The second chapter from the new spotlight report.
CHAPTER 2: FINANCING FOR DEVELOPMENT
How the EU is impacting people’s lives
Caroline Muchanga works seven days a week from 5.45 a.m. to 9 p.m. in Nakambala market in Mazabuka, a town in southern Zambia. At her small kantemba (market stall) she sells drinks, toiletries and foodstuffs, including bags of the ‘White Spoon’ sugar that is produced on Zambia Sugar’s vast plantation and in the factory less than a kilometre away. On a good day, Caroline makes ZK 20,000 (about US$ 4).
At 7 a.m. Caroline’s two daughters leave for their volunteer-run community school, where Caroline says the teaching is not always reliable. “We take our children there out of desperation, as we mostly want to prevent their staying at home,” she says. Government schools in Zambia have professional, paid teachers, and usually better facilities, but despite her 15-hour workdays Caroline cannot consistently afford to pay the cost of the books and uniforms. The Zambian government has pledged to make primary education free, but its education budget can still only provide around ZK 32,000 (US$ 6.50) per child per month, so most schools still charge additional parent-teacher association fees to cover the cost of books, teaching materials and school maintenance. Keeping up with these payments is simply beyond the means of some parents. Only 53% of Zambian school children complete their primary education, one-fifth fewer than a decade ago.
Every day, though, Caroline pays her business taxes. Indeed, she has no choice: each evening a council official comes around to collect a market levy of ZK 1,000 (US$ 0.20), whether Caroline has made any money that day or not.
Now, meet Zambia Sugar Plc, a subsidiary of UK food giant Associated British Foods and part of its Illovo group of companies – Africa’s largest sugar producer. Its factory just outside Mazabuka is the biggest sugar mill in Africa. Zambia Sugar makes nine-tenths of all the sugar produced in Zambia, both for the country’s growing consumer market and for export to the UK and elsewhere in Europe. Over the past five years the company has had record annual revenues of over ZK 1 trillion (US$ 200 million), and healthy profits of over ZK 83 billion (US$ 18 million) a year.
Who pays more tax: Zambia Sugar, or Caroline Muchanga who sells the company’s product? The answer is surprising. From 2008 to 2010, Caroline paid more income tax in absolute terms than the company whose US$ 200 million revenues have benefited from her sales. In these three years, while Caroline has duly paid tax on her income, Zambia Sugar has managed to pay no corporate income tax at all on theirs. In the fiscal years 2010/11 and 2011/12 the company did pay some income tax, but even then at a rate of just 0.5% of its income: 90 times less than Caroline, relative to her income.
Financing for development, as agreed in the Monterrey Consensus, covers many different flows: domestic financial resources, international resources such as development assistance, innovative sources of financing, foreign direct investment and other private flows, external debt, etc. For developing and developed countries alike, domestic resources, such as taxation, are by far the largest source of revenue for financing economic and social development, including public services. Furthermore, public sources of financing in general (including official development assistance (ODA), government borrowing and tax revenues) tend to be more predictable and stable. Most importantly, however, public resources have the potential to be more “pro-poor” by targeting the poorest and most vulnerable in society in a way that private flows cannot, and taxation has proved to be crucial for reaching the Millennium Development Goals: for example, a higher tax-to-GDP ratio allows for the provision of free primary education. In addition, the mobilisation of domestic resources also represents a step forward in implementing the country ownership principle.
Yet taxation is not a shortcut to development. Success depends on political leaders making a long-term commitment to expanding the tax base and developing transparent fiscal systems that ensure progressive collection and redistribution and a focus on gender-responsive policies – even if this means challenging powerful political interests. Indeed political leaders should do this anyway, not least because, if it is not devoting the “maximum of its available resources” to upholding the economic, social and cultural rights of its citizens, a country is violating these rights.
In mobilising enough resources to finance their development, however, developing counties often face a number of barriers, largely because of tax dodging by transnational companies that take advantage of inadequate international regulation. Effective levels of taxation in relation to GDP are far lower in developing countries than in the developed world (18% average in sub-Saharan Africa, compared to around 38% in Europe). To make matters worse, between US$ 859 billion and US$ 1,138 billion escaped developing countries as illicit financial flows in 2010 alone. Approximately half this money (US$ 429.5 to US$ 569 billion) represents profit-shifting by transnationals, resulting in a loss to developing countries of at least US$ 100 billion a year in tax revenue. Recent research also shows that just under one in every two dollars of large corporate investment in developing countries is now being routed from or through a tax haven.
If these illicit financial flows were taxed, instead of escaping developing countries, they would generate at least as many resources for a country as the aid it receives. This resource loss leaves countries unable to finance universal access to essential social rights for their citizens – rights such as a basic education, as in Caroline’s case, but also social protection and health care.
In addition to domestic resources, a developing country has a range of different types of external fin
ancial resources potentially available for development. These include (but are not limited to): foreign direct investment (FDI), remittances (see focus box 1), ODA and government borrowing.
Figure 1: Illustration of key external resource inflows and outflows of developing countries, compared by size.
Worryingly, the above diagram shows that the size of the illicit outflows of resources from developing countries – caused for at least half of them by companies’ tax dodging – is about the same as that of all the external inflows combined.
A number of EU policies have a positive or negative impact on the financial flows to and from developing countries. In fact, the EU has a direct or indirect influence over policies that allow tax havens and tax dodging by companies and cause billions of euros in revenue to be lost to developing countries. While on the one hand EU aid plays a crucial role in supporting developing countries, directly affecting the lives of the poorest and most marginalised people, at the same time there are a number of other EU policies, not related to development, that actually facilitate this illicit financial flight. The result of this incoherence between development objectives and certain EU policies is that developing countries are unable to raise sufficient domestic resources to finance their development.
This chapter looks into EU fiscal policies that are currently not coherent with EU development objectives because they allow massive illicit financial flows to escape developing countries and to remain hidden in tax havens, thereby undermining developing countries’ capacity to mobilise domestic tax revenues. The focus on the outflows of developing countries is chosen because in the coming years the EU will have clear opportunities to change policies that are currently having a harmful effect in this area.
How the EU can make its policies coherent for people’s development
1. Implementation of the May 2013 European Council Conclusions on taxation
Tax is the price every citizen and company must pay for the public services and goods we all need, be they roads, justice, health or education. More often than not, it is those best placed to contribute in this way – the wealthiest – who fail to do so, by using “offshore” bank accounts, by making deliberate attempts to manipulate the rules, or simply as a result of under-resourced tax administrations. Tax havens and harmful tax practices are detrimental to both developed and developing countries, as they not only deprive them of much-needed revenue, but they also undermine good governance, institutional development and democratic accountability between governments and citizens.
Up to now the EU has adopted only a few measures to combat tax evasion and tackle tax havens – measures that unfortunately do not benefit developing countries in any way. It has thus clearly allowed major inconsistencies to exist between its fiscal policies and its development objectives. Recently, however, EU has made a promising move. In 2013 several EU leaders made strong public statements calling for vigorous action to fight tax evasion and tax avoidance – as also called for by former UN Secretary General Kofi Annan (see quote box). At the European Summit in May 2013, Heads of State and Government called for “effective steps to fight tax evasion and tax fraud” and, in particular, the implementation of the European Commission’s Action Plan a
nd its two recommendations, published in December 2012. Now, therefore, is the time for the EU to be serious about fighting tax dodging and fulfilling its PCD obligations. In properly implementing the measures necessary for clamping down on tax havens and tax evasion, the EU institutions must incorporate developing countries’ needs into their new fiscal policies to a much greater extent than they have done with current policies.
CONCORD therefore makes the following recommendations:
The EU should support a global regime of multilateral automatic information exchange
The European Council’s decision to make the automatic exchange of tax information the new European and international standard shows the EU’s willingness to play a leading role in the OECD, G8 and G20 discussions on this matter. However, to be consistent with its development policy on good governance in tax matters, the EU should extend this system beyond Europe, to the developing world. This is the only way to promote lasting change, because it is the poorest who suffer most from tax evasion, and it is their governments who need this information in order to fight for the money and resources that are rightfully theirs.
The EU should support a multilateral regime for the automatic exchange of tax information that sets the highest standard, and that allows developing countries – such as Zambia, in the case of Caroline – to be included and to access the fiscal information they desperately need. This should go hand in hand with assistance to strengthen developing countries’ tax authorities and enable them to implement this regime efficiently, while, in the meantime, developing countries should be permitted to access the information stream without a requirement for full immediate reciprocation. Importantly, tax havens need to sign up to this multilateral system, and the EU should decide on counter measures for responding to any jurisdictions that do not join.
The EU should make it mandatory for transnational companies in all sectors to adopt country-by-country reporting based on the model already adopted for the EU’s banking industry
Building on the progress made with the Accounting Directive (for the forestry and extractive sectors) and the Capital Requirements Directive (for the banking sector), the EU should extend country-by-country reporting, and make it mandatory for all large companies operating within the EU in all sectors, by including it in all relevant Directives, e.g. the Non-Financial Reporting Directive (see this report’s climate change and natural resources chapter).
This will require companies to give a full picture of their actual economic performance, including figures for all of their subsidiaries, for every country in which they trade. This full global picture of a company’s cross-border operations would allow revenue authorities in both developed and developing countries to detect suspicious transactions, and would help them collect more revenue to finance their public services, such as health and education, for the benefit of poor people like Caroline in Zambia.
Country-by-country reporting based on the model already adopted for the EU banking sector should require a company to disclose, publicly, specific data for every country, in each of the following areas:
- global overview of the group: a list of every country in which the company operates, and the names of all its subsidiary companies operating in each of these countries;
- financial performance in every country in which the company works, publishing key information such as turnover (incomes or sales), profits (difference between turnover and costs), number of employees, and labour costs;
- assets: all the property the company owns in each country, its value, and what it costs to maintain it;
- tax information: for each particular tax, full details of the amounts owed and those actually paid.
This information would allow governments to make a company responsible for paying a fair share of its profits, and for civil society to make governments responsible for spending the gains on the most impoverished citizens in their country.
The EU should introduce a binding definition of tax havens, and impose effective sanctions for non-compliance
An essential step, in order to help clamp down on the global system of tax havens, is to agree on common EU criteria for identifying tax havens, as proposed by the Commission. These criteria must be binding and comprehensive, combining – at a minimum – secrecy features of banks and legal entities, non-cooperation and harmful tax measures such as:
- fiscal advantages granted only to non-resident individuals or legal entities, without requiring substantial economic activity to be carried out in the country or dependency;
- a significantly lower effective level of taxation, including zero taxation for natural or legal persons;
- laws or administrative practices that prevent the automatic exchange of information with other governments for tax purposes;
- legislative, legal or administrative provisions that allow the non-disclosure of
the corporate structure of legal entities (including trusts, charities, foundations, etc.) or their ownership of assets or rights.
To be effective, EU leaders should publish a European blacklist of any non-cooperative jurisdictions based on the objective use of these criteria, thereby ensuring greater coordination of sanctions. Non-cooperative jurisdictions should face automatic countermeasures applied by all EU Member States. Sanctions should also apply to companies that do not comply with EU tax standards. They would include being banned from accessing aid or public procurement, as called for by the European Economic and Social Committee. This would be an important step towards ending tax havens, making it much harder for companies to avoid paying taxes in developing countries like Zambia.
In conclusion, CONCORD recommends that the EU should:
○ support a global regime of multilateral automatic information exchange
○ make country-by-country reporting – based on the model already adopted for the EU banking industry – mandatory for transnational companies in all sectors
○ introduce a binding definition of tax havens, and impose effective sanctions for non-compliance
The EU urgently needs to come up with a way to take these measures forward, in order to meet its obligations on policy coherence for development and to clamp down effectively on tax evasion and tax havens, for the benefit of the people living in both developed and developing countries.
2. The EU Anti-Money Laundering Directive
Another important element for the EU in the global fight against tax evasion and tax havens is to know who the real owners of a company are. In this area too, EU policies can have a direct impact on developing countries’ ability to curb illicit financial flows.
The objective of money laundering is to “clean” money that is illegal because of its origin (such as drugs), its use (such as terrorism financing), or its transfer (such as tax evasion, which is when money is transferred to avoid paying taxes to public authorities).
Internationally agreed rules to prevent money laundering already exist, drafted by the Financial Action Task Force (FATF), an inter-governmental body. Based on the new FATF recommendations published in February 2012, the EU is now preparing its fourth Anti-Money Laundering (AML) Directive. This process presents the EU with a good opportunity to play a central role in the global fight against tax evasion and provide greater coherence between its development objectives and its financial policies, which at present do not sufficiently hinder European banks or other financial institutions from receiving dirty money from anonymous companies and wealthy individuals, who often shift money from developing countries to avoid paying taxes there.
CONCORD therefore makes the following recommendations:
The EU should ensure greater transparency of “beneficial owners” through centralised public registries
The current EU Directive contains loopholes that allow criminals to hide behind anonymously owned corporate structures. According to AML rules, banks and other financial intermediaries (like lawyers and other professionals) are obliged to carry out checks to find out who their customers are. But the fact that banks do not have to really investigate who the real human owners of companies and other corporate vehicles are makes it easy for illegal money to be moved around the global banking system, and out of the reach of tax collectors. Companies, trusts and foundations can hide the real person – or “beneficial owner” – behind a bank account, and in that way they can facilitate the laundering of the proceeds of crimes such as tax evasion, corruption, drugs, and human trafficking. Tax evaders and avoiders use many of the same mechanisms as international criminals – so, shining a light on these anonymous structures would make tax dodging far more difficult.
Under the current EU Directive, every bank is supposed to identify the beneficial owner of each company for itself, regardless of whether another bank has already done so. For carrying out due diligence on each company, therefore, creating centralised, publicly accessible registries is a more efficient and less costly solution, and one that will prevent the excuse that the beneficial owner cannot be found.
- Having such registries will enable tax authorities to access
information on beneficial ownership very quickly, and without companies knowing when they are being checked. The current Directive gives companies carrying out an illegal activity plenty of time to move their dodgy business elsewhere, before responding to the authorities’ investigation with (now) nothing to declare.
- Making sure that these registries can be publicly consulted by a wide range of actors will make it possible to spot inaccurate information – and more difficult for criminals to lie about their beneficial ownership. It will also dramatically increase the deterrent effect, ensuring a far higher rate of compliance. Increased transparency and public debate can give EU Member States the public support they need to clamp down on tax fraud.
The EU should make tax crime a serious offence connected to money laundering
Money laundering is by its very nature a secondary crime. It is the process of concealing and using the proceeds of a “predicate offence”, i.e., a serious primary crime such as drug smuggling or corruption. FATF provides guidance on how to tackle the most serious crimes by suggesting a list of specific offences that should automatically be regarded as predicate offences.
The current EU Directive contains both a list of five specific crimes that are always predicate offences (drug smuggling, corruption, terrorism financing, organised crime and fraud affecting the Union’s financial interests), and a more general catch-all threshold for serious crimes. For the first time, the international anti-money-laundering standards from FATF explicitly recommend that tax crimes be specifically listed as a predicate offence.
It is vitally important for the EU to comply fully with this new standard and to list tax crime as a predicate offence for money laundering.
- This will send out a strong political signal, showing that tax evasion is a crime as serious as other international offences like drug trafficking, corruption or the financing of terrorism. While corruption and drug trafficking have international conventions to provide comprehensive measures against them and a framework for international cooperation, this is not (yet) the case for tax evasion.
- Clearly listing tax crimes among the list of predicate offences in the future EU Directive will boost the fight against tax havens, which do not usually regard tax evasion as a predicate offence.
- Making tax crime a predicate offence for money laundering will mean that all financial professionals (such as banks, accountants, etc.) will have to consider and report on a greater range of risk factors in their due diligence, such as transactions with tax havens. Improved due diligence will make it harder for tax evaders, whether from another Member State or a developing country like Zambia, to get their money into the EU’s banking system. To avoid falling foul of the rules, professionals will be much more likely to report those they suspect of tax evasion, while planners will also be deterred from dreaming up illegal tax evasion schemes.
In conclusion, CONCORD recommends that, in the fourth Anti-Money-Laundering Directive, the EU should:
○ ensure greater transparency of “beneficial owners” through centralised public registries
○ make tax crime a serious offence connected to money laundering
In order to stop illicit financial flows from depriving Caroline Muchanga, her family in Zambia and other poor people of their basic social rights, the EU should be aware that several of its policies are having a negative impact on developing countries’ ability to finance their own development – and should act accordingly. Financing for development is not just a matter of aid: it also involves policy coherence for development. By changing policies and – by clamping down on tax dodging and tax havens – taking steps that make it harder for illicit financial flows to escape developing countries, the EU would be supporting the mobilisation of financing for development that has a positive impact on the poorest of the poor. Never before has the EU had such great momentum behind it for doing so.
 This case is an example taken directly from the ActionAid (2013) report: Sweet Nothings. The human cost of a British sugar giant avoiding taxes in southern Africa, p. 5.
 Moreover, domestic resources have been growing as a share of GDP over the last decade. CONCORD’s AidWatch publication (2013): Global financial flows, aid and development.
 See note 2.
 EADI (2011): Linking Taxation to the Realisation of the Millennium Development Goals in Africa.
 European Report on Development (2013), pp. 114-115.
 Tax Justice Network Germany (2013): Taxes and human rights – Social Watch.
 Oxfam (2011): Owning Development: Taxation to fight poverty.
 Global Financial Integrity (2012): Illicit Financial Flows from Developing Countries 2000-2010.
 Raymond Baker (2005): Capitalism’s Achilles Heel; Global Financial Integrity (2010): The Implied Tax Revenue Loss from Trade and Christian Aid (2008): Death and Taxes: The True Toll of Tax Dodging.
 ActionAid (2013): How Tax Havens Plunder the Poor.
 Numbers taken from CONCORD’s AidWatch publication (2013): Global financial flows, aid and development.
 World Bank (2013): Migration and Development Brief.
 See note 13.
 United Nations Development Programme (2011): Towards Human Resilience: Sustaining MDG Progress in an Age of Economic Unc
 M.N.V. Seriona and D. Kim (2011): How do International Remittances Affect Poverty in Developing Countries? A Quantile Regression Analysis (Journal of Economic Development, Vol. 36, No. 4), p. 25.
 R. Adams and J. Page (2003): Poverty, Inequality and Growth in Selected Middle East and North Africa Countries, 1980-2000 (World Development, 31(12), pp. 2027-2048.
 CONCORD (2009): Spotlight on Policy Coherence for Development, pp.22-23
 Council Conclusions on Taxation, 22 May 2013.
 European Action Plan and recommendations Commission Communication on strengthen the fight against tax fraud and tax evasion COM(2012) 722 final, COM(2012) 8805 final and COM(2012) 8806 final, 06.12.2012.
 Directive 2013/34/EU of the European Parliament and of the Council of 26 June 2013 on the annual financial statements, consolidated financial statements and related reports of certain types of undertakings, and Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms.
 See note 20.
 EESC (2013): Civil society urges the Council to end tax evasion, 22 May 2013.
 For more on specific recommendations, see Concord Denmark (2013): What the EU should do to make taxes work for the poor.
 FATF (2012): International Standards on Combating Money Laundering and the Financing of Terrorism & Proliferation – the FATF Recommendations.
 CONCORD – Beyond 2015 European Task Force position on a post-2015 framework (2013): Putting people and planet first.
 European Commission Communication on Beyond 2015: towards a comprehensive and integrated approach to financing poverty eradication and sustainable development, COM(2013) 531 final, 16.07.2013.
 Africa Progress Panel (2013): Africa Progress report 2013: Equity in Extractives. Stewarding Africa’s natural resources for all, pp. 6-7.