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by Pietro Toigo
Illicit financial flows – flows of financial resources leaving a jurisdiction through illegal or illicit means – are the largest drain on developing countries’ ability to finance the Sustainable Development Goals agenda. Africa is particularly affected: the African Development Bank estimated that the continent lost over a trillion dollars since the 1980s, making it a net creditor to the world. As seen in the figure below, not only Africa is the worst-affected region in the world, but at nearly 6% of GDP, annual Illicit Financial Flows (IFFs) amount to over a quarter of the revenues it raises domestically.
Percentage of GDP lost to Illicit Financial Flows by region
This leaves a significant gaping hole in Africa’s development finance. As highlighted by the Africa Progress Panel report, the $69 billion lost by Africa to IFFs in 2012 exceed the average annual funding gap of $55 billion that would deliver universal access to energy in the continent.
A significant share of IFFs are generated in the extractive sector, through trade mispricing and targeted use of transfer pricing. For example, the Africa Progress Panel suggests that the Democratic Republic of Congo (DRC) in the period 2010-2012 lost at least US $1.36 billion from just five mining deals hidden behind a structure of complex and secret company ownership structures. Beneficial ownership – that is, the physical person(s) that ultimately owns, benefits economically and controls a company is often unknown to tax authorities in developing countries. There are good reasons for a multinational company operating in a risky business to use complex corporate structures: maximizing its ability to raise finance in different parts of the world; ring-fencing risk; complying with different regulatory regimes, etc. However, concealing who ultimately owns and controls an extractive company opens up opportunities for tax evasion (when a company shifts profits across its company structures towards less taxed jurisdictions) or outright corruption (when, for example, policymakers can hide their interest in a company and benefit from a conflict-of-interest). Mandatory disclosure of beneficial ownership can make it easier for tax authorities to “follow the money” and assess the correct tax liability of an extractive company operating under their jurisdiction, as well as highlighting potential conflict of interest for politically exposed persons.
Given the cross-boundary nature of the phenomenon, a sustainable solution can only come from coordinated global action. The international community is awakening to the importance of beneficial ownership disclosure. The G8 group of industrialized nations has set out a common set of principles to stem the use of corporate structures as vehicles for financial crimes, including mandatory disclosure of beneficial ownership. The UK, Denmark and France have announced the intention of setting up public registers of beneficial owners of domiciled companies (although the perverse incentives of Brexit might test the resolve of the former).
The Extractive Industries Transparency Initiative, which since 2003 support the disclosure of payments between extractive companies and governments, has recently extended its scope to beneficial ownership and now requires implementing countries to ensure companies disclose its beneficial owners, with a view to reach full disclosure by 2020. The early EITI pilot mapping beneficial ownership, involving 11 countries (of which seven are in Africa), shows a number of gaps and difficulties in getting to the bottom of complex corporate structures, highlighting that significant work is needed both at the technical and the political level. Initiatives like the Alpha corporate filing database put together by Open Oil can usefully complement the EITI work, offering civil society, tax authorities and the broader public a compass to map extractive companies’ structures.
So the road to full disclosure of beneficial ownership is still arduous; the potential fiscal benefit are significant and some progress is being made, though mostly driven by the G20 and by global initiatives. Is there a role for African institutions at the regional and continental level to reinforce these efforts? I would resoundingly argue that this is the case.
First, Regional Economic Communities have an important role in setting common reporting standards and ensuring there are no “race to the bottom” dynamics between neighboring countries, whereby a government is tempted to apply looser disclosure and reporting standards in order to attract investors.
Second, there is a role for DFIs and financing institutions to lead the advocacy for tighter corporate disclosure requirements, as well as apply them as a requirement to access their own funding. For example, among DFIs the Asian Development Bank has recently enacted important reforms to its lending safeguards to take into account tax evasion and tax integrity. “Know your customer” requirements already imply disclosure of beneficial ownership for companies invested into, but could be tightened and made explicit. Most crucially, policy dialogue should increasingly include the need for coordinated action on beneficial ownership, both in country receiving investment and countries originating them.
The issue of tax transparency is a pressing one for developing countries, and systemic disclosure of beneficial ownership of extractive companies can tip the balance in its favour. But effective implementation requires a critical mass of countries that embrace it as the prevailing business standard. The solution can only be a global one, where industrialised countries agree to make it a minimum requirement, and design the standard in a way that is geared towards increasing tax compliance in Africa and other developing countries. This is an agenda that will require African institutions to influence strongly the global initiatives, to ensure they serve the interest of the continent.
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