Illicit financial flows (IFFs) have increasingly become a critical issue in the global economy, with multinational companies (MNCs) playing a significant role through aggressive tax avoidance schemes. These schemes involve complex strategies that exploit legal loopholes and inconsistencies between tax systems of different countries to shift profits and minimize tax liabilities.
By utilizing methods such as trade mis invoicing, Double Taxation Agreements (DTAs), money laundering, transfer pricing, treaty shopping, profit shifting to low-tax jurisdictions, use of offshore tax havens, these corporations manage to reduce their tax obligations substantially.
Tax avoidance by multinational corporations has been on top of the international tax policy agenda since the global financial crisis. The tight fiscal constraints in the aftermath of the crisis amplified long-standing concerns in many countries that large MNCs pay very low effective tax rates.
According to the World Bank, tax avoidance is widespread among the world’s wealthiest individuals and corporations. They seek out jurisdictions with minimal or no taxes on personal or corporate income, dividends, and capital or research and development expenditures, and establish their business activities there for tax purposes. Although this practice is legal, public pressure has grown on governments to close the loopholes in the international tax system that enable these strategies.
This practice not only deprives governments of crucial revenue needed for public services and development but also undermines the fairness of the global tax system, exacerbating economic inequalities and contributing to the financial instability of many nations.
Estimates in the 2019 World Bank’s World Development Report suggest that “multinationals shift 40-50 percent of their profits to jurisdictions with low or no taxes. Governments worldwide are deprived of billions in revenue, particularly in the largest markets.”
Within the international tax framework, MNCs can use a wide array of techniques to shift profits between entities in the group to minimize their overall corporate tax liability. These techniques can be entirely legal, in which case they are referred to as tax avoidance—as opposed to tax evasion, which is illegal.
Examining Double Taxation Agreements (DTAs) reveals how these arrangements deprive Uganda of a fair share of revenue from its resources.
Uganda, like many other developing nations with limited bargaining power, has faced significant adverse effects from DTAs.
Double Taxation Agreements are treaties between two countries that determine tax rights over international transactions. These agreements do not impose new taxes but regulate which country can tax the same income.
Developing nations typically enter into DTAs with wealthier countries to attract foreign investment and multinational corporations.
However, due to significant disparities in negotiating power and expertise, and the complexity of these treaties, developing countries often relinquish vital taxation rights, leading to substantial revenue losses over time.
To prevent double taxation, DTAs usually restrict a country’s ability to tax cross-border transactions, particularly affecting the source country, where the economic activity occurs.
DTAs often limit or eliminate the source country’s ability to impose withholding taxes on cross-border payments like dividends, interest, royalties, and technical fees.
Consequently, MNCs can shift profits out of developing countries, resulting in minimal or no tax payments.
Uganda has established Double Taxation Agreements (DTAs) with several countries, notably Mauritius and the Netherlands, which are the most commonly referenced. Additional agreements are in place with Italy, Denmark, India, Norway, South Africa, the United Kingdom, and Zambia.
A foreign corporation conducting business in Uganda is governed by the Income Tax Act, which subjects it to the standard corporate income tax. Additionally, if the foreign corporation operates through a branch, it must pay an extra tax on profits repatriated to its country of origin or incorporation.
The Income Tax Act mandates a withholding tax of 15% on all payments to non-resident individuals or entities deriving dividends, interest, royalties, rent, natural resource payments, or management charges from Ugandan sources. The payer withholds 15% of the gross amount before remittance.
To circumvent paying taxes in Uganda, many multinational companies first establish branches in one of the countries with which Uganda has a DTA. This strategy allows them to benefit from reduced tax liabilities due to the provisions of these agreements.
Among the various Double Taxation Agreements (DTAs) Uganda has, the Uganda-Mauritius DTA stands out as one of the most frequently utilized.
To ensure that a taxpayer’s income is taxed only once, Uganda and Mauritius entered into this agreement, known as the “Convention between the Republic of Mauritius and the Government of the Republic of Uganda.” This agreement aims to avoid double taxation and prevent fiscal evasion regarding income taxes.
Under this DTA, a multinational company from any country looking to invest in Uganda often first registers and incorporates in Mauritius. After establishing its presence in Mauritius, the company then proceeds to register in Uganda.
This practice raises the pertinent question: why do these multinational companies choose to register in Mauritius first instead of directly registering in Uganda? The answer lies in the tax benefits provided by the DTA, which often result in reduced tax liabilities for companies operating between the two countries.
Below is How Multinational Companies Avoid Taxes Through DTAs
In December 2017, the High Court issued a high-profile judgment in the case of White Sapphire Limited and Crane Bank versus the Uganda Revenue Authority (URA).
This case brings new insights into when a taxpayer can apply a reduced tax rate under a Double Taxation Agreement, especially regarding the limitation on benefits provision in Section 88(5) of Uganda’s Income Tax Act.
In March 2014, Crane Bank Limited, a Ugandan resident company and licensed bank, paid a dividend of 11.2 billion shillings to its largest shareholder, White Sapphire Limited, a company incorporated in Mauritius.
White Sapphire Limited was wholly owned by an individual residing in Kenya.
Crane Bank withheld tax on the dividend at a reduced rate of 10% as per Article 10 of the Uganda-Mauritius Double Taxation Agreement.
However, the URA argued that White Sapphire Limited did not qualify for the reduced DTA tax rate, asserting that Crane Bank should have withheld tax at the standard rate of 15%. Consequently, the URA issued an assessment against Crane Bank for the additional 5% withholding tax, amounting to 559 million shillings.
Disagreeing with the URA’s interpretation, both White Sapphire Limited and Crane Bank filed a joint suit in the High Court to appeal the assessment.
The Court had to resolve two key issues: whether White Sapphire Limited was eligible for the reduced tax rate of 10% under Article 10 of the Double Taxation Agreement (DTA), and whether White Sapphire Limited was disqualified from this reduced rate due to Section 88(5) of Uganda’s Income Tax Act.
It’s important to note that Section 88(2) of the Income Tax Act stipulates that if the terms of an international agreement to which Uganda is a party conflict with the provisions of the Income Tax Act (excluding subsection 5 of Section 88, which addresses tax avoidance), the terms of the international agreement take precedence over the provisions of the Income Tax Act.
Ruling
The initial question was whether White Sapphire Limited could be considered a resident of Mauritius, thus qualifying to utilize the Double Taxation Agreement.
The Uganda Revenue Authority argued that because White Sapphire Limited was owned by a Kenyan entity, its effective management took place in Kenya. Consequently, the URA contended that the company did not qualify as a Mauritian resident.
However, the URA neither investigated nor provided evidence regarding the actual location of the company’s management. Instead, they assumed the management was based in Kenya due to the Kenyan shareholder’s location.
The Court rejected this argument and evaluated the question of residence according to the specific criteria outlined in Article 4 of the Double Taxation Agreement. This evaluation was further supported by the definition of a resident company in the Income Tax Act, which includes the place of incorporation as a key factor in determining residence.
Given the undisputed fact that White Sapphire Limited was incorporated in Mauritius, the Court concluded that the company was indeed a resident of Mauritius.
The Uganda Revenue Authority also argued that the Kenyan ownership indicated that White Sapphire Limited and Crane Bank were engaging in “Treaty Shopping,” thereby suggesting that the entire arrangement was a form of tax evasion.
The Court rejected this argument, emphasizing that the Double Taxation Agreement provided a clear and binding definition of residence. As such, the issue of Treaty Shopping was deemed irrelevant in determining the residency status of White Sapphire Limited.
Consequently, the first issue was resolved in favor of White Sapphire Limited. The Court affirmed that as a resident of Mauritius and the beneficial owner of the dividend, White Sapphire Limited was entitled to apply the 10% tax rate, rather than the 15% rate, as stipulated in Article 10 of the Double Taxation Agreement.
Treaty Shopping
Under Treaty Shopping, a multinational company intending to invest in a specific country will establish a branch in another country that has a Double Taxation Agreement (DTA) with the target country to minimize or avoid paying high taxes.
A good example is Heritage Oil, which was incorporated in the Bahamas. When it aimed to conduct oil exploration in Uganda, it first established and registered a branch in Mauritius due to the DTA between Mauritius and Uganda.
This would later lead to what many Ugandans came to refer to as the “PRESIDENTIAL HANDSHAKE.”
In 2011, Heritage Oil and Gas Limited filed a case with the Tax Appeals Tribunal against the Uganda Revenue Authority. The case challenged an income tax assessment of $404,925,000 levied by the URA following a sale and purchase agreement where Heritage sold its shares in a production sharing agreement and a joint operating agreement to Tullow Uganda Limited.
The agreed-upon facts of the case reveal that Heritage was initially incorporated in the Bahamas and subsequently registered as a tax resident in Mauritius in 2010.
On January 26, 2010, Heritage Oil entered into a sale and purchase agreement with Tullow, transferring its 50% interest to the latter.
On July 6, 2010, the Uganda Revenue Authority (URA) issued an income tax assessment of $404,925,000.
On July 26, 2010, Heritage executed an addendum to the sale and purchase agreement.
On August 18, 2010, Heritage objected to the assessment, and on November 12, 2010, URA made a decision regarding the objection.
Dissatisfied with the objection decision, Heritage filed this application.
One of the key issues was whether the sale of Heritage’s 50% interest to Tullow was taxable in Uganda.
Heritage argued that the sale of assets occurred outside Uganda, and therefore, the income could not be attributed to activities in Uganda since the relevant transactions in Uganda took place after the purchase price had been determined.
The Tribunal, after considering the evidence, ruled that although Heritage was incorporated in the Bahamas and later registered in Uganda, it did not qualify as a resident person under section 10 of the Income Tax Act.
Additionally, a witness testified that Heritage filed its tax returns in Mauritius, where it was registered by continuation on March 15, 2010, after the sale and purchase agreement had been signed. This indicated that Heritage was filing tax returns in Mauritius before its official registration there.
This situation illustrates that Heritage’s primary objective in registering in Mauritius, a country with a DTA with Uganda, was to avoid paying taxes in Uganda.
