3 August 2015

Ethiopia: Illicit Outflows - No End Without Global Cooperation

opinion

The recently concluded conference on development finance was remarkable. It was a platform to raise concerns, to debate on issues and to propose suggestions.

A consortium of civic associations took this opportunity to raise their voices on major issues that are crippling developing countries - illicit financial outflows and tax avoidance by multinational companies (MNCs).

Illicit financial flows, tax avoidance and evasion are so pernicious to developing countries. They increase poverty, wealth disparity, corruption and unfair competition.

The civic associations were not short of suggestions. They came up with the idea of establishing an international body for tax policies, and the need for tax justice. Unfortunately, as usual, their demands were downplayed by developed countries.

When the issue of tax havens is raised, the usual suspects that come to most people mind are small, sunny islands with palm trees and beautiful beaches such as Cayman or Jersey or Bahamas. That is not the only reality. Top tax havens are found in Europe and North America, such as City of London, Delaware, Luxembourg and Switzerland.

Notable features of tax havens are low or nil one or other form of tax rates, lax rules in regard to tax residency, simpler to set up trusts, foundations and companies while keeping the identities of real owners behind curtains, minimal scrutiny and questioning on movement of serious sum of money, unwillingness to exchange information with other countries' authorities and banks known for keeping the secrets of their clients to the grave.

The proliferation of tax havens has resulted in race-to-the-bottom tax competitions, whereby the tax rate is scratching the bottom in some jurisdictions, and strict privacy laws and opaque systems that provide shelter for tax dodgers, money launderers, looters, corrupt officials and illegal arms dealers.

In several jurisdictions, a shield of secrecy is deliberately set up to protect the identity of those using the regulatory system, and there is lax scrutiny on the movement of huge sums of money.Wealth is stashed away in these jurisdictions from all over the globe, using various channels to be re-channelled globally. If authorities of foreign countries need information, it is like facing a dead end.

It should be clear that the wealth is not necessarily in tax haven but the legal structure that owns the wealth. An African corrupt or a Russian oligarch does not need directly owning properties, bank accounts, shares, bonds, valuables in London or New York, but setting up an offshore trust or shell company that owns them for the benefit of him. Offshores entitles have strict privacy laws to protect the identities of those behind the trust or shell company.

MNCs and wealthy individuals use tax havens to shield their earnings from tax. They employ sophisticated structures and methods to shift their earnings to tax havens.

There are many ways of avoiding taxes. One common way is using transfer pricing, more correctly transfer mispricing, whereby to sell goods to related company, based in tax haven, at artificially low prices and re-selling the same goods to another related company, operating in final destination, at artificially higher prices and shifting the whole profit to tax haven. Another way of avoiding tax is levying hefty management fees, royalty charges, interest on loan by subsidiaries based in tax havens.

In reality, the tax avoidance technique may not be as simple as the above example in developed countries as there are several rules to tackle such abuses. But, MNCs with the help of well-armed accountants and lawyers are always ahead of tax authorities to play around the tax laws. In developing countries, such as Ethiopia, where tax authorities are not well-equipped, it is easier to avoid taxes using elaborate corporate structures and simpler techniques.

For example, Ghana has been a victim of ruthless tax avoidance by global giants. According to Action Aid, SAB Miller, the global brewer, in spite of having annual sales in Ghana over 100 million dollars, between 2007 and 2012, its brewery in Accra reported losses in every single year. This was helped by borrowing from its subsidiary in Mauritius, a tax haven, at a rate of 18pc per annum.

The case of flower and leather exporters in Ethiopia is also notable example. Exports to related-companies at artificially low prices make us suspect that there has been tax avoidance scheme.

It is mismatch in laws in different countries that creates fertile ground for illicit financial flows, tax avoidance and evasion. While developed and middle income countries are represented in the Organisation for Economic Cooperation & Development (OECD) to set tax and other rules, which are not binding but influential, developing countries are left out of having any say on important global matters. The problems are global so they need global cooperation.

As much as developing countries should be happy about foreign direct investments by MNCs, they have to update their tax and other laws, step up their tax collection infrastructure to tackle abuses by MNCs, encourage transparency, exchange information with other countries, and work with institutions that are airing their voices for fairer taxation and combatting illicit financial flows.

Ethiopia

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