Treasuries in Africa Mining Hubs Under Pressure

Note: this blog originally appeared as an op-ed in This is Africa on 6 July 2016

When the African Union’s members meet in Kigali, Rwanda, from 10 to 18 July, the dire state of their public finances will likely be a key topic.

The bust in mineral and oil prices has left many resource producers with budget shortfalls. The cuts in public spending that are likely to ensue threaten social spending and development plans. With USD 35bn worth of Eurobond debt maturing between 2021 and 2025, African mineral producers have only a few years to right the ship.

Data visualization by Giorgia Ceccinato for NRGI

As finance ministers weigh options to balance their budgets, they will want to ensure that taxpayers pay their due. But this is easier said than done. Tax administration in many countries is weak, and tax policies suboptimal.

This leaves governments vulnerable to maneuvering by multinational companies – in the mining sector in particular – whose complex corporate structures allow them to make the most of the many loopholes and peculiarities of the global tax system.

Mining structures

Subsidiaries of global mining companies in Africa mostly trade with companies with which they are affiliated. They sell mineral production to marketing centers, finance the development of a mine’s infrastructure, buy machinery or pay for legal and accounting services.

If miners did this business with unaffiliated companies, they would negotiate deals for goods and services at market prices. But because most of these transactions are between affiliated companies, deals take place at “transfer prices” set by tax accountants, legal experts and management controllers at the global level to maximize a multinational company’s profits.

This can run counter to the host country’s interests when the transacting affiliates undervalue sales or overvalue purchases to reduce the declared profits – and subsequent tax bill – of the local subsidiary.

As international attention has turned to the problem of tax base erosion, the OECD and the United Nations have developed rules and international agreements to prevent transfer mispricing. But how are these rules implemented in mineral-producing African countries?

To answer this question, we studied how Ghana, Guinea, Sierra Leone, Tanzania and Zambia have approached the problem. They face some major challenges.

First, when legislators draft international rules into national laws, they sometimes do not provide detailed specifications. This leads to uneven application and conflicts with taxpayers.

In Zambia, one mining company has exploited the lack of specification on the valuation of copper and cobalt exports sold to related parties to reduce its tax payments by as much as USD 74m.

Second, finance ministries and mining sector regulators often fail to coordinate. Different teams within these institutions and even within the tax administration would do well to share information and coordinate audits. This would help to build a comprehensive picture of transfer mispricing risks created by the mining industry.

In addition, there are capacity gaps that governments need to close. Even where resources are scarce, the case for investing in tax and transfer pricing experts who can capture tens of millions in fleeing tax revenue is undeniable.

Since its establishment in 2012, the international tax unit in Tanzania has generated approximately USD 110m in tax adjustments, with a budget of merely USD 130,000.

Another challenge is insufficient access to taxpayers information, originating both from taxpayers themselves and from authorities in foreign jurisdictions. Mineral rich developing countries face the additional challenge of assessing the quality and quantity of mineral exports.

Guinea and Sierra Leone, for instance, do not control the grade and humidity of the bauxite and iron ores shipped by mining companies to smelters in Europe, Russia, North America and China. This makes estimating value, and therefore taxes owed, difficult.

Amid these challenges, there are some promising developments.

In recent years, many civil society activists and engaged members of parliament have identified tax gaps as a major issue and lobbied for stronger rules. Such external oversight can help reinforce the political will to address transfer mispricing and reduce the influence of miners on governments.

International initiatives like the OECD’s work on base erosion and profit shifting are integrating developing country concerns with a landmark meeting seeking inputs from developing countries into international tax rules in Kyoto in late June.

Regional organizations such as the African Tax Administrations Forum provide both technical assistance to member countries and a platform to develop regional tools and approaches.

Some of these approaches are unorthodox, such as the move toward simplified tax rules that rely on publicly quoted mineral prices or set maximum deductibility ratios for a range of mining companies’ typical expenses.

However, creative solutions should be welcomed as mineral-rich African countries work to stop long standing practices that drain of public coffers and set back development.

Co-authored by Thomas Lassourd, senior economic analyst at the Natural Resource Governance Institute (NRGI).