Extractive sector: Why the country should care about illicit financial flows

Should commercial production of oil and gas begin before the government tightens loopholes that drives illicit financial flows (IFFs), the country should expect very little and in some cases nothing at all in any form or shape of the much needed oil revenues.

Oil and gas sector analysts interviewed for this article recommend that government do something almost immediately to plug IFF way before commercial exploitation of the country’s oil begins to flow.

This is because the oil resource expected to last for about two decades once commercial production starts, is one of the high stake economic sector that is extremely susceptible to IFFs maneuvers.

This is well exemplified in several studies including one by the United Nations Conference on Trade and Development (UNCTAD). According to the report, IFFs related to the export of extractive commodities (amounting to $40 billion in 2015, which is about Shs147trillion) remains the largest component of illicit capital flight from Africa.        

Illicit Financial Flows which is increasingly becoming a real challenge to revenue mobilisation, refers to movements of money and assets across borders which are illegal in source, transfer or use, according to the report entitled “Tackling illicit financial flows for sustainable development in Africa.”

Mostly, IFFs which deny the country its fair share of revenue, are being perpetuated by the multinational companies operating across the country’s economic sector, with key amongst which include players in sectors such as oil and gas (extractive), energy, telecommunication, ICT and manufacturing.

Every year, an estimated $88.6 billion (about 325trillion), equivalent to 3.7 per cent of Africa’s GDP, leaves the continent of Africa as illicit capital flight, according to UNCTAD’s Economic Development in Africa Report 2020.

For the case of Uganda, it is estimated that more than Shs2trillion, which is about three quarters of the general national budget support by development partners (donors) for the this financial year (2020/2021), amounting Shs 2.9 trillion, is lost as a result of IFF.

According to civil society coalition on oil and gas statement (CSCO), the situation is set to get worse with the commencement of commercial oil production if nothing is done to fix the tax leakage and abuses that most multinationals companies are evidently perpetuating.

Further, UNCTAD’s Economic Development in Africa Report 2020 says stopping illicit capital flight even for the case of Uganda could almost cut in half the annual financing gap of $200 billion (about Shs733trillion) that the continent of Africa faces to achieve the Sustainable Development Goals (SDGs).

Ugly head

Mostly, IFFs are being perpetuated by the multinational companies either operating or having presence in the country. Illicit Financial flows are normally manifested through tax evasion, money laundering and false declaration. Other illegal methods used include overpricing, transfer pricing, money laundering, corruption and false declarations, all largely responsible for denying the government the resources it needs to deliver much needed social service to the country. 

Since the confirmation of the existence of commercially viable oil in 2006, the government has put in place a comprehensive legal and  policy  regime  for  the  regulation  of  the  upstream  and  midstream  petroleum  operations  as  well  as, the  management  of  oil  revenues.

 “However,  the  challenge  that  the  country  has  to  manage  is in  respect to  guarding against minimising external petroleum revenue leakages, and in particular to ensure that oil companies pay their fair  share  of  revenues  as  provided  for  under  the  law,” Mr James Muhindo, oil and gas sector analyst told Prosper Magazine.

He continued: “Failure to manage illicit financial flows will undermine the country’s ability to generate the required revenue from its petroleum wealth which will perpetuate underdevelopment and poverty.”

Impact of IFFs

It is pretty obvious by now, according to Mr Muhindo for the government to realise that IFFs undermines the efforts of a country to  boost its domestic  revenues, and  consequently, its  ability  to  provide  basic  public goods and  services.

By perpetrating illicit financial flows, Mr Muhindo believes that multinational corporations enjoy a free ride while Small and Medium Enterprises (SMEs) as well as vulnerable groups such as the poor, women and youth bear the greatest brunt of the tax burden as government increasingly relies on Pay as you earn (PAYE) tax which is imposed on income of employees and Value Added Tax (VAT), where the final consumer pays the tax.  

 “In  this  way,  IFFs  promote  and  encourage  regressive  forms  of  taxation, something we are opposed to becausue it is unfair to the vulnerable groups,” says Ms Regina Navuga, a tax justice advocate.   

The fear should even be deep on the account that ultimately IFF undermines  the  legitimacy  of  the  tax  system  and  in  some  cases  that  of  the  ruling  regime especially where elements of state capture is evident.

State capture is a type of systemic political corruption in which private interests significantly influence a state's decision-making processes to their own advantage. It can also refer to the illicit control of the state for personal gain by corporations, the military and politicians, mainly through the corruption of public officials.

“Multinational companies, especially oil companies and generally oil and gas sector players have deep pocket and decades of years of experience in the business. This provides them some leg room for maneuver, including using their purse to influence decisions their way. So those dealing with them on behalf of the population must always remember that.

“And while engaging with them our officials must realise that there is nothing bigger than the country and there is no price for it apart from commitments that guarantee bright future of the country,” Mr Henry Mabzira, an oil and gas industry expert told Prosper Magazine.

Action time

In light of risks and the potential impact of IFF, which Uganda Revenue Authority doesn’t shy aware from, Ms Navuga proposes adopting regional approach to dealing with the increasingly deep vice.

She is of the view that East African Community Countries collaborate more, including through sharing information pertaining to multinational companies suspected to be involved in tax abuses of any related nature. 

Double Taxation Agreements, especially the one with the Netherlands and even Mauritius must have clauses that guard against reducing the country’s tax threshold and undermining the domestic tax regime especially the one that speaks to taxing income sourced and earned in the country.

This according, Mr Onesmus Mugyenyi who is the deputy executive director of Advocates Coalition for Development and Environment (ACODE), an independent public policy research and advocacy, must be accomplished ahead of the much-anticipated commercial commencement of oil production.

“For each of these treaties, the  government  of  Uganda  should  insist  on  inclusion  of  anti-treaty  abuse  provisions  to  the effect  that  multinational  companies  including  those  engaged in  petroleum  activities  in  Uganda cannot  benefit  from  the  agreement  where  the  principle  purpose  of  the  transaction  is  to  avoid payment of taxes,” he said.

Further, there is need to enact  a  dedicated  Extractive  Industries  Transparency  Initiative  (EITI)  law  to  support  the operationalisation of EITI standard following Uganda’s recent admission as a member country. The  EITI  law  should  among  other  things  put  in  place  a  framework  for  transparency  and accountability  in  the  disclosure  of  extractives  revenues  including  those  from  the  petroleum sector.