By Daniel Mulé and Eneya Maseko

In a move that will hopefully reduce corporate tax evasion in Zambia’s mining sector, multinational companies must now document all their “related party transactions” to show they aren’t using them to reduce their tax bill.

Traffic lights and speed limits set rules for driving on the road.  But traffic cameras and police radar guns can also serve as effective additional enforcement and even deterrents as drivers know they can be caught and punished if they don’t comply with the rules.

Is there a parallel lesson to be learned in combating corporate tax avoidance?

This month, Zambia’s Ministry of Finance adopted new regulations that give the government one more tool to reduce the chance that mining companies are dodging taxes.  Zambia is now hoping better informed tax auditing will deter corporations from manipulating the prices at which they sell goods and services to related companies, including parent companies, subsidiaries, and others within the same corporate structure.  And if not, Zambia’s tax auditors will have the information needed to more effectively audit and make tax adjustments.

What is transfer pricing and why is it relevant?

Imagine that it costs (fictional) Nsima Mining $5 to mine a kilogram of a certain mineral that it sells to its parent company, Nsima Global, which markets the minerals at a cost of $1, before reselling it for $10.  The group of Nsima companies has $10 in income, $6 in costs, and a total profit of $4.  But what price did Nsima Global pay Nsima Mining for the minerals?
Defining this “transfer price” – the price of the first sale between the companies – matters if Nsima Mining and Nsima Global are in two different countries, where the profit can be taxed by two different governments.  If the rates at which the profits are taxed in the two countries are different, companies may be able to increase after-tax profit by shifting their profits to the lower tax jurisdiction.

In the example above, surely Nsima Mining does not accept less than $5/kg, to cover costs, and surely Nsima Global does not pay more than $9/kg if it intends to resell the minerals at a price of $10/kg and had $1/kg of marketing costs.  Between $5 and $9, the Nsima group has some control over setting the price, but it would be artificial for the group to assign a price at either extreme, and would raise eyebrows for tax authorities looking to address tax avoidance.  For instance, with a transfer price of $5/kg, Nsima Mining reaps zero profit, meaning that the country where the minerals are being mined receives no profit tax.

The Mbeki Panel on Illicit Financial Flows has suggested that corporate tax avoidance may be costing Africa some $50 billion annually, and manipulation of transfer pricing is a key form of tax avoidance.  In Zambia, particular concerns over potential transfer mispricing have been raised in the mining sector, which dominates the Zambian economy.  Some of the largest mining companies, like Glencore’s Mopani Copper Mines, have been featured in the headlines over payments to related parties that may have significantly diminished their taxes paid.  Some reports suggests that transfer pricing and other forms of corporate tax avoidance could be costing Zambia hundreds of millions of tax dollars annually.  While it’s difficult to reliably quantify the scale of the problem, additional safeguards can be put in place to reduce the risk of transfer mispricing.

Combatting transfer pricing in Zambia

One common way in which governments often protect against profits being artificially located elsewhere is by requiring that the related companies use the “arm’s length price” – that is, the price they would get if the transaction took place between two unrelated parties.  If the transfer price is equivalent to the arm’s length price, the transaction may be considered valid.  In 2008, Zambia enacted incorporated an arm’s length pricing requirement (Income Tax Act Art. 97A).  However, determining what the arm’s length price is can be a challenge without sufficient evidence.

Fortunately, there is a growing body of guidance on how to address transfer pricing, including specific guidance to Africaand the mining sector.  In addition the African Tax Administration Forum (ATAF) has provided technical support to Zambia on transfer pricing.  In line with this guidance, the Natural Resource Governance Institute (NRGI) and Oxfam have specifically encouraged Zambia to require transfer pricing documentation to allow tax authorities to verify compliance.

With its new transfer pricing regulations, Zambia takes an important step, joining a growing number of countries around the world in using documentation requirements to protect against erosion of the  tax base and artificially shifting the profit.  The regulations require companies to document transactions between related parties and to demonstrate that the transfer is at an arm’s length price.  Multinational corporations must also maintain detailed information about the structure of the group of companies and their intra-group relationships.  The documentation must be ready annually by the tax filing deadline, and must be shared with the Zambia Revenue Authority (ZRA) within 30 days upon request.

A key challenge going forward will be to ensure that the ZRA has the human resources and technical capacity to review the documentation generated by the new requirements.  The ZRA must be well equipped both to assess transfer mispricing risks, so that it can request the most useful information, and to perform audits on the basis of such information.  If the ZRA is empowered and sufficiently resourced, the documentation requirement can have impact: reducing transfer mispricing, both via tax adjustments and as a deterrent.

By reining in transfer pricing risks, Zambia can limit profit shifting by multinational companies, ensuring that more tax revenues are generated.  If well managed, in part through stronger public finance management laws and efficient resource allocation and oversight, such revenues can provide Zambia the means to prioritize spending to address poverty as well as different forms of inequality, including gender and income inequality, as both Zambian civil society and the World Bank have recommended.

Daniel Mulé is a senior policy advisor for tax and extractive industries and Eneya Maseko, Extractive Industries Program Coordinator for Oxfam in Zambia.

The last time I spoke to Hakainde Hichilema, he was trapped in a panic room in his Lusaka home. Dozens of riot police had stormed the opposition leader’s house in a violent predawn raid, and were now waiting outside to arrest him or worse. “This guy, [President Edgar] Lungu, wants to kill me,” he said, his voice shaking on the telephone line, as the police tried to flush him and his family out of the panic room with teargas.

That was a little over a year ago. Lawyers eventually negotiated safe passage for Hichilema and his family, but he was still slapped with a treason charge. Prosecutors said that he had endangered Lungu’s life by blocking the presidential motorcade at a cultural celebration but most observers agreed that this was simply a pretext by Lungu to crack down on his major political rival.

Eventually the charge was dismissed but not before Hichilema had spent 127 days in jail. It was an experience that changed him as a person — and as a politician.

“Any normal person has to be changed by that experience,” he said, speaking to the Mail & Guardianat an upmarket hotel in Johannesburg. The scene is a world apart from the filthy, overcrowded Zambian prison cells that he describes.

“Our detention centres are death traps … In a room like this, you have 200 inmates spending nights. So you really don’t go to sleep. You take a nap by sitting, and someone has their body inside your legs. There is very poor ventilation something very simple to fix but it’s not there. Food, there’s no food. And when it’s there, it’s rotten beans, rotten kapenta [sardines]. Medical services are very poor. People go into prison and come out with diseases. During my stay we saw bodies being taken away, dead,” said Hichilema.

But at least he learnt something while he was inside. “It’s fortunate that I have been able to be put through this, so when our time in office comes we know which priorities need to be dealt with yesterday.” Needless to say, prison reform is near the top of that list.

The 55 year old was one of Zambia’s richest businessmen and the country’s second largest cattle rancher before turning his hand to politics. Now he leads the United party for National Development, which lost the 2016 elections by the slimmest of margins: the party was less than 100 000 votes short out of the 3.78 million votes cast.

Hichilema disputes the validity of that poll, arguing that Lungu manipulated the result in his favour. He refuses to recognise Lungu’s legitimacy as president, a stance that contributed to his arrest which, according to Hichilema, was merely the highest profile incident in a long list of human rights violations committed by Lungu’s administration.

Recently, Chishimba Kambwili, a member of Parliament, was arrested on corruption charges, which surfaced only after he defected from the ruling party. Nevers Mumba, the leader of another opposition party, was sentenced to three months in prison after being convicted of lying to a public official, a charge critics say was politically motivated.

Earlier this year, the M&G spoke to Pilato, a rapper, who fled into exile in South Africa after receiving death threats from ruling party loyalists after releasing a song that described Lungu as a “rat” whose “main job there is to steal”, a reference to the corruption allegations that have dogged the president.

“The abuse of human rights and freedoms in our country … has gone unnoticed beyond our borders,” said Hichilema. “Even to have peaceful demonstrations is almost impossible if you are not associated with the ruling party. If you see the sort of demonstrations you have around here [in South Africa], they don’t occur in Zambia … If you try to do that you will be met with brute force, where the police discharge live ammunition along with teargas wantonly.”
image is hard to square with Zambia’s hard won reputation as one of Africa’s most peaceful democracies. But civil society activists contacted by the M&G say Hichilema is not exaggerating, and in its most recent country overview Amnesty International confirmed this bleak picture.

“The authorities cracked down on critics, including human rights defenders, journalists and opposition political party members,” said Amnesty. “The Public Order Act was used to repress rights to freedom of expression, association and assembly. The police used unnecessary and excessive force against peaceful protesters and failed to address violence by groups close to the government. The judiciary came under verbal attack from the president. Levels of food insecurity in rural areas remain high.”

Zambia’s economy is also struggling yet another stick with which critics are beating Lungu. It doesn’t help that, under his administration, the country’s debt has officially quadrupled from about $2 billion to more than $8 billion. Hichilema claims more debt has been hidden, and that the true figure is about $16 billion about 75% of Zambia’s gross domestic product.

‘Nobody is listening’

Zambia’s political crisis is falling on deaf ears. “There are times I feel like nobody is listening,” said Hichilema, looking tired. And his fleeting visit to South Africa only emphasises this point: at a press briefing that took place just before our interview, only three journalists attended. Aside from the M&G, no South African media house was represented.

Hichilema said that international community representatives sympathise with Zambia’s problems but tell him that the situation is not as serious as elsewhere. But he argues that, if left unchecked, Zambia will turn into “another Zimbabwe”, or another Democratic Republic of the Congo.
He believes that South Africa, Zambia’s largest trading partner, should play a more active role in the country. So far, South Africa and the Southern African Development Community (SADC) have been entirely silent on Lungu’s abuses.

This may come back to haunt the region, warns Hichilema. “Zambia’s economy is not growing, there is abuse of civil rights, there is no rule of law, there is increasing violence. We are creating a recipe for disaster, not just for us but for the region.”

The disaster can be easily averted. Lungu is not immune to regional pressure, and a few firm words from Cyril Ramaphosa, the new president of South Africa and the SADC chair, would go a long way towards ensuring free and fair elections and the protection of basic civil liberties, the opposition leader says.

So far, however, Ramaphosa has shown no sign that Zambia is on his foreign policy agenda. No matter how loud Hichilema shouts, few are prepared to listen.

Mail & Guardian