By Lauralyn Kaziboni
Tax avoidance and evasion and ultimately the tax regulatory framework influence the financial system and the financing of development.[1] Tax evasion, which can be illegal, occurs when an individual or company takes an action to reduce their tax bill. Tax compliance on the other hand refers to when an individual or a company complies with all tax laws of the jurisdiction in which they operate, avails all the information necessary for tax claims, and aims to pay the due tax amount at the right time and place. Somewhere in between lies tax avoidance, which occurs when companies and individuals are willing 1) to pay less tax than stipulated by the tax laws; 2) to pay tax in other countries other than where the profit was earned; and 3) to pay tax at a later time period than when the profit was earned.[2] Unlike some forms of tax evasion, tax avoidance is considered legal. The legality of tax avoidance is substantiated by the fact that there is no global tax law and the complexity of sovereign country tax legislation leaves room for arbitrage in the form of so-called “tax havens”.[3]
Tax haven refers to jurisdictions where the tax legislation assists nonresident companies and individuals to avoid regulatory obligations in their home countries.[4] Interestingly, tax havens explicitly design their tax regimes to attract companies to invest, largely because these countries lack the scale and human capacity to compete on a global scale. This, of course, often occurs at the expense of the country where the tax revenue is ‘supposed’ to be paid.
Tax havens are increasingly influencing the direction of investments and revenue flows. Some of the well-known examples include Switzerland, The Bahamas, Cayman Islands, Channel Islands, Isle of Man, Netherlands and Mauritius.[5]
Mauritius is an interesting African case study. An increasing volume of investment into Africa and other emerging markets is being channeled through Mauritius. The country is viewed as an attractive destination for corporations and private equity funds. Between 2004 and 2014, 38 private equity funds have been approved in Mauritius. The scale of investments channeled through Mauritian-based firms is startling. For instance, 30% to 40% of investments from different countries into India have come through Mauritius for tax reasons, including some from Indian firms.[6]
The private equity funds have been set up through Global Business Companies (GBCs). GBCs are companies that do business elsewhere but are incorporated into Mauritius, regulated under the country’s Financial Services Act 2007. The companies are then incorporated as 1) a company limited by shares, 2) a company limited by guarantee, 3) a company limited by shares and guarantee, 4) an unlimited liability company, or 5) a limited life company. Thereafter, the companies can be licensed as Category 1 (“GBC1”) or Category 2 (“GBC2”) companies. The significant differences between these categories are that GBC1s have access to double taxation agreements and they have a maximum corporate tax of 3% on net income. On the other hand GBC2s have no access to double taxation agreements and do not have to pay corporate tax.[7]
Tax havens, firm behaviour and market structure
Tax havens allow companies and individuals (especially multinational companies) to maximize profit through lower operational costs by evading their home country’s high tax rates. For instance, the total tax rates in Europe account for about 50% of profit, while for the past decade in Mauritius they average 26.3%.[8] These provisions have played a part in the establishment of over 28 000 GBCs and 600 global funds setting up in the country between 1992 and 2010.[9]
Multinational companies from China, India and Africa are also establishing regional headquarters in Mauritius in support of their African and Asian group operations through GBC1s. For example in Africa, ActionAid argued that SAB Miller and Illovo Group are avoiding tax payments by setting up in Mauritius.[10] It is evident that not only are millions of dollars being channeled away from home governments to multinational companies’ coffers; these firms are able to also gain competitive advantage over their (smaller, domestic) rivals.
Unfair competition in the area of tax may result in inefficient allocation of resources (mostly financial capital) and reduced competitiveness. The flow of funds into and through tax havens can distort the normal processes of cross-border competition. It can also have negative effects on the efficient allocation of resources.[11] In some ways tax benefits of this nature are similar to the assessment of special cost advantages in abuse of dominance cases wherein some firms benefit from special incentives and allowances, while others do not.
On the face of it, these arrangements seem to only benefit large multinational corporations. For instance, there has been a series of bank buyouts by multinational banks and funds ‘based’ in Mauritius. This can lead to consolidation which is conducive to collusion. This is enhanced by the high barriers to entry in banking, and multi-market contacts between major banking conglomerates. Recent experience in Europe has shown that the banking industry is certainly not immune to cartel conduct despite its apparent sophistication and what seems to be a high level of competition.
Investments made via tax havens into Africa are also likely to have an impact on merger evaluations. For instance, a merger in which a shelf company or equity fund incorporated in Mauritius seeks to acquire a domestic firm in another African country is unlikely to be prohibited if that shelf company is shown not to have been involved in that line of business in that country before. This requires the authority to disentangle the web of partial ownerships and subsidiaries that the acquirer may have in other companies in order to assess whether there is in fact an overlap in the activities of the merging parties. In most cases the merger will be approved without accounting for the fact that the transaction may also be approved in another market within the region and the effects this will have on cross-border competition and trade. For instance, a firm that acquires two subsidiaries in the same line of business in two adjacent countries will not have the incentive to have those firms continue to compete across borders with each other. This is where regional competition authorities can add significant value.
Akin to the creeping merger phenomenon, a single acquisition by a large international bank or fund might not make much of a difference in a market in the short term, however, over time this could lead to highly concentrated and uncompetitive markets in the region.
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Notes
1. Cobham, A. (2005). ‘Tax Evasion, Tax Avoidance and Development Finance’ in Queen Elizabeth House Working Paper No. 129.
2. See note 1.
3. Gravelle, J. G. (2009). ‘Tax Havens: International Tax Avoidance and Evasion’ in National Tax Journal, 727-753.
4. Henn, M. (2013). Tax Havens and the Taxation of Transnational Corporations. International Policy Analysis.
5. See note 4.
6. See note 4.
7. Conyers Dill and Pearman. (2013). Mauritius Global Business Companies Publication.
8. World Bank Total Tax Indicator. Total tax rate measures the amount of taxes and mandatory contributions payable by businesses after accounting for allowable deductions and exemptions as a share of commercial profits. Taxes withheld (such as personal income tax) or collected and remitted to tax authorities (such as value added taxes, sales taxes or goods and service taxes) are excluded.
9. HSBC Bank (Mauritius) Limited and Kemp Chatteris Deloitte. (2010). Mauritius: A Guide to Global Business.
10. Lewis, M. (2013). ‘Sweet Nothings: The human cost of a British sugar giant avoiding taxes in southern Africa’. ActionAid.
11. Eden, L., and Kudrle, R. T. (2005). Tax Havens: Renegade States in the International Tax Regime? in Law and Policy, 27(1):100-127.