Later this year, the world’s most powerful countries will debate proposals for wholesale reform of the international corporate tax system. After several years of campaigning from ActionAid and many other organisations, they have finally agreed to take seriously the problem of so-called "Base Erosion and Profit Shifting" – an elaborate term for corporate tax avoidance. UK chancellor George Osborne has called on reforms to end the kinds of tax activities allegedly undertaken by high-profile names like Starbucks, Google and Amazon.
So what should countries be considering as they sit down to rewrite the international tax rules? Much of the public outrage around multinationals’ tax affairs has focussed on allegations of shifting profits into tax havens. Such 'profit-shifting' was also the main focus of ActionAid’s 2010 report on the tax practices of brewing giant SABMiller, Calling Time.
But profit-shifting isn’t the only mischief generated by weak international tax rules and ingenious financial engineering. 'Sweet Nothings', our new report on the Zambian tax affairs of British multinational Associated British Foods (ABF), also examines a different technique: routing cross-border payments via particular jurisdictions (often tax havens) to take advantage of loopholes amongst thousands of bilateral tax treaties.
In ABF’s case, we found that hefty management fees, and interest payments on foreign bank loans to ABF’s Zambian sugar operation, Zambia Sugar, are being routed through a special subsidiary registered in Dublin, called Illovo Sugar Ireland.
Why? Our investigation found that in reality Illovo Sugar Ireland appears to have no real office or activities in Ireland itself (indeed, when ActionAid visited Illovo Sugar Ireland’s listed address on the Dublin waterfront, the receptionist had never heard of the company). Management services are apparently being provided from South Africa and elsewhere. And the interest on the bank loans is going back to the UK branches of the banks that originally lent the money.
Ordinarily Zambia, like many other countries, withholds a 20% tax on such management fees and interest income (or 10% in the case of payments to the UK). Almost uniquely, however, a tax treaty signed back in 1971 between Zambia and Ireland denies Zambia any right to tax such payments. So the trick of ‘dog-legging’ Zambia Sugar’s payments via Ireland – at least on paper - has seen Zambia lose millions of dollars of cross-border taxes.
The same is true of Zambia Sugar’s profits when they are distributed back to its South African parent company as dividends. We found that these dividends are routed via a string of Mauritian and Dutch holding companies, including through a special hybrid company form called a ‘Cooperatief’. Thanks to an unbalanced tax treaty with the Netherlands, and loopholes in Dutch tax law governing Cooperatiefs, this arrangement avoids the majority of Zambian withholding taxes, despite the dividends not being taxed in the Netherlands either.
ABF themselves told us that the normal Zambian withholding taxes would have been due on Zambia Sugar’s interest payments were they not routed via Ireland, while denying any wrongdoing. Here’s how it works:
In theory, of course, tax agreements between Ireland and Zambia shouldn’t apply to South African managers, or UK banks. Routing transactions through such ‘conduit companies’ is a procedure commonly called ‘treaty shopping’. It’s not about shifting profits, but about avoiding taxes on cross-border income. While it’s not unlawful, the OECD calls it “abuse”, and has proposed a range of measures to stop it – most of which are absent from the outdated Ireland-Zambia and Netherlands-Zambia tax treaties.
Taxing payments of interest, dividends, fees and royalties is an important way for developing countries (and the UK) to get a fair share of the revenues from such cross-border income. Zambia, indeed, earmarks some of this tax specifically for government development programmes – helping to fund Zambia’s own fight against poverty. Some developing countries have started to renegotiate or even cancel loophole-ridden tax treaties where they are suffering ‘treaty shopping’ abuse: Indonesia cancelled its tax treaty with Mauritius for this reason, and Mongolia did the same with the Netherlands last December.
As our Zambian colleagues said in the press last week, we think Ireland should likewise offer Zambia a better tax deal, and close the loopholes in its 40-year-old tax treaty. Ironically, Zambia is one of Ireland’s nine ‘development partners’ and a major recipient of Irish overseas aid. Yet we estimate that since 2007 this single company’s transactions via Ireland may have deprived the Zambian government of revenues equivalent to one in every 14 Euros of Irish development aid to Zambia.
And while ABF have issued strong denials of profit-shifting, they’ve sadly been silent on the ‘treaty shopping’ that constitutes the majority of the tax avoidance identified in our report.
This isn’t just an important factual point. When Ireland, the UK and other OECD countries meet later this year to re-write the rules of corporate taxation, their agenda needs to look beyond profit-shifting and transfer pricing – the main target so far of public outrage over multinational tax avoidance. It needs to tackle a range of other tools in the tax avoidance toolbox too.
Individual countries, including Ireland, need to close loopholes in their outdated tax treaties. And the international standards governing the rights to tax cross-border income should close such loopholes everywhere, for good.