Analysis: Can we beat tax avoiding multinationals?
On October 8th, finance ministers from the G20 countries met in Lima, Peru to sign off on a new set of measures to combat tax avoidance by multinational companies.
The meeting came at the end of a two year process led by the OECD, the Organisation for Economic Cooperation and Development.
Back in 2013, world leaders battling with austerity came under increasing public pressure to do something about tax avoidance after a number of corporate tax avoidance scandals had hit the press.
Those scandals mostly followed a common theme. Companies such as Apple, Google and Starbucks set up companies in tax havens like Bermuda, Luxembourg and Switzerland. Offshore companies would then charge the operating company in a place like the UK for management services, loans, royalty fees, intellectual property rights and other such fees.
"Costs" would eliminate any profit in the countries where the real money is made, and in doing so eliminate the liability that company had to pay corporation tax. Instead, profit would end up in tax havens. The practice is called ‘profit shifting’ and is precisely the kind of process the OECD was mandated to take on.
Pretending there are no multinationals
To fight this kind of tax avoidance, tax authorities have employed the arm's length principle. What this means is that for tax purposes governments look at trades between related companies as if they were two independent parties. If the prices paid between the related parties were higher than the company would normally pay from an external provider tax authorities could add those costs back into the company’s pre-tax profits. This is supposed to stop companies overcharging their subsidiaries in order to take profit out of them.
You don't need to be a tax expert to see the immediate problems with this approach. The idea of a fair price is highly subjective, particularly when you are dealing with highly specialised services, or intangible assets that aren't usually traded.
What is a fair price for use of the Starbucks brand? 3% or revenues? 5% of revenues? A difference of a couple of percent equates to millions in profits and lost tax revenue.
In addition multinationals can set up hundreds of paper companies around the world that do nothing but shift money between themselves, making the work of tax authorities fiendishly difficult.
The complexity of these rules is why many multinationals invest millions in an army of tax lawyers and consultants. These transfer pricing specialists work out the optimum prices that will allow the company to satisfy tax rules, not the economic price of the goods and services for the company.
MTN and the Mauritian Billions
A new investigation by Finance Uncovered and amaBhungane demonstrates precisely the problems that tax authorities have in dealing with transfer pricing and profit shifting.
MTN is Africa’s largest mobile phone company. A staggering one in four mobile phones on the entire continent are on the MTN network and the company reported revenues of $12.43bn in 2014.
Journalists working in South Africa, Ghana, Nigeria and Uganda found the company moving large amounts of cash from the company’s operating companies to companies MTN had set up in Dubai and Mauritius. This included $562m in payments from MTN’s Nigerian operation between 2010 and 2013, in Ghana the company’s payments amounted to more than 9% of the company’s revenues.
Although MTN did employ staff in Dubai the reporting team found that most of the money went to a company called MTN International in Mauritius. These payments were supposed to be for management and technical services, but MTN employs no staff in Mauritius, MTN I is little more than a postbox.
MTN told reporters that MTN International remunerates companies in South Africa for management services performed on behalf of the company. They were unable to answer why the payments were made to Mauritius first.
Company documents published by MTN said that money in MTN Mauritius was used to repay external debts of the MTN group and dividends, rather than pay for management services.
After further questions were put to MTN, the company was forced to admit that not all of the revenue was passed onto South Africa. The company refused to disclose how much it kept in Mauritius.
For tax inspectors looking at transfer pricing the payments to MTN Mauritius should be a slam dunk. No independent company operating in the real world would buy in ‘management services’ from a company with no managers. And African tax authorities are not blind to the issue.
In 2011 the Ugandan tax authorities investigated a number of questionable payments being made by MTN in Uganda, the management fees paid to Mauritius were one of the them. A letter from the tax authorities to MTN seen by finance uncovered said:
“There is no proof of the relevance of the fees charged to MTN Uganda for the need that MTN Uganda had for those services... In an arm’s length situation, a company that has the skills and competence to carry out a particular activity does not go to a third party to source those services just because the third party is running the business of carrying out such activities.”
Uganda slapped the company with a tax bill of $69m. To put that in perspective, the amount represents the equivalent of around 20% of the Ugandan government health budget at the time.
However, four years later, the case has still not been resolved. MTN and the Ugandan Authorities are fighting over the payments in court.
Whereas MTN Mauritius may not have any employees, MTN Dubai presents a different problem. Although the company does not have a cell phone network in the United Arab Emirates, it does employ 115 staff which the company says are involved in company procurement, legal services, HR and other shared company services.
The revenues charged by MTN Dubai make it a very profitable part of the company. We calculated that on the basis of the fees paid from just Ghana and Nigeria each person at MTN I accounted for Rand 13.4-million ($1.6m) in revenue.
Bear in mind that the fees come from just two of MTN’s many subsidiary companies and MTN has confirmed that all the management fees collected from its operations outside South Africa and Swaziland are routed either through Mauritius or Dubai, so the figure is likely to be larger.
If we compare this to the average revenue per employee in other countries, we see that employees in Dubai generate substantially more income than in the rest of the company — other than in Nigeria.
In South Africa the company generates R5.5-million ($0.66m) per worker; in Côte d’Ivoire R6.3-million ($0.76m); R5.7-million ($0.68m) in Ghana; and R3.4-million ($0.41) in Uganda. In Nigeria the company generates R14-million ($1.62m) per employee, showing just how profitable the operation is there.
The difference between Nigeria and Dubai is that the Dubai operation is internal to MTN. It only sells its services to other MTN companies, whereas Nigeria receives money from its customers.
Of course, as MTN does not operate any phones in Dubai, it will also have significantly lower costs than other MTN companies. It does not need to pay for shops or the infrastructure needed to run a mobile network.
The picture is of a substantial amount of value being shifted from countries where MTN operates to Dubai, an emirate where the company enjoys a 0% tax rate.
There is no suggestion that MTN is doing anything unlawful with its Dubai operation. The high revenues the company books in Dubai may be a consequence of the company moving highly valued services there. It does not necessarily mean that MTN Dubai is overpricing its services to the rest of the group.
However, the fact that the company has chosen to locate its shared services in Dubai highlights the difficulties revenue authorities have in taxing multinationals, which can easily move operations around the world, playing different countries off against each other. The issue becomes even more difficult when companies base these operations in secrecy jurisdictions.
If authorities in Uganda are struggling to win a transfer pricing case involving a post box in Mauritius, what chance do they have unpicking a substantive operation like MTN Dubai?
OECD to the rescue?
Unfortunately the OECD proposals are unlikely to bring these practices to an end, and could even make the whole process even less transparent.
The OECD has embraced the arm’s-length concept and many of the solutions it proposes are simply aimed at giving tax authorities more and better tools to use in their transfer pricing investigations. There will be better access to comparable data to determine prices, bigger books of guidance for tax authorities, but in the end tax authorities will continue to need to rely on complex investigations and highly subjective analysis of the complicated internal structures of multi-national companies.
Conscious that the combination of better tooled revenue authorities, relying on subjective rulings, driven by political pressure to combat tax avoidance, corporations saw the potential of the OECD rules to increase conflict. Their solution, embraced by the OECD was to have mandatory dispute resolutions between multinationals and tax authorities.
The result of this is that in future disputes about tax of the kind currently underway between Uganda and MTN could be resolved in a private and unaccountable international tribunal in secret. The BEPS proposals could end up being the TTIP of the tax world.
The arm's length principle may make sense conceptually but is irrelevant to the reality of the modern multinational. The solution being proposed by people like the Independent Commission on the Reform of the International Corporation Tax is simple. Treat multinational companies as if they were one company (which in reality they are) rather than a series of hundreds of separate companies spread across the world (which in reality they are not).
This kind of approach would see the profits of multinationals attributed to where the economic activity of that multinational actually happens. There are a number of ways of achieving that goal, but whichever is favoured the purpose should be to cut out the tax havens from the business of multinationals.
But change will only come with public pressure. It is important that the public see the OECD process as the beginning of the road rather than the end of a journey. We will need more investigations exposing how multinationals use the international system to avoid tax like that undertaken by Finance Uncovered to continue the pressure on organisations like the G20 to do better than treating taxation at arms length.
Photo credit, the OECD via Flicker using a Creative Commons Licence