By Abubakar Jimoh
Although taxation is the most important source of revenue that enables governments to finance development and provide services required by citizens, however, Illicit Financial Flows (IFFs) has continued to yield devastating effects on African economic by hampering governments’ developmental efforts .
Discussions around Illicit Financial Flows have continued to gain momentum in the international policy arena since 2013. It would be recalled that Global Financial Integrity (GFI) has observed that money laundering, tax evasion, deliberate trade misinvoicing, leakages in the balance of payment and international bribery make bulk of Illicit Financial Flows.
GFI estimated that between 2003 and 2012, the developing world lost US$6.6 trillion in illicit outflows; and after a brief slowdown during the financial crisis, illicit outflows hit a new peak of US$991.2billion in 2012, when Sub-Saharan African recorded US$68.6 billion.
Trade misinvoicing in the analysis of GFI remains by far most popular way to illicitly move money out of developing countries, comprising 77.8 percent of the global ten-year IFFs total in real terms.
Meanwhile, multinational companies and investors are reportedly finding ways to dodge taxes across African countries, resulting in total loss of $50-$60 billion annually to IFFs, with two-third of the total traced to manipulation of commercial transactions. It would not be a surprise when the United Nations High Level Panel on IFFs estimated that $39 billion are lost to tax evasion and avoidance mechanisms.
As African countries enter into Double Taxation Treaties or Agreements to facilitate investment and create fiscal certainty for investors to inform investment decisions, Civil Society Legislative Advocacy Centre (CISLAC) finds it is worrisome that they signed onto such Treaties in favour of developed countries and multinational companies rather than ensuring Africa countries retain the right to corporate tax profits generated in the continent.
There is growing attention on the tax treaties signed by developing countries. According to Tax Justice Network-Africa (TJN-A), there are almost 300 tax treaties in force in sub-Saharan Africa countries. Another report by SEATINI-Uganda confirms that the network of double taxation treaties is one of the mechanisms used by companies to avoid paying taxes, leading to illicit financial flows and tax losses in most African countries.
Since double tax treaties determine which country has the right to tax corporate profit when a company has subsidiaries in two or more countries, a company could rely on treaties to ensure that it is either taxed in a country where the tax rate is lower, or that it is not taxed anywhere.
“Some countries operate as conduit countries where multinational companies will set up a subsidiary only to avoid being taxed in the country of operation. Instead by using such conduit countries, profits end up in developed countries, with minimal taxes paid in the countries where production happens”, SEATINI noted.
Tax Treaties or Agreements pave way for dreadful corporate tax incentives, which are fiscal provisions offered to investors. As highlighted by Tax Justice Network-Africa, corporate tax incentives include reduced tax rate or ‘full holiday’, whereby companies pay no taxes for certain time periods. “These incentives permit companies to pay less tax on their profit than normal, or benefit from reduced or no tax on services such as water, electricity or land”, it explained.
In West Africa, since most countries are faced with weak socio-economic and political environment for investment opportunity, corporate tax incentives are used by the regional governments as mechanisms to attract foreign direct investments into their countries. This notion has been challenged in a recent report by International Monetary Fund (IMF) which revealed that Nigeria losses 0.5 percent of its GDP in corporate tax incentives given to companies with Pioneer status alone; this would amount to around $2.6billion a year.
In 2014 Fiscal Year, the Nigeria Budget Office reported that the country is further losing about $327 million annually on import duty exemptions. The Office reported $2.9 billion loss from Company Income Tax and Import duties, amounting to more than double of the 2014 Federal Government budgetary allocation to health and more than that of education.
TJN-A has estimated that West African countries raise an average of only 10-15% of their GDPs in taxes, compared to 25-30% for the Southern African group of countries. Since the regional governments continue to struggle for resources, some of them have shifted attention to increase Value Added Tax to compensate for revenue losses to corporate tax incentives.
The most prevalent incentives are tax holiday. A survey by TJN-A discloses that 46% of 40 firms in Nigeria, Ghana and Cote D’Ivoire receive tax holidays; 10% of the firms have complete exemption from corporate income tax; 10% pay reduced corporate income tax; and some 15% of indicated receiving discretionary incentives by tax officials.
As related to trade misinvoicing, Illicit Financial Flows is perpetrated when the importers over-invoiced imports to deceptively reduce corporate profits, the profit margin is reduced, which allows the company to pay a lower corporate profits tax. GFI has confirmed that trade over-invoicing is also driven by foreign exchange from the government at a favourable rate for certain essential imports. This enables the importer to sell the excess currency in the black market for a profit.
Also, there is an incentive to over-invoice exports of goods that receive government subsidies. That is, if the imports serve the production processes as intermediate inputs to other goods, which are then subsequently exported, it may drive the producer to over-invoice the exports of the final good in order to claim a refund on the VAT paid on the original imports.
Another major driver of Illicit Financial Flows is poor governance, giving chance to corruption and money laundering. A recent report by African Civil Society Circle (ACSC) unsecured loans, money laundering, stock market manipulation and outright forgery constitute about 35% of Illicit Financial Flows in Africa, lamenting that despite high-level political commitments to work with the Intergovernmental Financial Action Task Force to address money laundering, majority of African countries have not made sufficient progress in implementing some of the action plans to stem money laundering.
While employment creation is a motivation for West African governments to promote corporate tax incentives, however, most of West African countries are doing poorly in terms of employment creation. For instance, TJN-A reported that in Nigeria, employment among firms receiving incentives stood at about 7,000 in 2013 from 30 million youths seeking employment. While over 80% of foreign direct investment in Nigeria is in oil, the sector employs less than 2% of the Nigerian workforce.
Experts have bemoaned the activities of development finance institutions which support multinational companies’ illicit efforts using the world’s most secretive financial centres. For instance, at Pan African Conference on Illicit Financial Flows (IFFs) and Taxation organized recently by SEATINI-Uganda, Mathieu Vervynckt of Eurodad raised concern over the ongoing support to companies using tax havens, poor accessibility of tax haven standards, and questionable due diligence and poor portfolio transparency.
It is noteworthy to highlight that multilateral Development Financial Institutions (DFIs) are government controlled financial institutions that invest in developing countries. According to IBIS, the International Financial Corporation (IFC), African Development Banks (AfDB) and Inter-American Development Bank (IDB) are three major global multilateral DFIs. While IFC operates in more than 100 developing countries, the AfDB and IDB are both the largest DFIs in their regions.
In 2013, a report by African Development Bank (AfDB) shows that AfDB private sector investment commitments rose from $257 million in 2005 to $1.6 billion in 2013, amounting to over 39% from 2012 to 2013. The 2014 Annual Report by Inter-American Development Bank (IDB) also shows that at IDB, private sector commitments went from 17 operations amounting to $683 million in 2005 to 63% private sector operations, amounting to $2.8 billion in 2014.
However, various reports have challenged the sincerity, effectiveness and due diligence in the management and implementation of DFIs, owing to the associated risk of financial crimes such as money laundering and tax evasion. DFIs are reportedly incorporated in low-tax or secrecy jurisdictions. They are directly and indirectly engaged in aggressive tax planning through support to multinational corporations or investment in them.
It has become imperative for African governments to eliminate corporate income tax holidays; public review all corporate tax incentives, and ensuring incentives commensurate with the expected to citizens; subject all phase of new incentives to legislative approval; refrain from entering into stability clauses when negotiating new corporate tax incentives and investment agreements; develop appropriate mechanisms for adequate oversight of corporate tax incentives; develop double tax treaty policy framework and a model treaty to define what policy outcomes are most beneficial to Africa; adopt and effectively implement Thabo Mbeki’s Panel recommendations on IFFs; mandate DFIs to take an active role in promoting responsible tax practice and policy and more effectively safeguard against harmful tax practices.
African governments are further urged to actively participate in the worldwide movement towards the automatic exchange of tax information as endorsed by OECD and the G20; treat trade transactions involving tax haven jurisdictions with the highest level of scrutiny by customs, tax and law enforcement officials; strongly enforce all anti-money laundering regulations.