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Rwanda Leading African Sustainable Investment Drive

Posted on Aug. 3, 2020

Rwanda envisions itself as the next Luxembourg or Singapore: a new financial center that will turn east Africa into an international power player and service financial transactions throughout the African continent and beyond. While other financial centers are often accused of being tax havens, Rwanda is determined to avoid that label. It says the new hub, the Kigali International Financial Center (KIFC), will not allow business activity designed to avoid taxation. Details are forthcoming but Rwanda Finance Ltd., the government entity that is developing the project, says all investments at KIFC must have a substantive business and economic purpose. Old KIFC strategy documents suggest the government is targeting modest tax rates, and a robust network of double taxation agreements and tax information exchange agreements to bolster the project.

Rwanda’s KIFC project has been years in the making. But development is now picking up speed despite the fact that Rwanda, like other countries, is contending with slowing economic growth and rising unemployment because of the coronavirus pandemic. For governments around the world, the pandemic has awakened a dire need for cash to pay for social safety net provisions and counteract sagging tax receipts and shrinking GDP. At the same time, the economic emergencies created by the coronavirus pandemic present a new opportunity for governments to reimagine taxation both domestically and internationally.

In many corners, there is a perception that global taxing systems are inequitable and riddled with loopholes. The OECD’s base erosion and profit-shifting project, launched in 2013, generated new standards and best practices that were supposed to solve this issue. However, some believe BEPS simply layered complex rules on top of an already complex system. In a similar vein, the OECD wants to overhaul global tax rules and create a new system giving governments greater taxing rights over digitalized companies, but the proposal is anything but unified. Battling the coronavirus pandemic has breathed new life and urgency into discussions, however, about sustainable and fair taxation on the domestic and international levels, and the appropriateness of increasing tax burdens on those who are potentially undertaxed to fund economic recovery.

Investment and the Social Contract

In this environment, there is an increased expectation that governments soliciting new investments will ensure that those investments generate sustainable tax revenue, especially as economists warn of a potentially protracted economic recovery period. Yet one cannot ignore the element of competition between governments. The looming question is: When does one’s tax sovereignty become another’s tax dilemma?

Allison Christians, H. Heward Stikeman Chair in Tax Law at McGill University, touched on this in a 2009 paper, “Sovereignty, Taxation, and Social Contract”:

Recognizing ourselves as parties to a global social contract would require a fundamental reassessment of the conventional standards of tax policy design. Instead of focusing on national tax policy as appropriately reflecting only or even primarily the needs and wants of national constituents, a global social contract would require national policy to reflect outward as well, to consider the needs and wants of the worldwide community.

We are seeing some pushback against perceived violators of this contract in Europe, where the EU has urged member states to deny coronavirus-related aid to companies with ties to alleged tax havens. (Prior coverage: Tax Notes Int’l, July 20, 2020, p. 390.) Already, several EU countries have adopted this strategy, including Belgium, Denmark, France, and Poland. France, for example, is denying bailouts to firms registered in tax havens, and Belgium is denying bailouts for companies linked to tax havens.

In a related vein, there are real questions about whether various kinds of tax incentives are helpful or harmful domestically, especially for developing countries. For example, is this the time to cut corporate tax rates in the name of economic investment? KIFC’s strategy document suggested a 15 percent corporate tax rate on companies in KIFC, which is half of the country’s usual 30 percent rate. The Independent Commission for the Reform of International Corporate Taxation says corporate rate cuts could actually increase inequality, particularly in developing countries in which corporate tax receipts account for a larger percentage of the budget.

On the other hand, policymakers could use the pandemic as a chance to craft more efficient, targeted incentives and policy choices, according to Sanjeev Gupta, a senior policy fellow at the Center for Global Development. According to Agustin Redonda, a senior fellow at the Council on Economic Policies, countries need to move with caution and should consider three important factors when designing these special regimes:

  • the cost of the incentive;

  • ways to track impact; and

  • the specific objective in mind.

The discussion is important at a time when foreign direct investment in several African countries has dropped, and there is an increasing focus on how African countries can generate their own sustainable financing for economic recovery. The African Development Bank is projecting that GDP across the continent will contract 1.7 percent this year but could shrink by 3.4 percent in a worst-case scenario.

In a policy report, “COVID-19 and Africa: Socio-Economic Implications and Policy Responses,” the OECD said recovery strategies on the continent:

should include a strong structural component to reduce dependence on external financial flows and global markets, and develop more value-adding, knowledge-intensive and industrialised economies, underpinned by a more competitive and efficient services sector.

Along these lines, potential tax incentives should not undercut domestic recovery efforts or generate a race to the bottom that affects the recovery of other countries. It is important to note that financing constraints facing developing countries, and African countries in particular, are partially attributable to taxation issues. Logan Wort, executive secretary of the African Tax Administration Forum, believes a lack of fair taxing rights has deprived those countries of revenue and has compelled them to seek outside funding from the IMF and World Bank in response to the pandemic.

Close Attention to Tax Details

As part of the KIFC project, Rwanda is touting its tax infrastructure. The country is advertising that its tax incentives, like capital gains exemptions for registered investors and a corporate tax exemption for some foreign companies headquartered in Rwanda, fall in line with OECD and EU tax transparency standards. Rwanda also plans to reform its financial sector tax policy, with details forthcoming.

But compliance with transparency standards tell only part of the story. By all accounts there’s room for Rwanda to do more. The IMF cautioned in 2018 that the country’s tax incentives were probably unsustainable, according to a report in Rwandan newspaper The New Times. However, Rwanda is a member of the OECD’s Global Forum on Transparency and Exchange of Information for Tax Purposes. Within that forum, the country has taken a lead on African tax issues. In early 2019 Rwanda hosted the forum’s sixth annual Africa Initiative meeting. That meeting centered on illicit financial flows in Africa and how African countries can further develop automatic exchange of information frameworks so that information is more accessible to them. As a follow-up, Rwanda Finance Ltd. in early June conducted a workshop on OECD tax issues.

Along these lines, more attention will likely be paid to developing partners in projects like KIFC. U.K. development finance institution CDC Group is a partner in KIFC. Over the years, CDC has been criticized for allegedly using tax havens for investments, but the group’s official tax policy statement says the institution will not make investments through intermediate jurisdictions that fail to pass the OECD’s global forum peer reviews and receive a “compliant” or “largely compliant” rating unless there are exceptional circumstances in which the benefits outweigh the costs. That caveat is likely to generate more scrutiny.

The KIFC project also shines a spotlight on tax treaty development, which will be important during the pandemic recovery period. In Africa, tax treaties with Mauritius — a robust financial center off the coast of southern Africa — have left a bad taste in the mouths of several countries. Mauritius is often a conduit for business between Africa and Asia, and several countries contend that the terms of their treaties with Mauritius give them insufficient taxing rights and could facilitate tax avoidance. Early this year, Senegal announced that it terminated its treaty with Mauritius and has a new one pending. Kenya had to rework its treaty with Mauritius after the Tax Justice Network Africa successfully filed a lawsuit alleging that the terms of the arrangement could enable Kenyan companies to avoid tax by routing their investments through Mauritian shell companies. In late June Zambia voided its double tax agreement with Mauritius and is seeking a renegotiation. Several years ago, Rwanda did the same.

Rwanda already has double tax treaties with Barbados, Belgium, Jersey, Mauritius, Morocco, Singapore, and South Africa. It is also a signatory to double tax agreements with three regional African networks: the Common Market for Eastern and Southern Africa, the East African Community, and the Economic Community of Central African States. But Rwanda is hoping to expand its treaty network and plans to focus on building relationships at the 2021 Commonwealth Heads of Government meeting. Rwanda has the double distinction of hosting the meeting and officially unveiling KIFC at that event. It will be important to watch Rwanda’s progress on this path, and the resulting treaties.

Multilateral Coordination

It has been suggested that the global political appetite for tax multilateralism is weak. (Prior coverage: Tax Notes Int’l, July 6, 2020, p.17.) Right now, country-specific tax responses to the pandemic seem to support that fact — jurisdictions are mostly concerned with managing their domestic affairs. But regional or project-based approaches could create a bridge between domestic tax sustainability and regional or international sustainability.

Some of this is already happening because of China. It has created a tax consortium to support its Belt and Road project, which is a plan to invest trillions of dollars in infrastructure projects around the world so China can transport goods more easily. The consortium, the Belt and Road Initiative Tax Administration Cooperation Mechanism (BRITACOM), is a collection of countries partnering in the project, and was created so participants can develop and pursue common goals. Chief among these is the promotion of economic growth and efficient collection of the maximum tax revenue possible. China has maintained that BRITACOM will not reinvent tax policy.

Even so, the organization seems to be taking steps that could, at the very least, reshape tax policy. That has become apparent from BRITACOM’s response to the coronavirus pandemic, which includes a recent coronavirus-related meeting for its members. BRITACOM says it is using its “multilateral tax dialogue platform” to help member countries discuss and compare their tax responses to the crisis. This is because BRITACOM views itself as a tool that member countries can leverage to help improve their social and economic development.

Ultimately, projects like KIFC and BRITACOM could push tax policy and economic recovery discussions forward in ways that larger, more traditional forums cannot. But only time will tell.

A version of this article was previously published on afronomicslaw.org as part of a symposium titled “Taxation and the Social Contract in a Post-Pandemic Era: Domestic and International Dimensions.” The symposium was jointly hosted by Afronomicslaw, the U.N. Development Programme (Africa), and the Centre for the Study of Economies of Africa.

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