Strengthening the capacity and effectiveness of tax systems needed to spur Intra-Africa trade

We argue that efforts should be made to restructure tax policies and systems to harness Intra-Africa trade  

By James Obuba

The newly created African Continental Free Trade Area (AfCFTA) in Africa has redeemed the Intra-Africa trade currently at a paltry figure of less than 20% and poised to hit the 52% mark in 2022. While the AfCFTA is an indication that a new dawn is upon us, it brings with it good tidings as well as a myriad of challenges such as the complex design of tax systems in the continent. . The tax systems, fiendishly complex, not only in Africa but across the globe has undergone little changes as compared to the metamorphosis in business, technology and trade. Member states of the Organization for Economic Cooperation and Development (OECD), have undertaken measurements and assessments to curb harmful tax practices through the Forum On Harmful Tax Practices (FHTP) for inclusive growth. This article argues there is need to re-examine the tax system in Africa for the well-being of Intra-Africa trade.

With this background in mind, African countries are to this day offering tax incentives to foreign companies to attract Foreign Direct Investment (FDI) by exemptions in import duties and value added tax. A good case in point is Nigeria which has incentivized motor manufacturing industry due to the dwindling oil revenues. Over time, such tax incentives have crowded out domestic investors leading to reduced trade operations in the continent. Action Aid, a non-governmental organization, estimates that governments in sub-Saharan Africa (SSA) lose an estimated US$38.6 Billion a year or 2.46% of their GDP to tax incentives. Trade misinvoicing has for decades been used for capital flight, tax evasion, bribe paying and money laundering. Trade misinvoicing occurs when importers and exporters inaccurately report; trade quantities, quality, pricing and values to revenue authorities. The Global Financial Integrity, a Washington, DC-Based consultancy, estimates capital flight loss of US$286 billion in trade misinvoicing  in the last decade translating to a 5.75% Gross Domestic Product of sub-Saharan Africa’s economy.

Total real capital flight adjusted for trade misinvoicing (million 1996 US$)

Source: Computations from the World Bank  and IMF indicators 2000,  (1970-1996)

Transfer pricing, a practice likened to multi-national enterprises (MNEs) who control up to 60% of Africa’s trade has led to tax dodging. Ernest &Young, a consultancy firm, during the 2014 Africa Tax Conference, conjectured that at least half of the African countries have adopted the OECD transfer pricing documentation practices. Due to the variance and sophistication of the revenue authorities, tax dodging by the MNEs was inevitable in Africa. The royalties rates which are prevalent in the extractive industry have been under taxed leading to lost tax revenues for the mineral rich African countries. Unpicking the bundle, the following action plans should be undertaken to revamp tax systems  in order to spur Intra-Africa trade.

First, there is need for African governments to have concerted strategies to tackle Informal Cross Border Trade (ICBT). According to the African Development Bank (AfDB), ICBT accounts for approximately 60% of regional trade. The ICBT participants are usually small businesses and individual traders, especially women who deal with processed and unprocessed merchandise which may be legal on one side of the border but illicit at the adjacent border. AfDB estimates that up to 43% of Africa’s population is dependent on ICBT as source of income. Nonetheless,  ICBT leads to deprivation of tax revenues due to unpaid customs duty and Value Added Tax (VAT). Developmental strategies like simplifying the documentation process, increased dialogue between customs authorities and traders including individuals with low literacy levels and closure of unofficial routes with no border posts, should be put in place.

Second, the tax incentives should be reduced or all together scrapped off. Many tax incentives awarded to companies are done in secrecy and away from the public. Action Aid, 2015, stated that tax exemptions are granted in exchange for political support, personal or political funding. African governments should institute good quality infrastructure, political stability and predictable macro-economic policies. Some of the investments emanating from tax incentives displace domestic companies that are well placed to serve local population and increase trade volumes.

Third, African countries through the Africa Union should create a unified platform for respective country revenue authorities. Unification of the taxes and systems is vital for the Agenda 2063 as enshrined in the 12 flagship programs with focus on commodities strategy. A unified tax system closes the loopholes like transfer pricing, tax sparing and profit shifting. The most recent trade dispute occurred between MTN, an MNE, and the tax authorities across Africa where MTN was suspected to be remitting ‘management fees’ to Mauritius, a lower tax jurisdiction country. A leaf can be borrowed from the EU Council of Economic and Financial Ministers who have seasonally been offering reports on Member States that levied lower taxes.

Fourth, renegotiating of tax treaties should be encouraged. Most of the tax treaties are post-independence in most African states. Out of the 124 members of OECD and Base Erosion and Profit Shifting (BEPS) as at November 2018, only 20 countries in Africa were signatories of the inclusive framework. More countries in Africa should participate in the initiative to curb FHTP through Mutual Agreement Procedure (MAP), peer reviewing and monitoring process.

Fifth, African countries should re-write the transfer pricing rules royalties rates, and management fee. Regulating of transfer pricing can be done in commodity trade where intra-firm trade takes place across African countries’ borders. The royalties’ rates in Africa have an average rate of 3% for both base and precious metals. There is need to revisit the rates and raise them to an average figure of 5% to cater for cash trapped countries in the continent and build on vibrant trade sectors.

Conclusively, revisiting tax systems and keeping up with the pace of the changing business environment by African governments will spontaneously translate to increased tax revenues. But, if countries in Africa can build their tax administration capacity, improve their tax policies and development trajectories at the same time, then this will spur Intra-Africa trade. Onward and upwards Africa!