Acknowledgment. BAN, is fully responsible for the content of the report, including any omissions or errors.

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2 Acknowledgment This report is based on research undertaken between December 2015 and June 2017 by the Budget Advocacy Network (BAN) with support from the Open Society Initiative for West Africa (OSIWA). The report has been written by the Budget Advocacy Network. Special thanks go to Abu Bakarr Kamara of BAN, Christian B. Hallum, staff of the Open Society Initiative for West African and the Sierra Leone National Revenue Authority Without their support, expertise and repeated comments, this report would not have been possible. BAN, is fully responsible for the content of the report, including any omissions or errors. About Budget Advocacy Network The Budget Advocacy Network (BAN) is a Network of Civil Society Organisations in Sierra Leone committed to work on budgets and budget policies to enhance policy making and implementation for sustainable and equitable development. BAN was established in BAN consists of local and international organizations such as the Christian Aid (CA) Campaign for Good Governance (CGG) Network Movement for Justice and Development (NMJD), Western Area Budget Education Network (WABEAN), Actionaid International Sierra Leone (AASISL), Search for Common Ground (SFCG), and Transparency International (TISL). BAN 2017 Page i

3 Table of Content Acknowledgement..i Table of Content.ii List of Tables iii List of Figures..iii Acronyms..iv Executive Summary Background and context Objectives of the study Structure of the report...5 Section 2: Trends in FDI and Foreign Participation in Sierra Leone Section 2: Trends in FDI and Foreign Participation in the Sierra Leone An overview of the role of multinational activity in Sierra Leone Illicit Financial Flow (IFF) from Sierra Leone...7 Section 3: Sierra Leone tax system and transfer pricing architecture Overview of tax reform measures in Sierra Leone Outcomes of reform measures in tax administration in Sierra Leone Reasons for low revenue collection Overview of transfer pricing architecture in Sierra Leone Overview of the Mining sector in Sierra Leone Section 4: Estimation of magnitude of transfer mispricing in Sierra Leone Methodological approach Computation of revenue loss owing to trade mis-pricing using illicit financial outflows Computation of royalty revenue loss using arm s length comparable uncontrolled price method Development Forgone. 25 Section five: Summary and recommendations 25 References BAN 2017 Page ii

4 List of Tables Table 1: Tax/ revenue concessions granted mining companies in Sierra Leone Table 2: : Duty-free Concession by Category of exemption, 2015 (in LeM). 16 Table 3: Growth in Duty waiver granted between 2014 and Table 4: Estimation of revenue loss due to transfer mis-pricing in Sierra Leone from in millions of US$ Table 5: Estimate of revenue loss from mispricing of minerals 24 List of Figures Figure 1: Trends in FDI in Sierra Leone in millions of US$.. 6 Figure 2: Foreign equity ownership index (100= full foreign ownership allowed)... 7 Figure 3: Illicit Financial Flows from Sierra Leone compared to average IFF from ECOWAS. 8 Figure 4: Trade misinvoicing (outflows) against IFFs from Sierra Leone.. 9 Figure 5: Component of illicit financial outflows in percentage of total illicit financial outflows... 9 Figure 6: Trends in Domestic revenue to GDP ratio.. 10 Figure 7: Sierra Leone revenue GDP compared to other selected countries...11 Figure 8: Trends in Tax-Mix in Sierra Leone. 12 BAN 2017 Page iii

5 Acronyms AEO - African Economic Outlook AML - African Minerals Limited CGT - Capital Gains Tax CWT - Contractor Withholding Tax DTD - Domestic Taxes Department EIU - Extractive Industry Unit FDI - Foreign Direct Investment GDP - Gross Domestic Product GFI - Global Financial Integrity GST - Goods and Services Tax IFF -.Illicit Financial Flows IMF - International Monetary Fund MLA - Mining Lease Agreement MNE - Multinational Entities MNCs - Multinational Corporations OECD - Organisation for Economic Cooperation and Development PCA - Post Clearance Audit BAN 2017 Page iv

6 Executive Summary Over the past decades Multinational Corporations (MNCs) have taken a prominent position in global international businesses. They have expanded beyond their local territories with branches, subsidiaries and stakes across the globe. Whilst transacting with others, it has often become necessary for MNCs to do so with their subsidiaries or part of their vertically integrated chain, either domestically or internationally. The prices set for such transactions are known as the TRANSFER PRICE, determined for tax purposes. It is not transfer pricing that is therefore the problem; it is the potential for transfer price manipulation that governments fear and want to prevent through regulations. By mis-pricing their internal transfers multinational companies can shift profits out of the jurisdictions where their production takes place, to jurisdictions with lower tax rates, leaving little to tax for the country that hosts the company. This study therefore attempts to assess and quantify the domestic revenue that is lost through trade and transfer mis-pricing by MNCs in Sierra Leone. It also identifies institutional and policy changes geared towards addressing transfer pricing practices among MNCs in Sierra Leone. The study takes two broad approaches to provide an estimate of trade and transfer mis-pricing. Firstly, we use the Trade Mis-invoicing Model to estimate tax revenue losses from illicit capital lflight. This model looks at trade mis-pricing, namely the overpricing of imports and underpricing of exports on customs documents, which allow the illegal transfer of money abroad. Secondly, we use the Arm s Length principle to estimate transfer mis-pricing for three main mining products for the periods 2013 and a principle that presupposes that national resources should be sold for not less than the market value. The products include Iron ore, Rutile, and Bauxite. We have used the Comparable Uncontrolled Price (CUP) method to establish whether the declared sales price for these minerals for the purpose of royalty payment, satisfies the Arm s Length principle. The study notes that in addition to the challenges of tax incentives to revenue performance, transfer mis-pricing and other forms of tax avoidance practices remain channels through which Sierra Leone loses huge tax revenue, annually. However, the government transfer pricing rules are largely untested and currently not being implemented to clarify what approach to follow in the implementation of the section dealing with transfer pricing in the Consolidated Income Tax Act Administratively, the revenue administration has no specific unit dealing with transfer pricing issues, and audits of transfer pricing issues are not carried out as part of general audits. Thus, the failure to have in place the commensurate administrative capacity to actively enforce Section 95(1) of the Income Tax Act 2000 has led to revenue loss. BAN 2017 Page 1

7 REVENUE LOSSES It is revealed in the study that the country has seen a strong growth in Foreign Direct Investment in recent years from as low as US$8.62 million in 2003 to as high as US$950.5 million in 2011 before declining to US$225.1 million (in 2012) and US$144.1 million (in 2013). However, this growth in FDI seems to have come with much stronger illicit financial outflows and trade mis-invoicing outflows. It was observed that the average Illicit Financial Flows (IFFs) between 2004 and 2014 more than doubled (i.e2.5 times higher) that of FDI for the same period. The study estimates that an average of US $83.7 million was forgone as corporate tax between 2004 and 2014 through trade mis-invoicing. And with the iron ore production since 2011, revenue loss from such practices actually increased from as low as US$ 14.1 million to US$ million between 2010 and This estimated loss is considered conservative since it does not capture other IFF channels such as thin capitalisation. Specifically, the study also estimates that between 2013 and 2015 a total of US$3.69 million was lost in respect of mis-pricing of iron ore sales, whilst US$1.28 million was lost due to mis-pricing in Bauxite trade for the same period. And for 2015, mis-pricing in Rutile trade resulted in a loss of US$0.773 million in respect of royalty payment. DEVELOPMENT FORGONE The study argues that despite the figures being conservative, the estimates highlight the magnitude and extent of the issue of trade and transfer mis-pricing on the mobilisation of domestic revenue in Sierra Leone. If fiscal authorities had been able to control such a practice, additional revenues would have been collected between 2010 and 2013 (US$ million) to fund over half of the financing gap of US$381 million to 1 implement the five-year education sector plan. Or alternatively, saving this amount would have been sufficient to implement the Health Strengthening Strategic Plan for 2015 with estimated cost of US$ million to implement the five pillars in the 1 plan for In terms of development forgone, US$3.96 million loss in respect of mis-pricing of iron ore is 5 times the cost of procuring text books and teaching and learning materials for all the pre-primary and primary schools in The mis-pricing in bauxite (US$1.28 million) is more than the amount required to construct a water supply system in Tiama Njala (as stated in the 2016 Budget). The mis-pricing in Rutile can improve Mile 91/ Yoni Bana water supply source system hence reducing the challenges citizens in that area are facing to access water. Alternatively, the combined losses can procure new ferries to ply between Freetown and Lungi hence easing the huge challenges citizens are facing to and from the airport town and its environs. RECOMMENDATIONS We recommend that: Civil society should push for the fiscal authorities to require multinational corporations to publicly disclose country reports which should entail their revenues, profits, losses, sales, taxes paid, subsidiaries, and staff levels, as a means of detecting and deterring abusive tax avoidance practices. Development partners should develop the individual and institutional capacity on transfer pricing of the revenue authorities in Sierra Leone. They should support civil society and legislators in their efforts to participate in tax dialogue, to monitor the operations of tax 1 The cost of implementing the Government of Sierra Leone Education Sector Plan (ESP) is Le 4.1 trillion (US$951 million over five years. Of this amount Le1.8 trillion (US$76 million) is required to achieve universal access and quality primary level education over five years. Of the total amount budgeted for the ESP, government has identified a revenue source of US$570.1 million with a funding gap of US$381 million (Education sector Plan ) BAN 2017 Page 2

8 administrators, and to hold government to account for their revenue and expenditure policies. The NRA should create and capacitate a transfer pricing unit within the Domestic Tax Department (DTD). This will require building the audit capacity in specialised sectors such as mining, finance and banking, telecommunications, etc. Efficiently implement the transfer pricing provisions in the Income Tax Act and issue transfer pricing regulations to clarify what approach companies should follow in complying with provisions in the Act. ATAF strongly encourages the strengthening of domestic tax laws and tax policy to expand the Africa tax base against international harmful tax practices and Transfer Pricing practices. In South Africa, the introduction of new a Transfer Pricing Rule in 2012 resulted in a USD 3.2 billion increase in revenue by In Zimbabwe in 2015, changes in the domestic rules and transfer pricing resulted in USD 105 million of tax revenue. The Government of Sierra Leone should boost customs enforcement by providing appropriate training and equipment to better detect the intentional mis-invoicing of trade transactions with support from Development Partners. One particularly important tool for stopping trade mis-invoicing, as it happens, is access to real-time, commodity-level world market pricing information. This would allow customs officials to tell whether a good is significantly underpriced or overpriced in comparison to its prevailing world market normal price. This variance could then trigger an audit or another form of further review for the transaction. To institute a process of verifying the quality and quantity of exports from the major mining sites, particularly that for iron ore, in order to counter trade mis-invoicing. As the price of a ton of iron ore varies significantly depending on quality, it is very important to ensure a fair valuation, otherwise it might be tempting for some exporters to continuously declare lower grade in order to evade taxes. Ensure that fiscal authorities are able to actively participate in the G20 and OECDendorsed global movement toward the automatic exchange of financial information (i.e. Global Forum on Transparency and Exchange of Information for Tax Purposes) with support from development partners. This will require technical assistance in data management and use. As an entry point, the African Tax Administration Forum (ATAF) has developed a practical manual providing guidance on how African countries can implement effective exchange of information, which fiscal authorities in Sierra Leone can benefit from given that the country is a member of ATAF. Make country-by-country reporting public, thereby ensuring that the National Revenue Authority, civil society and other stakeholders get access to relevant information which can expose risks of profit shifting. Ensure that an intergovernmental body on taxation is established under the auspice of the UN to lead on reforming international taxation.this will give the Government of Sierra Leone a seat at the table instead of the current situation where the OECD leads on international taxation. BAN 2017 Page 3

9 1.0 Background and context For over a decade, Sierra Leone s domestic revenue as a percentage of Gross Domestic 2 Product (GDP) - averaging 10.9 percent - has continued to remain below the average of 15 percent for Sub-Saharan Africa (SSA). Low revenue performance implies less resources available to be spent for development without direct donor involvement. Two studies on Sierra Leone, (Budget Advocacy Network 2013) and (Jibao, 2014), have shown that tax incentives granted to specific taxpayer groups through targeted tax deductions, credits, exclusions and tax holidays are responsible for such relatively low revenue-to-gdp ratio. The findings from BAN (2013) confirm that revenue loss from customs duty and Goods and Services Tax (GST) exemptions amounted to US$224 million (8.3% of GDP) in In addition, estimated annual average loss over a three year ( ) period was US$199 million. The analysis further projected an annual average revenue loss of US$131 million in the form of corporate income tax incentive granted to mining companies from 2014 to In addition to the challenges of tax incentives to revenue performance, transfer mis-pricing and other forms of tax avoidance practices remain channels through which developing countries lose huge tax revenue annually. Over the past decade Multinational Corporations (MNCs) have taken a prominent position in global international businesses. They have expanded their businesses beyond their local territories with branches, subsidiaries and stakes in businesses across the globe. Whilst transacting businesses with others, it has often become necessary for MNCs to do so with their subsidiary or part of their vertically integrated chain, either domestically or internationally. The prices set for such transactions are referred to as the transfer price determined for tax purposes. There are both internal and external motivations for MNCs to establish transfer prices for intra-firm trade in goods, business services and/or intangibles, which have been well established in the Literature. Many foreign affiliates are run as profit centres [Eden (2010)]; as a result, the rewards of the top management team in these affiliates depend on their affiliates profits. The setting of transfer pricing can therefore be internally driven, as a way to both motivate managers and monitor subsidiary performance. Externally, MNCs have to pay corporate income taxes on their domestic and foreign source income, necessitating that they set transfer prices for cross-border trade flows. Customs authorities also require transfer prices for intra-firm imports of parts, components and finished goods, either for customs duties or rules of origin purposes. Transfer mis-pricing, as distinct from transfer pricing, is the over- or underinvoicing of related party transactions in order to avoid government regulations (e.g. under-invoicing to avoid paying the Goods and Services Tax or to exploit cross-border differences in these rates - for example, shifting deductible expense to the high tax location and revenues to the low tax location in order to reduce overall corporate tax payments). In the extractive industry, mispricing can occur in the form of understating the value of minerals sold to related parties or independent intermediaries. Such practice in the extractives industry would lead to potential reduction in Royalties (where linked to transaction value; Corporate Income tax; Excess Profit Tax; and Withholding Tax). For instance, Sierra Minerals - the only bauxite company - has a 20-year agreement to sell 90% of its bauxite to its owner Alum SA refinery registered in Romania and China. The bauxite is purchased by an aluminium company registered in the British Virgin Islands (a country regarded as a Tax Haven), affiliated with the parent company (Alexandra 2015). Whilst this report is not making an accusation that Sierra Minerals BAN 2017 Page 4

10 is engaged in transfer mis-pricing, it nevertheless notes that such an arrangement risks underinvoicing given that the local company is selling to a related party that is registered in a country with a very low corporate tax rate. It is not transfer pricing that is therefore the problem; it is the potential for transfer price manipulation that governments fear and want to prevent through regulations. The risk of transfer mis-pricing is likely to increase as multinationals become more active in the country particularly through subsidiaries. The dominant role of multinationals in Sierra Leone over the past decade makes the country vulnerable to transfer pricing manipulation. However, issues relating to Illicit Financial Flows 2 (IFFS) especially trade mis-pricing have not received much attention in the country, thus Budget Advocacy Network and partners have commissioned this study to understand the magnitude, nature and direction of transfer and trade mis-pricing in Sierra Leone. 1.1 Objectives of the study Specifically, the study attempts to: Determine the revenue that is lost to transfer and trade mis-pricing practices and weigh it against benefits brought by the lured investors and the development forgone; Assess transfer mis-pricing governance, financing and politics/policies; Review Sierra Leone s transfer mis-pricing Patterns and Architecture; Establish the various modes of transfer mispricing being used by the MNEs; Provide information, using pictograms and the latest data available, on the breakdown of available transfer mis-pricing and patterns in Sierra Leone; Provide recommendations necessary for developing an advocacy strategy that will guide a coalition of CSOs working on tax in their lobbying and advocacy work in Sierra Leone. 1.2 Structure of the report Following the background and context is an overview of the importance of multinational activity in Sierra Leone over the past five years - i.e. trends in FDI in Sierra Leone, foreign participation authorised in different sectors, exports and imports. The next section assesses the tax system as well as the main drivers of transfer mis-pricing in Sierra Leone. The legislative framework to curb the practice is also discussed in this section. This is followed by an assessment of capacity and resources of the National Revenue Authority (NRA) to understand and implement transfer-pricing rules. Another section estimates the magnitude of transfer mis-pricing. The final section recommends and concludes. Section 2: Trends in FDI and Foreign Participation in Sierra Leone 2.1 An overview of the role of multinational activity in Sierra Leone Foreign Direct Investment (FDI), it has been argued, is very relevant in boosting the development agenda of developing countries. Proponents of the FDI-development nexus argue that Multinational Corporations (MNC) and their affiliates have over the years helped create millions of jobs, transferred technology, upgraded skills, fostered competition, and contributed to the fiscal standing of many economies. 2 Illicit financial flows are different from capital flight, a term that includes both licit and illicit capital. Licit capital flight is recorded and tracked, significantly lowering the probability that it has a corrupt or criminal source. In contrast, IFFs are by nature unrecorded, and cannot be used as public funds or private investment capital in their country of origin. The vast majority of illicit financial outflows is due to trade mis-invoicing (see Global Financial Integrity Report, 2014). BAN 2017 Page 5

11 Through capital spillovers, FDI has encouraged the adoption of new production technologies; and foreign investment has also helped break up cozy local oligopolies and cartels (World Bank, 2010). Critics of FDI however argue that its impacts are often limited and in some cases detrimental owing to the consequences of crowding out local competition, enclave production with limited forward and backward linkages, and race to the bottom effects often related to labour and environmental issues (World Bank 2010). Whilst it is beyond the scope of this study to analyse in detail the pros and cons of FDI, it is noted that the dominant role of multinationals in developing economies makes the region mostly vulnerable to transfer pricing manipulation. 3 In Sierra Leone the importance of FDI has grown over the years from as low as US$8.62 million in 2003 to as high as US$950.5 million in 2011 before declining to US$225.1 million in 2012 and US$144.1 million in But it started increasing again in 2014 (Figure 1). Year-on-year since 2008 FDI doubled and between 2010 and 2011 it actually quadrupled. In terms of GDP, the net FDI increased from 3.1% in 2003 to a high 38.7% and 32.9% in 2011 and 2012 respectively before declining sharply to 12.9% and 5.8% in 2013 and 2014 respectively (IMF, 2014). When compared to total FDI in the Economic Community of West African States (ECOWAS), Sierra Leone's share of FDI also increased from as low as 0.2% in 2003 to 4.7% in 2011 before plummeting to 1.3% and 1.0% in 2012 and 2013 respectively; its shares however increased to 3.1% in The significant growth of FDI in 2011 is due to the massive injection of foreign funds by the African Mineral Limited resulting from the Iron 4 Ore renaissance. A policy granting full foreign ownership of business entities has been used by most developing countries as a strategy to attract FDI and foreign subsidiaries in their respective countries. However, such a policy increases the risk of transfer mis-pricing as it allows multinationals to control their subsidiaries to the same extent as their equity proportion (total control), compared to situations where government is a key stakeholder of the company. Figure 1: Trends in FDI in Sierra Leone in millions of US$ Source: UNCTAD stat, The study does not however conclude categorically that an increased activity of MNCs immediately leads to increased transfer mispricing, but argues that such dominance of MNCs could pose a risk of transfer which requires policy makers to strike the right balance between FDI and tax losses. 4 With the rebirth of Iron ore in 2011, the country realized a huge inward investment as well as the significant rail and port infrastructure investment to support the operation of the project, via its subsidiary African Rail and Port Services (SL) Ltd. BAN 2017 Page 6

12 In Sierra Leone, the Investment Promotion Act (2004) provides for equal treatment of foreign and domestic investors with respect to ownership of local companies. Sierra Leone allows a large percentage of foreign ownership across multiple sectors (see Figure 2). Overt statutory ownership restrictions are imposed on only a small number of industries. As at 2010, foreign capital participation was prohibited in the air and sea port operation sectors, in particular, as these facilities were owned and operated directly by the government through the Ministry of 5 Transport and Aviation. Since 100 percent of net profits can be repatriated, full foreign ownership in key sectors (mining, telecommunications etc.) may be facilitating resource drain from the country. 2.2 Illicit Financial Flow (IFF) from Sierra Leone The United Nations adopted the Sustainable Development Goals (SDGs) in September 2015, which includes, in Goal 16.4, a target that countries will by 2030, significantly reduce illicit financial and arms flows, strengthen the recovery and return of stolen assets and combat all forms of organised crime. This statement, coupled with that seen in the Addis Action Figure 2: Foreign equity ownership index (100 = full foreign ownership allowed) 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 100% 75% 100% 100% 100% 100% 100% Agenda, underscores the international community s recognition of the severity of the illicit flows challenge and its embrace of efforts to tackle illicit flows in order to promote development and vigorous societies [ Kar and Spanjers (2015)]. Illicit Financial Flows is defined in the Global Financial Integrity (GFI) report as illegal 6 movements of money or capital from one country to another. GFI classifies such flows as illicit if the funds crossing borders are illegally earned, transferred, and/or utilised. If the flow breaks a law at any point, it is illicit (Kar and Spanjers, 2015). Report on illicit financial flows commissioned by the African Union/Economic Commission for Africa conference of Ministers of Finance, Planning and Development in 2012 estimates that currently Africa is losing US$50 billion annually in IFF; and it is estimated that Africa needs an additional $30 $50 billion annually to fund infrastructure projects (Foster and Briceno-Garmendia (2010) in AU/ECA 2015). In Sierra Leone, IFFs in cumulative terms amounted to US$1.58 billion between 2003 and 2014 with an unweighted annual average of US$558 million for the same period. 80% 100% 100% 100% Source: World Bank The port is now privatized and a private company Bollore, a foreign firm now owns capital in the port operation. 6 These funds typically originate from three sources: commercial tax evasion, trade misinvoicing and abusive transfer pricing; criminal activities, including the drug trade, human trafficking, illegal arms dealing, and smuggling of contraband; and bribery and theft by corrupt government officials. BAN 2017 Page 7

13 Figure 3 shows that Sierra Leone s IFF has been fluctuating; it decreased from US$152 million in 2003 to US$94 million in 2004; increased continuously to US$309 million and US$891 million in 2005 and 2006 respectively before dropping sharply again to US$45 million in Sierra Leone recorded its highest ever IFF in 2009 and 2010 with an IFF of US$1.915 billion and US$1.791 billion slightly below ECOWAS average of US$1.939 billion and US$1.980 billion respectively. It was observed from this study that for Sierra Leone, there is a strong positive correlation between FDI and IFF with an estimated correlation coefficient of 0.68 (r=68) 7 between 2004 and More importantly, the average IFFs between 2004 and 2014 more than doubled (i.e.2.5 times higher) that of FDI for the same period. GFI measures illicit financial outflows using two sources, namely, deliberate trade mis-invoicing (gross excluding reversals or GER) and leakages in the balance of payments (hot money narrow or HMN). Trade mis-invoicing (outflows) is the primary measurable means for shifting funds out of developing countries illicitly (Kar and Spanjer 2015). 8 In the case of Sierra Leone, on average trade mis-invoicing (outflows) had accounted for about 95.7% of IFFs whilst leakages in the balance of payment accounted for the remaining 4.3%. Figure 4 depicts that since 2004 a greater 9 portion of illicit financial outflows from Sierra Leone is due to trade mis-invoicing.with regards the component of IFFs, Figure 5 depicts that about 94% of trade mis-invoicing outflow between 2004 and 2014 was due to import overinvoicing in Sierra Leone, whilst the share of hot money narrow to IFFs is 4% and only 2% is 10 accounted for by export under invoicing. Figure 3: Illicit Financial Flows from Sierra Leone compared to average IFF from ECOWAS Source: Kar and Spanjers computation (2015) 7 The correlation result shows that there is co-movement between FDI and IFF in Sierra Leone and this relationship is significant at 5% level of significance. 8 Illicit capital flight amounts to stealing from already poor countries. illicit flows have a negative impact on the countries development efforts: the most serious consequences are the loss of investment capital and revenue that could have been used to finance development programmes, the undermining of State institutions and a weakening of the rule of law ( Ministerial statement issued after the meeting of the ECA Conference of African Ministers of Finance, Planning and Economic Development in March 2014 in Abuja. BAN 2017 Page 8

14 Figure 4: Trade misinvoicing (outflows) against IFFs from Sierra Leone Source: Kar and Spanjer s computation (2015) Figure 5: Component of illicit financial outflows in percentage of total illicit financial outflows Section 3: Sierra Leone tax system and transfer pricing architecture 3.1 Overview of tax reform measures in Sierra Leone One major administrative reform that took place in the Sierra Leone tax system was the creation 9 10 of a semi-autonomous revenue administration. Following an in-depth study on the hitherto revenue generating departments of the Income Tax and the Customs & Excise a semiautonomous revenue administration called the National Revenue Authority (NRA) was created in 2002 by an Act of Parliament. This Act mandated the NRA to collect both direct and Both export under-invoicing and import over-invoicing lead to an understatement of corporate profits. Whilst the former undervalues export sales the latter raises import costs, lowering corporate profit whilst shifting a significant portion abroad. There may be an added incentive to over-invoice imports in Sierra Leone as import duty for most MNCs are exempt from both import duty and GST, and much lower for raw materials and other production inputs. Note that under invoicing accounts for about 95% of total trade mis-invoicing inflows in Sierra Leone between 2004 whilst the remaining 5% is due to export over invoicing. BAN 2017 Page 9

15 indirect tax revenues. Following this creation, a modernisation reform programme which came through recommendations by a 2004 IMF Fiscal Affairs Department Mission began. Since the modernisation of revenue administration initiative was recommended and embraced by fiscal authorities in the country, several programmes have been implemented. Reforms have ranged from the formation of the Non-Tax Revenue department (NTR) in 2004, the introduction of Taxpayer Identification Numbers (TINs) in 2009, the launching of the Automated System for Customs Data (ASYCUDA++) and the implementation of the Goods and Services Tax (GST) in 2010, establishment of the Domestic Tax Department (DTD) in early 2011 and Post Clearance Audit Unit (PCA) 11 in 2011, the introduction of the Domestic Tax Information System (DTIS) in 2013, introduction of small and medium term regime in the same year (2013), and the establishment of Figure 6: Trends in Domestic revenue to GDP ratio the Extractive Industries Revenue Unit (EIRU) in Outcomes of reform measures in tax administration in Sierra Leone The trends in domestic revenue to GDP resulting from major reform measures 23 undertaken by the National Revenue Authority in Sierra Leone are shown in Figure 6. Figure 6 shows that in the first few years of the formation of the Revenue Authority, revenue collection surged from a low 7% of GDP prior NRA to peak at 12.0% in 2003, but subsequently declined to about 10.1% in It gradually increased to 10.7% in 2009 before remission again to 9.3% in This scenario is not uncommon as experience from other countries that have implemented administrative reforms Source: National Revenue Authority Revenue Report This unit is meant to serve as a fiscal safety net and to reduce intrusive examinations through risk audit based approach. In principle, this task is performed on all persons/companies involved in the accomplishment of customs formalities (import & export). The exercise is done to ascertain the correctness and completeness of all declarations and to further assess compliance with laid down Customs laws and regulations. As a trade facilitation tool, the PCA is anchored on a comprehensive annual audit plan. 12 Domestic Revenue defined as tax and non-tax public revenues excluding grant BAN 2017 Page 10

16 similar to those introduced in Sierra Leone in 2002 show similar trend. Recognising this trend, fiscal authorities in Sierra Leone embarked on conscious efforts to continuously deepen the reforms whilst at the same time consolidating the earlier successes through further expansions in the revenue base and modernisation of the operations of the authority to avoid the risk of a relapse into inefficiencies, corrupt practices and complacency on the part of the champions of the reform. With that, domestic revenue to GDP increased steadily to a high 12.5% in 2013 but declined to 10.6% and 10.1% in 2014 and 2015 respectively, owing to the twin shock of the Ebola outbreak and a drop in global commodity prices in the same period. The drop in commodity prices resulted in the administration of two major mining companies African Minerals Limited and London Mining. Figure 6 further indicates that at 10.1% in 2015 Sierra Leone tax-to-gdp ratio is far below the tax-to-gdp ratio of low income countries average of 15%, and lower than most countries in Africa (see Figure 7). In terms of tax mix, Figure 8 also depicts that since 2010 revenue from income, profit and capital gains has increased steadily whilst the share of customs and other import duties to total domestic revenue has declined. Revenues from mining royalties and licenses increased steadily between 2011 and 2013 but slightly declined in 2014 and 2015 due to the drop in commodity prices; domestic indirect taxes, especially from GST/VAT, have also shown an increased share since Thus, in terms of tax mix, it is observed that the importance of direct taxes has grown over the years and now accounts for an average 42% of domestic revenue collection. However, revenue forgone through relatively high level of both legal and illegal revenue 13 concessions and exemptions and trade mispricing (outflows) has the potential to erode the strength of domestic taxes in the country. Figure 7: Sierra Leone revenue GDP compared to other selected countries Source: IMF, Fourth Review (2015) 13 It is understood that this has developed through to a desire to attract investors to Sierra Leone, but many decisions have been made without a proper analysis of the benefits versus costs of granting such concessions. BAN 2017 Page 11

17 Figure 8: Trends in Tax-Mix in Sierra Leone Source: MRP/National Revenue Authority Revenue Reports ( ) Reasons for low revenue collection Tax Incentives and duty free concessions One major reason for such relatively low revenue-to-gdp ratio is the tax incentives granted to specific taxpayer groups through 14 targeted tax deductions, credits, exclusions and tax holidays in the tax system of Sierra Leone. Sierra Leone provides investment and mining companies with numerous arrays of tax incentives. These tax incentives, either provided through tax laws, any other law or any administrative order or agreement (called by Table 1: Tax/ revenue concessions granted mining companies in Sierra Leone whatever name), that allow special exclusion, exemption, or deduction from the tax base or which provide special credit, preferential rates of tax or a deferral of tax liability that includes tax holidays, duty exemptions, exemptions from royalty, etc. have revenue implications. In addition, the system under which these tax incentives are provided in Sierra Leone to mining companies is on a case-to-case basis without any unified approach or any broad policy framework and uniform legal basis (See Table 1). Revenue Handled General Legislation African Minerals Limited 2010 Koidu Holdings Limited 2010 Lease Rent US$500,000 As in law US$200,000 in 2011 & adjusted annually by 3% (USD XXX in 2014 London Mining Company Limited 2012 Sierra Minerals Holding Limited 2012 Sierra Rutile 2002 (& 2004 Amendment) As in law As in law US$400 in 1989 & adjusted annually by 5% (USD XXX in 2014 Tonguma Limited 2012 As in law 14 Sierra Leone is the world third producer of iron ore, also rich in Diamonds, Titanium Ore (Rutile), Illumenite, Bauxite, Gold, Manganese, Cocoa, Coffee, Fish, Ginger. Also has rich agricultural soil for the production of sugar and ethanol operates numerous large scale mines. BAN 2017 Page 12

18 Revenue Handled General Legislation African Minerals Limited 2010 Koidu Holdings Limited 2010 London Mining Company Limited 2012 Sierra Minerals Holding Limited 2012 Sierra Rutile 2002 (& 2004 Amendment) Tonguma Limited 2012 Royalty Precious stones (inc. special stones) 6.5%; precious metals 5%; Other minerals 3% As in law Precious stones (excl. special stones) 6.5%; Special stones 8% As in law As in law 0.5% through 2014; 3.5/4% from 2015 Precious stones (excl. special stones) 6.5%; Special stones 8% Corporate Income Tax (CIT) 30% 25% 35% or as in law if lower Years %; Years %; Year 11 onwards 30% or as in law if lower As in law Exempt through 2014; 37.5% or as in law if lower from % Resource Rent Tax Capital Allowance SL As in law As in law As in law As in law As in law As in law Loss Carry Forward 10 years from start of production As in law Unlimited Years limited such that tax is not less than 15% of tax due if no loss carry forward; No carry forward thereafter As in law Unlimited As in law BAN 2017 Page 13

19 Revenue Handled General Legislation African Minerals Limited 2010 Koidu Holdings Limited 2010 London Mining Company Limited 2012 Sierra Minerals Holding Limited 2012 Sierra Rutile 2002 (& 2004 Amendment) Tonguma Limited 2012 Turnover Tax 3.5% if chargeable income is below 7% of turnover (and no acceptable audited account is submitted) Exempt Exempt Exempt Exempt 0.5% through 2014; 3.5% from 2015 Exempt Contractor Withholding Tax (CWT) Residents 5%; Non-residents 10% Exempt As in law Years 1-6-5%; Years %; As in law thereafter Exempt Exempt Years %; As in law thereafter Dividend Withholding Tax (DWT) 10% 5% As in law Years 1-6-5%; Years %; As in law thereafter Exempt Exempt through 2014; 10% from 2015 Years 1-7 of production - 5%; Years As in law thereafter Interest Withholding Tax (IWT) 15% Exempt As in law Years 1-5-5%; Years %; As in law thereafter Exempt Exempt through 2014; 10% from 2015 As in law Management Fees Withholding Tax (MWT) Residents 5%; Non-residents 10% 5% Exempt Years 1-6-5%; Years %; As in law thereafter Exempt 10% Years 1-7-5%; Years As in law thereafter Duties & Taxes on Capital Imports Variables rates but minimum of 5% Exempt 5% or as in law if lower Years 1-8-1%; Years %; As in law thereafter As in law Exempt through 2014; 5% from % or as in law if lower Duties & Taxes on Other Imports Variables rates but minimum duty of 5% & GST of 15% Exempt 5% or as in law if lower Years % of prevailing rate; As in law thereafter As in law Exempt through 2014; 5% from 2015 As in law BAN 2017 Page 14

20 Surface Rent Community Development Fund Not specified to be agreed between company and landowners 0.1% of gross revenue Not specified agreed by mutual consent (xxx in 2014) Not specified agreed by mutual consent (xxx in 2014) Not specified agreed by mutual consent (xxx in 2014) Not specified agreed by mutual consent (xxx in 2014) Not specified agreed by mutual consent (xxx in 2014) Not specified agreed by mutual consent (xxx in 2014) As in law 0.25% 1% 1% 0.1% 0.25% Source: Tax Policy Unit of the Ministry of Finance and Economic Development database 2015 What is more worrisome is the fact that currently there is also no formal structure in place to monitor the potential benefits of tax incentives granted to businesses such as job creation, skills, technology transfer, etc. Besides, since these incentives, particularly those granted to mining companies, are granted on individual basis, not a uniformed legal basis 15 and broad policy framework, decisions to grant these incentives could favour one set of investments or concessionaires over the others. This, however, violates the efficiency criteria for any tax system requiring it to be neutral; create neither major distortions in consumption and production. More importantly most of the agreements, especially those benefiting the 16 mining and commercial agricultural companies, were never made public until recently agreements widely believed to contain some fiscal stabilisation clauses. Transparency can improve accountability and answerability in various ways. At the country level, the public disclosure of revenue statistics and budgets can help build accountability for taxes paid and public services delivered. At the international level, greater transparency can help to address issues such as misuse of transfer pricing, financial reporting by Multinational Enterprises and tax evasion. Encouraging transparency in exemptions and tax incentives (for instance, exemptions on aid-funded goods or tax holidays for Multinational Enterprises) is consistent with encouraging debate on tax simplification objectives and efforts to reduce discretionary decision making (OECD, 2012). In Sierra Leone a Revenue Management Bill was drafted and meant to be enacted since 2011, but progress has stagnant. This bill requires the government to publish a statement of its tax expenditure, detailing all tax exemptions, the beneficiaries and the revenue forgone. It also commits the Minister of Finance and Economic Development to review all tax expenditures and ensure that they meet the objectives of the budget, including revenue mobilisation. Furthermore, the Government of Sierra Leone committed itself in the Open Government Partnership National Action Plan ( ) to publish all tax incentives granted twice during the year. However, no progress has been made 15 The Ministry of Finance and Economic Development has since 2014 developed a Handbook on investment incentive guidelines and duty waiver procedures. The handbook summarises all investment incentives and import duty concessions that are provided for in current legislation, Income Tax Act 2000 (as amended), the Finance Acts 2010 and international conventions to which Sierra Leone is a signatory. 16 In the most recent past Sierra Leone has published the mining agreements for the five biggest mining operators in the country. BAN 2017 Page 15

21 so far in adhering to this commitment. Import duty and GST concessions Excessive granting of duty waivers continues to undermine revenue generation in Sierra Leone. Table 2 shows that import duty and GST waived for the Fiscal Year 2015 amounted to Le375.9 billion from Le372.3 billion in 2014 representing a one percent increase. This amount represents 69% and 17% of the total revenue reported by Customs Services Department (CSD) and NRA respectively. Of this total duty waived, import duty accounted for Le180.3billion (representing 48%) as against Le195.5 billion import GST (representing 52%). Of importance is the fact that duty waiver 17 categorised as others continues to increase significantly. Table 3 depicts that duty waiver granted this category increased by 38% between 2014 and However, owing to the decline in mining operation in the same period, duty waiver granted mining companies reduced by 87%. Table 2: Duty-free Concession by Category of exemption, 2015 (in LeM) Organisations Type of Tax Amount Waived Total Embassies Import Duty 7,487 12,574 Import GST 5,087 Public Int. Organisation Import Duty 39,776 80,618 Import GST 40,842 Non Governmental. Organisation Import Duty 13,598 30,834 Import GST 17,236 Mining/Expl. Co Import Duty 7,318 12,331 Import GST 5,013 Others Import Duty 112, ,543 Import GST 127,387 Grand Total Import Duty 180, ,906 Import GST 195,570 Source: MRP/NRA draft annual report The Others category which comprises constructions companies, MDAs, Private Sector and other beneficiaries alarmingly increased by 38% from Le173.3 billion in 2014 to billion in This category has been one of the major beneficiaries of duty free concession accounting for 47% and 64% of total duty waiver in 2014 and 2015 respectively. BAN 2017 Page 16

22 Table 3: Growth in Duty waiver granted between 2014 and 2015 Organisation Variance % Variance 372, ,905 3,617 1 Embassies 9,564 12,574 3, Public Int. Org 71,501 80,619 9, Non Govt Org 19,911 30,837 10, Mining/Expl. Co 98,008 12,333 (85,675) (87) Others 173, ,542 66, Informal Economy Another challenge facing revenue administration in Sierra Leone is the high level of participants in the informal sector. Workers and companies operating outside the reach of the law or tax administration are a major obstacle to broadening the tax base and collecting income taxes. In Sierra Leone, the informal sector is estimated to account for 42.9% of GDP (Elgin and Oztunali, 2012), slightly higher than that of sub-saharan Africa average of 40 percent. Taxation of the informal sector may be labour intensive but could drive broader governance objectives by linking more people and traders to the state. Interviews with officials in the Domestic Taxes Department of the NRA indicate that taxing this sector is a way of building a culture of tax compliance among SMEs. One main opposition to the taxation of the informal economy, however, is sometimes raised on equity grounds, as the operators of informal sector firms are frequently low-income, thus making taxation of such firms potentially regressive. And the concerns are exacerbated if efforts to tax this sector also increase the risk of relatively coercive or corrupt behaviour by tax officials. (Joshi, Prichard and Heady ). Weak Capacity of revenue authority Furthermore, weak capacity generally characterised by poor governance is identified as one of major factors underlying low revenue uptake in Sierra Leone. Whilst published data was not available on staff numbers and competencies, 19 weak capacity gap - such as inadequate skilled staff, inadequate Information Technology infrastructure, inadequate knowledge and expertise in transfer pricing issues, etc. - was identified by senior officials of the Domestic Taxes Department of NRA to have undermined the potential of the revenue administration to correctly ascertain the actual declared profit of companies. Exacerbating this capacity problem is the influence of globalisation which has seen the impact of borders decline due to the establishment of Multi-National Enterprises (MNEs). The huge foreign investment in Sierra Leone of 19 The NRA through the MRP Department has conducted a comprehensive Skills Audit on its Employees in Final report is pending review and comment from different departments within the authority (NRA draft annual report 2015). BAN 2017 Page 17

23 US$1.58 billion between 2004 and 2014 due particularly to the influx of mining companies has come with challenges of transfer pricing and thin capitalisation (see next section for estimation of magnitude of transfer mis-pricing). Such trend does put more pressure on the existing limited capacity of tax administrators and policy makers generally in Sierra Leone. Thus, what is needed now in the Sierra Leone Revenue administration is not to push for more taxation, rather to push for better taxation. Such efforts hold the potential to stimulate further growth and investment whilst also allowing for increased levels of tax collection. 3.2 Overview of transfer pricing architecture in Sierra Leone The ability of tax administrations to identify and address transfer pricing risks is highly dependent on the existence of commensurate legislation and sufficient expertise backed up with adequate capacity within the revenue administration. Sierra Leone has basic provisions in place 19 dealing with transfer pricing in Section 95 (1) of the Consolidated Income Tax Act 2000 (as amended). The Mines and Minerals Act reinforces the transfer pricing provision in the Consolidated Income Tax Act The Mining Lease Agreements (MLA) do also make provision for arm s length, though vary by mining companies. For instance, the previous MLA with African Minerals Limited (AML), now Shandong Company, requires royalties to be calculated consistent with the market value; the former agreement with London Mining goes further to specify that the market value shall be the sale value receivable by LMC in an arm s length transaction, free on board (FOB). The MLA with Sierra Minerals also specifically referenced the OECD Transfer Pricing Guidelines as a basis for calculating the arm s length price on transactions with affiliates (Readhead, 2015). Despite these provisions in the different pieces of legislation and agreements, the country does not have in place appropriate and functional 21 transfer pricing documentation rules and until the enactment of the Finance Act 2016 the country had no rules or regulations requesting MNCs to submit the following documents that could aid transfer pricing implementation: The method used to determine the transfer price and the reasons for its selection; The application of the method including the calculations made and price adjustment factors considered; The global organisational structure of the enterprise; Details of the transactions under consideration; The assumptions, strategies and policies applied in selecting the method and; such other background information as may be necessary regarding the transaction. Annual disclosure requirements for relatedparty transactions; Effective documentation requirements with penalty and/or burden of proof for transfer pricing The section states that in any transaction between taxpayers who are associates, the Commissioner may distribute, apportion or allocate assessable income, deductions or credits between the taxpayers as is necessary in an arm s length transaction. Section 154 of Mines and Minerals Act 2009 states that where a mineral rights holder are to sell mineral products to their affiliates this must be done according to the arm s length price that they would otherwise get if the parties had not been affiliated. This requirement applies only to holders of large scale mining license. The Finance Act 2016, has however, sets out basic documentation requirements for MNC to follow, repealing sections 95 of the ITA Modalities to enforce the implementation of these documents requirements are yet to be put in place. BAN 2017 Page 18

24 ATAF strongly encourages the strengthening of domestic tax laws and tax policy to expand the Africa tax base against international harmful tax practices and Transfer Pricing practices. In South Africa, the introduction of new Transfer Pricing rule in 2012 resulted in a USD 3.2 billion increase in revenue by In Zimbabwe in 2015, changes in the domestic rules and transfer pricing resulted in USD 105 million of tax revenue. Other domestic revenue gains that resulted from adjustment to tax policy and laws include Uganda (USD 423 Million) and Rwanda (more than USD 400 Administratively, the revenue administration has no specific unit dealing with transfer pricing issues, and audits of such issues are not carried out as part of general audits. Added to the lack of unit to handle transfer pricing issues, a lack of transfer pricing expertise is also identified as one of the reasons for the non-implementation of transfer pricing rules set out in the different pieces of legislation. Currently the Field Audit Unit and the newly formed Extractive Industry Revenue Unit (EIRU) manage transfer pricing issues but their capacities need to be enhanced. Furthermore, the level of coordination between the EIRU that reports directly to the Commissioner General and the Field Audit which reports to the Commissioner of Domestic Tax Department needs to be enhanced and strengthened also. The PCA unit established in the Customs Services Department has however made some gains with regards to fighting trade misinvoicing (inflows). A total of 123 audits were 22 completed as against a target of 120 audits for the 2015 fiscal year (exceeding its target by 2.5%). The audit exercise recovered revenue to 23 the tune of Le 1.5 Billion. The amount of monies recovered in 2015 was largely from penalties for misclassifications, variation in historical values, under assessment, and wrong freight among others (NRA draft Annual Report 2015). With regards domestic taxes audit, the audit team was only able to complete 48.5% of the audit for the Small Medium Taxpayers, whilst 53.7% of general audit planned for Large Taxpayers was completed in The exchange of information on transfer pricing issues is critical but remains a challenge for developing countries. This is mainly due to limited access to existing tax information between tax authorities. Sierra Leone is yet to become a member of the OECD s Global Forum on Transparency and Exchange of Information 24 for Tax Purposes. Clearly the capacity challenge within the revenue administration, particularly the manual nature in which information is kept in Sierra Leone revenue administration, undermines their potential membership to such 25 exchange of information arrangement. 22 There are no indications however about any mechanism put in place at the NRA to curb trade mis-invoicing outflows, which is very critical in the determination of appropriate taxable income of firms in the country, is one main channel through which profit is shifted out of the country. Section 154 of Mines and Minerals Act 2009 states that where a mineral rights holder are to sell mineral products to their affiliates this must be done according to the arm s length price that they would otherwise get if the parties had not been affiliated. This requirement applies only to holders of large scale mining license. 23 In 2014, a total of 106 audits were completed as against 180 audits set as target (a shortfall of 74), with a revenue of Le 2.7 billion recovered. 24 Within ECOWAS only four countries Burkina Faso, Liberia, Nigeria, and Senegal are members of the OECD s Global Forum on Transparency and Exchange of Information for tax purposes. 25 International tax cooperation is based upon reciprocity, requiring tax administrations to have robust information systems. BAN 2017 Page 19

25 3.3 Overview of the Mining sector in Sierra Leone Sierra Leone recorded double-digit GDP growth rates of 15.2% and 20.1% in 2012 and 2013 respectively. This impressive growth 26 was largely driven by iron ore mining, agriculture, construction activities and an expanding services sector (AEO country report, 2015). Whilst 27 agriculture - which includes forestry, fishing and hunting - continued to account for more than half of GDP in 2014, its relative weight has been declining (50.5%) in 2014, down from 58.2% in 2009) indicating a structural shift towards mining and quarrying (20.2% in 2014 up from 3% in 2009). Manufacturing accounted for mere 1.6% of GDP in 2014, largely unchanged since 2009 (AEO, 2015). In terms of its revenue contribution, the mining sector increased from a low 1% of total domestic revenue in 2007 to a high 10.6% in 2013 (or 1.4% of GDP) but slightly declined to 9.0% of total domestic revenue in 2014 due to the decline in the world market prices for commodities. Owing to the massive concessional rates and tax holiday granted some MNCs the country relies mostly on royalties to generate revenue from the major mining companies. 28 Legislative-wise, the volume of laws and regulations adopted by Sierra Leone over the past few years in relation to its mining sector is fairly extensive. This reflects a trend of government in developing economies to develop a more detailed and comprehensive legal framework for their extractive industries, often on the basis of laws and regulations adopted in more developed economies (Alix, 2015). Over the past decade Sierra Leone has adopted a number of laws and regulations which include 29 the following: In 2003 the Government of Sierra Leone with support from UK Department for International Development and World Bank, issued a Core Minerals Policy with 10 strategic objectives, including attracting private investments and ensuring Sierra Leone s wealth supports national economic and social development. In 2004 the Investment Promotion Act was passed, aimed at giving foreign investors a number of guarantees in terms of expropriations, transfer of funds and dispute resolution. And in 2006, the country joined the Extractives Industries Transparency Initiative (EITI); In 2008, the Environment Protection Agency Act was passed. This act provides that mining projects can only be undertaken following the preparation and approval of an environmental impact assessment and the issuance of an environmental impact assessment license; In 2009, a new Mineral and Mines Act replaced the 1994 Act which among other major changes includes mandating mines title holders to deliver to tax authorities certified copies of all sales, management, commercial and other financial agreements of fifty thousand United States Dollars or equivalent concluded with any other person, including 30 affiliates. 26 African Minerals started production on its Tonkolili iron-ore project in the north in quarter four, This sector is largely exempt from taxation, thus do not form a taxable base of the country African Minerals Limited, Koidu Holdings Ltd., London Mining, Sierra Minerals Holding, Sierra Leone Rutile Ltd and Tonguma Limited (see Table 1). See Alix Y Mining in Sierra Leone: an overview of the current legal framework- online article. 30 Mechanism to enforcement such disclosure cause in the ACT is yet to be formulated and aplied by the Revenue Authority. BAN 2017 Page 20

26 In 2014 all mining concessions were uploaded on a government website for public use. Added to the aforementioned, it is worth stating that more recently the Government has been developing a new core minerals policy expected to be completed by end of The Government, with support from donors, has also finalised a Benchmarking Report on the extractive sector using Natural Resource Charter framework. Section 4: Estimation of magnitude of trade and transfer mispricing in Sierra Leone 4.1 Methodological approach Owing to the paucity of data, and the secrecy surrounding the operation of mining companies, as well as the non-availability of comparable transaction data, it is difficult to estimate transfer mis-pricing using the input method. However, in 31 this study we used two broad approaches to provide an estimate of trade and transfer mispricing. Firstly, we used the trade mis-invoicing model to estimate tax revenue losses from illicit capital flight. The trade mis-invoicing model looks at trade mis-pricing, namely the overpricing of imports and underpricing of exports on customs documents, which allows the illegal transfer of money abroad. Data for the computation is collected from the Global Financial Integrity report (2015). The revenue losses due to trade mispricing are computed in this study using aggregate figures reported in the GFI, and based on the following assumptions: The non-dutiable import accounts for an unweighted average of 64.9% of total imports in Sierra Leone between 2011 and (SSL2013) and such trend is expected to be similar in 2014 and It is also assumed that these categories of imports are mostly inputs and equipment meant to promote investment, and therefore mostly deductible in computation of profit for corporate tax purposes. Thus it is assumed in this report that 64.9% of trade mispricing is due to transactions of companies and businesses granted duty and GST concessions. Companies paying import duty and GST have no incentive to over-invoice import and therefore could not engage in import over-invoicing. That the only incentive for companies to over-invoice their import is that it can increase their costs and therefore shrink taxable profit. Most or all of these profits are shifted to other tax jurisdictions with lower corporate tax rate. Thus all income saved from import over-invoicing would be taxed at the concessional corporate income tax (CIT) rate of 25% given most of the major mining companies are taxed at concessional corporate rate of 25% since We do however note that Sierra Rutile Company was granted corporate tax exemption from 2002 through 2014 (see table 2). Trade mis-pricing conservatively makes up 33 about 60% of IFFs making for possible errors in GFI that could arise due to missing data for some years covered in the report. In Sierra Leone, data from GFI indicates that trade mis-invoicing accounts for 95.7% of IFFs and import over-invoicing accounts for 94% of trade mis-invoicing (See Figure 5). 31 Estimating the extent of shift of profit from Sierra Leone to possible tax havens thereby lowering corporate revenue is difficult because of paucity of data on the volume of transaction (input purchases) of mining companies in Sierra Leone with other related subsidiaries companies registered in tax heavens. 32 See Foreign Trade Statistics Bulletin-2013 produced by the Economic Statistics Division of Statistics Sierra Leone. 33 UNECA, Third Meeting of the Committee on Governance and Popular Participation. BAN 2017 Page 21

27 4.2 Computation of revenue loss owing to trade mis-pricing using illicit financial outflows Using the aforementioned assumptions Table 4 depicts that total illicit financial outflows from Sierra Leone between 2004 and 2014 ranged from US$94 million to US$ billion and that illicit financial flows from trade mis-pricing alone range from US$56.4 million to US$1.149 billion in the same period. The average total illicit financial flows for the period amounted to US$558 million and the average US$334.8 million for the same period. These figures are already high 34 but are likely to be grossly underestimated. Tax revenue loss from trade mis-pricing is computed on the assumption that if IFFs stemming from trade mis-pricing were retained in Sierra Leone and duly declared to tax authorities, they would be taxed at the concessional corporate income tax (CIT) rate of 25%. With that, an unweighted annual average of US$83.7 million was lost as corporate tax between 2004 and 2014, and with the mining boom since 2010 revenue loss from such practices actually increased from as low as US$14.1 million to US$ million between 2010 and As stated earlier, this estimated loss is considered conservative since it does not capture other methods of tax avoidance which MNCs can use to limit their tax payment such 35 as thin capitalisation. 35 Despite the figures being conservative, the estimates highlight the magnitude and extent of the transfer mis-pricing issue on the mobilisation of domestic revenue in Sierra Leone. If fiscal authorities had been able to control such practice, additional revenues would have been collected between 2010 and 2013 (US$ million) to fund over half of the financing gap of US$381 million to implement the five-year education sector plan. 36 Or alternatively, saving this amount would have been sufficient to implement the Health Strengthening Strategic Plan for 2015 with estimated cost of US$ million to implement the five pillars in the plan for Global Financial Integrity records the figures for some years as zero, due to a lack of data which affects the average. For instance, 2009 and 2012 were recorded as zero due to data non-availability. Thin capitalization refers to securing debt financing through a holding company located in a low-tax jurisdiction. Specifically, the subsidiary in the high tax-jurisdiction borrows from the holding company and gets to subtract the interest paid to the holding company from its profits (ATAF, transfer Pricing in the Extractive Industry: a taxing exercise for Sub-Saharan Africa, 2014). The cost of implementing the Government of Sierra Leone Education Sector Plan (ESP) is Le 4.1 trillion (US$951 million over five years. Of this amount Le1.8 trillion (US$76 million) is required to achieve universal access and quality primary level education over five years. Of the total amount budgeted for the ESP, government has identified a revenue source of US$570.1 million with a funding gap of US$381 million (Education sector Plan ). The five pillars are: Patient and health worker safety with estimated cost of US9.08 million; Health Workforce (US$32.50 million); Essential Health Services (US$63.04 million); Community Ownership (US$8.64 million); and Information and Surveillance (US$13.77) given a total of US$ million for BAN 2017 Page 22

28 Table 4: Estimation of revenue loss due to trade mis-pricing in Sierra Leone from in millions of US$ IFFS (in millions of US$) Mispricing (60% of IFFS) Revenue loss (25% of pricing value Average from Minimum Maximum Average from (Commodity boom) Source: author s computation using data from GFI report Computation of royalty revenue loss using arm s length Comparable Uncontrolled Price Method We also used the arm s length principle to estimate transfer mispricing for three main mining products for the periods 2013 and The products include: Iron ore, Rutile, Bauxite and Diamond. We have used the comparable uncontrolled price (CUP) method to establish whether the declared sales price for these 38 minerals for the purpose of royalty payment satisfies the arm s length principle. We focused on royalty because data on intra-company transaction is not available to assess corporate tax loss for specific 39 company. Issue of access to comparable prices is a challenge when using the Arm s Principle, thus for this study we have used the fair market price 40 from international data (Mundi index database) 41 to benchmark the declared price for royalty The Comparable Uncontrolled Price ( CUP ) method compares the price charged for property or services transferred in a controlled transaction to the price charged for property or services transferred in a comparable uncontrolled transaction in comparable circumstances. Under the ALP approach, transactions between group companies are compared with transactions between unrelated companies under comparable circumstances. Where there is no comparable transactions, an alternative comparism maybe made with unrelated companies that perform similar functions, own similar assets and bear similar risks. We do note that such databases provide a very imprecise pool of financial data for comparability purposes. It is also acknowledged that such databases as do exist currently provide very limited financial data on companies operating exclusively or primarily in individual developing countries, including countries in much of Africa, Eastern Europe and South America. This is largely because of the limited number of sizeable independent companies, the absence of a requirement for the public registration of statutory accounts or difficulties in obtaining access to statutory accounts where there is a public registry for statutory accounts. We note that product comparability is key; in this case we shall endeavor to factor-in the grade or quality of export of minerals to both related and unrelated parties from Sierra Leone. BAN 2017 Page 23