Tuesday, December 23, 2014

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Looted in Plain Sight: Kenya and its Multi-Billion Dollar Invoicing Problem

Kenya lost over $700 million in taxes in 2012 due to smuggling. But despite popular belief, the main problem with smuggling isn't corruption. It's tax havens, phantom firms and secrecy.
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Overlooking skyscrapers in the Nairobi skyline. Photograph by Curt Carnemark/World Bank.

At the end of January, the Kenya Sugar Board, acting on a tip off, seized and impounded over 1,800 bags of illegally imported sugar. Arrests were made and the board vowed to begin a country-wide crackdown on other cartels who smuggle tons of sugar into the country each year.

This could not come soon enough. The impacts of smuggling sugar − whose prices can easily undercut that of legitimate products − on Kenya’s domestic sugar industry have been devastating. Mumias Sugar Company, which is responsible for over 60% of Kenya’s domestic sugar production, for example, named smuggling as a contributing factor to the company’s pre-tax losses of $26m in 2013.

However, Kenya’s problem with import smuggling extends well beyond sugar. Using bilateral trade statistics provided to the International Monetary Fund, Global Financial Integrity (GFI) has calculated that since 2006, nearly $10 billion worth of goods have been smuggled into the country. And the problem has been worsening − of that $10 billion worth of goods that appear to have vanished at the border, $2.5 billion came in 2012 alone.

In fact, the problem is so ubiquitous that nearly one out of every six dollars worth of goods imported into Kenya goes unreported to customs authorities. This creates a huge loss of tax revenue to an already cash-stricken government. At average tariff and VAT rates, proper reporting of smuggled imports would have added $721 million to government coffers in 2012 − that's the equivalent of an astounding 12% of the total tax revenue the government collected that year.

Perhaps of even greater concern, however, is smuggling’s impact on domestic industry within the country. Smuggled goods can be turned around and sold on the black market for prices up to 30% lower than their competitors. If its impact on the sugar industry is any indication of the damage smuggling can do to the broader economy, Kenya stands to gain a lot from stopping this illicit flow of goods.

Smuggled in plain sight

The first step in doing this would be to ask where these goods coming from. Recent seizures of sugar suggest that smuggled goods don't necessarily come from Kenya’s neighbours, but can arrive from places as far off as Brazil and Dubai.

The really pressing question, however, is how these smugglers manage to slip billions of dollars worth of goods through Kenyan ports under the noses of customs officials in the first place. Sugarcane from Brazil certainly isn’t being carried by the ton into Kenya in suitcases, and nor are computers from America or mobile phones from China.

Instead, the billions in smuggled goods are almost all “smuggled” in the plain sight of authorities. Through a process called 're-invoicing', importers deliberately alter their export and import invoices to change the values at which the goods are declared to customs. Goods destined for Kenya leave a country with one value, but end up in Kenya with a drastically lower one, meaning the importer pays substantially less in tariffs and VAT for the exact same amount of goods.

What's worse is that re-invoicing is completely legal in many countries, and some companies even exist to guide traders through the process, operating out of shady locales such as the Seychelles, the British Virgin Islands, and other known tax havens. These service providers help traders use anonymous shell companies and secret bank accounts to avoid taxes and sneak goods or illicit money into or out of countries such as Kenya without leaving a trace.

Furthermore, customs officials often have no way of knowing when traders are manipulating prices. The importer’s invoice for the goods and proof of payment to a tax haven shell company appear completely legitimate, giving an unknowing customs official no grounds on which to challenge the listed value. The financial secrecy of the tax havens enabling re-invoicing meanwhile makes this sort of foul play even more difficult to detect − even if a sceptical customs official identifies an invoice as incriminatingly under-valued, it is almost impossible to tie the importer to their offshore shell company or bank account.

Schemes such as this are also used to extract wealth from Africa. A GFI report released in December 2013 noted that an average of 5.7 % of sub-Saharan Africa’s GDP left the continent annually through illicit financial outflows in the decade ending 2011, much of it through re-invoicing.

The real culprits

In most cases of smuggling, blame is often focused entirely on petty corruption within the customs administration. But while sneaking in contraband and unreported goods is a lot easier if you can pay a small bribe to have a customs officer look the other way, this is only a small part of the problem. Kenya’s problem with smuggling has a much more complicated origin − namely the use of tax havens, anonymous shell companies, and the shadow financial system.

Although corruption in government, and more specifically customs, facilitates smuggling, the true culprits of the vast smuggling problem crippling the economies of Kenya and other African nations are the secret jurisdictions that allow these tax-evading methods to flourish. Unless global efforts are taken to end financial secrecy and eliminate anonymous shell companies, problems of smuggling and other forms of illicit flows of goods and capital cannot possibly be curtailed.

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