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Bleak growth exposes malaise of revenue shortfalls

09 November 2015   (0 Comments)
Posted by: Author: Malcolm Ray
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Author: Malcolm Ray (IOL)

First it was the scourge of public sector corruption, until now the mortifying spectacle of South Africa’s post-apartheid transition. Now, with the ground shifting beneath the world’s sclerotic economy – and the past few years have produced more tremors than ever in the 21 years of democracy – it’s a legal juggernaut of lost revenue due to profit shifting by multinational corporations.

Every year, quite literally, billions of rands in lost revenue are shuffled out of South Africa through dizzingly circuitous routes in low tax jurisdictions and offshore tax havens, fuelling an already crippling budget deficit. Indeed, if public sector corruption has tarnished the triumph of a new economic dynamism, another calamity – this time driven by the private sector – is plunging the economy into even deeper depths of despair.

A staggering shortfall in annual revenue – mainly in the mining, services and electronic commerce sectors – has emerged on the back of the worst economic downturn since 1994, according to estimates by the Davis Tax Committee, a government effort to tighten loopholes in the tax system and align tax policy with the developmental goals of the National Development Plan.

South African Revenue Service (SARS) data indicate that corporate tax revenues in South Africa were fairly stable before the 2008 global economic crisis, declining sharply in the wake of the crisis. The decline should spark worries in the government.

or one thing, the revenue decline is already fuelling anxieties about the funding shortfall of the Higher Education Department. Earlier this week, Higher Education Minister Blade Nzimande told a media gathering that the government was at a loss as to how to fund the freeze on university fee hikes next year. "We don’t know where we will get the money. That’s a fact,” he said.

If a major part of the problem and solution is cost-recovery support from SARS, the university fees crisis is a snapshot of the hard reality of a growing tax gap and its socioeconomic corollary: declining tax to gross domestic product (GDP) ratios and jobless growth.

Weak monitoring

Statistics on the exact size of the tax gap are scarce due to non-disclosure by companies and weak monitoring capacity by tax authorities. In its interim report, entitled Addressing Base Erosion and Profit Shifting in South Africa, the Davis Committee found that corporate tax revenues in South Africa declined from 7.2 percent of GDP in 2008/9 to 5.5 percent in 2009/10 and 4.9 percent in 2010/11. Drawing on 2013 National Treasury budget data, the committee found that this ratio recovered marginally in 2011/12 to 5.1 percent, but dipped to 4.9 percent in 2012/13.

Implicit in the committee’s report – although not outwardly expressed in its findings – is an emerging realisation of the magnitude of transactional flows directed offshore since 2008: a whopping R205 billion in large corporate transactions recorded by the South African Reserve Bank in the digital, services, engineering, mining, manufacturing and agricultural sectors.

By the Davis Committee’s own admission, these figures do not directly reflect the size of the tax gap, but the magnitude and prevalence of cross border transactions "is an indication that illicit tax base migration through avoidance schemes and practices is taking place.”

Perhaps unwittingly, and not for the first time since 1994, we may be paying a heavy price for trade and financial liberalisation that – beyond attempts at transforming the economy – is looking more like the dark side of the post-apartheid transition. By conservative accounts, the economy may be losing R50 billion in revenue each year due to tax base migration.

The picture now emerging is a distressing one of the pace and volume of revenue collected by the government, utterly out of whack with national expectations of rapid delivery: a Higher Education funding shortfall and consequent failure of government to meet its policy commitment of free higher education, a service delivery backlog in impoverished black townships, massive youth unemployment, and the cumulative impact of an energy shortfall working its way through the economy and ballooning government debt, merely expose the deeper malaise of tax revenue shortfalls.

At stake is nothing less than the failure of the current tax regime to face up to 21st century challenges of the liberalisation of trade and capital markets and their consequences – the shift of manufacturing bases from high-cost to low-cost tax jurisdictions as increased competition between countries as locations for foreign direct investment prompts multinationals to exploit legal arbitrage opportunities due to asymmetries in tax laws of different countries so as to minimise their global tax burdens.

And that’s the singular, perhaps all-important point. Although there are cases of illegal abuses (which are the exception rather than the rule), multinationals engaged in profit shifting generally comply with the legal requirements of the countries involved. As businesses increasingly integrate across borders, tax rules often remain unco-ordinated; so businesses come up with technically legal structures to exploit asymmetries in domestic and international tax rules.

Legal methods

In the case of mining, which accounts for 20 percent of offshore transactional flows and 60 percent of export earnings, there is evidence that multinational companies are using legal methods to circumvent the application of South Africa’s tax laws.

A recent investigation by Oxfam of diamond mining import and export certificates found that transfer mis-pricing – that is, the manipulation of intra-company transactions by transferring profits from a company in one country to another country with lower tax rates – is spread over a number of years by including high value imported diamonds, not for the purpose of sale, but on a round-tripping basis, to create the impression that the arms-length price assigned to domestic exports is fair, even though when controlling for imports, it turns out to be less than the value of production recorded at mines.

Between 2009 and 2011, the undervaluing of exports appears to have generated $806 million in "lost” value for diamond exports compared to official registered values. From 2005-2009, excluding the years 2007 and 2012, this increased to $1.143bn (R15.8bn) in lost value, value which had it appeared on the balance sheet would have been subject to tax and royalties.

The sheer scale of the problem has widened the scope of the Davis Committee’s work – from merely increasing the tax take of government, to fortifying the economy against everything from tax evasion and profit shifting by multinationals with considerable investments offshore, barriers to investment and job creation, and diminishing returns to the fiscus.

The big fear, of course, is that the system’s failure to balance government’s investment and growth priorities with aggressive anti-avoidance rules will affect investment and check economic growth or, worse, become self-reinforcing. Indeed, the problem is now so dramatic that it has prompted the Davis Committee to call into question the long-term investment implications of aggressive tax measures.

To be sure, the country cannot increase its tax take without increasing its taxable base. As one committee member put it, "The solution should be a virtuous circle of value creation, value capture and value circulation. A lack of investment reduces growth and the potential tax take.”

That, so it seems, is the vexing issue.

* Malcolm Ray is a policy analyst at Africa Empowered and Senior Research Fellow at the University of Johannesburg.

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