Tracking dirty money

The Panama Papers along with them stories of corruption in high places have remained in the media headlines now for nearly 15 months, almost on a daily basis. And it had also remained, again on a daily basis a titillating topic of discussion by chattering classes given to rumour mongering at their evening meets. Meanwhile, the country's economy has continued to remain stuck in a state of status quo with the ruling elite, made up of mostly big business and a minority of feudal aristocracy, unwilling to introduce the essential reforms aimed at enhancing accountability and transparency through restructuring.
This has made it almost impossible the job of the Joint Investigation Team (JIT) constituted by a three-member Supreme Court Bench to find answers to eleven questions related to the four London flats owned by Prime Minister Nawaz Sharif's son Hussain Nawaz suspected of having been bought allegedly with laundered money. For years, development economists were said to have puzzled by the lack of growth in developing economies like Pakistan's despite large aid inflows. The conclusion has been illicit financial outflows-facilitated by secrecy in the global financial system-are bleeding developing countries dry.
Trade under-over invoicing is said to be one of the most in-use methods for moving illicit money across borders clandestinely, misreporting deliberately the value of a commercial transaction on an invoice submitted to customs. By fraudulently manipulating the price, quantity, or quality of a good or service on an invoice, criminals can easily and quickly shift substantial sums of monies across international borders.
Broadly, there are said to be four primary reasons that criminals under-over invoice trade:
-- Money laundering - Criminals or public officials may seek to launder the proceeds from crime or corruption.
-- Directly Evading Taxes and Customs Duties - By under-reporting the value of goods, importers are able to immediately evade substantial customs duties or other taxes.
-- Claiming Tax Incentives - Many countries offer generous tax incentives to domestic exporters selling their goods and services abroad. Criminals may seek to abuse these tax incentives by over-reporting their exports.
-- Dodging Capital Controls - Many developing countries have restrictions on the amount of capital that a person or business can bring in or out of their economies. Investors attempting to break these capital controls often under- or over-invoice trade transactions as an illegal alternative to getting money in or out of the country.
Take for example a case of import over-invoicing: A Pakistani importer imports $1 million worth of used cars from a US exporter. He then uses a third country intermediary to re-invoice the amount up to $1,500,000. The US exporter gets paid $1 million. The $500,000 that is left over is then diverted to an offshore bank account owned by the Pakistani importer. The transaction thus facilitates an illicit outflow of $500,000.
A March 2017 report from Global Financial Integrity, "Transnational Crime and the Developing World," finds that globally the business of transnational crime is valued at an average of $1.6 trillion to $2.2 trillion annually. The study evaluates the overall size of criminal markets in 11 categories: the trafficking of drugs, arms, humans, human organs, and cultural property; counterfeiting, illegal wildlife crime, illegal fishing, illegal logging, illegal mining, and crude oil theft. Counterfeiting ($923 billion to $1.13 trillion) and drug trafficking ($426 billion to $652 billion) have the highest and second-highest values, respectively; illegal logging is the most valuable natural resource crime ($52 billion to $157 billion).
Money laundering is said to be the process of disguising the proceeds of crime and integrating it with the legitimate financial system. Generally, money laundering can be broken down into three stages:
-- Placement - the initial entry of illicit money into the financial system
-- Layering - the process of separating the funds from their source, often using anonymous shell companies
-- Integration - the money is returned to the criminal from legitimate-looking source
Because laundering money almost always requires it to pass through one or more banks, the primary strategy against it, according to researchers, is to require banks to perform certain checks and monitor transactions to make sure their accounts are not being used for money laundering.
In recent years, there have been a number of high-profile Western bank scandals over money laundering. Most notably, HSBC admitted to violating the Bank Secrecy Act by failing to monitor over $200 trillion in wire transactions between its Mexico and US subsidiaries, among other crimes. $881 million in drug money from the Sinaloa and Norte de Valle drug cartels were found to have been moved through HSBC-Mexico's accounts to HSBC-USA via the unmonitored wire transactions.
The GFI which conducted this research has offered several policy recommendations to address money laundering:
1. Make all felonies predicate offenses for money laundering. In many countries, certain key crimes such as tax evasion cannot be the basis for a money laundering charge.
2. Countries should comply with all FATF standards. According to a 2013 OECD report, and the latest Transparency report many FATF countries show poor compliance with key standards designed to prevent money laundering.
3. Better enforce existing criminal laws. Bankers who knowingly commit crimes and allow bank accounts to be used to shelter criminal money should be held personally accountable. To date, enforcement has generally focused on moderate-sized fines and promises by banks to improve compliance. No bank should be "too big to jail."
Despite recent progress, there are still plenty of places all over the world where one can stash their money without scrutiny. Tax havens aren't tax havens just because they have low taxes-rather, what makes a tax haven is its opacity of financial information. This is why tax havens are often more accurately referred to as 'secrecy jurisdictions,' and why they facilitate many more problems than just tax evasion.
While the legal regimes that tax havens set up to enable this secrecy are complex, their basic outline is simple-banks, companies, trusts, or other financial actors in the country are allowed to accept money from basically anywhere without reporting it to the authorities in the country where it originates or from which it is controlled. In some cases, it is actually illegal to disclose that information, but in many places, it is simply because the banks or other entities aren't required to disclose it and there is no mechanism to force them to do so.
Laundering criminal proceeds through a tax haven is therefore merely a matter of finding a bank in that country to accept your deposit without asking questions, shuffling the money around a bit, and then sending it to wherever you'd like to spend it or to wherever you'd like to receive it. Evading taxes through a tax haven works similarly-disguise income or assets as passing through that country and fail to report it to your home country's tax authority.
For the less criminally inclined, tax havens often also offer a great legal way to avoid paying taxes, simply by characterizing income as passing through that country and using loose tax treaties or loopholes in one's home country tax law to claim that the income is un-taxable there.
What is needed to curb this practice is a law requiring automatic exchange of financial information. Countries need to automatically exchange information on bank accounts, transactions, and financial flows with each other on a periodic basis, enabling law enforcement and tax authorities to follow up on any leads they may have.
The G20 nations declared in 2013 that automatic exchange is "the new global standard," and pledged to begin exchanging financial information automatically by the end of 2015. In 2014, every OECD member-state and a group of several other countries endorsed a standard system for multilateral automatic exchange of financial information.
GFI believes that any multilateral system of automatic exchange should also serve the interests of the world's smaller economies, but must also take into account the capacity of these countries to effectively utilize the data they would receive from this system. Technical assistance and capacity-building programs will be crucial to this effort, but developed countries should also consider exchanging information to developing countries without obligating them to return the favor, at least initially.
Multinational companies (or 'MNCs') use tax haven secrecy in slightly different ways than criminal tax evaders and money launderers. In general, MNCs use complicated corporate structures involving layers of tax haven entities and accounts to disguise or alter the character of their income in ways that (often legally) reduce their corporate tax bill, a process known as 'tax avoidance' (in contrast to 'tax evasion,' which is illegal). These strategies can be wildly successful for MNCs, bringing their tax bills down to zero or even triggering a tax refund from the government, while they enjoy massive profits.
Cracking down on tax avoidance often requires closing the seemingly endless number of loopholes in tax treaties and tax laws one at a time. However, one way to greatly expedite this process, as well as bring public pressure to bear on rampant tax avoiders, is to require them to own up to their tax schemes.
GFI recommends that all multinational companies be required to publicly disclose basic financial information, such as their sales, profit, taxes paid, and number of employees, in each individual country in which they operate. This policy, called "country-by-country reporting," will not only help both rich and poor countries better enforce and amend their tax laws, but it will also make free markets more transparent for investors and the public at large.
The combination of high profits and low risks for perpetrators of transnational crime and the support of a global shadow financial system perpetuate and drive these abuses. The report also emphasizes how transnational crime undermines economies, societies, and governments in developing countries like Pakistan.