Illicit Financial Flows (IFFs) FACT SHEET September 2019

Illicit Financial Flows (IFFs) FACT SHEET September 2019 For any enquiries please contact: Robert Ssuuna Policy Lead - and International Financial Architecture Tax Justice Network Africa E: [email protected] TABLE OF CONTENTS

1.0 Introduction 6

1.1 Definition of IFFs 6

1.2 Sustainable Development Goals and Illicit Financial Flows - Synergies, Policy Contradictions and -Offs 7

1.3 Illicit Financial Flows - Characteristics 10

1.4 Illicit Financial Flows - Drivers 11

1.5 Indicators and Red flags of Illicit Financial Flows 12

1.6 Illicit Financial Flows - Measurement 12

1.7 Illicit Financial Flows - Magnitude 13

1.8 Illicit Financial Flows - Impact & Implications 15

2.0 Combating Illicit Financial Flows - Key Actors 15

3.0 Tax Justice Network Africa and the Efforts to Curb IFFs in Africa 16 Illicit Financial Flows | FACT-SHEET

1.0 INTRODUCTION 1.1 Definition of IFFs

Agenda 2063 is Africa’s blueprint for The UN broadly defines IFFs as ‘all transforming Africa into the global cross-border financial transfers, which powerhouse of the future1, it’s the strategic contravene national or international framework that aims to deliver inclusive and laws’3, where the stress is placed on sustainable development for the continent. the illegal action of IFFs and requires Central to delivering these goals is increasing the codified criminal nature of the flow the Domestic Resource Mobilisation for it to be classed as an IFF. These (DRM) within African economies. This flows have three sources under the UN places importance on improving national definition, the proceeds of commercial tax systems and enhancing government , revenues from criminal revenues, it also places importance in activities and public corruption.4 The combating Illicit Financial Flows (IFFs). This HLP takes a different approach where burden on the national governments comes they define IFFs as ‘money that is at a time where the risks for the global illegally earned, transferred or used’5 economy have begun to materialise. but includes , as opposed to just evasion, as a type of IFF. This There have been downgrades in global moves the debate around IFFs from the growth projections by members of the illegality of IFFs to include the moral UN Inter-Agency Task Force on Financing dimension. This definition is one that Development2. Combining this with the the Tax Justice Network Africa (TJNA) advancement of globalisation and the agrees with as we believe that IFFs growing ease of doing business across should include any flow that deprives borders, the problem of IFFs becomes more the source country of the revenue important. needed to finance her development needs. The problem of IFFs have been looked at by many different organisations; a High- This more stringent definition places Level Panel at the African Union level more responsibility on governments (HLP), the UN, World Bank, IMF, OECD to reform their tax architecture to best and many individual countries. However, retain as much of the flows as possible there is no firm agreement on conceptual which are needed for DRM in the and definitional issues related to the increasingly competitive and globalised term of IFFs. This creates difficulties in world. developing methodologies for monitoring and assessments of progress in tacking IFFs which means that recommendations are often not enacted.

1. African Union, Agenda 2063: The Africa we Want 2. UN, Financing for Sustainable Development Report 2019, Inter-Agency Task Force on Financing for Development, pg. 1 3. UN, Coherent Policies for Combatting IFFs, UNODC and OECD, Issue Brief Series from the Inter-Agency Task Force on Financing for Development, July 2016 4. UN, World Economic Situation and Prospects 2016, (UN 2016), Footnote 19, pg. 103 5. http://www.uneca.org/sites/default/files/PublicationFiles/iff_main_report_26feb_en.pdf

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1.2 Sustainable Development Goals and It is therefore paramount that in Illicit Financial Flows - Synergies, designing interventions to curb Policy Contradictions and Trade-Offs IFFs, governments must take into consideration the various relationships The risks posed by illicit financial flows between SDGs and IFFs. are recognized in the 2030 Agenda for Sustainable Development, especially This will help identify if such in target 16.4 of the Sustainable interventions are enablers or disablers Development Goals (SDGs) that calls of IFFs, which interventions can act to, “by 2030, significantly reduce as synergies to address IFFs and illicit financial flows and arms flow, which ones may cause risks of policy strengthen the recovery and return of contradictions. Policy Coherency stolen assets and combat all forms of is critical in designing strategies to organised crime.” combat IFFs and also ensure high level political support. The Addis Ababa Action Agenda on financing for development also calls for The table below presents some of the a redoubling of efforts to substantially linkages between SDGs and IFFs in the reduce IFFs by 2030. In addition, the ascending order and the likely impact Action Agenda invites the “appropriate of interventions targeting IFFs at a international institutions and regional policy level. organizations to publish estimates of the volume and composition of illicit financial flows”.

Beyond SDG 16.4, Illicit Financial Flows directly or indirectly interact with other SDGs.

By 2030, significantly reduce illicit financial flows and arms flow, strengthen the recovery and return of stolen assets and combat all forms of organised crime.

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Table 1.2 Interaction between SDGs and IFFs

SDG & Summary Target Relationship with IFFs Impact of Interventions

2.3 Agricultural Production of drugs and Measures aimed at boosting agricultural Productivity / narcotics is a breeding productivity in agrarian based economies Incomes ground for Illicit funds. could act as a disincentive for narcotic production.

3.a Tobacco control Illicit trade in tobacco is a Designing an efficient tobacco regulatory major source of funds. regime including revisions in tobacco taxation policy could reduce IFFs

5.2 Violence against Illicit finances can be Strict migration policies and international women generated through human collaboration to curb human trafficking trafficking will reduce proceeds from such practices.

8.3 Small and Medium There is a need to create a Interventions to curb IFFs in this area may Enterprises (SME) conducive environment to include stringent registration processes Development allow SMES start up and requiring comprehensive information flourish. relating to beneficial ownership and forms of . This will not render the process of business start up protracted but also risks generating extra costs for business in their effort to comply to regulations. Interventions in this area can generate a policy conflict and or require a policy trade off with the attainment of the SDG.

8.10 Access to financial Universal access to financial Curbing IFF may require strict services services is critical to identification documents to counter development. The ability of possibilities of money laundering. This the poor to access finance is too may prove a policy contradiction and a vital for their progress and or require a trade off with attainment of social inclusion. the SDG.

10.c Cheaper Fluidity of the financial Stricter requirements to ascertain the remmitances system is critical to allow sources of remmitances and details of both remmiters and recipients (purpose) of the funds can recipients obtain funds at reduce risk of illicit funds. This may lower costs. however contradict attainment of the SDG and or necessitate a trade off.

10.5 Financial Regulation of Financial Poorly regulated financial markets can Markets Markets ensures macro facilitate tax evasion and facilitate other Regulation economic stability and forms of IFFs. provides certainty to investors. This is a pre- Therefore interventions to curb IFFs in this requisite for economic area are in sync with the SDG objectives. growth and development.

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Table 1.2 Interaction between SDGs and IFFs

SDG & Summary Target Relationship with IFFs Impact of Interventions

10.7 Safe Migration Illicit finances can be Interventions in this area include generated through human prevention against activities relating to trafficking. of migrants which generate illicit funds. The interventions to curb IFFs in this area are in sync with the SDG objective. 12.7 Public Transparent and corruption Interventions geared towards addressing Procurement free public procurement of opaqueness of public procurement to public works and avoid attainment of illicit funds are in construction improves sync with the service delivery and SDG. promotes inclusive development. 12, 14, 15 Transparency, responsible Exploitation of natural resources Sustainable use investment and exploitation including fisheries, forests and of oceans and natural resources is critical extractives is prone to corruption terrestrial for inclusive development. and a potential source of illicit funds. Eco-systems Interventions to regulate such risks in this area creates synergy with the objectives of the SDG.

16.5 Reduce Corruption A corruption free economy Interventions to corruption at any level provides impetus equitable help address IFFs are in sync with the service delivery and inclusive SDG. development.

16.6 Sound Institutions Pro-people development Sound institutions are also a prerequisite hinges on strong institutions and discouragement to risks of IFFs to promote universal social- economic development. 16.10 Information assymetries Interventions to promote transparency Public access to are a hindrance to public and access to information enable information participation and inclusive citizens to hold the Government development. accountable to facilitate development. However the SDG may require that such interventions consider business secrecy, censorship and data protection rules which can cause contradictions with measures aimed at curbing IFFs.

17.1 Strengthen Funding critical development Measures to address tax evasion , Domestic needs requires adequate aggressive tax planning and other forms Resource resources among which of IFFs, can shield erosion of domestic Mobilisation domestic resources is the resources. Such measures are an enabler largest component. to development.

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1.3 Illicit Financial Flows - Characteristics • Tax Base Erosion and Profit Shifting (BEPS): these are The three sources of IFFs, commercial the tax avoidance strategies activities, criminal activities and that exploit the gaps in tax corruption each contribute to a regimes that shift profits to differing level of the totality of IFFs. low or no tax locations. Commercial activities constitute the bulk at 65%, criminal activities 30% and • Abuse of : the corruption makes up 5%. manipulating of trade pricing within companies between However, corruption is a facilitator for subsidies to minimise the other channels of corruption so its Multinational Companies tax role goes beyond the 5% of IFFs and bills should be treated with the necessary importance. • Trade Mispricing of Goods and Services: the It is important to note that IFFs are manipulating of trade constantly evolving and therefore the invoicing of imports and characteristics of IFFs are constantly to deceive tax changing and requires constant authorities or manipulate adaptation to effectively tackle IFFs and markets. therefore this list is not exhaustive. • Abusive Tax Exceptions: a) Commercial Activities refers to the offering of tax Commercial activities include incentives and exceptions a variety of channels can be for MNCs in a race to the characterised as: bottom with the premise of increased FDI.

5% 30% 65%

Corruption Criminal Activities Commercial Activities

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Here the definition is important 1.4 Illicit Financial Flows - Drivers as many tax avoidance strategies within BEPS and the incentives The drivers of IFFs are diverse and offered by governments are not cut across multiple sections of illegal and, therefore, wouldn’t society. These can be characterised be included in some definitions as three interconnected categories, but these make up a substantive macroeconomic drivers, structural part of IFFs and need to be tackled characteristics and overall governance. if African countries are going to have the required Domestic Macroeconomic drivers are the Resources Mobilisation to meet economic characteristics that cause Agenda 2063. companies and people want to move their money across borders. These b) Criminal Activities are often characterised in the old Criminal activities generate arguments using capital flight as the money illegally and then used integral component for IFFs. Studies and often transferred illegally have shown while this is still a driver it and thus constitute an IFF. These is a component not the entire reason include poaching, drugs, arm for IFFs. These can be a multitude dealing, oil and mineral theft and including high and variable inflation, money laundering. The proceeds overvalued real effective exchange from these activities often use the rate, negative real rates of return and same mechanisms that are used external debts. in the commercial sector to evade and duties to move The structural characteristics refer to the money abroad. the structured economy which includes fiscal and monetary architecture as well c) Corruption as the composition of the economy. Corruption refers to the paying of public officials and their misuse Inequality is included within this of public funds either through category as a large Gini coefficient, nepotism or embezzlement. meaning a unequal society, will have Non-transparent government larger savings rates at the higher procedures and supply chains incomes level of society in the perpetuate opportunities for economy and combining this with the these practises and thus facilitate macrocosmic drivers such as negative the commercial and criminal real rates of return will mean these aspects of IFFs. Trying to stop savers will try to move their money IFFs without tackling the issue abroad. of corruption will be almost impossible and thus requires the Fiscal regimes here can refer to Double relevant attention. Taxation Agreements (DTAs) where companies can move their earnings away from the source country to pay lower or no tax.

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These tax treaties are often in part • Failure to ascertain and verify the associated with poor governance. Ultimate Beneficial owners (UBOs) Corruption of officials can influence in the awards process. their decisions when signing these treaties as a clear example however, • Weak enforcement of anti-bribery governance includes a larger category. and corruption laws.

The informal economy can be • Encouragement of a monopolistic characterised as a governance driver of market to favour certain individuals IFFs, as most of the informal pay little or companies. to no tax which reduces the ability of a government to fund the countries • Diversion of revenue from development. government coffers to individuals and companies. There are a lot of overlap with macroeconomic instability as political • Non-enforcement of uniform instability often is the cause of many standards. market characteristics that would create the conditions for IFFs. • Rent-seeking by authorities within Thus, as many of the drivers for IFFs an industry or sector. are cross-cutting there needs to bea multifaceted approach in tackling IFFs 1.6 Illicit Financial Flows - Measurement and a concerted effort to not only focus on one driver of IFFs. Different measurement approaches yield different results of the magnitude 1.5 Indicators and Red flags of Illicit of IFFs. Some of the empirical Financial Flows approaches used include;

There are certain tell-tale signs that IFFs a) Balance of Payments (BOPs) are present and can be used as a basis The Balance of Payments has three for further analysis of your economy to components. (1) The Current see if there are any IFFs. account, (2) The Financial account and (3) The capital account. • The involvement of shell companies in the award process of The Current Account measures licenses and contracts. international trade, net income on investments, and direct payments. • Involvement of blacklisted and sanctioned individuals and The Financial Account describes companies in the award process. the change in international ownership of assets. The Capital • Abuse of office and conflict of Account includes any other interests by Politically Exposed financial transactions that do Persons (PEPs) in the awards not affect the nation’s economic process. output.

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These methods attempt to held offshore and estimate the capture the value of illicit flows by proportion housed there to evade contrasting what a country claims taxes. it imported from (or exported to) the rest of the world with what The Tax Justice Network(TJN), for the rest of the world states it example, estimates that between exported to (or imported from) $21 trillion and $32 trillion of that given country. private wealth is registered in offshore international financial b) Mirror Trade Analysis (Partner centers. Country Analysis) Kahler et al. (2018) wrote that (2013) uses data Mirror Trade Analysis seeks to on aggregate worldwide reported identify IFFs that take place assets and liabilities and cross- through the channel of trade mis- border deposits provided by the invoicing (under or over-reporting Bank of International Settlements the value of imports or exports to estimate that approximately 8 to generate unreported side % of household financial wealth is payments). held overseas. Motives can be trade-based money laundering (using mis- 1.7 Illicit Financial Flows - Magnitude invoicing as a means to transfer money), evading tariffs and taxes, A key finding from the HLP on IFFs or evading currency controls. is that they are large and increasing, Mirror Trade Analysis is the basis regardless of what methodology and for the widely cited trade mis- definition that you use. IFFs from invoicing studies, such as those developing countries per year were carried out regularly by GFI. estimated to hit US$1 trillion in 2012 up from around $200bn in 2002 The partner - country trade analysis approach for estimating This trend has continued since and it mispricing in international trade means that IFFs are larger than each of is based on the assumption that FDI, portfolio investment, remittances, one of the two trade partner’s external debt and ODA which flow into statistics are reliable, that is, developing countries. that the declared and import values reflect legitimate Globally IFFs are around 6% of the total pricing that would have occurred GDP, this is significant as most of this between unrelated parties. money would be taxable as is either profit or money gained from criminal c) Extrapolation from International activities as seen by the characteristics offshore wealth of IFFs. Often the highest IFFs as According to Kahler et al. (2018), a percentage of GDP are in those this method seeks to identify countries where they need the money the stock of financial assets the most. With some countries in

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Africa, Chad, Republic of the Congo and b) Country Specific examples Zambia having over 16% of GDP leaving The Democratic Republic of the the country through IFFs. Congo is a country with large natural resources and therefore is a) IFFs in Africa very susceptible to IFFs, especially The Economic Commission for as their government is weak with Africa (ECA) estimated that during little regulatory power. Several the period of 2000 - 2015, the net Congolese commission and UN IFFs between Africa and the rest experts have documented illegal of the world averaged $73 billion mineral exploitation and exports, per year from trade mis-invoicing some of which the proceeds even alone. Given the global trends go to arms groups. of increasing IFFs this most likely skewed so that the IFFs now are The diamond sector has come a lot higher than the $73bn. The under international monitoring Global Financial Integrity (GFI) through the Kimberly Process estimates that the other avenues Certification Scheme, but even of IFFs from Africa make up a with these its estimated that 30 - total of $26.7bn per year. There 50% of the value of the diamonds is recent evidence that these IFFs are exported without proper are growing at a faster rate than declaration and valuation. In trade-mispricing so that in the copper about $23.7m may have future they will play an even more been embezzled from a $100m significant role than they currently signature bonus for a mining do. In the last 50 years, its contract. estimated that the total outflows by IFFs from Africa is in excess of In Tanzania its estimated that $1trn which is the same as all ODA more than $8bn has been lost to received during the same period. IFFs during the period of 2002 - 2011, most of this was due to If IFFs are tackled this will go a trade mispricing. This means that long way to the estimated $614bn the government may have missed needed per year to meet all the an average of $246m per year in goals set out by Agenda 2063 revenue. and the Sustainable Development Goals. Within trade-misspricing, In South Africa, trade mispricing the extractive sector, particularly has been particularly relevant oil and precious metals and in their diamond sector where minerals make up most of diamond exporters have the outflows. This means that downplayed the market value of countries that are particularly their rough diamond exports by reliant on the extractive sector are $3bn in the period 2005 - 2012. susceptible to IFFs. Tracking these diamonds, they were then sold at market prices around the world.

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In Egypt tax evasion has thrived • IFFs stop the redistributive effects due to a mistrust between the of tax which causes inequality to taxpayers and the tax authorities. rise in the country which creates a This low tax morale combined disparity and gap in society which with weaknesses in the tax system causes discontent in society to has encouraged tax evasion and rise. This makes creating effective has deprived the country of much policies harder and polarises needed revenue. society.

This evasion has come from the • IFFs Perpetuates Africa’s economic top where an estimated one dependence on external aid. billion Swiss francs have been frozen by the Swiss authorities • There is a constant need for which are linked to the leaders of governments to have resources four countries, Egypt, Libya, Syria to fund services, IFFs mean that and Tunisia. In total, its estimated governments are losing a critical that in Egypt alone the annual cost resource for these. This means of tax avoidance is $10bn, a third that governments must rely on of all . foreign aid, which often comes with conditions attached which 1.8 Illicit Financial Flows - means that the government is Impact & Implications limited in what they can and can’t do. In some African countries There are many implications of IFFs Official Development Assistance which touch all areas of society which accounts for 70% of the total have negative consequences contrary . to a peaceful and prosperous society. • Erode the public trusts in • First They drain resources and government institutions. IFFs tax revenues needed for public undermine the institutions such investment and social spending. as banks and financial intelligence units and the legal mechanisms • IFFs mean that the government for detecting and prosecuting has less money from DRM, which perpetrators of IFFs. It means that is critical in the current financial the government will have a harder climate, for public investment time enacting new legislation and and social spending. They also creates a disconnect between the decrease the private investment government and the population. in the country which can be used to increase the GDP of the country • Decrease tax morale. When IFFs which will increase the tax intake are high, many people see them for the government and conclude that they shouldn’t have to pay tax when often • They create governance issues richer people aren’t paying taxes by exacerbating inequality and themselves. This creates a positive encouraging rent seeking.

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feedback loop where people will 2.0 COMBATING ILLICIT FINANCIAL try avoiding paying taxes meaning FLOWS - KEY ACTORS more people will try to not pay, this reduces further the amount Illicit Financial Flows are complex in nature. of money governments have for Therefore curbing IFFs requires concerted DRM. efforts by various actors in the ecosystem. There is a dire need for Governments to • Increase reliance on indirect taxes. consider that linkages between, duties and As IFFs decrease the money that all responsibilities amongst these actors are governments take in on profits and well streamlined. income, they must find another avenue for getting money. This The Diagram below provides a conservative means that governments rely on lay out of the actors that are instrumental in indirect taxes which are easier addressing IFFs. to collect. However, they are often regressive which further exacerbates inequality and creates lost revenue in the future.

• Central Bank Policy • Ministry of Finance Level • Ministry of Justice • Ministry of Foreign Affairs

• Financial Intelligence Units Operational • Tax Authority / Customs Level • Police • Development / Investment Agencies

Prosecution • Company Registry • Internal Audit • International Cooperation Unit Financial & • Asset Recovery Professional General Oversight Oversight • • Companies • Financial Institutions • Businesses and Professions

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3.0 TAX JUSTICE NETWORK AFRICA on whether the information should AND THE EFFORTS TO CURB IFFS IN be automatic or on request, plus AFRICA there is too high burden placed on developing countries on the associated Tax Justice Network considers that a vital step administrative costs of Country-by- in tackling IFFs requires the consultation of Country reporting and responding to various CSOs and African Countries to aid in information requests. supporting and developing steps to reform the international financial architecture that There needs to be more capacity to will lead to a reduction in tax evasion and utilise Beneficial Ownership data for avoidance. investigation of tax crimes. a) The OECD BEPS Process, its The arm’s length principle has failed effectiveness, failures and to deliver results, there needs to implications for developing be a general agreement to move countries towards unitary taxation or formulary We acknowledge the success of apportionment. the OECD BEPS project in raising awareness and momentum to curb The decision-making process of the tax evasion through tax regime and OECD remains largely disproportionate regulatory reforms. Their strict rules with developing countries being of beneficial ownership, anti-treaty prescribed solutions without adequate shopping provisions and transfer participation from the developing pricing regulations are particularly countries, this needs to change. commendable. b) The Digitalised Economy as an However, the non-adaptability enabler or Disabler of IFFs with tax jurisdictions in developing The global regulations surrounding countries and some other non-OECD the digitalised economy are still being countries whom have technical and drawn up, however, without the desired infrastructural capacity challenges presence of developing countries. regarding exchange of information, weak legal framework for deterrence, There needs to be further research detection and punishment for tax into the current tax architecture to find avoidance and evasion, needs to be out how MNCs utilise the digitalised amended. economy to engage in tax malpractice such tax avoidance, tax evasion, and The current threshold of Eur 750m potentially creating an avenue for IFFs of annual turnover for Country-by- from developing regions so that the Country reporting is too high especially same mistakes aren’t repeated in the for MNCs operating in developing construction of the regulations on the countries. The requirement that digital economy. information exchanges between jurisdictions must be used only for tax The efforts by the OECD to find a purposes needs to be broadened to unified global solution on solving tax include other characteristics of IFFs. challenges of a digitalised economy There needs to be a common position are being bogged down by unilateral

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interventions by some members such a breeding ground for as France and the UK. and a soft landing for MNCs to perpetuate tax avoidance. The allocation of taxing rights remains largely unfair towards developing The Platform for Collaboration on Tax countries. (PACT) needs to take into consideration of developing countries requirements TJNA supports the efforts by developing through increased collaboration with countries to exercise their taxing rights regional tax institutions such as ATAF. of MNCs in the digitalised economy sector specifically where value creation Furthermore, Regional agreements can occurs. be used to advance the collaborative agenda on an international tax c) The Governance of International architecture that takes consideration of the peculiarities of developing If the international rules setting in countries. taxation remain as is, with some countries adopting unilateral policy TJNA supports the establishment of changes while others embracing the an inclusive Intergovernmental Tax OECD-BEPs inclusive framework, it Commission under the auspices of the is most likely that international tax United Nations, where all countries have competition will intensify. an equal say in setting international tax standards and the works of the Global This fragmentation generates Tax Justice movements are a right uncertainty in the international direction towards promoting tax justice business climate and serves to weaken which is TJNAs core mandate. long-term efforts for designing multi- lateral solutions.

There is no doubt that unilateral decisions by large players have global percussions such as the US tax reforms of 2017 or the UK reducing her by 2%.

In Africa the re-establishment of the Accra International and Kenya’s proposal for the Nairobi International Financial Centre provide

Regional agreements can be used to advance the collaborative agenda on an international tax architecture.

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19 Tax Justice Network – Africa (TJNA) P. O. Box 25112 – 00100 GPO Nairobi, Kenya T: +254 (0)20 247 3373, (0)728 279 368 E: [email protected] www.taxjusticeafrica.net