Why Africa’s economic development is bringing tax and trade issues to focus

The continent beckons, teeming with fresh free trade agreements and green projects, but take steps to ensure consistent transfer pricing.

In brief

• Eager to stimulate sustainable growth, the continent is implementing a wide range of structural changes.
• Fast-evolving African Continental Free Trade Area is a major step toward a single-market, promising fewer restrictions and enables greater scale in operations.
• In terms of taxation, companies operating on an Africa-wide basis will similarly need to examine their transfer pricing to ensure fairness and consistency.

As Africa undergoes rapid social and economic change, Larry Eyinla of EY provides an overview of the trade, tax and sustainability developments in the region, and the opportunities and challenges for business investors, in the latest article of the IN FOCUS series.

Africa is undergoing rapid social and economic change, starting with the continent working to formalize an Africa-wide free trade agreement, which has the potential to be the largest free trade area in the world. African nations are also actively shifting their economies away from reliance on extractable commodities toward a broader goods and services orientation which includes telecoms, media and financial services.

A youthful energy is another factor—three quarters of Africa’s residents are currently age 35 or younger, with the World Economic Forum projecting 40% of the world’s births will be African by 2050. Following the same timeline, Africa’s urban population is expected to triple by 2050, with smart cities being planned, and under development. 

It is not just social and economic change that Africa is embracing, but also environmental. By some measures, Africa is attracting more than twice its share of global green investment. The continent is changing. According to EY Africa Tax Leader, Larry Eyinla, “Economic opportunities in Africa are clear and any investments will require close attention from corporate tax team.”

Continental Trade: Poised to Grow  

One key development in the region is the arrival of the African Continental Free Trade Area (AfCFTA). Launched in 2018 with trade phasedowns commencing Jan. 1, 2021, the pact aims at accelerating intra-African trade and boosting Africa’s trading position in the global market by strengthening Africa’s common voice and policy space in global trade negotiations. The deal also aims to bring 30 million people out of poverty, raise the incomes of 68 million individuals and cut red tape 

Prior to the AfCFTA, businesses intending to operate across the continent needed to navigate a patchwork of eight different trade pacts, including the Common Market for Eastern and Southern Africa (COMESA—21 countries), the Southern African Development Community (SADC—16 countries), and the Economic Community of West African States (ECOWAS—15 countries).

AfCTFA promises to break through such barriers to create an Africa-wide free trade zone. As its key provisions take hold, AfCTFA will:

• Eliminate multiple and overlapping regional economic community memberships (112 total “memberships” out of 55 nations).
• Aid in harmonization of trade and tax policies.
• Create a single continental market.

Initially forming the basis of a free trade zone, AfCTFA’s ultimate aim is to progress into a political federation—as per the African Union Agenda 2063 —achieving the highest level of customs and economic integration. Of Africa’s 55 nations, all except for Eritrea have signed on to the pact in principle. Meanwhile, 43 of these 54 nations have ratified the deal, meaning they are ready for trade once legal formalities are concluded. Currently, there are a number of negotiation rounds left, and it is anticipated the agreement will be fully operational in early 2023.   

What Will These Developments Mean for Business?

This will enable profound change. Being able to treat Africa as a single market should deliver enormous economies of scale. However, at the same time this means large companies should carefully examine their footprint to make decisions about rationalization of their supply chain. For example, a large multinational enterprise may today be operating with one plant in Southern Africa, with other plants in West Africa and North Africa, sites chosen in each case to benefit from prior regional trade agreements. As AfCTFA fully takes shape, these businesses may be able to consolidate operations to service African markets more efficiently.

Rationalization will require rigorous analysis of product lines, supply chains and production. Businesses will need to look closely not only at customs duty rates but also rules of origin. They will also need to carefully review classifications of goods as categorized under a series of six-to-eight-digit tariff headings.

An additional complicating factor is that in each country there are plans for customs duties to be phased in over time. For this process, each country is classifying their goods into three buckets, A, B and C:

• Product in bucket A: duties will be phased in over five to 10 years starting immediately
• Product in bucket B: after a delay in start-up, duties will be phased in over 10 years
• Product in bucket C: duties will be phased in over 15 years—or not at all

In short, rationalization is coming, and companies should understand the potential impact, and act if required.  By closely examining how AfCTFA differs from prior regimes, companies can not only operate more efficiently than before, they also may be able to identify a wide range of additional market opportunities across Africa.

It should be noted that envisaged benefits will take time and effort to fully evolve.  On a country administration level, the AfCFTA will face challenges, including differing levels of development and varying economic and political aspirations among the 43 nations who have ratified the agreement. Instances of protectionism could continue in some cases to impede free trade in goods and services.

Furthermore, Non-Tariff Barriers, such as import bans, quotas, employment law, can continue to be a challenge even where integration is more firmly established such as with a customs union and common markets. Certain African nations continue to rely on customs duties for a large portion of their revenue collection: such duties will ultimately be expected to be phased out for most products. However, it is believed that there might be an offset when any reduction on import duties begins to boost trade.  These nations will then be able to increase collections from other domestic taxes, including value-added tax and sales taxes, excise duty, corporate tax, employment taxes and other consumption and income taxes.

A Shift to Sustainability

Another significant development across Africa is the shift away from extractives, with their deep carbon footprints, toward greater sustainability. One of the continent’s most developed economies, South Africa, has already announced a shift toward renewables with a pledge to reach net zero by 2050. In fact, the entire continent is reorienting toward a greener future. Every nation in Africa has submitted their “Nationally Determined Contributions” plans (NDCs) to the United Nations. NDCs are national plans for climate change mitigation, including greenhouse gas emissions reduction.  

In addition, foreign direct investment patterns are signaling a shift, with a significantly greater number of projects and investment flowing to the services and manufacturing sector than to the traditionally dominant extractive sector. The continent is also currently receiving approximately 6% of global green funding twice the region’s contribution to global GDP (3.0%). This trend toward rising investments in services, technology and infrastructure is encouraging, because it provides a promising path to sustainable job creation.

From the tax perspective, South Africa implemented a carbon tax in 2019 and Senegal, Nigeria and Côte d’Ivoire are looking at the same. A global study of nature-based carbon solutions found that of the top 10 nations pursuing such an approach, three are located in the African continent. It’s clear the green movement is well underway across Africa, which means the region can play a key role in any global business’s net-zero planning.

Tax Issues Remain

While the economic opportunities are clear, any investments in Africa will require close attention from corporate tax teams. Tax teams will need to continue to proactively address transfer pricing (TP) approaches to better manage potential controversy. The way commerce is evolving in the region, significant differences are appearing in TP treatment for service-oriented businesses versus brick-and-mortar enterprises.

Service-based businesses should be focusing on: 

• The taxation of digital transactions. Authorities in the region are moving toward digital services taxes—as well as e-taxation.
• Greater information sharing. Multilateral and bilateral treaties, along with vastly improving communications, mean revenue authorities are doing more to share information with one another—making it essential for consistent TP policies.
• Management services or technical services fees. Management, technical, and other similar fees will be subject to intense scrutiny across the region.

Providers of physical goods will need to focus on:

• BEPS 2.0. Though the continent is not yet moving in this area, particularly as pertains to Pillar Two, it will be important to follow TP approaches in the region that are consistent with global justifications and practices.
• Compliance. With audits being a frequent and potentially complex reality in the region, companies should consider obtaining opinions in advance. Advance pricing agreements (APAs) are becoming more common and should be considered for the most significant tax risks. Eleven countries on the African continent today offer APAs or similar instruments—eight of these in Sub-Saharan Africa. While some of the APA regimes are still in implementation stages, in general, the path toward APA opportunities should be seen as a positive development.  Companies should also take care to ensure their customs valuations align with those used in TP.
• Sustainability. As such businesses purchase new instruments such as carbon offsets, they need to provide input to policymakers as to how these costs can be accounted for in TP approaches.

A Region of Opportunity

There is a clear commitment to building the business infrastructure that can fuel a future of growth for Africa. As governments in the region deliver on key priorities, more capital will consequently flow. Questions remain for investors; for example, how quickly can developments such as the AfFCTA and related reforms deliver potential benefits for businesses? But taken together, the developments signal opportunity.

The views reflected in this article are the views of the author and do not necessarily reflect the views of the global EY organization or its member firms.

Reproduced with permission. First published on 23 June 2022.  Copyright 2022 The Bureau of National Affairs, Inc. (800-372-1033) Bloomberg Industry Group