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Africa: Fraudulent Trade & Tax Evasion
AfricaFocus Bulletin
May 26, 2014 (140526)
(Reposted from sources cited below)
Editor's Note
"The fraudulent misinvoicing of trade is hampering economic growth
and potentially resulting in billions of U.S. dollars in lost tax
revenue in Ghana, Kenya, Mozambique, Tanzania, and Uganda, according
to a new report by Global Financial Integrity (GFI), a Washington DC-
based research and advocacy organization. The study -- funded by the
Ministry of Foreign Affairs of Denmark -- finds that the over- and
under-invoicing of trade transactions facilitated at least US$60.8
billion in illicit financial flows into or out of the five African
countries between 2002 and 2011."
This report is particularly significant in that it addresses the
major source of illicit financial flows as estimated in previous
reports by GFI and others. Unlike direct corruption through bribes to
a customs official or other government official, or money-laundering
through direct deposits in tax havens, trade misinvoicing is built
into the trade system itself. The sums, as estimated by GFI for these
five countries, represent huge losses in taxes to both African
countries and their trading partners.
Notably, the illicit financial flows due to trade misinvoicing
included flows both out of and into the country, allowing multiple
forms of tax invasion for both buyers and sellers, and depriving
governments of tax revenue both in Africa and in other countries. The
ultimate destination and ownership of the missing funds retained by
those involved in these transactions is unclear, and much of it could
end up in tax havens in third countries.
The system is complex, but promoting greater transparency and control
is essential for development in Africa, and for governments
everywhere to have the resources to meet essential public needs.
Governments in rich countries as well as in Africa are increasingly
aware that transparency, particularly about the real ownership of
shell companies and the real value of trade, is essential to the
sustainability of government services.
This AfricaFocus Bulletin includes brief excerpts from the tax
release on the report released by GFI and from the report, as well as
a short article by GFI staffer Brian Leblanc. The full press release,
report, and other background are available on the GFI website
(http://www.gfintegrity.org).
For a YouTube video with a very clear presentations of the general
issue of illicit financial flows by Raymond Baker of Global Financial
Integrity, visit https://www.youtube.com/watch?v=VzCQJWkK6z0
The key African network focusing on these issues is Tax Justice
Network Africa (http://www.taxjusticeafrica.net/). You can sign up
for their listserv, which contains relevant updates as well as
coverage in the African press, at https://groups.google.com/forum/#!forum/afritax
For an overview, see the special issue of ACAS Bulletin "Africa's
Capital Losses: What is to be Done?" at
http://concernedafricascholars.org/bulletin/issue87/
For previous AfricaFocus Bulletins on illicit financial flows and
related issues, visit http://www.africafocus.org/debtexp.php
For previous AfricaFocus Bulletins on trade, visit
http://www.africafocus.org/tradexp.php
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African Countries Lose Billions through Misinvoiced Trade
Fraudulent Trade Transactions Channeled at Least US$60.8 Billion
Illegally in or out of 5 African Countries from 2002-2011
Tax Loss from Trade Misinvoicing Potentially at 12.7% of Uganda's
Total Government Revenue, followed by Ghana (11.0%), Mozambique
(10.4%), Kenya (8.3%), & Tanzania (7.4%)
Global Financial Integrity
http://www.gfintegrity.org
[Global Financial Integrity (GFI) is a Washington, DC-based research
and advocacy organization, which promotes transparency in the
international financial system as a means to global development.]
May 12, 2014
Copenhagen, Denmark / Washington, DC - The fraudulent misinvoicing of
trade is hampering economic growth and potentially resulting in
billions of U.S. dollars in lost tax revenue in Ghana, Kenya,
Mozambique, Tanzania, and Uganda, according to a new report by Global
Financial Integrity (GFI), a Washington DC-based research and
advocacy organization. The study -- funded by the Ministry of Foreign
Affairs of Denmark -- finds that the over- and under-invoicing of
trade transactions facilitated at least US$60.8 billion in illicit
financial flows into or out of the five African countries between
2002 and 2011.
"It is deeply disconcerting that illicit financial flows are taking
such a serious toll on the economies of Ghana, Kenya, Mozambique,
Tanzania, and Uganda," noted Mogens Jensen, Danish Minister for Trade
and Development Cooperation. "Denmark has for several years supported
Ghana, Kenya, Mozambique, Tanzania, and Uganda in fighting poverty
and promoting economic growth and job creation. These efforts are
clearly at risk of being undermined by fraudulent trade transactions
which rob the people of these countries of funds that could otherwise
have been used for investments in infrastructure, schools, hospitals,
and other much needed public services. I hope that the study can help
the governments in their efforts to curb illicit financial flows."
"Trade misinvoicing is stymieing economic growth and likely
decimating government revenues in these countries," said GFI
President Raymond Baker, a longtime authority on financial crime.
"The consequences are simply devastating. The capital drained from
trade misinvoicing means that local businesses in Uganda and Tanzania
have less money to grow their companies and hire more workers. The
potential revenue loss from trade misinvoicing means that Ghana has
less money to spend on healthcare, Kenya has less money to devote to
education, and Mozambique has less money to invest in infrastructure.
Trade misinvoicing is perhaps the most serious economic issue
plaguing these countries."
Titled "Hiding in Plain Sight: Trade Misinvoicing and the Impact of
Revenue Loss in Ghana, Kenya, Mozambique, Tanzania, and Uganda:
2002-2011," the study estimates that, collectively, trade
misinvoicing may have cost the taxpayers of these five African
nations US$14.39 billion in lost revenue over the decade. The
potential average annual tax loss from trade misinvoicing amounted to
roughly 12.7% of Uganda's total government revenue over the years
2002-2011, followed by Ghana (11.0%), Mozambique (10.4%), Kenya
(8.3%), and Tanzania (7.4%).1
Authored by a team of GFI experts, the analysis reviews the
components and drivers of trade misinvoicing in Ghana, Kenya,
Mozambique, Tanzania, and Uganda, it estimates the potential impact
on tax revenue for each government, it analyzes the policy
environment in each country, and it provides general policy
recommendations as well as specific suggestions tailored to the
circumstances in each nation.
Policy Recommendations
Based around two themes -- greater transparency in domestic and
international financial transactions, and greater cooperation between
developed and developing country governments to shut down the
channels through which illicit money flows -- the report recommends a
number of steps that can be taken by these five countries to
ameliorate the problem of illicit flows of money into and out of the
country. Among other steps, GFI recommends that:
- Governments should significantly boost their customs enforcement,
by equipping and training officers to better detect intentional
misinvoicing of trade transactions;
- Trade transactions involving tax haven jurisdictions should be
treated with the highest level of scrutiny by customs, tax, and law
enforcement officials;
- Government authorities should create central, public registries of
meaningful beneficial ownership information for all companies formed
in their country to combat the abuse of anonymous shell companies;
- Financial regulators should require that all banks in their country
know the true beneficial owner of any account opened in their
financial institution;
- Ghana, Kenya, Mozambique, Tanzania, and Uganda should actively
participate in the worldwide movement towards the automatic exchange
of tax information as endorsed by the G20 and the OECD;
- Kenya and Uganda should follow the lead of Ghana, Mozambique, and
Tanzania in joining and complying with the Extractives Industry
Transparency Initiative (EITI); and
- Government authorities should adopt and fully implement all of the
Financial Action Task Force's anti- money laundering recommendations.
"It is our view that this is just the beginning of the conversation
surrounding trade misinvoicing and illicit flows in these countries,"
added Mr. Baker, GFI's president. "Our analysis makes it clear that
more research can and should be done to further identify areas for
improvement. It's our desire to work constructively with the
governments of Ghana, Kenya, Mozambique, Tanzania, and Uganda to
meaningfully curtail the scourge of illicit financial flows."
Methodology
GFI Chief Economist Dev Kar and GFI Junior Economist Brian LeBlanc
developed robust economic models that highlight the drivers and
dynamics of illicit flows in both directions for each of the five
countries analyzed. Nevertheless, GFI cautioned that their
methodology is very conservative and that there are likely to be more
illicit flows into and out of these countries that are not captured
by the models.
"The estimates provided by our methodology are likely to be extremely
conservative as they do not include trade misinvoicing in services or
intangibles, same-invoice trade misinvoicing, hawala transactions,
and dealings conducted in bulk cash," explained Mr. Baker.
Key Findings of the Report
Ghana
Over the decade:
- US$7.32 billion flowed illegally out of the country due to trade
misinvoicing;
- US$7.07 billion flowed illegally into the country due to trade
misinvoicing;
- US$14.39 billion in illicit capital flowed either into or out of
the country due to trade misinvoicing;
- Gross illicit flows were pegged at 6.6% of the country's GDP;
- Gross illicit flows roughly equaled ODA provided to the nation;
- The under-invoicing of exports amounted to US$5.1 billion;
- The under-invoicing of exports was the primary method for shifting
money illicitly out of the country;
- The under-invoicing of imports amounted to US$4.6 billion;
- The under-invoicing of imports was the primary method for illegally
smuggling capital into the country;
- Tax revenue loss from trade misinvoicing potentially totaled
US$3.86 billion, averaged US$386 million per
year;
- Tax revenue loss from trade misinvoicing roughly equaled 11.0% of
total government revenue.
[press release continues with similar estimates for the other four
countries]
Excerpt from GFI Report "Hiding in Plain Sight"
I. Understanding Trade Misinvoicing
Trade misinvoicing refers to the intentional misstating of the value,
quantity, or composition of goods on customs declaration forms and
invoices, usually for the purpose of evading taxes or laundering
money. Other reports use the term trade 'mispricing' to describe this
phenomenon, but this term is less accurate since it does not include
manipulations to the quantity or composition of the goods. There are
four basic categories of trade misinvoicing: import under-invoicing,
import over-invoicing, export under-invoicing, and export overinvoicing.
Most trade misinvoicing is done with the knowledge and
approval of the seller and the buyer in the transaction. The two
parties, if they are not part of the same company, will agree to the
misinvoicing and how they will settle the transaction outside legal
confines, often through a deposit into another bank account.
Each sub-category of trade misinvoicing offers particular advantages
to the parties involved. Export under-invoicing involves
under-reporting the amount of exports leaving a country in order to
evade or avoid taxes on corporate profits in the country of export by
having the difference in value deposited into a foreign account.
Similarly, export over-invoicing involves over-stating the amount of
exports leaving a country, which often allows the seller to reap
extra export credits. Companies or individuals may also be using this
form of trade misinvoicing to disguise inflows of capital, so as to
avoid capital controls or anti-money laundering scrutiny.
On the import side, traders often under-report the amount of imports
in a transaction in order to circumvent applicable import tariffs and
VAT, which could be significant depending on the tariff and tax
regime and the good. When an importer over-reports their imports,
they are often doing so in order to legitimize sending out additional
capital under the guise of legal trade payments. Import overinvoicing
disguises the movement of capital out of a country. This
could be a work-around for capital controls, and a company may be
able to subtract that input value from its year-end revenue report to
the government, which would lower the amount of taxes it owes to the
government.
An increasing volume of international trade occurs within corporate
groups. The OECD estimates that roughly one-third of global trade is
these types of intra-firm transactions among subsidiaries
of multinational enterprises. The value on invoices for these
transactions is referred to as the transfer price. The practice of
intentionally misquoting these values is known as abusive transfer
pricing.
Trade Misinvoicing, or How to Steal from Africa
The little-understood practice of misinvoicing or re-invoicing relies
on legal grey areas and financial secrecy and costs the continent
dearly.
Brian Leblanc
9 May 2014
http://thinkafricapress.com / direct URL: http://tinyurl.com/opwkohk
Lately, the media has been replete with stories about how Africa is
losing billions of dollars a year through a process called "trade
misinvoicing." The concept of trade misinvoicing is simple: companies
and their agents deliberately alter the prices of their exports and
imports in order to justify moving money out of, or into, a country
illicitly.
The practice is very common in Africa. To name just a couple
instances, it has allegedly been used to avoid paying import duties
on sugar in Kenya and to shift taxable income out of Zambia and into
tax havens abroad.
The amount Africa loses to trade misinvoicing is astounding. Global
Financial Integrity (GFI), a Washington, DC-based think tank,
estimates that $286 billion worth of capital was extracted out of
Africa using this process over the past decade. Between 2002 and
2011, due to illicit financial flows, sub-Saharan Africa lost 5.7% of
it's GDP, a 20.2% increase. Of these illicit financial flows, 62%
were due to misinvoicing.
The good news is the issue of trade misinvoicing has found its way to
the forefront of development talks.
Former UN Secretary General Kofi Annan, Nigerian Finance Minister
Ngozi Okonjo-Iweala, and former South African President Thabo Mbeki
are just a few African heavyweights who have been trying to urge the
international community to begin addressing the problem of illicit
financial flows and trade misinvoicing.
It's not just "poor governance"
Whereas the impact of trade misinvoicing is becoming well known,
exactly how it is done is not entirely understood. This is a problem,
considering the extremely technical nature of the issue. If public
policy decisions are going to be implemented to address trade
misinvoicing, a firm understanding of its mechanics is absolutely
necessary.
To start, the biggest myth associated with trade misinvoicing is that
it is entirely explained by corruption and poor governance.
Not only is this a false narrative, but it has no readily implemented
solution. It also puts the onus entirely on the country being
impacted, and fails to acknowledge the role the West plays in
facilitating such transactions.
The truth behind trade misinvoicing is that it is a two-way street.
The global shadow financial system, propped up by tax havens and
financial secrecy, is equally responsible for the propagation of
trade misinvoicing in Africa. This system of offshore banks,
anonymous accounts, and shell companies is largely created by
developed countries in the West.
This isn't to say corruption doesn't play a role. Yes, it may be easy
in many African countries to pay a bribe to a customs official to get
them to look the other way when a company is attempting to misinvoice
a trade transaction; however, the advent of tax havens has made this
largely unnecessary.
Why get your hands dirty when there is an easier, less-obviouslycriminal
means available? To quote Raymond Baker, the President of
GFI and a member of the UNECA High Level Panel on Illicit Flows: "onthe
-dock trade misinvoicing like this simply doesn't happen."
How it works
How do companies misinvoice trade then? One of the most widely used
processes is called "re-invoicing," which sidesteps quid pro quo
bribery and corruption and utilizes legal grey areas and financial
secrecy to do all the dirty work.
Instead of defining re-invoicing myself, here is a word-for-word
definition given by a company (operating out of a tax haven) which
exists specifically to assist companies who wish to misinvoice trade.
In fact, a simple Google search of "re-invoicing" produces hundreds
of results of companies openly advertising such practices. Here is
just one example:
"Re-invoicing is the use of a tax haven corporation to act as an
intermediary between an onshore business and his customers outside
his home country. The profits of this intermediary corporation and
the onshore business allow the accumulation of some, or all, profits
on transactions to be accrued to the offshore company."
In other words, companies have sent the process of trade misinvoicing
offshore. By the time the goods reach the docks, the prices have
already been manipulated. No need to pay a bribe.
The process can be extremely lucrative for the actor doing the
misinvoicing. Although the price varies from jurisdiction to
jurisdiction, many re-invoicing companies often only charge a 2%
commission fee on the profits shifted in such a manner. Additionally,
tax haven jurisdictions generally have little-to-no corporate taxes,
which makes the proceeds from re-invoicing tax-free. Compare that to
a 35% corporate tax rate in many African countries and you can
understand the appeal of shifting capital through re-invoicing.
Let's assume the following scenario: imagine a hypothetical Zambian
exporter of copper arranges a deal with a buyer in the United States
worth $1,000,000. Now, let's assume that the Zambian company only
wishes to report $600,000 to government officials to circumvent
paying mining royalties and corporate income tax.
First, the Zambian exporter sets up a shell company in Switzerland
which (because of anonymity) cannot be traced back to him. By doing
so, any transaction the Zambian exporter conducts with the shell
company will look like trade with an unrelated party. Thus, even if
the Zambian government suspects some wrongdoing, it will be very
difficult, or impossible, to tie the Zambian exporter to the shell
company in Switzerland.
Second, the exporter then uses the shell company to purchase the
copper from the exporter in Zambia for a value of $600,000, $400,000
less than the true value of the copper. An invoice that shows receipt
for the $600,000 copper sale is then forwarded on to Zambia tax
collectors.
Third, the shell company in Switzerland then re-sells the copper to
the ultimate buyer in the United States for the agreed-upon
$1,000,000. The importer is instructed to make a payment to the shell
company, and the goods are sent directly from Zambia to the United
States without ever even passing through Switzerland.
Thus, the Zambian exporter lowered its taxable revenue from
$1,000,000 to $600,000. The remaining $400,000 remains hidden in
Switzerland where it is untaxed and unutilized for development
purposes.
How to stop it
Under the international standard of the arm's-length principle, the
price of a good sold between two related parties must be comparable
to what the price the good would have been sold for had the two
parties been unrelated. If not, such as in the above example, tax and
customs officials have the authority to ignore the declared price and
assess taxes and tariffs based instead on the arm's-length price of
the good. Zambia adopted the arm's-length principle in 1999, but does
that mean trade misinvoicing is a thing of the past for the country?
Not in the slightest. Many of these transactions occur through
anonymous shell companies, hiding the fact that two companies may be
related. Even if a Zambian government official detects that a
particular trade transaction is misinvoiced, there is no way for that
government official to see through a shell company to identify its
beneficial owner.
Therefore, there needs to be a multilateral effort to disclose the
beneficial owners of shell companies operating in tax haven
jurisdictions. Until then, companies will continue to hide behind
them to misinvoicing trade offshore.
Misinvoicing is not just a sharp business practice, but a way of
spiriting out of the continent billions of dollars that should be put
to work in social and economic investments. Until something is done
about the network of offshore jurisdictions and financial secrecy at
a global level, Africa will struggle far harder than it should have
to in order to achieve social and economic development.
AfricaFocus Bulletin is an independent electronic publication
providing reposted commentary and analysis on African issues, with a
particular focus on U.S. and international policies. AfricaFocus
Bulletin is edited by William Minter.
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