LARGE CORPORATES BEHIND ILLICIT FINANCIAL FLOWS

LARGE CORPORATES BEHIND ILLICIT FINANCIAL FLOWS

Blue chip corporate organizations are at the heart of corrupt practices in Africa and are the biggest culprits in perpetuating illicit outflows followed by organized crime syndicates, a joint research by the African Union Commission and the United Nations Economic Commission has found.

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Blue chip corporate organizations are at the heart of corrupt practices in Africa and are the biggest culprits in perpetuating illicit outflows followed by organized crime syndicates, a joint research by the African Union Commission and the United Nations Economic Commission has found.

Through Illicit Financial Flows (IFF), the report says, Africa loses more than $50 billion annually, 13 percent of which is attributed to Southern Africa (Botswana included), West, North, Eastern and Central Africa account for 38 percent, 28 percent, 11 percent and 10 percent respectively.

IFF according to the Report, is money that is illegally earned, transferred or utilized. The funds typically originate from three sources: commercial tax evasion, trade mis-invoicing 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.

The Report details the fraudulent routes that big firms use to avoid tax or illicitly move funds from the jurisdiction of their taxman. Corporate entities, notes the report, commonly use base erosion and profit shifting. Base erosion and profit shifting refers to tax planning strategies that exploit gaps and mismatches in tax rules and legislation to make profits disappear for tax purposes or to shift profits to locations where there is little or no real activity but taxes are low resulting in little or no overall corporate tax paid.
“Africa must strongly call for an automatic exchange of tax information globally, subject to national capacity and to maintaining the confidentiality of price-sensitive business information,” recommends the Report in order to improve access to information to multinationals corporations. It further argues for an automatic exchange of tax information among Africans countries.

False invoicing: The practice of declaring the value of goods imported or exported to evade custom duties and taxes, circumvent quotas or launder money is another identified problem area. The value of goods exported is often understated or the value of goods imported is often overstated and the proceeds are shifted illicitly overseas. Most estimates of trade based illicit financial flows focus on this mechanism.

Trade mis-invoicing, which is the act of misrepresenting the price or quantity of imports or exports in order to hide or accumulate money in other jurisdictions is motivated the report reveals, in order to evade taxes, avoid customs duties, and transfer a kick back or launder money.

Transfer pricing: is the pricing of transactions occurring between related companies, in particular companies within the same multinationals group. “Governments set rules to determine how transfer pricing should be undertaken for tax purposes (since for example the level of transfer pricing affects the taxable profits of the different branches or subsidiaries of the firm), predominantly based on the arm’s length principle.” Arm’s length principle is an international standard that compares the transfer prices charges between related entities with the price in similar transactions carried out between independent entities at arm’s length. Much of the debate of tax motivated IFFs revolve around the shortcoming and the way in which they are abused for tax evasion and tax avoidance.

The Report says a transfer price may be manipulated to shift profits from one jurisdiction to another, usually from a higher tax to a lower jurisdiction. “This is a well-known source of IFF, although not all forms of transfer pricing abuse that results in IFF rely on manipulating the price of the transaction.” The report advises that national and multilateral agencies to make fully and freely available and in timely manner, data on pricing of goods and services in international transactions, according to accepted coding categories. “African countries should establish transfer pricing units as a matter of extreme urgency. These units should be appropriate situated in revenue authorities and should be well equipped in accordance with global best practices.
Trade based money laundering is a technique where trade mispricing is used to hide or disguise income generated from illegal activity.

Hawala transactions: Hawala is an informal system of money transfer between entities in different countries. Brokers use handshake deals and or agreements with counterparts in other countries to move money without physically transferring funds (especially across borders) or using bank transfers. Often extremely difficult to monitor, Hawala transactions are used primarily in the Middle East, East Africa and South Asia.

Secrecy jurisdiction: Secrecy jurisdiction are cities, states or countries whose laws allow banking or financial information to be kept private under all or all but few circumstances. Such jurisdiction may create a legal structure specifically for the use by non-residents. The originators of illicit financial flows may need to prevent the authorities in the country of origin from identifying them (e.g. the money is the proceeds of tax evasion, in which the flow will be directed to a secrecy jurisdiction). Because those directing IFFs seek out low taxes and secrecy, the reports says many tax havens are also secrecy jurisdictions, but the concepts are not identical.

Tax havens are jurisdictions whose legal regime is exploited by nonresidentials to avoid or evade taxes. A tax haven usually has low or zero tax rates on accounts held or transactions by foreign persons or corruptions, accordion to the report. “This is in combination with one or more other factors, including the lack of effective exchange of tax information with other countries, lack of transparency in the tax system and no requirement to have substantial activities in the jurisdiction to qualify for tax residence.” Tax havens are said to be the main channel for laundering the proceeds of tax evasion and routing funds to avoid taxes.

Shell bank: this is a bank without a physical presence or employees in the jurisdiction in which it is incorporated.

Tax avoidance: The legal practice of seeking to minimize a tax bill by taking advantage of a loophole or exception to tax regulations or adopting an unintended interpretation of the tax code. The Report says such practices can be prevented through statutory anti-avoidance rules: where such rules do not exist or are not effective, tax avoidance can be a major components of IFFs.