The Big Plunder of Resources

It’s no secret that illicit financial flows phenomenon is a huge global problem, and especially where multinational corporations operate in developing countries.

Experts say illicit flows, which include trade misinvoicing, tax evasion and transfer of corruptly gained funds into offshore bank accounts, are facilitated by global financial opacity. The impact of the looting is particularly damaging in developing countries when governments are denied much-needed revenues that could be used for development.

According to a report issued in December 2015 by US-based NGO Global Financial Integrity (GFI), trade misinvoicing is the largest aspect of illicit financial flows from developing countries, accounting for 83.4% of all illicit flows. GFI estimated a walloping US$1.1 trillion flowed illicitly out of developing countries in 2013 - greater than US$957.3 billion, the combined figure of foreign direct investment and net foreign aid for that year.

Trade misinvoicing occurs when companies over-invoice or under-invoice imports and exports in order to dodge taxes or to receive generous government rebates, depending on the jurisdiction.

The worst offenders for misinvoicing and secrecy, according to the GFI, are mining companies. For instance, Tanzania’s government loses out on about US$248 million per year in tax revenue from mining companies as a result of over-invoicing. The vast majority of import over-invoicing transactions are fuel imports, which have an import duty exemption for mining companies.

“Mining companies could be over-inflating their import costs to shift capital out of Tanzania illicitly with the added kick-back of lower taxable income due to artificially inflated inputs,” according to GFI.

In South Africa, there are documented cases of under-invoicing practices by platinum mining companies, and transfer pricing manipulation by diamond giant De Beers.

The growing consensus on the impact of illicit financial flows has helped to jumpstart various public and private sectors-led initiatives working towards finding effective solutions. These include the African Union’s High Level Panel on Illicit Financial Flows. UN’s Sustainable Development Goals framework also incorporates curbing illicit financial flows.

The AU panel’s revised estimate (2016) for illicit financial flows from Africa is between US$80billion and US$90 billion.

The author of a new report by The United Nations Conference on Trade and Development (UNCTAD) concurs with GTI’s finding on trade misinvoicing and its impact on economies of developing countries.

The UNCTAD report focused on five commodity-dependent countries (Chile, Côte d’Ivoire Nigeria, South Africa, Zambia) and found ‘substantial levels’ of trade misinvoicing in the five countries. Analysts perused up to 20 years worth of export data on commodities such as cocoa, copper, gold and oil.

The analysis shows patterns of trade misinvoicing on exports to countries including China, Germany, Hong Kong, India, Italy, Japan, the Netherlands, Spain, Switzerland, the UK and US.

“The (misinvoicing) patterns vary substantially across countries, products and trading partners. Some interesting patterns and contrasts emerge. At the product level, while trade in copper exhibits pervasive and large amounts of overinvoicing in Chile, the results for Zambia show substantial underinvoicing, as well as considerable overinvoicing in trade with Switzerland and the United Kingdom. Iron ore and gold exports from South Africa exhibit systematic underinvoicing. Relatively little gold appears in South Africa’s export data, although the country's trading partners record substantial amounts of gold imports from South Africa. Exports of oil from Nigeria and silver and platinum from South Africa show mixed results ? both underinvoicing and overinvoicing. At the partner level, the Netherlands presents the most peculiar case, with systematic export overinvoicing in trade with all the countries in the sample and for all the products. In other words, exports registered as going to the Netherlands cannot be traced in the Netherlands’ bilateral trade data. In contrast Germany’s trade with all the countries and products in the sample exhibits export underinvoicing.”

The report found massive underinvoicing of gold from South Africa. The country’s trade data showed cumulative gold exports amounting to US$34.5 billion from 2000 to 2014, whereas according to partner data for that period registers US$116.2 billion – under invoicing by over 300%. According to the report, the case of gold exports from South Africa is peculiar in that there is a perfect correlation between export underinvoicing and the volume of exports as reported by its trading partners.

“This suggests that export underinvoicing is not due to underreporting of the true value of gold exports, but rather to pure smuggling of gold out of the country. In other words, virtually all gold exported by South Africa leaves the country unreported,” states the report.

On Zambia, the report found US$28.9 billion of copper exports between 1995 and 2014 were bound for Switzerland, but these exports didn’t reach Switzerland.

Also, Chile’s recorded US$16 billion of copper exports to the Netherlands don’t reflect in the Netherlands trade data. 

Author Tim Worstall and regular contributor to Forbes poured cold water on the UNCTAD report, calling it ‘clueless and nonsense upon stilts’. [ - clueless! Worstall should have a look at the ownership of companies exposed in the Panama Papers to understand how multinationals manipulate their books – editor]

Economic-capture harms citizens

“Does commodity misinvoicing take place? Most assuredly it does. But the evidence being gathered here isn’t showing this at all… What then needs to be done is to consider whether there are other possible reasons for the trade statistics discrepancies,” Worstall writes.

For instance, paper data on Zambian copper shows it goes to Switzerland, but in reality it is shipped directly to buyers in other countries.

“It’s true that the Swiss import statistics and the Zambia export ones don’t match up. But that’s the nature of this form of trade, not some nefarious plot to deprive anywhere of tax revenues. The leap from the facts to the claim is the result of simple pure ignorance,” says Worstall.

Swiss companies such as Glencore (who operate in Zambia, DRC, Equatorial Guinea, Uzbekistan, and other countries with weak institutions and limited state accountability) might not be so innocent in this kind of thing, though.

Swiss NGO Berne Declaration’s book titled “Commodities: Switzerland’s Most Dangerous Business” sheds light on the role of Swiss companies in the natural resources sector and commodity trading in particular: “…The commodities business as practised in Switzerland today is dangerous for all countries in the southern hemisphere that are blessed with natural resources but at the same time suffer from weak or corrupt governments.”

The Financial Times quoted Lèonce Ndikumana, Economics professor and lead author of the UNCTAD report, saying that the discrepancies could not be attributed to administrative mistakes.

“Statistical errors don’t normally have a trend and keep growing over time. The implication is that it is the operators who are explicitly manipulating the invoices. There has to be complicity on both sides. There’s serious lack of transparency on both sides,” said Ndikumana.

UNCTAD secretary general, Dr. Mukhisa Kituyi, while launching the report at the sidelines of the UNCTAD fourteenth conference in Kenya said the organisation would invite the countries and companies concerned to help unravel the misinvoicing mystery.

“Importing countries and companies, which want to protect their reputations, should get ahead of the transparency game and partner with us to further research these issues,” he said.

Also calling for greater transparency is UK advocacy group Tax Justice Network.

“Overall, the (UNCTAD) study confirms that the current level of commodity trade transparency is simply insufficient. There are three important steps that follow,” says Alex Cobham, director of research at Tax Justice Network.

“First, Switzerland and other hubs must be prevailed upon to publish the data they collect on merchanting and transit trade, disaggregating by type and for freeports, so that there is equivalent transparency. Until they do so, partner countries may wish to consider whether Switzerland and other hubs are meeting their WTO obligations not to undermine the benefits of trade for other countries, by imposing this opacity.”

“Second, developing country commodity exporters may wish to step up their work at customs, and in particular to require final destinations for exports – so that a Swiss-based trader cannot be given as the recipient for copper destined for China, for example.”

Third, this study underlines the value of having fully disaggregated trade data. Customs authorities should consider sharing, and publishing – or at least making available to researchers in a consistent manner – their anonymised transaction-level data. Ultimately, it is only through identifying consistent abnormal pricing by particular traders that it will be possible to curtail sharply the illicit flows that Ndikumana et al show to be rife still.”

Multinational corporations conduct about 60% of global trade, often between subsidiaries of a parent company.

According to a 2009 briefing paper on illicit financial flows written by Tax Justice Network, Global Witness, Christian Aid and Global Financial Integrity, such intra-group transactions are not subject to the same market forces, so there is huge potential for profit shifting via under- or over-pricing of intra-group transactions in order to avoid tax liabilities.

“Profits are shifted from the country where they were earned, for example, a developing country whose natural resources are being exploited – to a tax haven where the corporate tax rate is

zero. Such mispricing can also occur by agreement between unrelated companies, with prices artificially manipulated to avoid tax.”

This technique, the NGO’s said, is also used to shift illicitly-acquired money out of developing countries to developed countries without detection.

The end result is that developing countries lose out on tax revenues.

The groups called for transparency in the way multinational corporations report and publish their accounts.

Consequently, on June 29, the US Treasury and the Internal Revenue Service (IRS) published a rule requiring the US parent company of large, public and privately held multinational companies to provide data to the IRS on a country-by-country basis. The information is meant to provide tax authorities with better tools to identify where a company might be artificially shifting profits into tax havens.

The new rule implements the US commitment to adopt country-by-country reporting, as agreed among the US and other OECD countries last year.

Under the new rule, the US government will provide (through bilateral agreements) the information supplied by its multinationals to the tax authorities in countries where the companies have subsidiaries.