/ 27 November 2015

Tighten legal looting loopholes

Out of the tax loop: Coca-Cola holds R33-billion in undistributed income offshore that is not taxed.
Out of the tax loop: Coca-Cola holds R33-billion in undistributed income offshore that is not taxed.

One trillion dollars. It’s a number that’s almost impossible to hold in your brain. Yet that’s what global illicit financial flows (IFFs) are estimated to amount to, every year.

What would it mean to countries, especially those struggling to raise quality of life for large poor populations, if we could rein in IFFs? Could we, for example, bring the dream of realising the sustainable development goals a little closer?

These much-vaunted and talked-of goals, the successors to the millennium development goals, aimed at reducing poverty and improving quality of life across the world, will cost trillions of dollars to implement. And then you have a trillion dollars a year (and climbing) being lost to economies that really need it. 

If you could tighten up on these vanished funds, “not every penny would stay in the economies, of course — only a certain percent would remain to be churned through the economy,” says Tom Cardamone, managing director of Global Financial Integrity (GFI), a Washington DC-based research and advisory organisation working to curtail illicit financial flows.

What are IFFs? “We define illicit financial flows as any money that is illegally earned, used or moved and which crosses an international border,” says Cardamone. 

In a September press release, GFI noted that its analysis showed that between 2003 and 2012 the global volume of IFFs grew by more than 9% annually. And $1-trillion is a conservative estimate; it may be much more than that.

Much of this is perpetrated by fine upstanding multinationals and other legal entities. 

“The data sets we use don’t allow us to determine how much is criminal in nature,” Cardamone says, but about three-quarters of this flow is related to trade fraud — companies moving money through shell companies, for example, or engaging in the common practice of trade misinvoicing — the deliberate over-invoicing of imports or under-invoicing of exports to avoid paying tax or levies. 

“This is extremely corrosive to efforts to build economies and end poverty,” which are some of the goals at the heart of the sustainable development goals, says Cardamone. 

“IFFs are funds that are not being put into social programmes such as health and education that can help people.” 

Illicit financial flows affect every country in the world, and GFI’s work shows that, even in countries where the level is relatively low, the effect “on the economy can be severe”.

Number 16

Getting access to these shadowy funds to tackle the sustainable development goals would bring them closer to realisation. There is one goal, number 16, which could be used as leverage against IFFs. The aim of 16.4 is: “By 2030, significantly reduce illicit financial and arms flows, strengthen the recovery and return of stolen assets and combat all forms of organised crime.”

Pascal Saint-Amans, director at the Centre for Tax Policy and Administration at the Organisation for Economic Co-operation and Development, spoke to the Mail & Guardian about one instrument that may help in this fight — the OECD/G20 Base Erosion and Profit Shifting (Beps) Project. 

“Beps refers to tax planning strategies that exploit gaps and mismatches in tax rules to make profits ‘disappear’ for tax purposes or to artificially shift profits to locations where there is little or no real activity,” says Saint-Amans. 

“The aim of the measures developed under the Beps project is chiefly to realign taxation with economic substance and value creation and ensure that corporate profits are reported for tax purposes where the activities that generate them are carried out.”

A story just published on 100 Reporters (100r.org) illustrates this point. South African financial researcher and writer Khadija Sharife notes that Coca-Cola has “$33-billion in undistributed income held ‘offshore’ by Coca-Cola, a United States incorporated entity, with as much as $11.5-billion in avoided tax, based on the 35% US tax rate (less any taxes owed to other governments such as India, Mexico, South Africa and so on). Though the funds are held ‘offshore’, this is only a legal technicality: formal repatriation of funds would trigger tax activity in the US. But in practice, the funds are already circulating.” 

The funds, in other words, are held in US banks and the company can get access to them; they haven’t been taxed because they are not formally there. 

South African traction

Saint-Amans says Beps has gained “important traction at the political level: the South Africa government has actively participated in the Beps project and contributed to the final shape of the Beps measures, the Davis tax committee has issued reports on Beps, analysing the project from a South Africa perspective and I understand there have been a number of discussions in Parliament regarding the interactions between Beps and tax policy reform”.

Although Beps focuses largely on legal tax planning, other work by the OECD and the OECD Global Forum on Transparency and the Exchange of Information is focused on combating offshore tax fraud and other economic crimes. “The global Common Reporting Standard for the automatic exchange of tax information is now becoming reality and will provide a step-change in countries’ ability to tackle and deter cross-border tax evasion,” says Saint-Amans. 

“Automatic exchange of information will begin by 2017 or end-2018, subject to the completion of necessary legislative procedures. Similarly, sharing information internally among different agencies involved in fighting economic crimes may prove a very helpful tool to identify and combat illicit financial flows.”

Trade mispricing

Cardamone homes in on shared information too. “Trade mispricing, for example, can be addressed in the customs department,” he says. “If developing countries utilised a global trade pricing database, it would be possible to compare invoiced prices with global average prices for that commodity or product. If it falls outside the normal range, the goods can be investigated. The customs officials could even open the container to see what’s being shipped.” 

The result? “Asset recovery will become less important — you’re not chasing it once it’s gone, you’re stopping it before it leaves,” he says.

Things have to be tightened up on the demand side as well, he adds. 

Country by country reporting by multinationals will show whether proper tax has been paid in the country where it was earned, which the automatic exchange of tax information would tackle.

Another tool commonly used by tax evaders, crooks and terrorists to launder money — anonymous shell companies — must be addressed through a beneficial ownership registry that gives information about the owner, names, the address and company name. 

This must, Cardamone says, be implemented universally. “That level of secrecy is a buffer between the company and law enforcement and, in many instances, a case will go cold simply because law enforcement cannot track the company owners down and follow up.”

Curbing actual criminal activities such as trafficking will be more demanding, of course, but simply tightening up on what is, really, basic governance could help the countries of the world find a lot of missing money that could be put to good work for everyone.

A G20 project aims to control illicit financial flows

Pascal Saint-Amans, director at the Centre for Tax Policy and Administration at the Organisation for Economic Co-operation and Development (OECD), explains the base erosion and profit shifting (Beps) project: “At the G20 finance ministers meeting on October 8 in Lima and at the G20 leaders meeting in Antalya on November 15 and 16, ministers and heads of states endorsed the package of measures developed under the Beps project. 

“They also urged a rapid, widespread and consistent implementation of these measures and requested the OECD to prepare a proposal for an inclusive framework by early 2016 in which all countries will participate on an equal footing. We are already seeing the practical effect of some of the measures, even before implementation, in terms of taxpayers’ behaviours. Beps measures make aggressive planning an unattractive proposition and many multinationals have understood that and are adjusting their structures. 

“The next step is ensuring widespread and consistent implementation. The OECD and G20 countries have extended their co-operation on Beps until 2020 to ensure an efficient and targeted monitoring of the measures and to carry out follow-up work at the technical level. 

“In terms of the tools for the implementation of the different measures, this obviously depends on the country’s legal system. In general terms, some of the measures may be immediately applicable, such as the revised guidance on transfer pricing, while others require changes in domestic laws and in bilateral tax treaties. To speed up the implementation of the treaty changes, we are developing a multilateral instrument that will enable them to amend their network of bilateral tax treaties in an effective and efficient manner. 

“Finally, we are designing a proposal for an inclusive framework to monitor and support implementation of Beps outputs, with all interested countries and jurisdictions participating on an equal footing.” 

This article forms part of an M&G partnership with the Southern Africa Trust to highlight issues of poverty in the region