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Curbing Illicit Finance Through Tax Transparency

According to the State of Tax Justice Report of 2021, countries are losing a total of US$ 483 billion in tax annually to global tax abuse committed by Multinational Corporations (MNCs) and wealthy individuals. This amount would be sufficient to vaccinate the global population against CovId-19, three times over! Of the US$ 483 billion lost annually, US$ 312 billion is due to cross border corporate tax abuse by MNCs while US$171 billion is due to offshore tax abuse by individuals. The report which was published in November 2021 highlighted that Kenya was the hardest hit in the region, losing US$ 558 million in taxes annually, which amounts to almost 1% of the nation's GDP. Research conducted by the Tax Justice Network (TJN) found that corporate tax abuse takes a greater toll on lower income countries where tax revenue is urgently needed. Key challenges in increasing tax revenue relate to compliance with laws and administrative capacity to collect taxes.

Tax evasion is a predicate offence for money laundering. In other words, funds derived from tax abuse are proceeds of crime, whose transmission through the financial system constitutes the act of money laundering. The Global Money Laundering and Terrorist Financing watchdog,  Financial Action Task Force (FATF) capitalizes on the skills and experience of member governments and their agencies to research how criminals launder the proceeds of crime. Based on the results from the research, the FATF sets global standards for mitigating the risks identified. Kenya adheres to the FATF global standards on anti-money laundering and is a member of the Eastern and Southern Africa Anti-Money Laundering Group (ESAAMLG), which is a regional FATF style body whose role is promoting the effective implementation of the FATF Recommendations by its membership. 
FATF has been working with the Organisation for Economic Cooperation and Development (OECD) since 1998 to improve international and domestic cooperation between tax and anti-money laundering authorities as a way of enhancing governments’ ability to combat economic crimes such as corruption and tax fraud. 

The OECD is an international organisation that works with governments, policy makers and citizens on establishing evidence-based international standards and finding solutions to a range of social, economic and environmental challenges. The political urgency of addressing global corporate taxation led to the establishment of the BEPS (Base Erosion and Profit Shifting) initiative at OECD, to reform international taxation rules and ensure that Multinational Enterprises (MNEs) pay a fair share of tax wherever they operate. BEPS refers to tax planning strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations where there is little or no economic activity or to erode tax bases through deductible payments such as interest or royalties. The OECD is working with 141 countries to build an inclusive framework on BEPS. Whereas some of the schemes used are illegal, most are not but BEPS undermines the fairness and integrity of tax systems. 

United Nations Conference on Trade and Development (UNCTAD) report of 2020 on Tackling Illicit Financial Flows (IFFs) records that corporate taxation is a more important share of government revenue in African countries than in OECD countries, mainly because African countries are unable to raise as much revenue from payroll taxes. The report further observes that total capital flight from Africa was estimated at US$ 88.6 billion annually, fuelled by tax evasion, corruption, money laundering and terrorist financing. This capital flight largely outstrips inflows in Foreign Direct Investment (FDI) and development aid. When tax abuse and malpractice directly or indirectly generate flows crossing country borders, they generate Illicit Financial Flows (IFFs).

IFFs driven by tax evasion are enabled by bank secrecy and opaque ownership structures, where governance frameworks are not robust enough to foster transparency and accountability. Global anti-money laundering watchdog FATF, has provided recommendations that address the transparency of beneficial ownership of legal persons and legal arrangements. FATF directs that countries should take measures to prevent the misuse of legal persons and arrangements for criminal purposes. These measures will ensure that accurate and up-to-date basic and beneficial ownership information is available to competent authorities in a timely fashion.

Pursuant to this recommendation, the Kenya Companies Act of 2015 was amended to require companies incorporated or registered in Kenya to keep a register of its beneficial owners with the relevant information relating to such owners. The Companies Beneficial Ownership Information Regulations were published in 2020 to aid tackling crimes such as tax evasion, corruption, money laundering and preventing people from hiding assets and ill-gotten wealth on which they have tax obligations. 

Operationalisation of the E-register by the Business Registration Services in October 2020 was a great milestone towards the tax transparency agenda in Kenya and will definitely bolster the efforts towards combatting IFFs and curbing money laundering. Kenya is not currently on the FATF List of Countries that have been identified as having strategic Anti Money Laundering (AML) deficiencies, however, Kenya is categorised by the US State Department as a Jurisdiction of Primary Concern in respect of Money Laundering and Financial Crimes.

Kenya prides itself in being the continental leader in access to digital infrastructure. Known as the “Silicon Savannah,” Kenya has seen its Information and Communications Technology (ICT) sector grow an average of 10.8% annually since 2016, according to a World Bank report.  Growth in the digital economy will require stronger digital foundations, such as new regulations and policy guidelines designed to support the digital transformation whilst addressing emerging risks related to money laundering and illicit finance.  

Illicit finance actors have found a safe haven in digital assets and virtual currencies, which allow criminals to tuck away funds derived from illicit activity and trading through complex layered structures. Virtual currencies like bitcoin and ethereum, which are collectively valued around US $2 trillion, offer investors a way to shield income from tax authorities. “Cryptocurrency already pose a significant detection problem by facilitating illegal activity broadly including tax evasion," a US Treasury report quotes. 

The U.S. Treasury announced proposed changes to cryptocurrency reporting last year, as part of President Joe Biden’s proposed American Families Plan. The plan would implement a new rule for businesses and crypto exchanges, requiring them to report any cryptocurrency transactions with a fair market value of US$ 10,000 or more to the Internal Revenue Services (IRS). Currently, global anti-money laundering standards require financial institutions to only report cash transactions equal to or exceeding US$ 10,000 to the relevant Financial Intelligence Units (FIU). The disclosure of crypto currency transactions will not only increase transparency, but also, create expediencies in detection of tax evasion and other money laundering crimes. According to the U.S Treasury, enhanced reporting of crypto currency transactions will bring in more tax revenue, to the tune of US$28billion over a decade and address concerns about cryptocurrency transactions not being taxed because they occur outside the tax authorities’ view. 

In Kenya, the Digital Service Tax (DST) introduced in 2021 may finally give rise to the recognition and regulation of crypto currencies, a move which will shine a light on virtual currencies. This has the potential to increase the tax base whilst taking away the opacity of virtual currency trading from government officials. Despite warnings by the Central Bank of Kenya (CBK) and the Capital Markets Authority (CMA) cautioning the public against trading in bitcoin and crypto currencies, Kenya is ranked top 5 in the world on global crypto currency activity according to Global Crypto Adoption Index by Chainalysis. 

Kenya has made significant strides in curbing tax evasion and IFFs. Nevertheless, gaps still exist in formulating frameworks to address emerging risks in digital assets and crypto currencies. Collaborating globally with tax authorities and partnering with anti-money laundering regulators will not only drive the tax transparency agenda but also strengthen the collective approach to curb tax evasion and the attendant money laundering risks. 

Grace Mburu is an Executive Director at Flywheel Advisory