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Africa: Capital Flight Updates

AfricaFocus Bulletin
Dec 17, 2011 (111217)
(Reposted from sources cited below)

Editor's Note

This week Global Financial Integrity released its latest report on illicit financial flows from developing countries, including data for 2009. The result: despite a drop in 2009 due to the recession, developing countries lost between US$723 billion and US$844 billion per annum on average through illicit flows over the decade ending 2009. In current dollar terms, the flows increased in current dollar terms by 15.19% per annum from US$386 billion at the start of the decade to US$903 billion in 2009.

This AfricaFocus Bulletin includes the "tip sheet" summary by Global Financial Integrity of the new report, and a blog post by one of the researchers highlighting the results for Ethiopia in particular. Although only Nigeria and South Africa rank among the top twenty countries worldwide in illicit financial flows (8th and 19th respectively), and sub-Saharan Africa accounted for only 4.5% of illicit financial flows worldwide, such flows from Africa were still large in comparison to the size of African economies, as illustrated by the Ethiopia case included.

An appendix to the full report, available at http://iffdec2011.gfintegrity.org/, contains country rankings for all countries for which data was available, ranging from Nigeria's estimated $18.2 billion a year of illicit financial outflows mid-ranked countries such as Botswana and Namibia with approximately $760 million a year each and countries with relatively modest losses of about $90 million a year each (Ghana and Mozambique).

Another AfricaFocus Bulletin sent out today by e-mail, and available on the web at http://www.africafocus.org/docs11/cap1112.php, provides excerpts from a new book by two of the pioneering researchers on this topic, Léonce Ndikumana and James Boyce, with additional background on the methodologies used for such estimates.

While such data estimating the scale of such illicit financial flows are increasingly available, actually recovering or reversing such flows requires fundamental reforms in international accounting standards, as stressed by Global Financial Integrity and, increasingly, prominent organizations such as the World Bank as well. High on the agenda are steps such as requirements for reporting on beneficial ownership of bank accounts and for country-by- country reporting by multinational corporations on their operations and taxes paid.

This AfricaFocus Bulletin also contains an excerpt from a recent report by Eurodad, outlining the need and the potential for reforms by European countries in particular.

For an additional commentary on the Global Financial Integrity report's findings on Ethiopia and related data, see the blog post by Alemayehu Mariam on http://open.salon.com/blog/almariam / direct URL: http://tinyurl.com/7og293j

For previous AfricaFocus Bulletins on debt, corruption, and illicit financial flows, see http://www.africafocus.org/debtexp.php

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

Tip Sheet: Illicit Financial Flows from Developing Countries over the Decade Ending 2009

New report updates January 2011 Global Financial Integrity analysis of illegal capital flight out of developing countries

December 15, 2011

[Full report and additional background available at http://iffdec2011.gfintegrity.org/]

Report Background:

In December 2008, Global Financial Integrity (GFI) released "Illicit Financial Flows from Developing Countries: 2002-2006," a groundbreaking report which used World Bank and IMF data to estimate the quantity and patterns of illicit financial flows coming out of developing countries. The original report found that illicit financial flows out of developing countries were approximately US$1.06 trillion in 2006.

In January 2011, GFI updated its 2008 study with its report, "Illicit Financial Flows from Developing Countries: 2000- 2009," which included illicit financial flow data over the time period 2000-2008 and incorporated predictions for the year 2009. The January 2011 report found that illicit financial flows increased from US$1.06 trillion in 2006 to approximately US$1.44 trillion in 2008.

December 2011 Illicit Financial Flows Report Update:

Updating its 2008 and January 2011 reports, GFI is now releasing illicit financial flows data for the year 2009 and updating existing figures based on new data.

Report Findings include:

  • Developing countries lost US$903 billion in illicit outflows in 2009. While this marks a significant decrease from the US$1.55 trillion they lost in 2008,1 the global financial crisis accounts for the vast majority of the decrease, rather than improved governance or economic reforms.
  • Developing countries lost between US$723 billion and US$844 billion per annum on average through illicit flows over the decade ending 2009.
  • Despite the onset of the global financial crisis, illicit flows increased in current dollar terms by 15.19% per annum from US$386 billion at the start of the decade to US$903 billion in 2009. Adjusted for inflation, illicit financial flows still grew by 10.6%.

Adjusted for inflation, annual illicit financial flow growth by region over the decade was:

  • Middle East and North Africa (MENA) - 18.82%
  • Developing Europe - 15.93%
  • Sub-Saharan Africa (Africa) - 15.74%
  • Asia - 8.07%
  • Western Hemisphere - 4.07%

Conservatively estimated, Asia accounted for 44.9 percent of total illicit flows from the developing world followed by the Middle East and North Africa (18.6 percent), developing Europe (16.7 percent), the Western Hemisphere (15.3 percent), and Sub-Saharan Africa (4.5 percent).

Top 20 countries with the highest measured cumulative illicit financial outflows between 2000 and 2009 were:

  1. China - $2.74 trillion
  2. Mexico - $504 billion
  3. Russia - $501 billion
  4. Saudi Arabia - $380 billion
  5. Malaysia - $350 billion
  6. United Arab Emirates - $296 billion
  7. Kuwait - $271 billion
  8. Nigeria - $182 billion
  9. Venezuela - $179 billion
  10. Qatar - $175 billion
  11. Poland - $162 billion
  12. Indonesia - $145 billion
  13. Philippines - $142 billion
  14. Kazakhstan - $131 billion
  15. India - $128 billion
  16. Chile - $97.5 billion
  17. Ukraine - $95.8 billion
  18. Argentina - $95.8 billion
  19. South Africa - $85.5 billion
  20. Turkey - $79.1 billion

Please refer to Table 5 in the Appendix for full rankings of countries by average annual outflows.

Illicit Outflow Drivers, Trends:

  • Trade mispricing was found to account for an average of 50.6% of cumulative illicit flows from developing countries over the period 2000-2009, down from its high in 2004 when it accounted for 57.2%. It remains the major channel for the transfer of illicit capital from China.
  • Illicit transfers of the proceeds of corruption, bribery, theft, kickbacks, and tax evasion, accounting on average for 49.4% of illicit outflows over the decade, are on the rise as a percentage of total illicit financial outflows.
  • Corruption, kickbacks, theft and bribery are the primary conduit for the unrecorded transfer of capital from oil exporters such as Kuwait, Nigeria, Qatar, Russia, Saudi Arabia, the United Arab Emirates, and Venezuela.
  • Mexico is the only oil exporter where trade mispricing is the preferred method of transferring illicit capital abroad.

Implications for Economic Development Policy:

The illicit outflows measured in this report are approximately 7-10 times the amount of official development assistance (ODA) going into developing countries. This means that for every $1 in economic development assistance which goes into a developing country, several dollars are lost via these illicit outflows.

Increasing transparency in the global financial system is critical to reducing the outflow of illicit money from developing countries.

Recommendations for achieving greater transparency:

  • Curtail trade mispricing.
  • Require country-by-country reporting of sales, profits and taxes paid by multinational corporations.
  • Require confirmation of beneficial ownership in all banking and securities accounts.
  • Require automatic cross-border exchange of tax information on personal and business accounts.
  • Harmonize predicate offenses [the underlying criminal offenses] under anti-money laundering laws across all Financial Action Task Force cooperating countries.

Illegal Ethiopian Capital Flight Skyrocketed in 2009 to US$3.26 Billion

December 5, 2011

By Sarah Freitas

Task Force on Financial Integrity & International Development

http://www.financialtaskforce.org

Sarah Freitas is an Economist at Global Financial Integrity in Washington, DC and a co-author of "Illicit Financial Flows from Developing Countries over the Decade Ending 2009," a December 2011 report from GFI.

An upcoming report by Global Financial Integrity finds that Ethiopia, which has a per-capita GDP of just US$365, lost US$11.7 billion to illicit financial outflows between 2000 and 2009. More worrying is that the study shows Ethiopia's losses due to illicit capital flows are on the rise. In 2009, illicit money leaving the economy totaled US$3.26 billion, which is double the amount in each of the two previous years.

The report, titled Illicit Financial Flows from Developing Countries over the Decade Ending 2009, shows that the vast majority of the rise in illicit financial flows is a result of increased corruption, kickbacks, and bribery while the remainder stems from trade mispricing.

Ethiopia is one of the poorest countries on earth. Plagued by famine, war, and political oppression, 38.9% of Ethiopians live in poverty, and life expectancy in 2009 was just 58 years. In 2008, Ethiopia received US$829 million in official development assistance, but this was swamped by the massive illicit outflows. The scope of Ethiopia's capital flight is so severe that our conservative US$3.26 billion estimate greatly exceeds the US$2 billion value of Ethiopia's total exports in 2009.

The people of Ethiopia are being bled dry. No matter how hard they try to fight their way out of absolute destitution and poverty, they will be swimming upstream against the current of illicit capital leakage. The global shadow financial system happily absorbs money that corrupt public officials, tax evaders, and abusive multi-national corporations siphon away from the Ethiopian people.

What can be done? The first step the international community should take is to hamper the ability of corrupt and taxevading Ethiopians to launder their money in the global financial system. This could be accomplished by establishing a global system of automatic exchange of tax information. In this way, Ethiopian authorities could much more easily track the bank accounts their tax evaders have established around the world. Furthermore, the G20 governments could push for an end to shell companies by calling for beneficial owners of all companies, trusts and foundations to be known to government authorities. This would make it far more difficult for the corrupt and the criminal to hide their ill-gotten gains behind a wall of corporate secrecy.

These two measures would immediately curtail the flow of billions of dollars leaving the country each year. And, by preventing the flow of so much money, countless lives will benefit.


Exposing the lost billions: How financial transparency by multinationals on a country by country basis can aid development

21 November 2011

European Network on Debt and Development

http://www.eurodad.org/whatsnew/reports.aspx?id=4720

The international community has repeatedly stressed the need to mobilise domestic resources in developing countries, as the most sustainable way of financing development and ending aid dependency. Yet, many developing countries are affected by a number of challenges that limit their capacity to collect taxes. One such challenge is multinational companies' lack of accountability regarding their operations and more specifically regarding the taxes they pay. This report explains how the cross border nature of multinational companies' operations combined with the absence of adequate transparency regulations have very damaging implications for a country's ability to mobilise domestic resources. Although this is relevant for both developed and developing countries, the report focuses on the impacts for developing countries, which have weaker capacities to face this challenge.

Section 2 of the report describes the problem of illicit financial flows with a specific focus on those stemming from tax dodging by multinational companies (MNCs) which account for more than half of the total estimated illicit financial flows from developing countries. Companies use subsidiaries located in tax havens in order to dismantle the added value they are producing, concentrating their profits in tax havens and current accounting rules allow them to obscure this.

Section 3 of the report analyses the existing regulatory framework for MNCs financial transparency. It explains current regulatory initiatives on country-by-country reporting in the extractive sector such as the Extractive Industries Transparency Initiative (EITI), and the recent stock exchange reporting regulations in the US and in Hong Kong. It explains why the civil society proposal for full country-by-country reporting, contributes to addressing tax dodging by MNCs, which the current regulatory initiatives fail to do.

Section 4 focuses on the European agenda, it shows that implementing ambitious standards is a matter of political will. The review of the transparency and the accounting directives in 2011 and 2012 provide a unique opportunity to make real progress by proposing ambitious measures on country-by-country disclosure requirements for European companies. The European Union also has a key role to play by pushing this within the G20, OECD and International Accounting Standards Board (IASB). Section 5 outlines civil society's proposal for a truly effective country-by-country reporting that would contribute to address MNC tax dodging. Section 6 shows that such country-by-country reporting is feasible and is also desirable for a wide range of stakeholders including CSOs, tax administrations and investors. It provides statements from investors arguing in favour of this disclosure.

Part 2 of the report develops in detail two case studies of companies operating in developing countries the brewery SABMiller, operating in Ghana and Swiss mining company Glencore operating in Zambia. These examples show how country-by-country reporting would have enabled the identification of illegal and ethically questionable tax practices that deprive developing countries of much needed tax revenues.


Excerpts from Part 1: What Taxation and Transparency Matter for Development

Taxation is essential to development. Tax is necessary for a state to raise predictable revenues, redistribute income and provide infrastructure and basic services such as health and education to its citizens. Taxation also strengthens democracy and government's accountability to its citizens. As citizens demand their taxes are spent wisely and for their benefit this leads to greater public participation in a country's political process.

While governments in countries that are members of the Organisation for Economic Co-operation and Development (OECD) tend to raise around 35 % of GDP in taxes, the proportion of tax to GDP is much lower in developing countries (see chart below). In sub-Saharan Africa, the percentage of tax revenue to GDP increased from less than 15% in 1980 to a little over 18 % in 2005. However, this rise was due almost exclusively to the increase in revenues stemming from natural resources.1 Despite their volatility, natural resources revenues can generate substantial tax income for developing countries. For this reason, governments and civil society organisations (CSOs) have particularly emphasised the need of better revenues management in this area.

Why do developing countries gather fewer taxes?

Many developing countries are affected by a number of domestic challenges that limit their capacity to collect taxes, including the following:2

  • Revenue authorities are often weak, which makes some types of tax unfeasible to levy, and reduces the effectiveness with which those that are levied are collected;
  • tax legislation is drafted in ways that makes it hard to enforce - for example lack of specificity in the area of transfer pricing;
  • reluctance to challenge political influence of larger tax payers undermines the fairness and effectiveness of the overall tax mix - for example in the areas of land value taxation and tax incentives for foreign investors;
  • the size of the informal sector makes monitoring of economic activities and the collection of taxes a huge challenge;
  • they are ill-equipped to monitor and effectively tax international financial flows;
  • in some cases there is corruption in governments and tax authorities, undermining trust and diminishing the incentives for citizens to pay tax.

But developing countries do not make such decisions in a vacuum. They face external pressures to adopt policies that are not always in the interests of their poorest citizens:

  • Conditionalities and advice attached to grants and loans in the last few decades have often encouraged countries to shift the burden of taxation away from large corporations and onto ordinary citizens4;
  • tax competition pushes countries to lower tax rates and offer tax holidays and exemptions in the hope of attracting foreign investment;
  • developing countries' capacities to negotiate fair deals with big companies are often weak, as some of the biggest multinational companies (MNCs) have more power and global influence than many of the countries in which they operate5;
  • MNCs' lack of effective accountability regarding their operations and the taxes they pay. This report will focus on this particular concern, which is exacerbated by limited international cooperation in tax matters and the lack of participation of developing countries in (or indeed their direct exclusion from) international fora where tax matters are discussed.

In addition, lack of transparency facilitates corruption. Opacity surrounding the operations of MNCs and the taxes they pay means that companies can easily avoid or evade taxes. Financial secrecy in tax havens makes it easy for individuals and companies to hide financial activities from governments around the world and especially from illequipped tax administrations in developing countries.

Curbing cross border illicit capital flight is therefore a crucial part of the jigsaw when seeking to boost domestic resource mobilisation as a predictable source of development finance.

Why is corporate transparency needed?

The first and most obvious reason relates to the scale of multinational operations and their importance for the global economy. While the scale of operations in a particular developing country is often minor for these companies, the significance for the host countries' economies can be huge. An example of this is that in 2010, the combined revenues of the world's 10 largest companies exceed the combined GDP of India and Brazil. This is also true for developed countries. In 2010, revenues of the 50 leading European companies accounted for 22% of the European Union's GDP.

The massive volumes of trade occurring within companies but across borders creates enormous complexities for taxation. This is especially the case for trade in intangible products and services, on which information is scarce, but which has a huge impact on companies' tax bills. The extensive use of tax havens in these transactions makes it very hard to measure the impact of transfer pricing8 on the distribution of taxable profits within multinational enterprises, because one cannot see how much profit is distributed to tax havens. As developing countries begin to adopt global transfer pricing standards, there is an urgent need to understand this impact.

An NGO investigation analysed the 50 largest European corporations' annual reports and found that at least 21% of their subsidiaries are located in tax havens.9 Similarly, another NGO study showed that 98 of the FTSE100 largest companies in the London Stock Exchange have subsidiaries in tax havens.10 As a result, there is a complete disconnection between the geography of MNCs' real economic activities and the story they tell in their financial accounts. Companies use subsidiaries located in tax havens in order to dismantle the added value they are producing, concentrating their profits in tax havens. Although this is very difficult to track given the lack of available information, recent investigations - such as the cases explained in part two of this report, show that disclosure of financial information on a country-by-country basis would shed light on such tax dodging schemes.

Such complexities also create power asymmetries: MNCs with expertise and resources can easily exploit this system to their own advantage, while developing countries11 struggle to monitor and stand up to companies. Even where countries do have the capacity to challenge companies, they may be reluctant to make life difficult for foreign investors.

Another reason relates to social factors such as tax morale (the willingness of citizens to pay tax) which are strongly affected by the perception of equity in the system.12 In order to change a culture of nonpayment of tax, a perception that the big players are paying their fair share becomes crucially important.

Finally, it is a matter of mutual accountability. On the one side developing countries make efforts to provide a legislative framework under which companies can operate efficiently. On the other side, corporations are meant to provide benefits to the country, including the creation of jobs, development of infrastructure, and fair payment of revenue to governments. Yet, while real pressure is put on developing countries' side, including by international financial institutions in order to improve the ease of doing business, when it comes to the other side of the equation, companies remain largely free to set the rules.

In this report we argue that a number of challenges faced by developing countries, such as the fact that they are not getting a fair tax return to MNCs, could be addressed by the implementation of full country-by-country reporting:

At the country level, country-by- country reporting would help promote a public debate within countries, in the absence of local accounting regulations that would put the subsidiary accounts in the public domain. But it would only pose questions, not answer them. The debate would be about:

  • The effectiveness of the revenue authority in securing companies' compliance.
  • The effectiveness of national taxation rules, especially on transfer pricing and tax incentives.

At the global level, a country-by-country reporting standard would:

  • Provide a global picture of a company's activities. It would give tax inspectors in developing countries much more to go on when investigating companies, including indications of where they need to investigate. Even with the information they can get from tax information exchange agreements (TIEAs) and transfer pricing documentation rules, tax authorities cannot find out as much as they say they would like to about the fellow subsidiaries of companies they are investigating.
  • Help illustrate the distribution of profits and tax revenues that results from the current transfer pricing system. This is important information that would help stakeholders - including CSOs - to evaluate the impact of the current transfer pricing rules on developing countries14. At present nobody is able to study this.

Requiring companies to report their financial activities on a country-by-country basis is a crucial step that should be taken at the international level to help both developed and developing countries monitor the activities of companies operating within their borders and challenge abusive behavior.

The European Union has a key role to play by pushing this within the G20, OECD and International Accounting Standards Board (IASB) but also by implementing measures at the European level. The review of the transparency and the accounting directives in 2011 and 2012 provides a unique opportunity to make real progress by proposing ambitious measures on country-by-country disclosure requirements for European companies.

What needs to be done?

Eurodad and many other CSOs in Europe and other regions of the world support the idea of "country-by-country reporting disclosure" of the following information in MNCs' annual financial statements:

1 The name of each country in which it operates;

2 The names of all companies belonging to it, trading in each country in which it operates;

3 Its financial performance in each country in which it operates, without exception, including:

  • Its sales, both third party and with other group companies;
  • Purchases, split between third parties and intra-group transactions;
  • Labour costs and employee numbers;
  • Financing costs split between those paid to third parties and to other group members;
  • Its pre-tax profit;

4 The tax charge included in its accounts for the country in question, as indicated below;

5 Details of the cost and net book value of its physical fixed assets located in each country;

6 Details of its gross and net assets in total for each country in which it operates.

Tax information would need to be analysed in more depth, requiring disclosure of the following for each country in which the corporation operates:

1 The tax charge for the year split between current and deferred tax;

2 The actual tax payments made to the government of the country in the period;

3 The liabilities (and assets, if relevant) owing for tax and equivalent charges at the beginning and end of each accounting period;

4 Deferred taxation liabilities for the country at the start and close of each accounting period.


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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