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Africa must strike a delicate tax balance to nurture investment

Africa’s growing attractiveness as an investment destination is at risk if it fails to strike the right balance between international tax trends and the needs of its varied national economies.

“Africa is a developing continent experiencing unprecedented growth. But realising its potential will, to a large extent, depend on its success in balancing the needs of its developing economies with global realities,” says Keith Engel, Africa tax policy leader at EY, commenting on some of the key issues raised at EY’s 2013 Africa Tax Conference.

Engel suggests that African governments are largely focused on ways to broaden their tax bases and raise the revenue needed to build infrastructure and fight poverty. The reality is that they currently rely too heavily on customs duties, mineral and petroleum royalties, and donor funding. While the value-added tax is now a common feature of the African landscape, personal and company tax rates remain relatively high in global terms (albeit with significant exemptions to facilitate export-oriented businesses). Enforcement has now become a common means of raising revenues with certain African revenue-enforcement agencies being given explicit and implicit incentives to raise revenues above and beyond voluntary compliance.

“The challenge will be to prevent this need for enhanced tax revenues to erode African countries’ attractiveness as an investment destination, particularly when one considers the global tax environment,” says Engel.

Internationally, governments have built up considerable deficits in the five years since the 2008 financial crisis. While the official line is that they will rely on renewed growth to begin reducing sovereign debt, there is tacit acceptance that tax hikes will be needed to balance budgets. Instead of outright tax increases that could undercut competitiveness, most governments will take the more politically expedient rout of a broadened tax base via closed loopholes and tightened enforcement.

In Organisation for Economic Cooperation and Development (OECD) countries, policies to reduce base erosion and profit shifting have emerged as the primary means to achieve this end. OECD rules contain recommendations to close perceived cross-border schemes via new domestic legislation, tightened transfer pricing, changes to tax treaties and increased cross-border transparency, among others. These formal anti-avoidance mechanisms are being supplemented by political “name-and-shame” tactics that have left many CEOs and chief financial officers wary of aggressive tax avoidance.

“The concern is that many African countries could adopt their own versions of these rules in order to increase their tax revenues. Despite the fact that many African countries already have extensive provisions against base erosion in the form of high withholding taxes with little treaty relief, systems triggering tax for the cross-border payments of cash regardless of traditional notions of tax source as well as non-tax regulatory protections (such as exchange control),” Engel argues. “Before adopting new amendments aimed at preventing base erosion, African governments should earnestly consider the context. If the new rules reduce profits below required hurdle rates, multinationals could reconsider their investment strategies.”

Part of that context, he adds, is existing uncertainty around tax regimes that already bedevil the business environment in many African countries.

On balance, Engel concludes, while multinationals will have to make some sort of African investment to maintain market share, it is important to mitigate their concerns about tax so as to maximise the amounts they invest. At the same time, though, means must also be found to ensure that multinationals provide each African country in which they operate with a fair share of the profits made in that country.

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