Wednesday, September 29, 2010

Investments for Development: derailed to tax havens


TJN, together with five partner organisations, has produced a new report entitled Investments for development: Derailed to tax havens which looks at the use of tax havens by Development Finance Institutions - state-owned companies that use their capital to invest in businesses in developing countries (similarly to what the World Bank's International Finance Corporation does). The most well-known of these is Britain's scandal-plagued Commonwealth Development Corporation (CDC,) which we (and Private Eye) have written a fair bit about in the past.

Written by TJN Senior Adviser Richard Murphy, the new report looks at how DFIs invest in developing countries. As Murphy notes:
"DFIs have a duty to maximise their economic footprint in the countries in which they invest and that means they have a duty to pay tax in those places if they are to pay tax anywhere. I stress, the argument is that they should actually seek to pay tax there, support the tax systems of those countries, and encourage the development of those tax systems if necessary. This is an explicit component of the development agenda.

We argue they don’t do that. They invest in two ways. The first is directly, holding minority stakes in companies in developing countries. But increasingly they invest via funds in private equity style, often partnering with private equity partners. In both cases they use secrecy jurisdictions, either as intermediate holding companies or as the location in which funds are located.

DFIs argue this is necessary, to avoid double tax, to pool capital, to use legal infrastructure and to provide legal certainty.

The report does not agree with this. We argue there are seven reasons why investment in developing countries through tax havens is harmful. They are:

—Contributes to the loss of tax revenues by developing countries.

—Contributes to maintaining tax havens

—Contributes to supporting structures that facilitate illicit financial flows, even though there is no suggestion DFIs engage in such activities

—Contributes to the misallocation of investment funds

—Contributes to the risk that investments fail to meet governance criteria

—Contributes to the risk that DFIs are not democratically accountable

—Contributes to development ineffectiveness

Summarised, apart from the clearly inappropriate action of supporting tax haven behaviour that is demonstrably harmful to developing countries there is also the straightforward problem that the opacity of the arrangements into which DFIs enter – often made even more opaque by the now common tiering of structures through tax haven locations – makes governance harder and increases risk as a consequence. If risk is increased the rate of return required is increased to compensate. That increases the hurdle rate at which investment takes place so the volume of investment falls and the diversity of activity diminishes – often with consequence for the very poorest in developing countries and as a result aid effectiveness is diminished. That is not an unfortunate side effect of tax haven structuring, it is a foreseeable and inevitable consequence."
The report then outlines a new proposed Code of Conduct for DFIs. Now read on.

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