U4 ISSUE January 2014 No 2 Tax-motivated illicit financial flows A guide for development practitioners Martin Hearson Anti- Corruption Resource Centre www.U4.no U4 is a web-based resource centre for development practitioners who wish to effectively address corruption challenges in their work. U4 is operated by the Chr. Michelsen Institute (CMI) – an independent centre for research on international development and policy – and is funded by the Australian Department of Foreign Affairs and Trade, BTC (Belgium), CIDA (Canada), Danida (Denmark) DFID (UK), GIZ (Germany), Norad (Norway), Sida (Sweden) and the Ministry of Foreign Affairs Finland. All views expressed in this Issue are those of the author(s), and do not necessarily reflect the opinions of the U4 Partner Agencies or CMI/ U4. (Copyright 2014 - CMI/U4) Tax-motivated illicit financial flows: A guide for development practitioners Martin Hearson U4 Issue January 2014 No 2 ! 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A- B(9!(+3!2CC,D!EF*!',!3*'+G!=F()H! !---------------------------------------------------------------------------------------------------------!?I! ! ! ?"! )'+101I102'H;I06(0'>&8./284+&0'&(.9.6250'>&72I'180.+&""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""&:P ! ?"3 #8$'+5$8.'7B&""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""&?R! ?":! )'1.8'$102'$6&7225.8$102'&""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""&?F! >- @*+5/4,'*+,!(+3!$%5*;;%+3()'*+,!<*$!8$(5)')'*+%$,! !----------------------------------------------------------------------------!AI! ! ! ! iii iv Tax-motivated illicit financial flows: U4 Issue 2014:2 www.U4.no A guide for development practitioners Abstract Tax revenue can help governments finance development and decrease reliance on foreign aid. But tax- motivated illicit financial flows – tax evasion, tax avoidance and aggressive tax planning – undermine these efforts. Non-specialists may find that the complex discussion on taxation and IFFs is further complicated by the lack of clear definitions of relevant concepts, and by the often polarized nature of policy debates. This issue paper explains the terms and helps development practitioners and policy makers navigate the tax and illicit financial flow debates. It also gives an overview of donors’ interventions in this area. There is a growing recognition that tax-motivated illicit financial flows are facilitated in part by the policies of donor countries, hence policy coherence emerges as an important goal for the future. About the author Martin Hearson is a doctoral researcher in the international relations department of the London School of Economics and Political Science. He focuses on the political economy of international taxation in developing countries. v Tax-motivated illicit financial flows: U4 Issue 2014:2 www.U4.no A guide for development practitioners Abbreviations ATAF African Tax Administration Forum BEPS base erosion and profit shifting CDC Commonwealth Development Corporation CIAT Inter-American Center of Tax Administrations CUP comparable uncontrolled price DFID United Kingdom Department for International Development ECOSOC United Nations Economic and Social Council EITI Extractive Industries Transparency Initiative EU European Union FATCA Foreign Account Tax Compliance Act GAAR general anti-avoidance rule GDP gross domestic product GIZ German Society for International Cooperation HMRC Her Majesty’s Revenue and Customs IFC International Finance Corporation of the World Bank Group IFF illicit financial flow IMF International Monetary Fund IT information technology LTU large taxpayer unit MAP mutual agreement procedure NGO nongovernmental organisation Norad Norwegian Agency for Development Cooperation OECD Organisation for Economic Co-operation and Development PE permanent establishment SAAR specific anti-avoidance rule TIN Taxpayer Identification Number TP transfer pricing UK United Kingdom UN United Nations US United States VAT value-added tax WHT withholding tax ZDA Zambia Development Agency ZRA Zambia Revenue Authority vi Tax-motivated illicit financial flows: U4 Issue 2014:2 www.U4.no A guide for development practitioners Glossary Arm’s length principle. Tax treaties and transfer pricing regulations generally state that transfer pricing transactions within a group of companies will only be recognised for tax purposes to the extent that they observe this principle. It requires that the terms of these transactions be consistent with those that would have been arrived at by independent companies. This is intended to prevent companies from manipulating their transfer pricing transactions to reduce their tax bills. (Sections 2.8, 3.5) Base erosion and profit shifting (BEPS). According to the OECD (2013c), this refers to “tax planning strategies that exploit gaps and mismatches in tax rules to make profits ‘disappear’ for tax purposes or to