How detecting and deterring “transfer mispricing” in Zambia’s billion dollar mining sector can boost government coffers in a time of fiscal crisis.
This post was co-authored by Eneya Maseko, Program Coordinator for Extractive Industries for Oxfam in Zambia.
Corporate tax dodging is not a victimless act. When corporations employ aggressive means to avoid paying tax in developing countries, citizens inevitably foot the bill. Corporate tax avoidance deprives governments of desperately needed tax income for the provision of public goods and services forcing governments to choose between cutting public services or collecting additional tax from citizens. So, while companies report eight and nine figure profits, citizens face eroding hospitals and schools and struggle to pay higher prices for basic goods. However, when companies do this while in the process of extracting a high value, exhaustible commodity from beneath citizens’ feet, the offense is all the more egregious.
According to the Mbeki High Level Panel on Illicit Financial Flows, multinational tax avoidance in the oil and mining sectors across Africa is rampant. In countries like Zambia, where extractive industries contribute a significant portion of the country’s overall revenues, preventing aggressive tax avoidance is all the more critical for reducing inequality. This is especially true now in the context of Zambia’s fiscal crisis as the country turns to the IMF and capital markets for fiscal support.
According to a report by the Natural Resource Governance Institute, the mining sector in Zambia accounts for nearly 80 percent of all exports, contributes 12 percent of the country’s GDP and 30 percent of its tax revenue. Despite such positive statistics, ample evidence suggests that the Zambian government also loses a significant amount of mining sector revenue due to tax avoidance by multinational companies operating there as well as lax government regulations and enforcement. It doesn’t have to be this way. Governments are not powerless and can enact strong regulations to help prevent corporate tax avoidance. The situation in Zambia shows how relatively concrete actions taken by government could make a big difference.
Reforms necessary to address avoidance
One central tax avoidance tactic used in the Zambian context is transfer mispricing. Transfer mispricing involves the manipulation of prices used in a sale between two associated companies that serves to artificially shift profits out of a given country to reduce taxes owed. For instance, a subsidiary of a multinational mining company operating in Zambia could sell copper to an affiliated company in Switzerland at an artificially low price in order to minimize its income tax liability in Zambia and transfer the income to Switzerland, thus misrepresenting the true value of the minerals sold and depriving the Zambian government of tax revenue due.
The central challenge for regulators, tax authorities, and oversight institutions is to determine whether transfer mispricing has, in fact, occurred. The example above illustrates one basic challenge for regulators: to determine whether the price at which the mineral or another good was sold or a service rendered between related corporate entities was done at a fair market price.
In order to do this, tax authorities must be able to assess the validity of the transactions by comparing a transaction between two associated entities with other similar market transactions. For tax authority officials in Zambia to undertake this type of comparable analysis, tax authorities and oversight bodies must have the necessary information regarding all controlled transactions between Zambian-based mining companies and their associated entities. Without this basic information, the Zambia Revenue Authority is unable to monitor risky transactions and identify potential transfer mispricing.
Governments around the world commonly require transfer pricing documentation from companies so they must maintain, if not regularly submit, timely and accurate information about their related party transactions. However, there is currently no legal requirement in Zambia for the maintenance of transfer pricing documentation. This oversight is a significant obstacle to tackling transfer mispricing since government officials do not have the basic information they need to monitor and evaluate related party transactions.
Furthermore, Zambia’s Income Tax Act, which could be used to regulate transfer pricing losses, currently mandates that mineral prices used in transactions between related entities be based on a reference price from an international exchange market. Unfortunately, the law also allows companies to make adjustments to the price used in transactions to account for specific details that may affect the price downward, such as ore quality. While this is a reasonable allowance, it does pose risk for abuse. This allowance increases the regulatory burden for the government, as it must also be able to evaluate the complex mineral valuation formulas used by companies to underpin the prices used in transactions.
In order to verify the valuation used by companies, the Government of Zambia must independently assess mineral quality. Mineral valuation responsibilities, including the monitoring of mineral exports, are shared between the Ministry of Mines and the Zambia Revenue Authority, along with other agencies all part of an initiative called the Mineral Value Chain Monitoring Project. While agencies are coordinating their work through the initiative, the protocol for mineral valuation procedures between agencies and the agency with ultimate jurisdiction over the matter is still unclear.
Progress made while key gaps remain
Recognizing these challenges and the need to increase revenue collection from the mining sector, the Government of Zambia has recently expanded efforts to improve mining oversight and prevent transfer mispricing. For instance, the government revised the Income Tax Act, strengthening Section 97 which sets out general transfer pricing guidelines and establishes the use of the arms-length standard as the basis for pricing all transactions between associated entities.
Such efforts are in line with ongoing efforts by Oxfam Zambia and partners including the Zambia Tax Platform to strengthen revenue generation, tax policy and payment transparency in the country’s mining industry.
Oxfam welcomes the efforts of the Zambian government to protect the mining tax base by improving its legal and regulatory capacity to address transfer mispricing in the mining sector. Additionally, the government of Zambia must build on its existing practice, and require transfer pricing documentation in the forthcoming regulations (“statutory instruments”) to the Income Tax Act. The regulations for the Income Tax Act should also include clear protocols for coordination between government agencies for the independent valuation of minerals.
While the regulations have stalled for some time, it is important that they are passed without further delay so as to provide a strong basis for regulating transfer pricing in Zambia’s mining sector.
With these changes, Zambia will have a better chance of capturing much needed tax revenue from corporate tax payers, preventing the need to make regressive policy choices that hurt Zambians.