3 October 2013

Africa Tax Policies May Threaten Investment

analysis

"The challenge will be to prevent the need for enhanced tax revenues from eroding Africa's attractiveness as an investment destination"

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.

Fiscal revenue is needed to upgrade critical infrastructure, but ill-considered tax adjustments could undermine investor sentiment.

African governments are largely focused on ways to broaden their tax bases and raise the revenue needed to build infrastructure and fight poverty, but the reality is that many of those governments currently rely too heavily on customs duties, mineral and petroleum royalties and donor funding.

While value added tax (VAT) is now common in Africa, personal and company tax rates remain relatively high in global terms (albeit with significant exemptions to facilitate export-oriented businesses).

Enforcement has become a common means of raising revenues with certain African revenue-enforcement agencies being given explicit and implicit incentives to collect taxes.

The challenge will be to prevent this need for enhanced tax revenues from eroding African countries' attractiveness as an investment destination, particularly when one considers the global tax environment.

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 route of a broadened tax base via closed loopholes and tightened enforcement.

In 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, amongst others.

These formal anti-avoidance mechanisms are being supplemented by political "name-and-shame" tactics that have left many business leaders wary of aggressive tax avoidance.

The concern of business is that many African countries could adopt their own versions of these rules in order to increase their tax revenues beyond what is needed to prevent avoidance.

For instance, many African countries already have measures to prevent base erosion, such as high-withholding rates (even after treaties are taken into account), newly established transfer pricing rules and various forms of exchange control.

Before adopting new amendments, African governments should earnestly consider the context.

They do not suffer the same forms of base erosion as the European countries driving the international agenda, and they can ill-afford to generate further uncertainty around tax regimes - a problem that already bedevils the business environment in many African countries.

On balance, 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 amount they invest.

At the same time, means must also be found to ensure that multinationals provide each African country in which they operate with a fair share of local profits.

That will require a careful balancing act.

Keith Engel is Africa tax policy leader for Ernst & Young

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