was particularly concerned about designing the tax in a way that is administratively efficient and avoids unintended consequences.

The proposed one-off tax is a quick development considering that the Davis Tax Committee had recommended that the government first focus on reforming government expenditures and cracking down on tax evasion before implementing a wealth tax.

Ingrid Woolard, professor of economics at Stellenbosch University and a member of the Davis Tax Committee, emphasized that while the design may never be perfect, it’s important to get political buy-in by generally making net wealth taxes as inclusive as possible.

“You want to limit the number of exemptions, you want the tax base to be as comprehensive as possible. As soon as you start to argue about exemptions you quickly begin to erode the tax base and your ability to have a well-functioning tax,” Woolard said at the conference. “It’s very important for a country like South Africa and other developing countries to include taxpayer offshore wealth, which has to be a key component for developing countries.”

Mandatory self-reporting on assets and liabilities is an important first step for countries considering a net wealth tax, according to Woolard. But she and other panelists emphasized that there cannot be any robust wealth tax regime without the automatic exchange of information, particularly in Africa because estimates are that 30 percent of wealth in the continent is held offshore.

Hakim Hamadi, head of the technical assistance unit at the OECD’s Global Forum on Transparency and Exchange of Information for Tax Purposes, said there is a critical information gap that must be addressed, because many developing countries lack international exchange agreements or have a narrow exchange framework.

He noted that over €100 billion of additional tax revenue have been identified via treaty information exchanges since 2009, and €27 billion of those were by developing countries. But treaty information exchange is insufficient. In 2018 developing countries sent less than 2,500 requests while France sent almost 4,000 requests, Hamadi said.

“Implementation of [automatic exchange of information] in developing countries is more complex. The first challenge is to implement appropriate information security management framework. The second point is to develop a strategy to develop that information. What can you do with megabytes of information if you cannot identify the taxpayer appropriately?” Hamadi asked.

India is trying to move the needle on this, at least where middle market countries are concerned. In late May, tax authorities from Brazil, Russia, India, China, and South Africa convened to discuss the tax impacts of the COVID-19 pandemic and areas for cooperation, according to the Indian Ministry of Finance. Finance Secretary Ajay Bhushan Pandey said the countries need to engage in a “whole government approach” and collaborate more deeply on tax information exchanges.

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