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This blog shares some key learning points that may contribute to a broader Illicit Financial Flows agenda (IFFs) for civil society from the High Level Panel on Illicit Financial Flows held in Pretoria, South Africa from 14 to 15 July.  The conference was open for all stakeholders on the 14th which is the main focus of this blog. The 15th was a closed session involving mainly government officials. Some of the key learning points include the importance of understanding the seemingly elusive phenomenon of IFFs, the magnitude of the problem, the socio-economic impact, the enablers and causes as well as the measures being taken to stop the illicit flows. The major emphasis was the need to shift focus from compliance to implementation. Whilst good laws and regulations are important, however, interest should be on how national authorities should use the power they have.

Before going into the gist of the conference presentations and discussions, it will be remiss not to share some attention grabbing snippets from the key note address  given by Pravin Gordhan, South Africa (SA)’s Minister of Finance. The key note address gave a timeline of SA’s fight against IFFs. As a passionate development practitioner, I was challenged to take stock of and reflect on major events and various initiatives taken by my country Zimbabwe to stem illicit flows. Likewise, the challenge equally applies to Civil Society Organisations (CSOs) with interest in sustainable development and poverty eradication initiatives.

Some key talking points in SA’s timeline on efforts taken to curb IFFs include the acknowledgement in 1994 that IFFs were a major threat to South Africa’s development agenda.  In 1995, Transfer Pricing (TP) legislation which enabled profits to be taxed where value is created was enacted.   In 2003, South Africa signed the UN Convention against Corruption. As part of his concluding remarks, Pravin Gordon made some remarkable points. 1. No matter how well intentioned our laws are, without political will the fight against corruption and IFFs will not be won. 2. Citizens must be educated to understand the IFFs flows phenomenon. This constitutes an important democratic factor in demanding accountability from government and companies. 3. Coordination by enforcement agencies is very important and no to silo mentality. 4. Multi-National Corporations (MNCs) must stop their aggressive tax practices and this calls for a fundamental shift in culture, values and practice. 5. Taxes must be paid where value is created to safeguard fiscal capabilities of producer countries. 6. There must not be any sacred cows; all countries must be subjected to the similar standards and conformity which is measurable and demonstrable in the fight against IFFs. 7. Tax havens must be closed.

Understanding the seemingly elusive definition of IFFs was the first discussion point for the conference. There are several definitions of Illicit Financial Flows (IFFs). It is important to flag out that how the problem is defined has a bearing on understanding the causes and the solutions that can be applied to solve that particular challenge. The inherent risk here being a poorly defined IFFs problem can lead to a diagnostic measures which waste resources without achieving the intended impact. Most definitions on IFFs from World Bank Group (WBG), Organisation of Economic Corporation and Development (OECD) and Global Financial Integrity (GFI) have one common thread. That is, the illegal nature of IFFs activities. GFI defines IFFs flows as money that is illegal earned, transferred or utilised across borders.  The WBG dimension considers the illegality of IFFs if they are in violation of the laws of the country of origin.

The strength of defining IFFs through the prism of illegal activities gives room to focus on solutions that are simply steeped in administrative efficiency in terms of enforcing compliance as well as reviewing of legislation. Caution was drawn, complicated laws and administration burden incentivizes noncompliance. It is interesting though to look at the IFFs definition from the High Level Panel report known as the Mbeki report. Tax avoidance, though not deemed illegal but against the spirit of the law, is an added on feature to the illegal activities in the definition of IFFs by the Mbeki report.

Likewise, the amount of funds lost due to IFFs varies depending on the source. United Nations Economic Commission for Africa (UNECA), for instance, estimated that Africa is losing $50 billion annually. Significantly, focus should not be on the varying IFFs estimates.  Clearly, the varying estimates carry one important message. Amounts involved are quite substantial and pose a huge roadblock to Africa development agenda. Official Development Assistance (ODA) and Foreign Direct Investments (FDIs) traditional known anchors of development finance are dwarfed by IFFs as illustrated by the table below

Moreover, Africa’s huge external debt problem can be settled by a portion of lost revenue due to illicit flows. The UNECA Report noted that Africa’s external debt stood at $279 billion in 2008 and the debt constituted a third of amount lost to IFFs at that time.

Mbeki report was endorsed by African head of states, a signpost that IFFs are a major threat to Africa’s development initiatives. The Third Conference on Finance for Development held Addis also conceded that IFFs poses a major risk to development and measures must be put in place to mitigate and stop the illicit flows by 2030.

There is a causal relationship between IFFs and lost social and infrastructure investment opportunities.  This relationship though must not detract the necessity of analysing if past and current public investments are transparent and efficient so as to underline if curbing IFFs will yield the intended results. In other words, focus on IFFs should not overshadow work that drives efficient public investments. IFFs also give unfair advantage to companies who enjoy the use of public infrastructure which they are not also keen to finance through payment of taxes to government. Inequality is perpetuated and worsened by IFFs small to medium enterprises and consumers bear the disproportionate burden of taxation.

My own take is that the impacts of IFFs financial flows are broader than socio-economic and governance issues. The impact also extends to the environment especially for the extractive sector.  By nature, the extractive sector is ominously destructive to the environment.  Ostensibly, IFFs can incentivize mining companies to make illegal profits at the expense of the environment. Whereas the argument that minerals are an intergenerational wealth is quite prominent, the ecological debt brought by mining is another intergenerational ecological debt issue which must not be overlooked at all costs. It will be folly to try to maximize the benefits from the extractives without comprehending the underlining costs, the environment costs in particular. Notably, if compliance mechanisms remain weak, IFFs will not solve the environmental challenges related to the extractives.

Although IFFs strip revenue through illegal activities such as tax evasion and not so illegal but nonetheless immoral aggressive tax avoidance strategy, essentially, resource rich countries are also stripping themselves of taxation rights through harmful tax incentives. Hence the discussion on revenue leakages should not solely pivot on IFFs but should also consider the impact of harmful tax incentives. After all, stopping harmful tax incentives can be much easier compared to IFFs. There is need to disclose the cost of tax incentives as part of fiscal transparency.  Countries such as Burkina Faso have started doing that.

Double Taxation Agreements (DTAs) were also pin pointed as another avenue where tax rights are easily given away through badly negotiated deals. However, DTA are not necessarily the problem, if negotiated well, they can translate to better flow of FDIs and trigger automatic exchange of information which can be valuable to curb double non taxation.

On governance issues, transparency was deemed a vital cog in the fight against corruption and IFFs. No wonder why the extractive sector with its well-known opaqueness is hit hardest when it comes to IFFs. More transparency leads to accountability and better management of the sector. This is what drives the Extractive Industry Transparency Initiative.

The issue of unraveling Beneficial Ownership (BO), that is the unmasking the natural beneficiaries normally hidden in the faceless web of shell companies is part of ammunition to fight corruption and IFFs. BO ownership is not an entirely new concept as the banks are already implementing the “know your client” principle. Hence the Companies Act should be reformed to stop the practice where nominees or shell companies are identified as owners without paying attention to identities of natural persons benefiting.  Transparency measures such as Country by Country (CBC) reporting have potential to curb tax evasion and promote greater transparency in the financial sector.

To wrap up this blog, citizens must drive the agenda of policy and practice reforms to curb the illicit flows. CSOs have a duty galvanise aggregate citizens’ demand for accountability from Government and companies on actions against IFFs. Government has interest in curbing IFFs as it can recoup much needed revenue to fund social and infrastructure programmes. Companies stand to gain from stemming IFFs as the cost of doing business is lowered and long term investments are made passible due to a stable investment climate.