Pacific Money | Economy | Society

Fixing Immoral and Abuse Global Tax Practices: The Problem of Illicit Financial Flows

Illicit financial flows are costing developing countries billions in tax revenue.

By Matti Kohonen and Sakshi Rai for
Fixing Immoral and Abuse Global Tax Practices: The Problem of Illicit Financial Flows
Credit: CC0 image via Pixabay

The 74th session of United Nations General Assembly concluded on September 30, 2019. This year, calls were made for a Green New Deal to mitigate climate and inequality emergencies. Amid rising socioeconomic inequality and populism across the globe, an underlying issue that missed everyone’s attention is the growing phenomenon of illicit financial flows (or IFFs).

Countries lose huge sums in revenue to IFFs—money that could finance such a deal and more and the issue is not new. In a report published by members of the Financial Transparency Coalition, estimates show that developing countries lose nearly $416 billion from tax abuse annually.

The issue has been discussed previously in terms of capital flight, hot money flows, or dark money, but it usually encompasses illegal elements like money laundering, corruption, crime, and tax evasion. More recently, we have either seen investigative leaks, where wealth is being held offshore or squandered in various tax abuse scandals by multinational companies and the rich. All of these offer us a glimpse into the ‘grey’ areas. Unfortunately, there is no international consensus in how IFFs are defined.

It is interesting to note that several developed countries have taken notice of such scandals in their national contexts. For example, while examining how Starbucks, Amazon, and Google manage their financial arrangements and tax liabilities in the UK, Labour MP Margaret Hodge as chair of the Public Accounts Committee on November 12, 2012, said to them that “we are not accusing you of being illegal, we are accusing you of being immoral” for not paying their fair share of corporate taxes.

But in global platforms developed countries often block any efforts on the part of developing countries to act on international tax reform.

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Local Politics vs. International Relations?

It is no surprise that the Global South is on the front lines of fighting the issue of IFFs – ranging from trade mis-invoicing to tax avoidance and evasion; many such activities continue to be deemed legal and legitimate in developed nations and tax havens. It is therefore a critical need for countries in the Global South to inform and frame the discourse and politics of the language surrounding illicit financial flows.

The report sheds light into tax abuse-related controversies in Nepal, Argentina, Ghana, and India influenced by geopolitics with potential human right impacts. Although such practices may not always be illegal in all jurisdictions, they nonetheless cause harm in terms of public revenue losses. Multinational companies maximize their profits by routing trade, financing, and investment through countries and jurisdictions that minimize their taxes.

Unfairly negotiated double tax avoidance agreements (DTAAs) open up new loopholes for profit shifting, abusive treaty shopping, and other forms of cross-border tax avoidance too. Despite evidence that DTAAs cause considerable and unnecessary loss of revenue from countries in the Global South, many developing countries in particular are by design forced to enter into exploitative and unjust treaties to attract FDI in the absence of any alternatives.

The Nepalese case of capital gains tax avoidance by Ncell provides insight into how the country’s largest telecoms operator allegedly employed various practices like abusive treaty shopping, complicated ownership arrangements and the abuse of loopholes in the Norway-Nepal DTAA to avoid paying capital gains tax (CGT) owed in Nepal. On May 20 2019, using a 1993 bilateral investment treaty between Nepal and UK, a request for arbitration was filed by Ncell and Axiata UK against the Federal Democratic Republic of Nepal with the International Centre for Settlement of Investment Disputes regarding the CGT bill, with Axiata UK claiming that the Nepalese tax department calculated the bill incorrectly. The Centre is a part of the of the World Bank Group, based in Washington DC.

As of September, 2019, the case is currently pending. States, especially developing countries, may not always have the full extent of available instruments to define, investigate and remedy abuses linked to illicit financial flows. It is almost habitual for multinational companies and investors to approach international arbitration bodies to sue developing countries into bending rules that serve their interests.

Update: After publication, The Diplomat received comment from Axiata Group Berhad, the parent company of Ncell:

Any suggestion that Ncell has engaged in tax avoidance is without any basis in fact or in law. In particular, there has been no finding of tax avoidance against Ncell either by the Nepalese courts or by any other judicial body…  [T]he suggestion that Ncell is avoiding liability for CGT [capital gains tax] is entirely misconceived… Ncell and Axiata’s position is that, according to Nepalese law, this transaction was not subject to CGT in Nepal.

A Case for the UN

Clearly, this is a systemic issue and needs to be understood under the rights-based framework. Ultimately, it is about where the power resides and who makes the rules and norms in the global economy regarding these issues. We can see from the membership of Northern based institutions that multinational companies have a greater say than some developing countries with less economic and geopolitical weight. The current international financial system deprives developing countries of not only the necessary revenue, but also the sovereign space required to make decisions or challenge historical ones on taxing rights.

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The UN is the only place where 193 member states gather to discuss important issues that plague the world. Therefore, there is a need for consensus on how we define IFFs.

Developed countries must join developing countries who have advocated for an intergovernmental UN Tax Commission, in which all countries would enjoy equal status, to set international tax norms and policies, as well as regional tax bodies to address tax-related concerns of illicit financial flows.

Recognizing immoral and abusive tax practices under the ambit of illicit financial flows remains central to fighting the world’s broken financial system.

Matti Kohonen works with Christian Aid and can be reached at [email protected]. Sakshi Rai works with Centre for Budget and Governance Accountability and can be reached at [email protected].