It is common knowledge that tax revenue is the most sustainable source of government funding. Unfortunately, data shows that most African countries have an extremely low tax to Gross Domestic Product (GDP) ratio. The tax to GDP ratio measures a country's tax revenue relative to the size of its economy.
According to the findings in the OECD's publication titled Revenue Statistics in Africa 2023, the unweighted average tax-to-GDP ratio of 33 African countries was 15.6% in 2021. In comparison, the average tax-to-GDP ratios in Asia and the Pacific, Latin America and the Caribbean, and the OECD were 19.8%, 21.7% and 34.1% in that order, during the same period.1
One may wonder why Africa's tax to GDP ratio is incredibly low when it has the highest average corporate tax rate among all continents at about 27%.2 What are the limiting factors? I have summarized the possible factors as follows:
- Negotiating international tax rules on equal footing.
Since 2016, African countries have been part of the Inclusive Framework on Base Erosion and Profit Shifting (BEPS). BEPS refers to tax planning strategies used by multinational enterprises (MNEs) to take advantage of gaps and mismatches in tax rules in two or more jurisdictions to avoid paying tax. According to the OECD, BEPS costs countries a whooping $240 billion annually. The more recent proposals on Pillar One and Pillar Two under BEPS 2.0 (Addressing the tax challenges of digital economy) makes one wonder whether the negotiations are on equal footing.
The conditions for triggering payment of additional tax under the proposed solutions are skewed in favour of the developed countries. For example, the Income Inclusion Rule (IIR) under Pillar Two imposes a top-up tax on a parent entity in respect of the low-taxed income of a constituent entity (majorly in Africa and other developing countries) if it meets the revenue threshold of EUR750 million. The IIR will be applied mostly by developed countries because only a handful of African headquartered MNEs have operations in developed economies.
On the other side, the rule on the re-allocation of residual profits (Amount A) of MNEs to market jurisdictions, mostly developing countries is hinged on an MNE having turnover of EUR20 billion (27 times of the initial proposal of EUR 750 million) and profit before tax above 10%. In addition, a market jurisdiction will only be eligible to tax Amount A if the in-scope MNE derives more than €1 million in revenues from that jurisdiction or €250,000 if that jurisdiction's GDP is lower than €40 billion.
This beacons a question. Is Africa really gaining more than it is losing in its collaboration with the OECD on international tax policy reforms?
- Are tax incentives still a relevant option?
It is a concern whether tax incentives are still relevant in attracting foreign direct investments into any jurisdiction including Africa. Investors are more likely to be interested in the stability of the economy, the strength of the judicial system and the ease of doing business in considering investment destination.
Tax incentives negatively impact the tax to GDP ratio. Moreso, the incentives offered to constituent entities of MNEs in the form of tax holidays, excessive tax allowances and deductions will be eroded under the IIR rule mentioned above. Africa needs to reconsider who benefits from tax incentives. It may still be possible that tax incentives can be applied in a way that the effective tax rate does not trigger the IIR rule.
- Deployment of artificial intelligence (AI) in tax administration
AI is changing every business and organisation and the tax authorities in Africa should not be left behind. AI can be deployed for risk assessment and selection of taxpayers for audit and investigation. It can also be used in analyzing broader and larger amounts of data, thereby saving time and resources that could be deployed to bringing more companies into the tax net. As tax administrations invest in AI, they should prioritize AI governance, risk, and compliance to give taxpayers a high level of comfort that their data will not be compromised.
- One African voice through the African Tax Administration Forum at the BEPS Inclusive Framework
Majority of African countries signed up to the BEPS 2.0 Pillar 1 and Pillar 2 solution even though bulk of the $240 billion is due to the developed countries. Nigeria, for example, refused to agree to Amount A in Pillar One due to the negative impact some of the provisions will have on her sovereign right to impose tax on income sourced within its jurisdiction.
Presently, the Multilateral Instrument for BEPS 2.0 requires all countries to remove all digital sales tax and other similar unilateral measure. By implication, MNEs operating remotely will be out of scope and no new measure can be introduced to bring such MNEs into the tax net in source countries. The only justification one can think of is that the solutions will have very limited impact on a considerable number of African countries. This notwithstanding, tax authorities in Africa should have a common position. This will increase their negotiation power at the comity of nations.
Concluding remarks
Tax revenue is critical to achieving sustainable economic development and societal well-being. Therefore, addressing the limiting factors is imperative for unleashing Africa's potential and ensuring Africa is not left behind in attaining the UN sustainable development goals, agenda 2030.
MNEs should keep themselves abreast of all the developments around BEPS 2.0 and how it would impact them when the rules come into force. For MNEs with tax presence in Nigeria for example, the unilateral measure to tax digital economy (Significant Economic Presence Order, 2020) will continue to be in force.
On a final note, as companies are embracing AI and other innovative technologies, tax authorities need to keep up with the pace to remain resilient.
Footnotes
1 OECD/AUC/ATAF (2023), Revenue Statistics in Africa 2023, OECD Publishing, Paris, https://doi.org/10.1787/15bc5bc6-en-fr
2 https://www.oecd.org/tax/tax-policy/corporate-tax-statistics-third-edition.pdf
The opinion expressed in this article is solely personal and does not represent the views of any organization or association to which the authors belong.