In recent years international lawyers and accountants have built a web of corporate opacity which has enabled tax avoidance and corruption on an alarming scale. Private financial wealth sitting in tax havens has grown to around $21 trillion, of which $9 trillion is from developing countries. Some miniscule jurisdictions, such as the Cayman Islands, have become the legal home to trillions of dollars of corporate assets through offering the unbeatable attractions of zero taxation plus secrecy. Some industries are now dominated by them: half the world’s shipping is registered there.
Although corporate opacity is hugely profitable it is manifestly not in the global interest. It has developed because it cannot be curbed by actions at the national level. It can be addressed only through high-level political cooperation between the major economies. The most practical forum is the G8 and this year the issue is on the agenda.
Tax avoidance thrives on exploiting over 700 independent tax jurisdictions, each of which can be the location for ownership of a company. Competition between them has created tax havens. When combined with the web of reciprocal tax treaties originally intended to avoid double taxation, we arrive at what Pascal Saint-Amans, head of taxation at the OECD, aptly refers to as ‘double non-taxation’.
The simplest form of tax avoidance is transfer pricing, by which a subsidiary in a high-tax jurisdiction sells its output to one in a lower-tax jurisdiction at a price below its true value. G8 countries limit this through scrutinizing the prices used for intra-corporate transactions, but it remains an acute problem in Africa where tax authorities lack capacity. For example, when I discussed with the Zambian tax authority why the copper companies were paying so little tax despite the high world price of copper, its officials ruefully explained that there were few smart accountants in Zambia and they all worked for the companies. The G8 can do a lot to help Africa tackle this sort of corporate abuse. Mis-pricing can be contained by scrutiny. Africa suffers because its tiny jurisdictions cannot realistically each build the necessary capacity. The remedy is to provide guideline price information internationally. The OECD wants to create such a database, and the G8 could give it political impetus. International companies operating in Africa would be required either to use these guideline prices, or to report and justify deviations.
The problem of tackling transfer pricing in G8 countries is tougher. The technique that is now used to avoid tax is not the mis-pricing of transactions but the mis-location of activities. High-value intellectual property is legally located in tax havens where it has not been produced. Subsidiaries in higher-tax jurisdictions purchase these rights, thereby transferring profits. Curbing mis-location is complicated: there is no ideal technical fix. One option would be for companies to be required to report the apportionment of their global profits. Transparency could discourage tax avoidance because it would sometimes impose damaging reputational costs. Britain’s Institute of Chartered Accountants already recommends that companies adopt the benchmark of being willing to defend the arrangement in the public domain. If transparency is not enough, reporting could be supplemented by internationally agreed rules under which tax authorities are empowered to set aside the labyrinth of corporate structures.
Corporate opacity not only assists tax avoidance, it is the key vehicle for corruption. In Africa, and other poor regions, corruption is a huge impediment to decent governance. With reason, African leaders point out that it takes two to tango: the bribing foreign company as well as the bribed official. Corruption is illegal everywhere, but honest African political leaders and officials face overwhelming difficulties in enforcing legislation because corruption is difficult to prove and its proceeds are easy to conceal.
But Africans who say ‘it takes two to tango’, though right in spirit are wrong in detail. Corruption takes three players: the briber, the bribed, and the facilitator. Corrupt money is laundered through fake companies and untraceable bank accounts. The lawyers and bankers who facilitate these transactions are not based in Lagos and Bangui; they are in London and Berlin. African governments are impotent to address money laundering, but the G8 could close it down. Fake companies, known as ‘shell companies’, are the major vehicle for bribes. A study by the World Bank of 150 cases of grand corruption found that shell companies were important in 70 percent of them. A shell company conceals its true owners and it is astoundingly easy to establish one. A recent experimental study by Griffith University in Australia sent 7,000 emails to law firms around the world requesting one to be set up. Some emails included incriminating information indicative of corruption: a premium on normal fees was offered to maintain secrecy. The emails attracted a 40% positive response, somewhat higher for those with this incriminating offer. G8 countries were high in the global league table of the legal lackeys of embezzlement.
Untraceable beneficial ownership of companies has been a concern of the Financial Action Task Force. The FATF is a technical group of the major countries with the power to blacklist those financial systems that do not meet adequate standards of transparency. Its primary concern has been to curb terrorist finance. While the FATF can set rules and make recommendations, it is up to each country how vigorously they are implemented. Beyond the high-profile issue of terrorist finance, the FATF has lacked the coordinated high-level political support for its work to be sufficiently effective. Compliance with its anti-money laundering procedures has tended to degenerate into a culture of box-ticking. For the true ownership of companies to become a matter of public record a new approach is needed. It would combine tighter responsibility for reporting, increased investigative effort, tougher penalties, and automatic exchange of information.
Corporate opacity is not inadvertent: it is the cumulative achievement of some of the most brilliant professional minds on the planet. These people should hang their heads in shame. In the advanced economies their actions are undermining the tax base. Yet worse, their actions bleed the world’s poorest societies of tax revenues, and facilitate the mass looting of the public purse. The resource booms of the current decade are Africa’s decisive opportunity: if the history of plunder were to be repeated it would be a tragedy of awesome proportions.
Professional brilliance has enabled the lawyers and accountants who facilitate these evils by exploiting outdated systems to stay within the letter of the law. This is sufficient to unshackle greed from the constraints of conscience. That is why we need a top-level push from the G8. Even once launched, it may take civil servants years to bust corporate opacity. But only leadership can get started.
Paul Collier is professor of economics and public policy at the Blavatnik School of Government, Oxford University. He has been assisting the British Government with the G8 agenda. This article is written in a personal capacity. A fuller version in English appears in the April issue of Prospect Magazine.
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