17 Jan 2018

IFFs and money laundering / Pain, no gain: Africa’s relationship with international tax havens

Tax evasion is considered an IFF, while tax avoidance is not. Here’s why that matters for Africa.

With the release of the Paradise Papers last year, the world’s attention has increasingly turned to the role of tax havens in facilitating tax avoidance, tax evasion, and illicit financial flows (IFFs) more broadly. This may feel like déjà vu, with the release of the Panama Papers exposing the offshore dealings of some of the world’s wealthiest elite in 2016. However, there does seem to be a distinction between the issues raised in the two leaks.

The Panama Papers revealed dealings associated more closely with tax evasion and illicit dealings, while the transactions uncovered by the Paradise Papers seemed to consist largely of tax avoidance.

The difference is not just semantics – it has important ramifications for developing an appropriate response. While both flows negatively affect sustainable development in Africa, tax evasion tends to generate a much greater response than tax avoidance. Cases of tax evasion subsequently also provoke stronger political will to crack down on tax havens.

Focus on legality may undermine international efforts to combat tax-related illicit financial flows

Understanding the differences between tax evasion and avoidance, their influence in Africa and whether they qualify as IFFs is essential when developing effective responses.

Both tax evasion and tax avoidance are attempts by an individual or corporation to pay fewer taxes. Tax evasion is illegal, however, while tax avoidance is legal. In practice, the distinction between the terms is not always clear. The Inter-Agency Task Force on Financing for Development (IATF) describes tax avoidance practices as existing in a grey area that exploits differences in legal standards across countries; weak legal systems in some countries; and different interpretations and acceptance of norms on international taxation.

Whether these flows qualify as IFFs is complicated. There is general agreement that IFFs are the financial side of criminal activity and efforts to define IFFs contain common elements, but many definitions still exist. One definition, which has increasingly gained traction, is ‘cross-border transactions of money illegally earned, transferred or used’. However, there is still a lack of general consensus on the term’s definition.

Of particular relevance to the Paradise Papers and Panama Papers leaks is determining whether the flows are illicit, which takes into account both the legality and the legitimacy of the flow.

International mechanisms for tackling IFFs can be impaired by differences in national legislation

Many definitions of IFFs are limited to flows that are illegal. As tax evasion is illegal while tax avoidance is legal, focusing only on legality may undermine the application and effectiveness of international efforts to combat tax-related IFFs. Determining what constitutes IFFs also depends on the legislation of a particular state, due to differences in legal frameworks. This means that international mechanisms designed to tackle tax-related IFFs can be impaired by differences in national legislation, as well as a lack of capacity or willingness to enforce the laws.

Assessments that judge the legitimacy of a flow take into account factors such as rules, customs and fairness. It is widely considered legitimate for an individual to avoid paying taxes, but illegitimate for an individual to evade paying taxes. This distinction is important for determining whether an action is classified as tax avoidance or evasion. Thus, as illustrated by the World Bank, tax evasion is considered an IFF while tax avoidance is not. IFFs fuel criminal economies, contribute to violence, perpetuate existing inequalities, subvert government institutions and undermine the integrity of legal and financial systems. For example, IFFs reportedly inhibited the achievement of some Millennium Development Goals (MDGs) in sub-Saharan Africa.

It is widely seen as legitimate to avoid paying taxes, but illegitimate to evade paying taxes

Tax avoidance and evasion can reduce the funds available for sustainable development in Africa. They both have especially detrimental consequences when considering their impact beyond monetary losses. While both thwart Africa’s development, flows that are classified as tax evasion – and thus IFFs – generate much more swift and tough international responses.

Specifically, this shapes the perception and treatment of tax havens. One challenge to developing cohesive international frameworks for cracking down on tax havens is contrasting views about the value and threat of tax havens. This includes tensions between stakeholders from developed, northern nations and those from developing southern countries.

Some argue that tax havens might have a positive effect on the global economy, facilitating greater global investment and allowing firms and individuals opportunities for tax avoidance to sidestep poorly designed tax systems. However, a rapidly growing body of evidence shows that these so-called ‘treasure islands’ (and the resulting tax avoidance and evasion) help to facilitate criminality and drain Africa’s resources. African actors and IFFs figured prominently in the Panama Papers leak, as documented by the African Network of Centres for Investigative Reporting (ANCIR).

Both tax avoidance and tax evasion thwart Africa’s development

This is problematic for Africa, as northern counterparts tend to have a stronger voice and greater leverage in the creation and enforcement of laws and regulations governing the financial sector. As an illustration, not a single African nation is a member of the Organisation for Economic Co-Operation and Development (OECD), and only South Africa belongs to more than one of six influential international financial institutions, including the Financial Action Task Force (FATF).

Also, when the OECD and the G20 designed the Common Reporting Standard (CRS) – a standard for information exchange and the basis for bilateral agreements between states – they did so without meaningful consultation of low-income states.

The result, as explained by the Financial Transparency Coalition, is ‘a system designed by wealthy nations, with wealthy nations in mind, making many of the prerequisites impossible for countries that don't have sizable tax administration budgets or advanced technical capacity. To make matters worse, some wealthy countries are choosing to share information predominantly or exclusively with other wealthy countries.’

Africa must have a stronger voice in international financial institutions

While a wide-ranging and varied set of responses will be necessary to combat tax avoidance and tax evasion, as well as IFFs more broadly, increasing the contribution of African states in international financial institutions is essential.

While there is a grey line between transactions that are considered tax avoidance versus tax evasion, there are weighty ramifications for responses. Significantly greater resources are aimed at preventing, identifying and combating IFFs (including tax evasion) than tax avoidance.

If Africa is to ensure that priority is given to the flows that most negatively affect sustainable development, the continent must have a voice within international financial institutions to ensure regulations, policies and responses reflect African priorities.

Without this shift in participation, Africa’s relationship with tax havens will continue to be one of pain and no gain.

Marcena Hunter, Senior research analyst, Global Initiative against Transnational Organised Crime


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