How to deal with tax leakages in Double Taxation Agreements

Uganda Revenue Authority (URA), the country’s tax prefect, has raised a red flag over the abuse of the Double Taxation Agreement (DTA) after it has become obvious that the real benefits of the treaty are thoroughly being abused by multi-national companies and some wealthy individuals who shouldn’t be having difficulties paying their fair share of taxes.

Unlike previously, the tax collector (URA) now has no second thoughts regarding the damaging effects of DTAs, considering its ability to accentuate a growing risk of revenue losses to the country.

Uganda has DTAs with nearly a dozen countries, including Netherlands, a tax haven jurisdiction. Soon, China and United Arab Emirates (UAE) – who all accounts for a growing number of major investments in Uganda, will join the list.

Already, through the legally binding agreements, multinationals and wealthy individuals are taking undue advantage of the low tax rates provided for in the DTAs to avoid and evade paying their due taxes, all at the expense of domestic revenue generation efforts which URA has, for years, been trying to widen.

“DTA is a tax leakage point; and this concerns us a lot,” URA Commissioner General, Ms Doris Akol said last week in a sideline interview.
She continued: “This is because it (DTA) creates an avenue for people to take away income earned here and have it recognised as income earned in jurisdictions with low tax rates.”

Profit shifting
Then there is profit shifting. Here, what should technically be a profit that the corporation has made is characterised as another form of income that attract no taxes or pays very little revenue if at all. According to Ms Akol, this ‘immoral’ method is increasingly rearing its ugly head.

She said: “Recently, profits that should pay corporation tax are being characterised as intellectual property (IP). And this is because in many of the DTAs, intellectual property is paid to jurisdictions that own it (IP) and in many cases, its tax rate is low.”

All these, according to tax experts does not happen by default but by design, particularly after combing through the DTAs looking for any advantage to exploit to the fullest.

In case of a dispute, according to Ms Ruth Namirembe, a tax and legal expert, DTAs supersede the Income Tax Act, making it almost impossible for the likes of tax prefects to win back any tax rights given away by the treaty to another country.

The recent ruling of the High Court of Uganda on what constitutes a permanent establishment among other issues, further exemplifies the effects of DTA to a country’s rights to collect taxes earned within its jurisdiction.

In this matter, URA carried out a comprehensive tax audit on Target Well Control Uganda Limited (Target Well Uganda) and assessed tax of Shs1.9 billion in relation to Corporate Income Tax, Withholding Tax (WHT), Pay As You Earn (PAYE) and Value Added Tax (VAT).

The tax collectors demanded Withholding Tax (WHT) on lease payments by Target Well Uganda to Target Well Control (UK) Limited in respect of leased directional drilling equipment. URA also disallowed input VAT arising from supplies made by Neptune Petroleum (U) Ltd (Neptune) to Target Well Uganda.

Target Well Uganda objected to the assessments on grounds that lease payments are not subject to WHT under the Uganda-UK Double Taxation Agreement (DTA). Despite URA objection, the High Court ruled in favour of Target Well Uganda, thanks to the DTA. URA is believed to have appealed this decision because of its impact on domestic revenue mobilisation.

Way forward
There is a mixed reaction regarding government’s view and understanding of DTAs. On one hand, the government seemed concerned about its effects and on the other, it looks unbothered by the state of affairs.

In an interview with the acting director economic affairs at the Ministry of Finance, Planning and Economic Development, Mr Moses Kaggwa, it emerged that the government fully understands the extent of the damage that the DTAs have on the country’s ability to internally generate revenue, explaining why the government took the decision to suspend DTAs in 2014.

But he is also cognisant of government’s policy to attract FDI into the country using all sorts of sweeteners and baits, with DTA, despite being a revenue leakage tool, being one of the hooks used to achieve that end of the bargain, even as studies indicate that this kind of initiative does not hold water; for tax and related issue come down the pecking order of a serious investor looking to invest in a country.

In an interview with an economist and a tax expert at the Ministry of Finance, Planning and Economic Development, Mr Gerald Namoma, it was clear that government is not about to ditch DTAs but try to reform them with reflection of the country’s current and future aspirations.

“There is no we way can discuss DTAs in isolation of the international context because if you do so you will be an island,” Mr Namoma said.

He continued: “Others will sign them (DTA) and you could lose out. The important thing is to have control over them and that is what we are trying to do.”

According to Mr Namoma, DTA relevance far supersedes FDI claims, stressing that it is needed to help to relieve tax constraints that could arise between two countries.

He disclosed that government is currently renegotiating with some tax havens over DTAs such as The Netherlands.

Eventually, all DTAs will be reviewed and renegotiated as the Cabinet, according to Mr Namoma has already been put on alert by the minister of finance.

“We are doing this because we are aware about the revenue losses caused by DTA,” he said.

About Double Taxation Agreement
A Double Taxation Agreement is all about who has taxing rights. The purpose is to ensure that taxes are not paid in two jurisdictions. Multinationals who operate in more than one country therefore plan their taxes in such a way that they pay where the tax rates are low.

Transfer pricing
For Uganda, according to Ms Akol, DTAs are being used to perpetuate transfer pricing, resulting into revenue losses that the country should have otherwise collected.

Through transfer pricing, a multinational corporation can “transfer the prices” of income and expenses to a low-tax jurisdiction to reduce taxation or get away with it should opportunity arise.

As if that is not bad enough, multinational companies have also taken to treaty shopping to further abuse DTAs. Under this, the corporation does business here but chooses to register the entity in a jurisdiction that has DTAs with Uganda to take advantage of the treaty and not pay its due share of taxes yet the income of the business is being earned in the country, making it taxable here, according to Ms Akol.

Solving DTA issues
As for Mr Gerald Byarugaba, a specialist in Extractive Resources, Policy and Governance at Oxfam, Parliament must play an active role during DTA negotiations and have the last word on it by endorsing it before enforcement. Currently, DTA is almost exclusively a Cabinet affair and a few government ministries, namely Ministry of Finance and Ministry of Foreign Affairs.
He also suggested that an anti-abusive clause is provided in the DTA, saying that will go a long way in plugging tax leakages emanating from the treaty, further stressing that no matter the circumstances, DTA shouldn’t take away tax liabilities. This, he said, should be in addition to denying third parties any opportunities to cash in on DTA.

Mutual benefits needed
For the Commissioner Customs, Dicksons Collins Kateshumbwa, government shouldn’t shy away from tackling this matter which has since become a global concern. To benefit from DTA, Mr Kateshumbwa said the benefits between the countries involved must be mutual.

“There is always a danger if you have a DTAs with a country that perhaps you don’t have any trade or economic relations with or very minimal for that matter. With that, you will be giving away perhaps a lot than the benefits you accrue,” said Mr Katehsumbwa in an interview last week.

Already in an effort to deal with the challenges emanating from DTAs, whose actual objective is to avoid paying taxes in two different jurisdictions, the tax prefect has set up International Tax Division that specifically manages multinationals companies.

Aggressive tax planning
To reduce the abuse of DTAs, Ms Akol said: “We are beefing up our capacity with help from international tax organisations to enable us recognize all these aggressive tax schemes which are increasingly being frowned upon at international level.

“Aggressive tax planning now being identified as tax evasion is frowned upon. There are moves to create sanctions for it. Listed companies and their regulatory agencies also frown upon aggressive tax planning and we think this is a good gesture,” Ms Akol said at the sidelines of URA E-Hub closure last week.
Automatic exchange of information to profile multinationals and understand whether they use DTAs to avoid paying taxes in both countries is becoming a practice among revenue authorities.
She also disclosed that URA has always advocated for renegotiations of DTAs especially, “Where we see a lot of investment being reported as if doing business with Uganda and yet that may not be entirely the case.”

Importantly, DTAs shouldn’t be viewed as investment attraction instrument but rather bilateral investment treaties, according to Ms Akol. These will be more appropriate because there will be no requirement to lose tax revenues.