Public services are crucial not only for the individuals who depend on them, but for economic development. Businesses rely on roads, and schools, police and lawcourts, just as individuals do, but these things cost money. In a world of globally integrated businesses, internet commerce and intangible assets, taxation systems are becoming strained. Reforming international taxation rules, and strengthening their implementation, so that states are able to collect sufficient domestic revenue, without constraining economic activity,  is crucial for sustainable development.

Last week Action Aid released a ‘tax dodging’ report (pdf) on Zambia Sugar. Zambia Sugar is majority owned by Illovo Sugar, which itself is part owned by Associated British Foods, the group that includes household names in the UK like Primark, Twinnings and Silverspoon. Promoted with headlines like “Busted” and “Scandal” the report made a big splash in the media and on twitter.

Here is the infographic from Action Aid summarising the case.

After you’ve read that you probably think that

1. The scandal is that Zambia sugar has paid ‘virtually no’ corporate income tax on $123 of profit
2. The amount in question is $27m
3. This is explained by exploiting loopholes and tax havens
4. There is a fair amount of certainty about these claims

You can read the full report and you will probably come away with the same impression.

Associated British Food responded that they have been wronged. They state that the reason that they have paid no corporate income tax from 2008-2012 is due to capital allowances from investment in a new sugar plant.  Action Aid in turn responded  that ABF were misrepresenting the arguments.

This seemed odd to me. The debate about tax avoidance  is generally seen as being about whether companies are doing something  immoral, irresponsible or unfair within their legal tax affairs. How could there be such a fundamental disagreement between ABF and Action Aid, not just about whether what the company was doing was moral, but the actual fact of why they had paid so little tax in the first place?

Action Aid publishes its correspondence with the company , so I read this stack of letters-back-and-forth (pdf) to get a better idea of how to interpret this apparent disagreement over the facts of the matter. I also got chatting to Mike Lewis and Chris Jordan of Action Aid on at Martin Herson’s thoughtful  blog  on tax and development.

I am sharing my assessment here for anyone else who may be confused. I am not a tax expert, just a particularly dogged reader. If I have got anything wrong in my interpretation please do let me know.

Zambia sugar paid “virtually no tax” from 2007-2012

This is the core undisputed bit of the story. The quotation marks around virtually no tax are there because these are ABF’s own words.

ABF’s explanation is that  Illovo Sugar  invested R1.6bn (£150m) to double the size of the sugar mill in Zambia and the resulting capital investment allowances are the reason why it has paid so little tax in since 2008. As I understand it, capital allowances are quite ordinary normal measures for working out tax due. If a business buys an asset, it does not subtract that expenditure from its operating profits. For accounting purposes they put the capital item on the balance sheet and then write it off through depreciation over its useful economic life. Regulations generally instruct companies to write off investments more quickly for tax purpose than for accounting purposes, through the system of capital allowances. If the capital investment is large enough a company can make a loss for tax purposes (i.e. after deductions), while reporting operating profit, for several years.

The Action Aid report recognises that capital allowance is ‘a plausible explanation for some of the discrepancy between the usual Zambian rate of corporate income tax and the far lower tax rate applied in practice to the company’s pre-tax profits.’  It  does not formally claim that there is anything dodgy or immoral  going on here. However it would be easy for a reader get the impression that it has its suspicions.

Not only do the headlines focus on the corporate income tax rate, but the  the report says Zambia Sugar had  an ‘extraordinarily low tax bill’ and contrasts it with operating profit, and with the income tax paid by local market traders.  It describes the matter of in these terms:

Although the company has had to use some of these operating profits to pay off loans taken out in 2007 to finance a major expansion of its Nakambala sugar estate and mill, the cost of interest and loan repayments have already been offset by record revenues since the expansion was completed.

 Zambia has lost an estimated $27m since 2007

The first important thing to note about this figure is that it is not an explanation for why Zambia Sugar paid “virtually no income tax”. There may be some overlap between this figure and the reasons for the gap between 15% and the actual corporate income taxes paid by Zambia sugar between 2007-2012, but the report does not specify what this overlap is.

Again it would be easy for readers to get the wrong idea and think the $27m number refers to the apparent corporate income tax gap. For example the call to action for supporters to email the CEO of ABF states:

Associated British Foods, has been paying virtually no corporation tax in Zambia – one of the poorest countries in the world. This has cost Zambia an estimated US$27 million since 2007.

Does this distinction matter? I think it does, because different parts of the big number refer to different allegations, different potential problems, and different policy recomendations. Bundling them all together into one number and letting people interpret it as explaining Zambia Sugar’s corporate income tax rate may be good for getting a message out, but it is not good for understanding the reality of the situation.

So whats in the number?

• The first item is US$3 million which relates to a discount on the general tax rate of 35%, down to the 15% which Illovo Sugar won in a tax tribunal in 2007 by arguing that it should be taxed at the ‘farming rate’. This is an undisputed  corporate income tax loss to Zambia within the period covered by the report. My assessment: There may be a case to be made about whether Zambia Sugar should have been granted farming rate reduction, but this was agreed by the court, and republishing this figure from the company’s 2008 annual report should not be interpreted as ‘exposing a scandal’.

• The second item US$6.3 million relates to back payment of the same discount, from 2001 to 2005 (this is a undisputed corporate income tax loss but it is outside of the period of the report). My assessment: It is confusing to include a tax rebate from previous years in discussing tax paid over the period. The difference between getting a tax rebate for a previous year and a change in the tax rate for the current year, is something that is generally well understood and it is not necessary or useful to conflate the two.

•  The third item relates to payments made to Illovo Suga’rs sister company in Ireland for management services and other fees. ABF says these payments are for export services, third party contractors, and expat  salaries. Action Aid estimates that these cost the Zambian exchequer US$7.4 million by ‘siphoning’ off US$47.6 of pretax profits. My assessment: If this estimate is anywhere near accurate it is indeed scandalous, and as far as I can tell illegal behaviour in both Ireland and Zambia (more on this below).  

•  The fourth item is US$3 million that ABF saved by routing borrowing via Ireland. This is a Witholding Tax loss (unrelated to corporate income tax). My assessment: this appears undisputed and could be ‘treaty shopping’.
• Finally is US$7.4 tax forgone because ABF routed dividends from the company  via a ‘cooperative’ structure in the Netherlands. This is a Witholding Tax loss to Zambia, and as far as I can tell undisputed, and open to the charge of treaty shopping.

So in summary this how I read estimate figures on page 33 of the Action Aid report (‘The Bill’) –

•  $3 m from income tax reduction from domestic processes, undisputed, unscandalous.
• $6.3 m from income tax reduction from domestic processes, undisputed, unscandalous, irrelevant to the tax rate in 2007-2012.
• $7.4 m income tax dodged from funnelling pre-tax profits to Ireland, disputed, if accurate this is scandalous, most likely illegal.
• $3m withholding tax forgone by routing interest payments via Ireland, undisputed, possible treaty shopping.
• $7.4m withholding tax forgone by routing dividend payments via Netherlands, undisputed, possible treaty shopping.

It looks like there is case in here to support the argument that  Zambia loses on Witholding Tax due to treaty shopping. How important this is depends on an economic analysis on whether there are dynamic benefits in attracting FDI through reduced Witholding Tax. There are clearly  policy questions  on whether and how these tax treaties should be renegotiated. But I don’t think this on its own would have garnered public outrage or ‘scandal’ headlines.

 So what is the scandal?

The figure that stands out as an allegation of a real scandal is the estimate that Zambia Sugar has avoided $7.4m of corporate income tax by making payments of US$47.6 to its sister company in Ireland.

Oddly enough, this potentially explosive assertion at the heart of the report is explained made through this difficult to decipher sentence.

 While this complex and contradictory network of transactions makes it difficult to determine the substance and ultimate destination of Zambia Sugar’s payments to Ireland, we can nonetheless assess the straightforward losses to Zambia from offshoring these expensive management functions: we estimate that payments to Zambia Sugar’s Irish sister company, deducted from its own taxable profits and avoiding 15-20% Zambian withholding tax, have reduced the company’s Zambian tax bill by around US$1.2 million (ZK6 billion) a year: US$7.4 million (ZK32.6 billion) since 2007.

I was not sure whether the $7.4 million here refers to corporate income tax or withholding tax, but Mike Lewis from Action Aid confirmed to me that it does refer to corporate income tax. This is also confirmed by Action Aid’s most recent statement to ABF which states that the estimate for foregone withholding tax amounts to $10.4m (i.e.the estimates relating to the interest and dividend payments).

What is undisputed here is that Illovo Sugar transferred nearly $50m to its sister company in Ireland over six years. The company says this was used to pay for expat senior staff; engineers, agronomists and senior management, as well third party contractors.  It says that these people could not have been contracted at the same price (or possibly at all) by  Zambia Sugar Plc.

Action Aid said that when they visited the registered office in Ireland they found it was a simply a company services offices, forwarding correspondence. They said that despite extensive research they were unable to establish or verify the nature or substance of services for these services provided from Ireland.

As readers it is impossible for us to get to the bottom of this. Was the company in Ireland overcharging for management services and siphoning profits out of Zambia, or was it contracting expat staff and contractors at value-for-money rates? We have no way of knowing (but we hope that the Zambian tax office does).

What we can work out is what the estimate for forgone corporate income tax in Zambia would be in each scenario (the tax rate was 15%, except in 2006/7 when it was around 22%).

If Illovo Sugar Ireland did indeed provide $47.6m of services to Zambia, as the company contends, then the forgone income tax in Zambia must be zero. In this case, if  Zambia Sugar were to have kept the money, foregoing any services it would have got, it would have had to contracted them elsewhere at the same price or greater. In this scenario the money is not ‘pre-tax profit’ but ‘legitimate business expense’.

What if Illovo Ireland was overcharging? Say they charged $47.6m but only provided $20m worth of services, managing to shift $27.6m of profit out of Zambia. The lost corporate income tax would be about $4m.

So what would they have to have done to avoid $7.4m of income tax figure? My understanding is that for this figure to be true, Illovo sugar could have had to have provided zero value to Zambia sugar for $47.6m apparent costs. I cannot see any other way to interpret this (if any tax people are reading this, please let me know if I am missing something?)  In other words, if ActionAid’s estimate is accurate it implies that Zambia Sugar spent nearly $50m on phantom contractors over six years.  That seems like an extraordinary claim to make on the basis of the scant evidence and suspicions (and indeed the report says it is not alleging that Zambia Sugar or its parent company have done anything unlawful – or even particularly unusual).

It seems to me that if the $7.4m estimate is true it would indeed be a scandal – of interest to both the tax authorities in Zambia and Ireland and to shareholders.

Why have I spent too long of my weekend writing this blog post?

Tax  is a complex and forbidding subject. Most of us try to avoid thinking about it too hard or too often.

NGO campaigns, and good journalism  play an important role in bringing these kinds of important-but-complex topics into an informed public debate.

Trust in the NGO underpins the supply chain from in-depth research to 140 character soundbite. Most people have neither the time nor the interest to investigate everything they read. The NGO brand assures us that the messages we are getting are 100% beef and no horsemeat. As with purveyors of meatballs and hamburgers, particular care needs to be taken when the research approach  involves taking a few rough estimates for different areas of a complex issue, adding them together and moulding them into a story. Estimates are useful, but they should not be confused with evidence.

The report and associated publicity welds together the two international stories; one about ‘treaty shopping’ and the other that appears to imply tax evasion (as well as the domestic issue about the tax rate).

These distinctions are hard to work out from a detailed reading of the report. They are impossible to work out from some of the communications.

Zambia Sugar may have questions to answer over their tax affairs. Concerns about treaty shopping  are legitimate. But I think overall this report and the associated communications has added more heat than light to the debate.

Tax avoidance and evasion and the need for tax reform are serious subjects. NGOs  owe it to the subjects of their research, and to their supporters to take a high standard of responsibility when publishing information and to do their utmost to avoid misunderstanding. Anything less risks both NGO’s reputation, and the quality of informed public debate, both in Zambia and the UK.

I don’t think this high standard has been upheld here.

Transparency and integrity in campaigning

I have a couple of practical recommendations  to avoid rogue ‘meatballs’ getting out in future.

1)     When assessing effects of a campaign, measure misunderstanding as failure, not success. When counting up tweets, column inches to assesse the reach of a message, do not take the view that all publicity is good publicity. If most people reading this report, and its associated publicity got the message that the problem here is that Zambia sugar has paid zero income tax in recent years, or come away with the idea that the company has done this by ‘siphoning’ a third of its pre-tax profits into tax havens,  then this doesn’t reflect an accurate picture of what is going on.

2)     Get some critical friends to provide an independent commentary. Get together a review panel  of experts to read the draft report. Their role is not to represent the company’s interests or positions, but to represent the interests of readers. Does the report represent its findings with accuracy and clarity? Is it open about levels of certainty, areas of dispute and ranges of estimates?  Could it give rise to misunderstanding?   Where are clarifications needed?  The panel could include accountants and accountancy professors, senior development wonks, people with relevant experience in business, and regulation, and in other areas of assurance. They should be tasked with offering feedback before the final draft but also asked to write an independent commentary to help non-expert readers make sense of the claims, and attesting that they are reasonable.