Illicit capital flight costs poor countries $1.4b yearly

December 5, 2011
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, NAIROBI, Kenya, Dec 5 – A staggering Sh125.1 trillion ($1.4 billion) in unreported funds are siphoned from developing countries every year, a phenomenal that a recent report blames on many multinationals’ inclination towards evading tax.

According to the report titled ‘Bringing the Billions Back’ published by a Swedish democracy and rights organisation Forum Syd, multinationals account for two thirds of the capital flight, which ends up in tax havens, while a third of this amount originates from criminal activities such as human and drug trafficking.

This is mostly done through practices such as transfer pricing, falsified invoicing and round tripping.

“When a multinational company deliberately is manipulating the prices they charge for goods or services to artificially high or low prices to shift profits to low tax jurisdictions, this is called transfer mispricing,” the report explained.

And contrary to popular belief that the greatest contributor of capital flight is corruption, the study showed that this only accounts for a small share of between three to five percent of the total unreported financial flows.

The report’s co-author Kristina Froberg is warning that the vice, which has been termed as the most severe obstacle to development, is accelerating.

“Illicit capital flight amounts to 10 times the annual global aid flows, and twice the debt service developing countries pay each year. For each dollar that goes to the developing world in aid, almost $10 come back to developed countries through illicit means,” the findings showed.

Besides skewing the level playing field in the favour of these foreign firms, this situation has the negative effect of sucking in local companies that expand into other countries where they adopt these unfair tactics, which makes it difficult to break the chain.

The menace does not just hinder fair competition but also has political and social implications as well.

For instance, it is estimated that poor nations are losing between $160 billion per year in tax revenue through mis-pricing and ‘false invoicing’ by multinational companies alone.

This is four times the $40 billion that the World Bank estimates would be needed in these countries to achieve the Millennium Development Goals.

“It is rich individuals that have the means to open an account in a tax haven and place money there without reporting it to their tax authorities. When this is done, tax revenue that could have contributed to social services like health care and education is lost. Both health and education are prerequisites for individuals to raise income,” the report documented.

But without this financial yoke, many countries would be able to effectively reduce the debt burden that comes with getting aid from the various donor agencies.

According to a report from Global Financial Integrity, for instance, Africa lost $854 billion in cumulative capital flight over the period from 1970-2008.

Closer home, conservative figures show that in 2010, accumulated illicit capital flows for Kenya stood at Sh562.2 billion compared to a total external debt stock of Sh660.4 billion registered in 2008.

Analysts argue that if eradicated, this would not only be enough to wipe out the continent’s total external debt, which as at end 2008 stood at approximately $250 billion but would also potentially leave a substantial amount for economic growth and poverty alleviation.

This and a myriad of other benefits Froberg opined, is reason enough for developing governments to put in place measures to curb the vice.

Among other things, she reckoned that multinationals should be compelled to report their financial activities with a breakdown for each country where they operate as opposed to the consolidated reporting.

While national laws would not be enough to combat this practice, the report recommends the signing of multilateral information exchange agreements between states which would make it possible for governments to track illicit capital flight through tax evasion, criminal activities, and corruption.

Observing that capital flight emanates also from lack of information on and awareness of illicit capital flight, the other co-author Attiya Waris proposed that the dilemma can be curbed by having proactive civil society organisations that demand accountability from their governments on how public finances should be utilised.

At the same time, donors too have a responsibility in trying to make specific efforts aimed at recovering and repatriating stolen assets to African states, she pointed out.

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