Saturday 16 December 2017
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Legal discrimination: How double taxation treaties discriminate against lower-income countries

Multinational treaty shopping and tax avoidance is commonplace throughout the world, particularly in poorer countries. The secretary-general of the OECD, Angel Gurría, believes that developing nations lose three times more money to tax havens then they receive in aid each year (The Economist, 2015).
This treaty shopping is made possible by lax tax laws which often unfairly discriminate against poorer, less developed nations. @ucdpolitics student, Hannah Twomey, argues in this blog post that it is not just tax havens that cost developing countries tax revenues. Double Taxation Agreements are legal agreements which often discriminate against lower income countries and deny them access to vital tax revenue which could be used for the development of the particular country.
Tax treaties, as defined by the ‘Oxford Dictionary of Business and Management’, are essentially legal agreements between two countries that identify the “treatment of income, profits, or gains that are subject to tax in both countries”(Law, 2016). The aim of tax treaties is to prevent double taxation.
Thus two countries divide up and limit each other’s taxing rights.
With regards to large multi-national companies, only one country may tax the profits. Tax treaties stay in place until they are renegotiated or terminated.
Thus, there are tax treaties still in place from the colonial era. For example the tax treaty between Malawi and the UK was signed in 1955 (Barr, 2016).
There are over 3000 tax treaties operating in the world, and over half of them are between a developed and a developing country (Hearson, 2016). Developing nations are “caught in a race” to conclude more stringent treaties (Roy & Nunnenkamp, 2014). However these lower-income countries rarely benefit from these treaties. Tax treaties divide the right to tax a multinational company between source based taxation (the country where the corporation makes money) and residence based taxation (the country where the corporation is based) (Hearson, 2016). Source based taxation is severely limited in most tax treaties. In lower-income countries the majority of large business’ and corporations are multi-national, and it is unlikely that these low-income countries have many companies based abroad. Thus residence based taxation is generally useless for low-income countries, with most relying on source based taxation (Hearson, 2016).
The total loss of revenue from tax treaties for developing countries has not been calculated. However individual countries have made their own estimates. It is estimated that “developing countries lost €770 million in 2011 as a result of treaties with the Netherlands, and the IMF estimates that US tax treaties cost non-OECD countries around US$1.6 billion in 2010” (Hearson, 2016). Although treaties can have benefits for lower income countries, they are “inherently discriminatory” and it is clear “that countries should not enter treaties lightly” (International Monetary Fund, 2014).
I will shortly look at the specific case of Zambia to further understand the effects of these treaties on lower-income countries.
The figure below outlines the amount of restrictive treaties in place.
These discriminatory restrictions benefit wealthier nations. (Action Aid, 2016).There are three tax rights, highlighted by Action Aid that drastically discriminate against lower-income countries. They are profit tax, withholding tax and capital gains tax.
Profit Tax. These tax treaties decide how established a foreign company must be in a country before it begins paying taxes on its profits. Treaties often give multi-national companies a significant amount of leeway in how much they can expand within a country before they may be considered established or resident in that country (Hearson, 2016).This restricts countries from collecting residence based tax. As was mentioned previously, source based taxation is generally more constricted in treaties thus it is not in lower-income countries best interest to be prevented from applying residence based tax.
Withholding Tax. This prevents the transfer of untaxed earnings from the country, by taxing the earnings as they are generated. It is a simple form of taxation and thus it is vital for developing countries as their tax-authorities are usually poorly resourced. However there is a worrying trend which shows that lower income countries are tending to sign away their rights to withholding taxes (Hearson, 2016).
Capital Gains Tax. This involves the taxing of profits made when a capital asset is sold for higher than the purchase price (Business Dictionary, 2016). Action Aid notes that capital gains taxing rights may be undermined in forty-nine percent of treaties examined (Hearson, 2016).
Whilst tax treaties are put in place to prevent double taxation, they can also lead to double non-taxation. Many multinational companies engage in treaty shopping in order to avoid paying any taxes on profits. Tax havens and countries which have a tax treaty in place that allow free flow of profits allow multinational companies to exploit the system for their own benefit.
Although double non-taxation damages all countries regardless of wealth, it is the poorer countries that rely the most on multi-national tax revenue and are thus affected the most.
The case of Zambia
I will study the case of Zambia in order to observe the effects of harsh taxation. Action Aid rates tax treaties and scores them based on how restrictive they are. With 0 being the most restrictive and 100 the least restrictive (Action Aid, 2016). Profit tax in Zambia is severely restricted. The treaty between Japan and Zambia was given a 6.
This is the strictest treaty with regards to profit tax. The treaty between the UK and Zambia was the least restrictive with regards to profit tax, it scored 49 (Action Aid, 2016). According to the terms of the UK Zambia treaty a multi-national company may only be taxed by the country it is permanently established in (HM Revenue & Customs, 2014). The definition for what is considered permanently established is expansive with regards to this treaty.  As opposed to the Japan Zambia treaty which is more restrictive.
Withholding tax is also restricted in Zambia. The most restrictive treaty with regards to withholding tax is with the United Kingdom, rated a 10. The least restrictive treaties were Norway and Denmark, each treaty was rated 47 with regards to withholding tax.  The capital gains tax is the most restrictive aspect of most of Zambia’s treaties. Treaties with Italy, Ireland, Japan and Sweden were all rated 0 with regards to this tax. The treaty with Seychelles was rated 44 with regards to how restrictive it was on capital gains tax.
Zambia is an example of tax treaties being exploited by multinational companies in order to pay little or no tax. According to Action Aid, a British owned Corporation Zambia Sugar paid almost no corporate tax between 2008 and 2010 despite generating profits of US$123 million in Zambia (Hearson, 2016). If the company was to run a loan from Zambia to the United Kingdom it would be subject to a 10% withholding tax on interest charge (Hearson, 2016).
However the Zambia Sugar avoided this charge by routing the loan through Ireland. Zambia’s government has since renegotiated the terms of the treaty which made this possible.
Zambia was classified, by the World Bank, as a lower-middle income country in 2011 yet it remains poverty stricken (World Food Programme, 2016). Zambia has one of the highest rates of undernourished people in the world and its poverty levels stand at sixty-three percent (World Food Programme, 2016). If Zambia renegotiated its 13 highly restrictive treaties the tax revenue generated could be used to combat its extreme poverty and inequality. Zambia’s case is similar to many other lower-income countries with restrictive tax treaties.
The outrage of the Irish people with regards to Apple tax avoidance is understandable. However legal tax treaties made possible by countries like Ireland, as we saw with Zambia Sugar, cause lower-income countries to suffer to a far greater extent. Tax treaties discriminate severely against lower-income countries. These countries need tax revenue in order to fund their own development and progress however they are being exploited by multi-national companies and occasionally wealthier countries.
The OECD has recognised the problem and aims to tackle Base Erosion and Profit Shifting. Yet this mainly focuses on instances of tax avoidances. Although tax avoidance is a problem that needs to be addressed, it mainly affects wealthier countries while poorer countries continue to be affected by Double Taxation Treaties. Many wealthy countries lend thousands in state aid to lower-income countries. If tax treaties were less restricted this may not be necessary.
By negotiating fairer tax treaties it is possible lower-income countries may begin generating enough income to raise themselves out of poverty.
Hannah Twomey is in her second year of a BA in Politics and Philosophy in University College Dublin. She works part-time in a busy Dublin pub, and is involved in various societies on campus. She completed this blog post for her UCD politics module, capitalism and democracy.

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