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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

++++++++++++++++++++++end editor's note+++++++++++++++++

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.

AfricaFocus Bulletin can be reached at africafocus@igc.org. Please write to this address to subscribe or unsubscribe to the bulletin, or to suggest material for inclusion. For more information about reposted material, please contact directly the original source mentioned. For a full archive and other resources, see http://www.africafocus.org


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