In Sierra Leone, the tax authority’s total budget allocation for 2015-16 was USD 13 million, about 0.5 percent of Australia’s. It has six staff responsible for auditing extractive industry taxpayers in a country where, pre-Ebola pandemic, roughly 20 percent of gross domestic product was a result of mining. None of the staff are transfer pricing specialists, and Sierra Leone’s tax court was only set up in 2015.
“We do not have capacity to get involved with legal issues,” the deputy minister of mines said. “Companies have the best lawyers; as a ministry we don’t have the best lawyers.”
Faced with such limitations, what lessons can Sierra Leone learn from countries like South Africa, Zambia, and Tanzania, which are finding context-relevant and innovative ways to limit the ability of foreign multinationals to avoid paying taxes?
NRGI’s regional report on preventing tax base erosion showed that many mineral-rich countries in Africa face similar challenges in applying “global standards” led by the Organisation for Economic Co-operation and Development to stop multinationals from using cross-border transactions to avoid tax. In particular, tax authorities struggle to apply the arm’s length principle, which compares the price of a transaction between related parties with the price of similar transactions carried out between independent parties. This is because accessing appropriate comparable data is so challenging.
NRGI is publishing case studies on South Africa, Tanzania and Zambia that describe alternative legal and institutional mechanisms that these countries have put in place to control the price of mineral exports, operational and capital expenditures, and the cost of debt.
South Africa is one of the first countries in the world to introduce a law to limit the deduction of interest payments to foreign-related parties. Deductions that exceed 40 percent of turnover are disallowed. This hard cut-off means the South African Revenue Service can protect the tax base without getting into the nitty-gritty of pricing loans. (As this recent Chevron case in Australia shows, pricing loans is extremely difficult.) Action 4 of the OECD Base Erosion and Profit Shifting (BEPS) project has adopted a similar approach, while recommending a higher cap between 10 percent and 30 percent of turnover.
In Zambia, taxes from the mining sector have disappointed the public, particularly as copper prices hit historic highs. Civil society organizations believed that mining companies were selling their copper to foreign related parties under market rate to pay less tax in Zambia and accumulate profits offshore. In response, Zambia adopted an additional transfer pricing method that requires mining taxpayers to use publicly quoted benchmark prices—for example, from the London Metals Exchange—to calculate all mineral sales to related buyers. The rule makes it harder for companies to distort their mineral sale price to avoid tax.
“It removes a free kick for companies,” says one Zambian tax official.
The government of Tanzania has recognized that tax officials alone cannot detect and mitigate tax avoidance by mining multinationals. They need support from mining industry experts. The Tanzania Mineral Audit Agency (TMAA), set up in 2009, is responsible for monitoring the quality and quantity of mineral exports and the financial performance of mining companies. TMAA’s efforts have helped the tax authority collect USD 64.8 million in additional corporate tax, accounting for roughly 7 percent of mining tax receipts between 2009 and 2015 and twice the TMAA’s budget over that period.
South Africa, Zambia, and Tanzania have decided that they do not have the resources to audit all of the transfer pricing practices of multinational companies. They have therefore tried to avoid getting into unwinnable battles by introducing clear, objectively verifiable and easy to administer tax rules, as well as strong government institutions to oversee the mining sector. Other mineral-rich countries should take note.
Thomas Lassourd is a senior economic analyst at NRGI. Alexandra Readhead is an independent consultant specializing in international taxation and extractive industries.