Judge Davis wants further probe into profit shifting in SA
The tax committee head wants an investigation into the ‘significant leakage’ that is robbing the fiscus of at least R7bn a year
Head of the now-terminated Davis Tax Committee, Judge Dennis Davis, believes further investigation is required into base erosion and profit shifting, which is estimated to be robbing the fiscus of at least R7bn annually.
Davis said in an interview with Business Day on Thursday that he would be speaking to finance minister Tito Mboweni about whether further work should be undertaken into what is being done by both multinationals and SA-owned companies to shift their profits offshore in order to avoid SA’s higher corporate tax rate.
At 28%, SA’s corporate tax rate is four percentage points above the world average.
The judge said recent studies had shown that profit shifting by multinationals alone was a “significant leakage” in the system.
With the Treasury having no further room to manoeuvre in raising taxes in the current context of low economic growth, other sources of revenue had to be found, he said. One way would be to clamp down on profit shifting.
Davis said one mechanism for shifting profits out of the country through transfer pricing is for a company to house its intellectual property in a tax haven and charge its SA subsidiary a royalty for its use at an inflated price. The cost would qualify as a tax deduction on the SA subsidiary’s profits.
Another way would be to charge significant amounts for input costs to the SA subsidiary.
Davis said a study is needed of not only of what other tax authorities internationally are doing to curb base erosion and profit shifting but also into how SA-owned companies are using it with their offshore subsidiaries. The R7bn estimate could be low when this is taken into account as well.
While the Davis Tax Committee did do some work on base erosion and profit shifting, Davis said its work was hobbled by former SA Revenue Service (Sars) commissioner Tom Moyane, who refused to give the committee access to the information it required to do its work.
Moyane was also responsible for dismantling the dedicated and highly skilled transfer pricing unit within Sars, which Davis says needs to be reconstituted as soon as possible, preferably with the same expert individuals who left Sars during Moyane’s disastrous reorganisation of the tax authority, which led to a drastic decline in enforcement.
It is essential to determine in the most expeditious way possible how to fix the haemorrhaging that had taken place in the tax system over the last few years, Davis stressed.
The judge’s comments come in the wake of two research papers on corporate tax avoidance in SA, reported on by the Financial Mail last week, which found that the authorities had grossly underestimated the scale of unlawful profit shifting out of the country. This was conservatively estimated at R7bn a year in foregone taxes, with large multinationals among the biggest culprits.
The research was conducted by University of Copenhagen doctoral fellow Ludvig Wier as part of a new research programme SA-Tied, which is a tie-up of the Treasury and other economic cluster ministries with several international research institutions.
In the first tax paper, “Big and Unprofitable”, Wier and the Treasury’s Hayley Reynolds estimate that on average businesses with parent companies located in tax havens avoid taxation on as much as 80% of their true income by understating it in SA. In SA’s case, the authors estimated that a combination of high profits and more aggressive profit-shifting results in the top 10% of foreign-owned firms accounting for 98% of the total estimated tax loss.
Wier conservatively estimated that Sars was being short-changed by about R7bn a year due to profit shifting. This is equal to about 4% of total current corporate income tax receipts.
Mining companies were the worst offenders, accounting for almost 30% of profit shifting, followed by financial services firms, accounting for 19%.