Trade Based Money Laundering: A Shady Side of Globalisation
Trade based tax evasion costs the developing world an estimated US$160 billion a year. How can this be stopped?
Charles Goredema, Programme Head, Organised Crime and Money Laundering Programme, ISS Cape Town Office
Contemporary international trade involves the movement of huge volumes of exports and imports, supported by high-value financial transactions, generally attracting significant levels and forms of taxation. The volumes and value involved also create opportunities for tax evasion by one or more of the trading parties. There has been a growing body of literature, particularly in the last five years, showing the multiple methods used to evade trade-based tax. It has become conventional to divide these methods into two broad categories, depending on whether the transactions involve related or unrelated parties.
As between related parties in commercial transactions, the most common method used to evade trade-based tax is the intra-group abuse of transfer pricing. It typically takes the form of one of the related companies in a multi-national enterprise (MNE) ‘selling’ commodities to the other at a lower price than it would have done to an unrelated party, or even at a loss. Intra-group transactions are often not subjected to neutral and independent market valuation. Assuming that the purchasing company is the selling company’s only client, the result is to erode the taxable income of the selling company. Such income could also be eroded without resorting to artificial pricing, but by cost shifting. This is a mechanism by which the production and freight costs of the subsidiary of an MNE can be raised to substantially cut its profits.
Intra-group transfers involve more than just goods and tangible commodities. Related companies may also enter into a transaction in which one provides services, such as management services or finance (in the form of a loan). It is not uncommon for the brand of a commodity to be owned by an affiliate of the manufacturing company. For instance, the branding rights to most of the products marketed by an MNE with strong South African roots, SAB Miller vest in an affiliate that is registered (and technically resident) in the Netherlands. By manipulating intra-group transactions, multi-national corporations can evade taxes in certain countries while shifting the proceeds to countries with lower tax rates.
Research conducted in the United States a few years ago found that corporate transfer pricing abuses cost the US Treasury about US$53 billion a year in tax revenue (Pak & Zdanowicz 2008). Trade price manipulation also facilitates the concealment of illegal commissions and the transfer of capital. Christian Aid estimates that abusive transfer pricing costs the developing world US$160 billion a year. This equates to more than one-and-a-half times the combined aid budgets of developed countries – US$103.7 billion in 2007.
A recent study by Global Financial Integrity (GFI) titled Illicit Financial Flows from Africa: Hidden Resource for Development contends that while much focus is placed on the leakage of resources from Africa through corruption, smuggling and drug trafficking, the contribution of corporate criminality to the drainage is far greater. ‘The proceeds of commercial tax evasion, mainly through trade mispricing, are by far the largest component, at some 60 to 65% of the global total’ (Global Financial Integrity 2011). GFI also found that, between 2000 and 2008, abusive transfer pricing accounted for an average of 54,7% of cumulative illicit flows from developing countries and was ‘the major channel for the transfer of illicit capital from China’.
Some MNEs active in Africa have been recently implicated in shifting profits through abusive transfer pricing. An audit of one of the subsidiaries of Swiss-based resources company Glencore, the Mopani copper mine in Zambia, found that through an inexplicable increase in production costs at the copper mine, Glencore minimised the mine’s profits, thereby lowering its tax bill. The audit, commissioned by the Zambia Revenue Authority and conducted by Grant Thornton, concluded that Glencore owed more than US$200 million over a three-year period. At the time of writing, the debt is still being disputed. SAB Miller is also entangled in a dispute emanating from questionable transfers of part of its income from operations in Ghana. Diamond extraction from the Marange area in eastern Zimbabwe has attracted more than a few entrepreneurs, among them an MNE that is based in South Africa, mining through a company registered in Zimbabwe, but conducting its banking through a subsidiary resident in Mauritius. The Mauritius company exists only on paper.
Abusive transfer pricing transactions inevitably involve low-tax jurisdictions, in which the MNE conducts much of its banking and intermediation activities, and to which income earned from resource extraction activities is channeled. Tax havens are popular destinations for such income.
Despite their suspected prevalence, abusive transfer pricing transactions are not yet attracting the attention of relevant authorities in African countries. Departments mandated to regulate resource exploitation (e.g. mining ministries), customs departments and the emerging financial intelligence units (FIUs) are all part of the infrastructure with potential oversight responsibility. The data necessary to determine risky international business sectors or risky transactions is often scanty, clouded in a mixed mass of information and scattered in disparate locations. Customs departments have an important role in detecting fraudulent transactions because of their presence at points of entry and exit of commodities. The advent of FIUs in various countries might feed the belief that money-laundering control is within their exclusive domain, with the other institutions only playing a supportive role. Unfortunately, FIUs frequently question whether they should pay any attention to fraudulent trade price manipulation, whose scale has yet to be demonstrated. Detecting abusive transfer pricing transactions requires both sector specific risk profiling and individual ‘spotlighting’ in order to access information on the webs of ownership, and on intra-group trading transactions. As so few countries in sub-Saharan Africa have criminalised abusive transfer pricing, FIUs still lack the basis for devoting resources to it. In Southern Africa, only Botswana, Namibia and South Africa have done so to date. Perhaps, as the Task Force on Illicit Financial Flows pointed out in 2008: ‘[F]urther work, methodologically and statistically, is needed. Statistics and analysis are needed – not to determine that illicit financial flows are of major proportions – but in order to inform policy development and target responses. A compiling of existing estimates, including for instance from countries’ own figures on tax evasion, should be considered….’
In view of the recurrent clamour for effective, transparent and accountable tax systems, and the regional integration initiatives that are gathering pace, such work is long overdue. It will require the collaboration of researchers and repositories of information in both the public and private sectors in the region and beyond.
