Is the South African effort toward reducing money laundering optimal?

Author:Bernd Schlenther
Position:South African Revenue Service (SARS), Pretoria, South Africa
SUMMARY

Purpose – A measure of how much money is laundered is required to determine the effectiveness of any anti-money laundering regime and the reduction of money laundering in targeted areas. In the absence of useful estimates, authorities need to look at the best quality data available to arrive at a meaningful estimate and a consequent target for reduction of money laundering. Since tax... (see full summary)

 
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Introduction

Tax crime is one of the top three sources of “dirty money” that is hidden in the financial system (OECD, 2009). Put differently, it is estimated that more than two thirds of illicit financial flows involve tax evasion (OECD 2012, p. 72). The links between tax crimes and other financial crimes are well recognised. Tax crimes are predicate offences to money laundering in many countries and this is now recognised as an international standard by the Financial Action Task Force (FATF).

In 1998 the International Monetary Fund (IMF) indicated that although some members' anti-money laundering (AML) legislation does not apply to the proceeds of tax evasion, there are inevitably close linkages between the two. Money that has evaded taxes must be disguised, and laundered money must be kept hidden from the tax authorities. In view of the former, the IMF states that its policy and technical work helps its members to improve their tax collections and therefore, assists in the fight against money laundering, both directly and indirectly, depending on the relevant legislation in the individual country (IMF, 1998). The same sentiment is echoed in South Africa's Budget Review of 2000, where it is emphasised that tax evasion is a crime which is often linked to other criminal activity, including organised crime and money laundering. The South African Revenue Service's (SARS) has therefore a role to play to help to combat crime and in making the country safer and more prosperous (Budget Review, 2000, p. 70).

Because money laundering affects economic stability, erodes the tax base and facilitates capital flight it is critical to gauge the extent thereof and to target the areas where it manifests. Measuring the scale and impact of money laundering accurately is also of increasing significance since:

  • money laundering promotes criminal activities in South Africa because it allows criminals to keep the benefits that they acquired through their criminal activities; and
  • increased efforts of combating money laundering involve compliance costs (enforcement cost and administrative burden) (Van Jaarsveld, 2011; Unger, 2009).
  • Money laundering is aimed at hiding money generated by crime and as Schneider (2007) and Walker (2009) point out, a large portion of money being laundered is ascribed to tax evasion. In addressing money laundering and tax evasion, cognisance should be taken of the fact that AML and counter terrorist financing (AML/CFT) regimes supports economic development and that the three primary goals of the global AML/CFT regime are:
  • to serve as an additional tool in fighting and preventing crime and tax evasion;
  • to protect the financial system from criminal influences;
  • prevention of the insertion of tainted money into the economy as a whole; and
  • to contribute to good governance and to promote the rule of law for the society as a whole (Yikona, 2011, p. 5).
  • Background

    The Oslo Dialogue (named after a 2011 OECD Forum on Tax and Crime held in Oslo, Norway) identified three key priorities for addressing tax and financial crimes, namely improved inter-agency cooperation with particular focus on the contribution that tax administrations can make; the use of international cooperation mechanisms1; and the benefits of the whole of government approach in supporting development and fiscal transparency.

    The scope of this paper is limited to inter-agency cooperation and the contribution the tax administration can make in identifying the scale of illicit financial flows attributed to money laundering. It is suggested that the foundation for cooperation lies in information sharing and collaboration which is premised on a shared line of sight. Specific tax data can be indicative of the scale of money laundering attributed to tax evasion and can serve as a rough lower bound for target setting and an understanding of vehicles used to hide assets. As stated in the Economist, the best weapon against illegal activities is transparency, which boils down to collecting more information and sharing it better (Economist, 16 February 2013).

    The above is also in line with the 2012 FATF Recommendations which require that countries identify, assess and understand the money laundering and terrorist financing risks facing them and adapt their AML system accordingly. In South Africa inter-agency cooperation is provided for under the Financial Intelligence Centre Act (FICA) 38 of 2001 which establishes a Financial Intelligence Centre (FIC) with the principal objective of assisting in the identification of the proceeds of unlawful activities and the combating of money laundering activities and the financing of terrorist related activities. Further objectives of the centre are:

  • to make information available to investigative authorities, intelligence services and the SARS to facilitate the administration and enforcement of the laws of the Republic; and
  • to exchange information with similar bodies in other countries regarding money laundering and similar offences (FICA Section 3).
  • In theory the FICA creates a special relationship between the FIC and SARS in that the FIC data will assist the SARS to combat tax evasion and to collect taxes more effectively. In fact, Section 29 explicitly requires all businesses to report any transactions that may be relevant to the investigation of any evasion or attempted evasion of a duty to pay a tax, levy or duty under any legislation that is administered by the SARS. The SARS, in turn, is required by FICA to divulge certain information relating to the possible abuse of an accountable institution for laundering, or its possible involvement therein, to the FIC ( De Koker, 2007, pp. 22-23 ).

    The relationship between tax crime and money laundering

    Money laundering refers to any act that obscures the illicit nature or the existence, location or application of proceeds of crime; money laundering legislation typically provides for three substantive offences (concealment, arrangements, acquisition and use of criminal property) in respect of money laundering ( De Koker, 2007, pp. 1-4 ). Three stages are generally distinguished in the money laundering process: placement, layering and integration. During the placement stage money enters the financial system; the layering process separates the illicit proceeds from their criminal source and the final stage integrates all of the funds. Layering may entail a complex series of transactions which are solely aimed at blurring the money trail.

    For money laundering schemes to achieve their objective, they typically exhibit certain characteristics: appear to make commercial sense, be structured in tax efficient way2, have the appearance of legitimacy and be transnational in nature. The assistance of professional advisors in law, banking, accounting and finances is part and parcel of sophisticated laundering schemes ( Young and Cafferty, 2005, p. 43 ). The economic and socio-political environment also plays a role in that jurisdictions with high levels of corruption and with a high prevalence of organized crime and drug production or distribution will have a greater incidence of laundering.

    Tax evasion is a criminal offence and is punishable by criminal sanction. Tax evasion represents illegal and intentional actions by which evaders fail to pay legally due obligations ( Thuronyi, 2003, p. 154 ; Cordes et al., 2005, p. 401 ). Tax evasion is also a predicate offence to money laundering because, by definition, money laundering can only take place when there is an underlying crime referred to as a predicate offence which gives rise to illegal proceeds which are then laundered. What is evident from the above is that both tax evasion and money laundering entail some form of concealment. In the case of the former, tax evaders conceal assets and they do not, or do not fully, declare income accrued (legal and illegal income). The objective of money laundering is to disguise the source of wealth. Both involve transactions designed to deliberately present a blind alley to any revenue investigation ( Schlenther, 2013, p. 131 ).

    Tax evasion can be part of both financial fraud and money laundering. Already, in studies in the 1990s, tax evasion topped the list of income from criminal proceeds in the USA ( Reuter and Truman 2004, p. 22 ) Tax evasion includes evasion of value-added tax (VAT), customs duties through smuggling and trade mispricing, corporate income tax evasion and abuse of incentives schemes and exemptions. Money laundered also represents income that evades taxes and misreporting or underreporting income is one of the most common methods of conducting money laundering. Consequently, money laundering negatively affects tax collection efforts (Unger, 2007, p. 10).

    The objective of money laundering is to disguise the source of wealth. Both money laundering and tax evasion involve transactions designed to deliberately confuse and confound inquiry ( Maciandaro, 2004, p. 181 ) and both contribute to the tax gap. The tax gap is generally defined as the difference between the tax which would be raised under a hypothetical, perfect enforcement of tax laws and the actual tax payments (Fuest and Riedel, 2009). In South Africa the tax gap is defined as a measure of tax evasion that emerges from comparing the tax liability or tax base declared to the tax authorities with the tax liability or tax base calculated from other sources (SARS Annual Report, 2003).

    The rationale for estimates of the...

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