Taxation Of Foreign Investments In Malawi. Lessons From Japan
Munich Personal RePEc ArchiveTaxation of Foreign Investments inMalawi. Lessons from JapanJames, KenaniYokohama National University, Yokohama, JapanMay 2010Online at https://mpra.ub.uni-muenchen.de/28191/MPRA Paper No. 28191, posted 19 Jan 2011 12:40 UTC
Taxation of Foreign Investments in Malawi. Lessons from JapanByJames Manuel Wilson Kenani1Yokohama National UniversityMay 20101The author is grateful to the valuable comments given on this paper by Professor Masahide Chiba of the National Tax College of Japan.The author is also greatly indebted to the following officials of the Malawi Ministry of Finance: Mr. C.C. Kulemeka, Mr. T.S. Makamba,Mr. Wazi Ligomeka, Ms Tiyamika Kanthambi, Mr. George Harawa and Grecium Kandio.
AbstractForeign investments remain an important source of economic growth in both developingand developed countries. Their contribution to capital formation, employment opportunities,revenues and technology to the host countries are likely to continue creating strongcompetition among countries in attracting them. In order to be competitive, developingcountries provide generous tax incentives to MNEs which tend to encourage high incidenceof tax avoidance and evasion. With inadequate institutional capacity to ensure taxcompliance, governments are losing more tax revenues from the MNEs who use complexaccounting mechanisms to avoid tax payments. This paper has explained how MalawiGovernment has been taxing foreign investments to achieve optimal balance of increasingdomestic resource mobilization and considerably attract new foreign investments. Thecentral objective of the paper was to investigate taxation of the foreign investments inMalawi. The study primarily focused on Malawi tax system in comparison withinternational taxation from Japanese tax system. Furthermore, the paper investigated taxanti-avoidance measures that are available in domestic legislations which ensure taxcompliance from the MNEs. The paper also discussed tax erosion practices that areassociated with MNEs such as transfer pricing, internal debt arrangements among othersthat help to reduce taxable income of the MNEs. The paper has provided the shortfalls ofMalawi international taxation system and some practical solutions have beenrecommended emanating from Japanese tax system.i
Table of ContentsAbstract . iAbbreviations and Acronyms .ivChapter One . 11.0Introduction . 11.1Problem Statement . 41.2Rationale of the study. 51.3Objective of the Study . 61.4Methodology . 71.5Organization of the study . 7Chapter Two . 82.0Literature on the Taxation of Foreign Direct Investments . 82.1Background on the growth of Multinational Enterprises . 82.2International Taxation of Multinational Enterprises . 10Chapter Three . 173.0Taxation of Foreign Investment in Malawi . 173.1Corporate Tax. 183.2Withholding Taxes . 213.3.0Anti-Avoidance Tax Measures . 223.3.1Transfer Pricing Rules . 223.3.2Thin Capitalization Rule . 233.3.3Controlled Foreign Company Rule . 23ii
Chapter Four. 244.0Taxation of Foreign Investments in Japan . 244.1Corporate Tax. 254.2Withholding Taxes . 274.3.0Tax Anti-Avoidance Measures . 284.3.1Transfer Pricing Rules . 284.3.2Thin Capitalization Rules . 304.3.3Controlled Foreign Company (CFC) Rules. 304.3.4Corporate Inversion Rule . 31Chapter Five . 325.0Conclusion. 325.1Recommendations . 34iii
Abbreviations and AcronymsALPArm’s Length PrincipleAPAAdvanced Pricing ArrangementCFCControlled Foreign CorporationCUPComparable Uncontrolled PriceEPZExport Processing ZoneEUEuropean UnionFDIForeign Direct InvestmentGDPGross Domestic ProductKStGKörperschaftsteuergesetz (German Corporation Tax Law)MNEsMultinational EnterprisesNEPADThe New Partnership for Africa’s DevelopmentOECDOrganization for Economic Co-operation and DevelopmentSARSSouth African Revenue ServicesTNMMTransactional Net Margin MethodTWNAThird World Network AfricaUNCTADUnited Nations Conference on Trade and DevelopmentUNUnited NationsUSAUnited States of AmericaVATValue Added Taxiv
Chapter One1.0 IntroductionTaxation is an integral and stable source of revenue for countries in financing theireconomic agenda. It forms an important part if well coordinated with other economic anddevelopment policies to shape the environment for investment and international trade inorder to achieve high economic growth of a country. Taxation provides a predictable andstable flow of revenue to finance physical infrastructures and social programmes which arepillars of attracting Foreign Direct Investment (FDI). It is a known fact that investors areattracted to the countries with good economic growth and development performance.Michalet (2000) supported this point and included a number of conditions notably politicalstability, institutional flexibility, transparency and non-discriminatory legal and regulatoryenvironment as also critical determinants of attracting Multinational Enterprises (MNEs).In addition to the non-tax determinants, empirical and theoretical results have alsosupported the fact that taxation plays a significant role in attracting foreign investments.As a result of the factors above together with rapid change in technology and tradeliberalization the world has seen an unprecedented growth of MNEs in the last four decades.According to UNCTAD (2009) statistics, the world inward stock of FDI increased to 14.91 trillion in 2008 from 1.94 trillion in 1990. Correspondingly, the world figures ofoutward stock of FDI increased from 1.7 trillion in 1990 to 16.21 trillion in 2008.Nevertheless, these factors have also diversified geographical growth pattern of MNEs withdeveloped countries having a large share of the inflow and outflow compared to developing1
countries. From the UNCTAD statistics, developed countries are ranked highly by havingan inward stock of 68.5% of the world FDI compared to 31.5% of developing countries inthe period between 1990 and 2008. At the same time, developed countries had a share of84% outward stock of FDI while developing countries contributed 16% of the outwardstock of FDIs.Despite the 2008 financial crisis, MNEs continued to grow in developing countries vis-àvis developed countries. African countries’ inflow rose by 88 billion in 2008 from 2007stock with main recipients being natural resource rich countries. Southern African countriesreceived 31% and their inflow rose to 27 billion in 2008 from 19 billion in 2007, whileoverall inward stock increased to 166.4 billion in 2008 from 117.2 billion in 1990. Aspart of Southern African countries, Malawi’s share of FDI inflow increased from 228million up to 628 million and outflow increased to 21 million in the same period.However, despite the increasing share of inward FDI and higher economic growth rate,developing countries’ tax revenues have been decreasing as a percentage of GDP from2.9% in 1992 to 2.3% in 2001. The revenues are not enough to finance much needed socialand physical infrastructures and to reduce developing countries’ dependence on foreign aid;yet developed countries were able to increase their tax revenues as a percentage of GDPfrom 1.9% to 2.5% in the same period, Goodspeed (2006). The reduction of revenue indeveloping countries is attributable to excessive tax subsidies or concessions as well as taxavoidance and tax evasion practices by MNEs. As a result of these practices, developing2
countries have failed to finance their social and physical infrastructures which are ideal tofasten economic growth and development.Almost all governments in developing countries are competing to attract FDI by providingtax incentives that are believed to encourage higher FDI inflows. In the African context,most countries are facing challenges of finding optimal balance between taxation regimethat can be business and investment friendly, while at the same time collect enoughrevenues to provide necessary services that would make their economies attractive to FDI.According to NEPAD-OECD (2009) report, African countries have lost an estimated 7.6%of the continent’s annual Gross Domestic Product (GDP) in cash from 1991 to 2004 whichin effect make African countries net creditors of donor countries.Malawi is not an exception to the taxation challenges that most countries are facing. Thecountry has for decades foregone millions of dollars in tax revenue because of itsgenerosity in tax subsidies, or concessions, inadequate institutional capacity that can ensuretax compliance as well as tax avoidance and evasion practices by MNEs. With the largestmining company investing in Malawi in 2006, it is estimated that the country will forgomore than 124.5 million in revenues over the life-time of the project from the reducedincome tax rate and royalty rate among other tax treatments.Now the central argument remains to tax policymakers in developing countries to designappropriate tax regime that would optimize tax revenues to provide enough funds forfinancing their development priorities and also attracting investments.3
1.1 Problem StatementThere has been a tremendous increase of FDI stock in Malawi since early 1970’s andreached its record high in 2008 of U 627 million. Almost all the FDIs in Malawi areexport-oriented as opposed to domestic market-oriented. The largest stock has beenobserved in the manufacturing sector compared to the distribution and financial sectors. In2006, Malawi registered a major mining investment from Australia, Paladin (Africa)Limited. It is the first ever high capital-intensive investment as most of the manufacturinginvestments were labour-intensive vis-à-vis technology-intensive and capital-intensive.Although empirical and theoretical evidence show that FDIs contribute to economic growththrough capital formation, technology, revenues, advanced management skills, increasedtrade and other positive spillovers with domestic enterprises, Malawi has lost much revenue.The revenue loss is attributed either to poor design of tax policies or tax avoidance andevasion techniques by the MNEs. The country has widely used incentives such as taxholidays, export zones and secret contracts to compete with other countries to attractinvestment. These tax incentives, together with incidences of tax avoidance and evasiontechniques by MNEs, have left Malawi Government Treasury without enough finances thatcould otherwise have been used to fund social and physical infrastructures necessary tofacilitate economic growth and development.These poor tax policies interwoven with inadequate capacity of tax administrators have ledto country-wide concern, both from public and civil societies about the future of taxpolicies which are not in tandem with the integration of national economies in the world.4
Against this background, there is need for a country to design tax policies that will strikethe balance between collecting revenues necessary for public spending and at the same timeinvestment friendly as well as transparent to be monitored through budget process by allresidents.1.2 Rationale of the studyMNEs will continue to grow because of rapid technological change, trade liberalization,privatization and geological resources. Many countries regard these MNEs as a source ofeconomic growth and development. MNEs contribute to capital formation, createemployment and provide physical infrastructures such as schools and hospitals, technicalknow-how and management skills. Above all MNEs provide governments with revenueeither directly or indirectly. These factors have led to strong competition among countriesboth developed and developing to attract these investments into their jurisdictions.Developing as well as developed countries are using incentives to attract FDI but theydiffer very much as developed countries use reduced local taxes and subsidized loans plusbetter market and infrastructures that leave developing countries with no option butresorting to the use of tax holidays or exemption. Developed countries are also reshapingtheir tax systems to attract more MNEs and also realize more revenues to sustain theirgrowth and development policies while developing countries are distorting their taxsystems and losing revenues. Usually most developed countries use world-wide taxationsystem and have double tax treaties between them to relieve double taxation on foreignearned income. On the contrary, most developing countries use territorial taxation system5
where income earned outside their borders is not taxed as it is deemed to be taxed where itis generated.Malawi being a developing country taxes income based on territorial taxation system. Thetax system does not reflect the growth in international business and also providesdiscretionary powers to individuals to provide incentives to investors. It is this backgroundof lack of proper tax regime for international companies and also inadequate institutionalcapacity that has influenced this study. The lessons that will be learnt from this study willbe instrumental to tax policy makers to formulate tax policies that are transparent andfollow fundamental principles of international taxation policy. It is believed that Malawican formulate appropriate tax laws that can attract MNEs but also that will benefit thecountry through increased revenues, capital formation, technology, advanced skills andemployment opportunities.1.3 Objective of the StudyThe underline objective of the study was to analyze the taxation of foreign investments inMalawi and attempt to harmonize the tax regime to international taxation principles.Specifically, the study evaluated Malawian tax system based on Japanese tax system ontaxing international companies. The study also drew some lessons from Japanese taxsystem in order to align Malawi tax system to international tax principles.6
1.4 MethodologyThe study used comprehensive review of literature on international taxation of foreigninvestment. The study focused much on the tax systems of Malawi and Japan as well assome information on international taxation from OECD rules. These analyses intended toachieve the objective of understanding international taxation of foreign investment.1.5 Organization of the studyThe rest of the paper is organized as follows: Chapter two provides literature review oninternational taxation in both developed and developing countries. Chapters three and fouroutline taxation of foreign investments in Malawi and Japan. The last chapter will provideconclusion and policy recommendations.7
Chapter Two2.0 Literature on the Taxation of Foreign Direct Investments2.1 Background on the growth of Multinational EnterprisesTaxation of foreign investment requires a deeper understanding of the activities of MNEs,their growth pattern and interest in the host country among others. MNEs being entities thatconduct business in more than one jurisdiction, whether as a single taxpayer or group ofentities, provide complex taxation issues for both tax administrators and MNEs themselves.Going by their definition, MNEs’ activities in the world trade has increased significantlyfor the past two decades. For example, today the world has 82,000 MNEs with 810,000foreign affiliates and they are estimated to account for about a third of total world exportsof goods and services with 77 million employees among themselves, UNCTAD (2009).The increased role and growth of MNEs is attributed to rapid technological changeparticularly in the area of communication, advanced management skills within the firm,trade and investment liberalization, privatization, deregulation and political stability.In addition to the factors above, Ietto-Gillies (2005), also mentioned that economicstructure and natural resources have facilitated the growth of FDIs. These two factors havemade developing countries to be greater recipients of the FDIs particularly labour-intensiveMNEs with little in the services sector, whereas developed economies are greater recipientsof technology-intensive and services sector MNEs. Goodspeed (2006) supported thisobservation and reported greater disparity in growth of financial services among developedand developing countries between 1988 and 1999. Goodspeed further observed that during8
same period, financial services grew by 13.3% compared to 12.2% in manufacturing sectorwith developed countries receiving greater percentage than developing countries.Goodspeed (2006), further indicated that even within the developing countries FDI differsignificantly from country to country or within regions with some benefiting greater in theservice and high-technology than manufacturing sector. The disparity is further deepeneddepending on whether MNEs are either export-oriented or domesti
Taxation of Foreign Investments in Malawi. Lessons from Japan By James Manuel Wilson Kenani1 Yokohama National University May 2010 1 The author is grateful to the valuable comments given on this paper by Professor Masahide Chiba of the National Tax College of Japan.
Taxation Law 1 Taxation Law 2 I. General Principles of Taxation II. National Internal Revenue Code of 1997 as amended (NIRC) I. General Principles of Taxation A. Definition and Concept of Taxation B. Nature of Taxation C. Characteristics of Taxation D. Power of Taxation Compared E. Purpose of Taxation .
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taxation law. My practice has been devoted to issues of taxation law in one or more subspecialties as described in Attachment A-2. Area(s) of subspecialty and nature of work done (e.g., estate planning, property taxation, corporate reorganization, employee benefit plans and other such limited areas): Provide brief description or list
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