An IMF working paper was released on 24 October 2018 entitled The Cost and Benefits of Tax Treaties with Investment Hubs: Findings from Sub-Saharan Africa. (Working Paper 18/227).

Double tax treaties can affect returns to foreign investment through the treaty provisions. They influence the returns to investment by establishing when a branch is liable for income tax; setting out the treatment of capital gains; or reducing the source taxation of dividends, interest and royalties. Their main purpose is to avoid double taxation but double tax agreements can also deplete a country’s tax base by restricting taxing rights and making possible the abuse of treaty networks using shell companies.

Mauritius has positioned itself as a conduit country for investment into the continent. As part of its strategy, Mauritius taxes corporate income at 15%, which can be reduced to an effective rate of 3%. Mauritius has negotiated favorable tax treaties with many African economies.

As only some of the countries in the sub Saharan Africa region have concluded treaties with Mauritius, the study can use data from both those that have concluded a treaty with Mauritius and those that have not.

The study does not find that the tax treaties increase Foreign Direct Investment (FDI) in the treaty partner countries. The study does indicate however that there are revenue losses in source countries after they have concluded a treaty with Mauritius and with investment hubs more generally.

These could indicate that concluding a tax treaty gives rise to rerouting of investment and income flows, and potentially increases incentives for base erosion and profit shifting, rather than increasing the overall investments made.

The study seeks to identify the abuse of a country’s treaty network using aggregate data.

Tax avoidance reduces tax collections and positively affects the optimal scope for optimal investments of multinationals by reducing their cost of capital and thereby having a positive effect on the optimal investment magnitude.

The preferential treatment of some investors, commonly resulting from tax treaties, provides tax avoidance opportunities. The study therefore identifies treaty shopping by measuring the effect on investment and government revenues of variations in the source country’s tax treatment of cross-border income flows. The results of the study indicate that treaty-shopping is an important driver of nominal investment flows and this reduces tax revenue across the region. The results of the study also suggest that treaty-shopping is more pervasive in countries that have signed tax treaties with investment hubs.

Rough estimates would indicate that the revenue losses from treaty-shopping reach around 5% of corporate income tax revenue across the sub Saharan Africa region. In countries that have concluded a double tax treaty with investment hubs these costs increase on average to around 15% of corporate income tax revenue.

These findings are rather higher than the estimates in previous studies. Other studies have looked at international tax avoidance by measuring the response to corporate income tax rate differentials using firm-level data. That method of measuring tax avoidance would not capture the effect of treaty-shopping incentives, which can significantly reduce the effective tax burden of a multinational group.

Another reason for the results could be that the sub Saharan Africa region is potentially more vulnerable to tax avoidance by multinational companies than developed economies, for example because of lack of resources in the tax administration. Also estimates of tax avoidance tend to be larger if they are based on macro-data because macro-data captures long-run responses or possibly because of statistical issues with micro- or macro-data.

In the view of the authors of the study one of the main reasons why empirical findings on the importance of tax treaties for FDI have been inconclusive is that taxation plays a subordinate role in investor decision making.

The study therefore generally indicates that in relation to sub Saharan Africa double tax treaties are not associated with increases in foreign direct investment in low income economies.