Curbing illicit financial flows key to reaching SDGs in Africa
NAIROBI — Curbing illicit financial flows out of Africa is a vital part of the domestic resource mobilization toward the Sustainable Development Goals, experts at the Pan African Conference on Illicit Financial Flows and Tax said last week in Nairobi.
The continent is estimated to be losing at least $50 billion through illicit financial outflows every year, according to the report of the High-Level Panel on Illicit Financial Flows from Africa established by the United Nations Economic Commission for Africa.
The Addis Ababa Action Agenda, which sets out a strategy to finance the SDGs, included commitments to combat tax evasion and illicit financial flows, or IFFs, through stronger regulation and international cooperation.
IFFs can result from numerous sources and for various reasons, from transnational crime to poor tax laws to corruption. The net effect is to remove resources from the continent, where they are outside the purview of local financial regulators. Funds flow offshore, including through deposits or securities, real estate, businesses, and other assets such as cars, art, and boats.
The majority of losses in Africa come from trade misinvoicing, which is a combination of tax, customs, and trade fraud, Logan Wort, executive secretary of the African Tax Administration Forum, said during a panel discussion. One example is transfer pricing, which is the undervaluing of imports and overvaluing of exports.
While there is broad acceptance of the problem, legal and administrative resources to tackle IFFs are in short supply. Experts at the conference recommended that African nations start by pushing for aggressive tax avoidance to be included in the international definition of IFF. Individual countries can also change laws to reduce tax avoidance and limit tax incentives, develop national strategies for the extractive sector, and scrutinize the flow of capital within government accounts.
Defining IFF and changing laws
There is no international consensus on how to define IFF, said Gamal Ibrahim, chief of the Finance and Private Sector Section at the United Nations Economic Commission for Africa. Among the contested issues is whether to include “aggressive tax avoidance” in the definition.
The United Nations Office on Drugs and Crime and the United Nations Conference on Trade and Development have been hesitant to include tax avoidance. Some other organizations don’t see tax avoidance as significant enough to include. A corporate lobbying campaign has also pushed against inclusion, said Alex Cobham, chief executive of the Tax Justice Network, in speech to the U.N. in May.
In addition to ensuring that an international definition includes tax avoidance, basic changes to domestic law can help countries regain some of the losses, said Wort. The African Tax Administration Forum provides guidance on how to draft legislation to target transfer pricing, for example. It provides governments tips on how to identify transfer pricing risks with intercompany financing and procurement services, among other transactions.
Tax incentives, used to lure in foreign investment or promote exports, are another source of outflows. Investors can incorrectly claim incentives or shift income to firms that qualify for lower taxes, according to the African Tax Administration Forum.
Tax incentives have a high fiscal cost and reduce resources for public spending on development, without providing a boon to investment, said Ibrahim. A 2013 World Bank survey of investors found that over 90 percent of investors in Burundi, Tanzania, Rwanda, and Uganda would have invested even if they hadn’t received fiscal or tax incentives.
Reforming the extractive sector
Extractive industries account for a significant portion of IFFs on the continent. The multi-stage value chain of a commodity offers ample opportunities for aggressive tax avoidance, said Kojo Busia, senior mineral sector governance advisor at UNECA.
For instance, during the exploration phase of mining, smaller companies that survey resources might flip their assets to larger companies that will invest in the actual extraction, but that sale of exploration rights to the larger companies often goes without taxation, said Busia.
In another scenario, mining companies might say that the skills or standards in a host country don’t meet their needs, so they have to import inputs, rather than sourcing locally. The duties that should be paid on these imports are often tax-free, he said.
Experts urged countries to consider drafting robust national strategies that include a framework for how extractive industries operate.
Combatting IFFs is a governance issues, said Aida Opoku-Mensah, senior advisor to the executive secretary on SDGs and Special Initiatives at the UNECA. She urged African nations to more assertively confront the systems that allow multinational entities to funnel funds away from the continent.
“Are we demanding of ourselves the same standards of the companies that siphon of the resources?” she asked the conference audience.
Few policymakers are fully engaged in this conversation, said Ifueko Omoigui-Okauru, commissioner of the Independent Commission for the Reform of International Corporate Taxation. Building their interest could take time, which is why she recommends targeting the next generation of policymakers through educational curriculum in schools at early ages that includes discussing good tax policies, so that these values can be engrained into national values.