Mistreated? Tax treaties and ActionAid

ActionAid, a NGO that works on development issues, has just issued Mistreated, a report condemning tax treaties’ impact on developing countries’ tax collection efforts. The report makes two critical errors in condemning tax treaties. It ignores the value of legal systems and it ignores accounting and economic reality. These mistakes are made over and over again by critics of offshore centers. However, we should praise the group for creating a database of tax treaties and for being transparent about its classification system. Too often, those asserting that there are billions of untaxed dollars, euros, pounds, RMB, and other currencies hidden around the world simply make undocumented claims. ActionAid properly shows its work and put its database of treaties on an Excel spreadsheet available on its website.1

Are tax treaties a problem or a solution?

mistreatedActionAid claims tax treaties facilitate tax avoidance by multinationals and thereby deny governments tax revenue that could be spent on schools, infrastructure, and other public investments. The group claims that treaty provisions which “set the rules about how established a foreign multinational has to be before it pays tax on its profits,” prohibitions on “withholding taxes” (i.e. taxes applied to payments leaving a jurisdiction), and restrictions on capital gains taxation all critically undermine efforts by developing countries to tax multinationals.

The value of legal systems

Like most of OFC critics, ActionAid doesn’t think investors need to make use of alternative jurisdictions when making investments into a developing country. For example, it criticizes Uganda’s treaty with the Netherlands for reducing the taxes Uganda can levy on investment coming into the country via the Netherlands. This raises the question of why Uganda has a tax treaty with the Netherlands. Was the Ugandan government simply hoodwinked by clever international investors into making a bad deal? This appears to be ActionAid’s position.

However, this ignores the role the Netherlands plays in the world economy. The Dutch have long been successful in creating a tax treaty network and a centerpiece of Dutch tax policy for decades has been avoidance of withholding taxes and taxation of dividends, royalties, and interest both generally and within groups of related entities. Why? The Dutch benefit by making the Netherlands an attractive location for holding companies. And more generally, the Netherlands is an attractive base for businesses to find customers because of its low corruption levels and its friendliness to international trade. The Netherlands ranked 5 out of 168 in the 2015 Corruptions Perception Index and in the 98th percentile for the 2010 Control of Corruption Index. Transparency International ranked it 5 out of 142 in the Global Competiveness Index (2012-13).

If we compare Uganda’s scores on these measures, we see why structuring a business in the Netherlands might be attractive to an investor. Transparency International ranked Uganda 139th out of 168 countries in the 2015 Corruptions Perception Index and in just the 21st percentile in the 2010 Control of Corruption Index. Similarly, Uganda ranked just 123rd out 142 countries in the Global Competitiveness Index (2012-13).

Moreover, the Netherlands has long had a policy of positioning itself as a platform for multinational business. The Dutch willingness to adopt a position of (mostly) tax neutrality for international businesses brings those businesses to the Netherlands, whose government then benefits from taxing the economic activity they generate by paying employees, buying goods and services, etc. Uganda benefits because investors who would either not be willing to invest at all or who would demand a higher return to compensate for the increased risk, are now willing to invest in Uganda.

ActionAid argues that tax treaties are not needed to promote investment, noting that there is US$112 billion of U.S. investment into Brazil in 2014 despite the lack of a U.S.-Brazilian treaty. This anecdote neglects to consider both the attractiveness of Brazil as a market and the dynamics of U.S.-Brazilian investment flows. The correct question is how much would investment change if there were a treaty, not whether there is any investment in the absence of a treaty. Moreover, the reason for the absence of a treaty appears to be due to significant policy differences over a range of issues including intellectual property rights and agricultural trade.

Ignoring accounting and economic reality

The reason there are double tax treaties is that it is often hard to reconcile tax obligations across borders. Indeed, the League of Nations abandoned its first efforts in 1927 on the grounds that “[i]n matters of double taxation in particular, the fiscal systems of various countries are so fundamentally different that it seems at present practically impossible to draft a collective convention, unless it was worded in such general terms as to be of no practical value.”2 Finding such solutions is hard, something that is rarely recognized by critics of international financial transactions.

Indeed, I would have expected ActionAid to be at least somewhat sympathetic to the difficulties in translating economic and accounting realities into formal systems given its own experience. In its Charity Navigator rating based on fiscal 2012 data, it earned a low rating for spending a large amount on administration (23 percent of money raised) and fundraising (23.8 percent). But when an International Business Times report was critical of ActionAid based on that, the agency responded that the percentages were high because it used accrual rather than cash accounting and so multiyear donations were booked when made.3 As a result, some years looked good, and some not so good even if expenditures were similar. Indeed, the current Charity Navigator report shows ActionAid doing much better: just 9.9 percent on administrative expenses and 11.9 percent on fundraising.4 The even more complex accounting issues involved in a multinational business are as easily misrepresented by the type of indicators on which ActionAid relies as this relatively simply impact of the choice of accounting method had on ActionAid.

If we dig in a bit and look at tax treaties’ restrictions on withholding taxes, we can see that ending withholding taxes is not the terrible move for a developing country that ActionAid believes it is. First, it is not a surprise that treaties eliminate or significantly limit withholding taxes. These taxes are often imposed as motivation to persuade other jurisdictions to enter into a treaty. Second, the economic impact of a withholding tax is not as ActionAid seems to believe. If, say, Uganda levied a 30 percent withholding tax on dividend payments to Dutch entities, the result would most likely be that the Dutch entities would either insist on a higher return on their Ugandan investment or forego the investment entirely. The rate of return on capital is the result of market forces evaluating the riskiness of the investment. Imposing a withholding tax on those investments would only cause investors to insist that the recipients of the investment pay more by providing a higher return on their investments.

This is not a theoretical point. When the United States cancelled the tax treaty covering the Netherlands Antilles in the 1980s, it initially did not take this into account and induced panic in bond markets.5 The U.S. had to quickly backtrack on the application of the withholding tax that the treaty cancellation restored to existing bonds. The dynamic impact of a withholding tax on foreign dividend payments from Uganda would thus be to make capital more expensive in Uganda, reducing investment into the country and slowing economic growth.


What the world needs are ways to reduce the cost of investment in developing economies to provide more opportunities for people there to build businesses, not ways to increase that cost. We need more investment in places like Uganda, as well as more competition with governments like Uganda’s, to induce them to serve their people’s needs. Unfortunately, ActionAid’s recommendations would move the world in just the opposite direction.


  1. The spreadsheet is available at http://tinyurl.com/j4c8hvz
  2. League of Nations, Double Taxation and Tax Evasion 8 (1927).
  3. Connor Adams Sheets, Ebola Relief Charities: 5 Aid Groups to Avoid Donating To, International Business Times (Oct. 10, 2014) available at http://tinyurl.com/lxrco6c.
  4. Charity Navigator, http://tinyurl.com/jno2daz.
  5. Craig Boise and I discuss this in Change, Dependency, and Regime Plasticity in Offshore Financial Intermediation: The Saga of the Netherlands Antilles, Texas International Law Journal 45:377 (2009) available at http://tinyurl.com/n8tlkx
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Andrew P. Morriss

Andrew P. Morriss, Chairman, is the D. Paul Jones, Jr. & Charlene Angelich Jones – Compass Bank Endowed Chair of Law at the University of Alabama School of Law. He was formerly the H. Ross & Helen Workman Professor of Law and Business at the University of Illinois,Urbana-Champaign. He received his A.B. from Princeton University, his J.D. and M.Pub.Aff. from the University of Texas at Austin, and his Ph.D. (Economics) from the Massachusetts Institute of Technology. He is a Research Fellow of the N.Y.U. Center for Labor and Employment Law,and a Senior Fellow of the Institute for Energy Research, Washington,D.C., as well as a regular visiting faculty memberat the Universidad Francisco Marroquín,Guatemala. He is the author or coauthor of more than 50 scholarly articles, books, and bookchapters, including Regulation by Litigation (Yale Univ. Press 2008) (with Bruce Yandle and Andrew Dorchak), and is the editor of Offshore Financial Centers and Regulatory Competition (American Enterprise Institute Press 2010).

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