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How ‘misinvoicing’ gets R300bn out of SA annually

Political uncertainty is a major incentive to move funds offshore.
Trade-related misinvoicing is one of the largest components of illicit financial flows globally. Image: Waldo Swiegers, Bloomberg

South Africa’s trade misinvoicing gap averaged $19.9 billion (R309 billion) per year from 2008 to 2017, according to a report by Global Financial Integrity (GFI). 

Released on March 3, the report – Trade-related illicit financial flows in 135 developing countries 2008-2017 – focuses on trade-related misinvoicing, one of the largest components of illicit financial flows (IFFs) between the 135 developing countries and 36 advanced economies.

The average size of the value gap between sub-Saharan Africa and the 36 advanced economies is $27.2 billion.

Trade misinvoicing

Trade misinvoicing refers to one party (the importer or exporter) deliberately falsifying the price, quantity or quality of goods being imported or exported, and in this way, illicitly transferring the difference, which may involve money laundering, customs duty evasion, and tax evasion.

Less than 2% of shipping containers are searched every year, raising a question mark over the veracity of customs invoices.

Import overinvoicing can be used to:

  • Shift money abroad (a seller can, for example, agree to pay the difference to another entity on behalf of the importer);
  • Overstate the cost of the imported product to reduce the income tax liability; and/or
  • Avoid anti-dumping duties.

Export underinvoicing can also be used to shift money abroad, evade income taxes and export taxes.

Illicit financial flows

Illicit financial flows pertain to illicit activity, and do not include tax avoidance. However, this is a moot point as there is increasing pressure by some (namely tax authorities and non-profit organisations) to include tax avoidance in the scope of illicit financial flows.

Presumably ‘trade-related’ illicit financial flows include the illegal drug trade, illicit arms deals, and the laundering of dirty money. After all, these illicit activities comprise the buying and selling of goods and services, and thus fall within the definition of trade. For example, transferring money from a mine rehabilitation fund offshore to be looted would be a trade-related illicit activity.

What about transfer pricing?

A transfer pricing transaction has two essential facets: it must be a transaction between persons who are connected persons or associated enterprises in relation to one and another; and the term(s) of that transaction must differ from a contract between two independent person’s dealing at an arm’s length.

An arm’s length transaction rests on the supposition that a transaction between two independent parties must be arm’s length (the terms and conditions including that the price has been fairly negotiated).

Transfer pricing rests on the assumption that the arm’s length price is the ‘real’ price, and that if the price of a transaction between two related parties differs from the arm’s length price, it has been ‘transfer priced’, and must be adjusted. Obviously, the calculation of the real price and the adjustment to be made results in a fairly high standard of living for the consultants who make their bread and butter this way.

In my view it is a far stretch to include transfer pricing under trade misinvoicing.

However, it is tempting for a tax authority to use the trade misinvoicing gap produced by the GFI as a target. Unfortunately, this could result in the tax authority using incorrect resources to chase this down.

Needless to say, transfer pricing can morph into tax evasion where there is an artificial break in the related-party link by, for example, inserting a non-related entity.

Resource-exporting countries

The GFI places emphasis on Africa’s resource-exporting countries losing illicit outflows of money and the tax thereon.

The exports of, say, gold, would have to be compared with the imports. There could be inconsistencies – for example, gold bars can have different gold content. Are apples being compared with pears?

Another example is that of diamonds. The value of a diamond is determined by its colour, clarity and size. There are many grades, and many shades. Certain ‘fancy’ colours demand a high value. Customs officials would have to be diamond experts to verify the value of diamond exports. Assuming of course that the diamonds are exported via official channels.

Companies could be tempted to falsify the price of their exports in order to maximise the benefits of rebates or take advantage of export subsidies.

A multinational may indulge in illicit activities and disguise them as legitimate business activities. This may include the payment of bribes, the incorrect labelling of goods (or services) imported or exported, illicit trade in and the smuggling of tobacco, and complex agreements to ensure that valuable intellectual property is housed in tax havens.

Many of these illicit activities are protected by first world countries in the race to entice direct foreign investment and encourage the international trading expansion of ‘their’ companies.

Developing countries

The GFI is of the view that much of the trade invoicing occurs in developing countries for the primary purposes of capital flight and tax evasion, as well as moving money from weak into hard currencies.

Political uncertainty acts as a major incentive to move funds offshore.

“Large profits generated from IFFs are often recycled through complex patron-client networks related to the particular features of the domestic political economy of a country, in which various interest groups develop a vested interest in perpetuating trade misinvoicing,” states the report.

Limitations of the analysis

Adjustments are made for direct import-export comparisons, such as converting all values to a ‘free on board’ (FOB) basis. This can lead to errors. Further, the value gap analysis cannot detect the overinvoicing of services, which would include management fees, interest payments, licence fees, royalty fees on intellectual property, and consulting services.

However, the GFI is of the optimistic view that the estimated value gaps are likely to be understated rather than overstated.

In addition, while the analysis can indicate that there is trade invoicing on the macroeconomic level, it is impossible to identify the trading partners that may have engaged in under- or overinvoicing. It is also impossible to determine the true price that should have been paid.

While this report cannot be used by the South African Revenue Service to pinpoint the companies to audit, nor by the National Prosecuting Authority to target IFFs, it is an indication that there is a lot of work ahead.

The ultimate success of any effort to curb illicit financial flows, whether trade-related or not, would be evidenced by the return of those funds and the successful prosecution of the enablers, such as the accountants, lawyers, bankers and estate agents.

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There are legal and approved channels to get funds for investment purposes out of the country. To argue that ‘political uncertainty’ is a reason to do so, is basically to provide a flimsy cover for people actively committing crime. The basic motif here is to ‘commit crime’ finish and klaar. That is why, the government should take stringent steps to bring those to book and to throw them ‘agter slot and grendel’ (behind bars, in addition to seizing those assets and proceeds from those criminal activities). If, people don’t like ‘political uncertainty’ they move to some other country where they have ‘certainty’ to a larger degree, but if they devote themselves to perpetrating crimes, that’s something else because they are contributing to economic woes that feed the very political uncertainty they claim to be worried about. Its a vicious cycle for the country and a seemingly virtuous one for them. You do the crime you should do the time! Period.

I wonder if our previous illustrious titans of industry (of Brenthurst Street) have been systematically engaged in this for the entire history of out country.

Concur Bage but it is easier to milk the middle class taxpayer than to go after the big fish – Mainly cause they do not know how or are complicit
!!

You say” You do the crime you should do the time! Period.”
I agree. In the real world. Here however, from my viewpoint, there is massive looting of hundreds of billions. The tax system facilitates this. Best if everybody tries to stay out of that crooked loop. You may have noticed there has never been an arrest amongst the usual suspects.
What do you think is going on here? Just boiling some frogs.

Another one is VAT and income tax!
There are hundreds of Asian Vendors operating in malls selling an array of products.

The Vendors in the malls invariably sell mobile phone accessories whilst others have stores. Combined (one owner owns many stalls and shops) they do in excess of a R1,0 mill pa yet are not VAT registered, not to mention paying income tax as their business is cash. Try paying with a card at one of these stalls!

It’s a known fact that they bring the containers in as a group despite creating the illusion that they’re competitors

How do they get away with this? Does our Government turn a blind eye or are they too lazy to investigate?

All major Retailers in this country have to conform to the law, and all blue collar workers pay income tax, why should immigrants be any different?

what government? lol

Barbs is right and wrong at the same time. A colleague of mine once stated that life’s all just a game. You just have to know the rules. It is easy to see who is ignorant of the rules: they are the ones squealing “unfair” the loudest. The problem is the ANC don’t know the rules. They have made up their own set of rules involving pillage, plunder and personal enrichment. If the goal is to create a safe prosperous society, then the ANC need to get back on the banana boat.

As with any socialist society, the ANC depends on force or threat of force. They have created a society where one’s person and property are not safe. This itself incentives externalisation. In fact they have given advance notice that they intend expropriating property without compensation. That there is a lot of work ahead for the NPA underscores the problem. The NPA (who create no wealth) can never police even of fraction of these transactions. To think so is naivete in the extreme. Part of the problem is the law is grey, particularly concerning transfer pricing which will make up a large fraction of the concerns. I just get the holding company in the tax haven to invoice the South African subsidiary an amount such that the SA subsidiary makes zero profit and thus pays zero tax. Easy.

The solution is quite simple. It is not about policing but instilling confidence and certainty back in the country. The regime needs to start doing what is right for the country not spewing forth their usual diatribe of short term vote-harvesting populism. Make South Africa a low tax capital haven. South Africa can draw capital from the moon with the right policies and a stable currency. Play the game.

…and “political uncertainty” has ONE SINGLE CAUSE: the ruling party is 100% responsible for such climate!

Is so-called ‘capital flight’ a crime, or is it a result of deep fear (similar to that of a refugee fleeing?)
If citizens fear an oppressive regime (anti-WMC, etc) in the financial sphere….is it an international crime to flee with your capital??

(Yes, one agree HOW certain methods of capital flight takes place, is criminal under a set of technical laws. But the regime that sits behind the cause of capital flight, isn’t it a “crime” to your citizens by “stealing their future”?

Is it considered a financial crime if an SA company OVERPAYS for a company or operation/subsidiary they a acquire abroad, to aim for so-called “diversified growth” outside SA? (e.g. Sasol’s LCCP; Woollies’ David Jones; mobile operators in African countries, REITS acquiring property companies in E/Europe or UK, etc etc.)

Perhaps, those that are found guilty of gross asset mispricing/misinvoicing, they must face same “severe punishment” as the ones now ‘tried’ under the Zondo Commission of State Capture. Stealing your country’s govt money should be treated like treason…yet it leads (so far) only to a commission that will drag things out into perpetuity (for Govt to show the public, they doing something about corruption. The snail trying to catch up with the F1 car.)

A “mis-invoicing commission of enquiry” will thus be a good place to start to punish those financial refugees fleeing SA.

“No Naked Man lost anything’’
Anonymous
Oh really? – Michael from Klerksdorp
‘’…and “political uncertainty” has ONE SINGLE CAUSE: the ruling party is 100% responsible for such climate!
(I think it should read ‘’the ruling party – at the time is 100 % responsible for such actions and climate!)
I can assure you that ‘’under and over invoicing’’ has been going on since the day that the SARB foreign exchange licences were granted to authorised dealers, in the late seventies.
It has always been part of this FX market and extremely hard to pick up. Money laundering could be on par with the ‘’coronavirus’ ’as it caused a lot of destruction, hence the amnesty on exchange control violations was introduced.
“Foreign assets derived from “unlawful activities”
It is apparent that the amnesty will not extend to foreign assets derived from so-called “unlawful activities” as defined in the Prevention of Organised Crime Act, 1998, other than any exchange control contravention or a failure to comply with any revenue Act in respect of which amnesty is being applied for. Whilst recognising the difficulty of distinguishing between serious and less serious crime, it would seem that a failure to provide for amnesty in respect of certain criminal activities (such as perhaps contraventions of the Companies Act), could hinder the success of the amnesty.

Mis-invoicing, under-over invoicing, transfer invoicing is it not all the same thing. We have an environment in South Africa where if one has the means being involved in international trade, import, export or both, or in the service industries related to them, the opportunity is there every day. Even Joe Soap can set up a basic import export business.

Why is it done – look at the exchange rate it was not so long ago at 11.50, last week it nearly touched 16.00.

For those of you old enough do you remember in the 80`s the 2 tier exchange rate system legally in place to attract much needed forex into SA – it was called the financial rand. as opposed to the commercial rand or the daily traded rand. If the commercial quoted rand was say $1.00 was equal to R1.50 – you could get closer to R2.50/ R2.75 if you met the SARB criteria for financial rand, i forget the exact difference but it was substantial, around 40% for bang for hard currency than the traditional rate. There were of course abuses – round tripping the financial rand by the well connected being one of them, bring in financial send out commercial bring back financial etc – 40% profit for nothing.

Something that has fascinated me since 1994 and something which to this day is largely responsible for people to seek out and exploit loop holes, is exchange control. I would have thought that as this was created at the height of APARTHEID that the ANC would have been very keen to remove them as soon as possible after the elections. this prehistoric organisation, i am referring to the thousands of people they have to employ unnecessarily to police 50 year old apartheid laws, checking western unions/ money grams/ foreign transfers for imports, even worst for exports. Why does Zambia, Kenya, Uganda and dozens of other African countries have no such thing in place and yet they are thriving by comparison to SA, also no BEE in those countries and you ca actually own 100% of your businesses and land.

Lets be honest anyone that really has big money to get out of RSA has already moved it decades ago certainly before the 94 elections and for the 10 years after that, whats left in SA now is here. The allowances for foreign investment are way above even most of the 3% of tax payers that there is nothing really stopping them sending everything they do not need in SA out of the country – so why keep exchange controls??? The story we are sold is they were afraid of a massive rush to the exists the day they did it, well maybe 26 years ago even 10 years ago but come on – i believe the exchange controls actually exacerbate ZAR volatility and the moves in both directions would be much less violent and extreme without them.

We tried to invest $40m as a group in SA some 8-9 years ago, for logistics development. Now this is money coming in and would employ 500 people. The hoops and forms and applications we had to fill in and paperwork were ridiculous, after 8 months it was declined as they wanted further information on overseas interest payments on the loan. The business was running through Durban into our neighbours – the chief investment officer in Geneva cracked and withdrew the whole plan, the business was opened in Zambia within 17 days – today that business employs 3700+ skilled Zambians, the IP and head office is in Lusaka and Copper belt and all the trucks, vans, abnormals etc are driven exclusively by Zambians, by 2021 i believe we will exceed 5000 workers across the board and Investment to date has now exceeded $124 million admittedly not a lot, the point is that this could all have been and was supposed to be a south African operation, not Zambian. The only South Africans employed are the ones that were head hunted from SA and now live in Zambia.

Policing this is impossible regarding mis invoicing. Fix what is wrong in this country and you will not have to police anything. As for money laundering, drug smuggling and arms trading this happens anyway regardless and they usually trade in plane loads of cash, into the middle east where they are happy to clean the money for a 25% fee and deposit same – no different to Malaysia and many other places. I wonder how much of the R160 billion savings for the next 3 years in the budget are being paid to the SARB policing department, to make sure you do not send your kids studying in the UK maybe $100 per month more than you are allowed to, or you put the wrong code on incoming funds that are then held or returned after 7 working days from where they came etc etc – remove the exchange controls and all staff related to policing that at the SARB and at all the banks and see what that saves annually. With that gone maybe foreigners would be less paranoid about future FDI.

To add one more comment, i think the Omnibus travel allowances are still in place. The last time we used them the limit was R20m per company per year, based on criteria you could be allocated the maximum or a % of it, basically it came down to how much revenue was being generated by forex, obviously big companies or companies with large turnovers allow the share holders to take quite large quantities of cash out perfectly legally through OR Tambo on the Omnibus facility – these days it would only make sense if flying into Asia or mid east as they do not care how much cash you are carrying, if you also carrying your original bank letter and Omnibus facility with all the stamps on which is the case as everyone would pick up before they checked in – ie source of funds – in Europe you would be screwed likely to be arrested but there are big companies that work as groups in SA different divisions but all the same entity, turnovers at R750m – R4b split into 5 separate divisions based on service or commodities, mining, agriculture and some of them used to have the max Omnibus on every single company – that allowed the collective share holders to move R100m a year in USD cash out of SA – this was granted by your bank and did not pass through the SARB – as i said not sure if this still exists. You also used to receive a letter from the SARB if your credit card spend exceeded R1m a year on overseas trips, if it was linked to a company with large revenue but no issues. Carry $500k in your carry on luggage using Omnibus and no questions very strange. My point is the companies i am talking about would not have remained in SA if they were not able to do this and have this flexibility as such that kept them from disinvesting and pulling out. With bizarre mechanisms like this in place and exchange control it is not surprising that people use to create their own hedging systems and move money in and out, under the radar, its about survival of the company and ultimately the owners i guess if we do go Zimbabwe way.

End of comments.

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