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Revenues for mining, Tax avoidance, Evasion and Incentives

February 23, 2021 / Ignatius Kamwanje

Malawi has abundant natural resources as one of the extractives and yet gains little tax revenue from the extraction of its resources, leading to lost opportunities to invest in public services such as education and health which are essential in tackling poverty. Multinationals/Privately owned companies are always caught up dodging in paying their fair share of taxes to host governments. In Malawi, there might be a considerable calculated amount that is avoided by mining companies only that it is not exposed. Prominent companies that were/have been in the playing field are exploration companies who do not owe much to the government because they are not yet into mining, the Kayelekera Uranium Mine(KUM) now under Lotus Resources, Cement and Coal companies just to mention at the moment. There have been complex reporting by OXFAM on details of tax avoidance including mispricing/dodging, production sharing agreements of oil/gas blocks. The report also describes other ways in which Malawi loses out on tax revenue, including illegal tax evasion by companies. One aspect of tax avoidance is the lack of access by government officials to information on company operations, production and pricing.

Combating tax dodging strategies will require adequate government capacity and expertise which currently does not exist in Malawi. With such developments, so many billions of kwachas are lost where if it was realized by the government, money could be spent on essential public services such as health and education. There is a heavy public outcry from civil society over lost tax revenues in Malawi and the nation hasn’t seen any action by the government to address how mining companies in particular avoid tax. There is need to reform the tax system although there can be resistance from mining corporations. An example is Zambia where when there was an attempt to introduce reforms in tax systems in mining, multinational companies threatened to cut thousands of jobs and billions of dollars of investment. The IMF also expressed concern over the impact of the measures and the impact of lower global commodity prices on government revenues. This pressure had an effect and the government rolled back on the proposed new measures.

Malawi is earning very little from mining and one of the contributing factors is the proliferation of illegal gold mining. During the SONA (State of Nation Address) by the State President Dr Lazarus Chakwera made during the official opening of the budget meeting of the National Assembly in 2020, it was alleged that about 85 million US dollars is lost by smuggling/exporting gold that finds its way to points of sale to the Middle East annually and this drew mixed reactions from stakeholders in the mining sector. In other countries, a string of NGO, media and academic reports in recent years have highlighted how mining companies, while producing a large amount of minerals, have been paying few taxes to the government.

1. Corporate tax avoidance

There are various reasons why mining companies pay lower taxes than they should, but one major reason is corporate tax avoidance. In most African countries the mining industry is identified as the biggest culprit in tax avoidance. The reason is that most of the mines for one reason or another always claim that they are making losses. Most of it is due to transfer pricing or tax avoidance. It is therefore very important for countries to develop laws that will criminalize false reporting. Mining companies avoid paying tax by means of two methods. One is through transfer pricing – the widespread practice whereby parts of the same company trade with each other at artificial prices determined by themselves, to minimize taxes. The other is that some parent companies lend money to subsidiaries at interest rates higher than market rates, in order to inflate costs and reduce taxable income. This in essence makes companies to be presented with a variety of ways to avoid paying tax, including over-reporting of costs and under-reporting of production.

2. Tax evasion

The big global mining companies are robbing the opportunities for the countries to advance. In addition to legal methods of tax avoidance, countries lose more revenues from illegal tax evasion. US-based organization Global Financial Integrity, which has pioneered recent research into illicit financial flows, estimates that some billions of US dollars from other countries must have left from the proceeds of crime, corruption and tax evasion. If this money were taxed at the prevailing corporate tax rate, it would increase the countries revenues. Some illicit outflows is attributed to trade misinvoicing, a process that deliberately misreports the value of a commercial transaction on an invoice submitted to customs. This form of trade based money laundering is the largest component of illicit financial outflows measured by Global Financial Integrity and is sometimes facilitated by global tax havens.

3. Tax incentives

Tax incentives given by the government to companies, especially in the mining sector, are another cause of lost revenues. Government offers a bunch of tax incentives to domestic and foreign companies. For example in other African countries companies investing over a certain amount pay no taxes on profits for the first five years, along with no import duties on raw materials, capital goods, machinery including dump trucks and specialized motor vehicles. Mining companies are entitled to 100% capital reductions on mining equipment and preproduction capital expenditure, the ability to carry forward losses and offset them against tax, and a rebate on import duties for certain mining equipment. In addition, all companies investing over certain million US dollars are entitled to negotiation with the government for additional incentives, thus all mining companies are given special tax deals. This is a major reason why many mining companies consistently declare tax losses. Malawi signed one of the funniest deals for a 10 year tax holiday with Paladin Africa Ltd, a company that held the Kayelekera Uranium Mine and yet production was run for less than 10 years until it was placed under “Care and Maintenance’

4. Key tax avoidance strategies

Companies seeking to avoid paying tax can use a number of different strategies. The key is for the government authorities to stop them doing so. Officials face problems with four key tax avoidance strategies.

(a) Transfer pricing abuse

In light of the fact that the global mining industry is dominated by multinational companies trading between different operating units in different countries, companies can reduce their overall tax payments by selling goods and services from an operating unit in a low tax jurisdiction to one in a higher tax jurisdiction at a relatively high price, transferring income away from the high tax jurisdiction.

 (b) Under-reporting production values

Mining companies report to the tax authority that their production is less than the market value. In such situations, they can under-report the volume of production or the grade of the mineral. A problem for the government is to check the quality and content of all production line which requires an understanding of the geology of the area being mined and the processing technology employed which requires close cooperation between the mine and the tax authority in providing sustainable checks and balances. This process becomes complicated by the often complex value chain involved in large-scale  mining like copper, where some refining and/or smelting is often carried out by separate or associated companies and elements of the potential tax base can be transferred.

(c) Interest payments on debt

 Involves deductions from profits when determining taxable income. This creates an incentive for a company to lend funds to a subsidiary at a high interest rate in order to reduce the subsidiary’s taxable profits.

(d) Purchase of derivative contracts

Mining companies that face volatile prices of their product, can guarantee a specific price for their output in the future. This acts as an insurance against a fall in the price of the commodity. It becomes a legitimate business activity but can also be used to shift income out of high tax jurisdictions. In this case, firms can deliberately trade in order to lose money in a subsidiary facing a high tax rate and to gain in another subsidiary facing a lower tax rate.

To combat these policies, it requires adequate government capacity, which in most cases does not exist. The trickiest part is that no one, except the mining companies themselves, knows what the costs of production really are and that it is not possible to determine how much return the mining companies make. Furthermore, excessive lack of resources and efforts by mining companies to hide data and manage perceptions leaves most states with virtually no information on the operations or production of the mining companies. Greater capacity and expertise is needed not only to monitor the mines’ production and accounts but also to propose different tax designs during the course of negotiations with companies. Ofcourse in other countries there may be support from donors/lenders to increase tax capacity in a form of cooperative programmes. It is on record that this also happened between the IMF, the Norwegian government and the Zambia Revenue Authority at one time.

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