Illicit Financial Flows: A Primer - Part II: Laws And Institutions

Laws and Institutions: the how and the who of tackling illicit financial flows (IFFs)

Part I of this brief series provided an overview of IFFs – what is meant by the term “IFFs”, what conduct facilitates and furthers IFFs, and whether South Africa is making adequate headway in addressing them. As to the last item on that list, the outlook is not promising[i]. The natural question that follows is who is tasked with curbing IFFs from South Africa? And, where this responsibility falls to a number of institutions, how well are each of them faring in meeting their obligations?

The answer to these questions will be explored in parts II and III. At the outset, it is important to recognise that, while the difficult task of tackling IFFs is divided between a number of institutions, it is not enough to find deficiencies and ascribe blame to any one actor. Rather, the goal should be to assess the effectiveness of the system – that is, how well its constituent parts work on their own and with each other bring an end to IFFs.

The Financial Intelligence Centre

The Financial Intelligence Centre Act[ii] (FIC Act) establishes the Financial Intelligence Centre (FIC) with the principle objective of assisting in the “identification of the proceeds of unlawful activities and the combatting of money laundering activities and the financing of terrorist and related activities”.[iii] Its ancillary objectives include sharing the information it collects with various agencies, including the National Prosecuting Authority, intelligence services, and the South African Revenue Services (SARS) to facilitate the enforcement of laws, the exchange of information with similarly situated bodies in other countries, and the supervision and enforcement of compliance with the FIC Act[iv].

The FIC is empowered to act only in relation to IFFs resulting from the proceeds of crime, money laundering, and terror financing.[v] It cannot act with regard to conduct such as trade misinvoicing or abusive transfer pricing – this is left to other enforcement agencies.

What is the legal architecture created by the FIC Act? One aspect is the creation of a number of “control measures” against money laundering and financing of terror activities. These include a prohibition against establishing a business relationship with anonymous clients or clients using a false or fictitious name[vi]. “Accountable institutions” – a defined term which includes attorneys, estate agents, banks, insurers, dealers in foreign exchange, and financial services providers – must verify the identity of the client. The FIC Act imposes a host of other obligations on accountable institutions, such as the development of a programme for anti-money laundering and counter-terrorist financing risk management and compliance, the requirement to keep records of customer due diligence[vii] and transactions[viii], as well as mandatory reporting requirements in respect of suspicious and unusual transactions[ix].

Some of these obligations were incorporated into the FIC Act in an amendment which was signed into law in April 2017. But this amendment was not without controversy. The introduction of enhanced due diligence requirements in respect of “foreign prominent public officials” and “domestic prominent influential persons” (otherwise known as “politically exposed persons”) was denounced by some as an affront to radical economic transformation.[x] These provisions require accountable institutions to obtain “senior management approval”, take “reasonable measures to establish the source of wealth and source of funds of the client” and “conduct enhanced ongoing monitoring of the business relationship” when conducting business with a foreign prominent public official or domestic prominent influential person.

In the era where South Africa reels from the aftermath of state capture, these provisions are better characterised not as an enemy of transformation, but a welcome advancement to ensure greater accountability from financial institutions. More importantly, the passing of the Bill brought South Africa’s regulations in line with the standards required by the Financial Action Task Force (FATF), a global inter-governmental body that sets standards relating to combatting money laundering, terrorist financing and other similar threats against the global financial system[xi]. The implementation of the amendments to the FIC Act brought the FATF’s targeted follow-up process in respect of South Africa to an end.[xii] The amendment to the FIC Act was a much-needed step forward in the fight against IFFs.

While the FIC has a key role to play in combatting financial crime, it is important to remember that it possesses no prosecutorial powers. Its investigative powers are also constrained. As recorded by the Director of the FIC:

“The financial intelligence provided by the FIC is used by investigating agencies in their investigations, but cannot be used as evidence in a court of law. We can be called upon to corroborate evidence that is produced by other government agencies based on information provided by the FIC, but it is incumbent on the law enforcement agencies to provide the evidence that will be used in a prosecution.”

It follows then that while the investigation and prosecution of offences relating to IFFs depends on the involvement of agencies such as South African Police Services and the National Prosecuting Authority, the FIC retains a vital role in the process.

The FIC recently released its 2017/2018 annual report.[xiii] The report suggests that it was largely successful in meeting its stated goals regarding its role in fighting financial crime, and details some significant improvements in performance from 2016/2017. The FIC contributed to recovering over R3 billion in criminal proceeds during the reporting period, a marked increase from R443.9 million in the 2016/2017 financial year. Some R55 million was blocked as suspected proceeds of crime (down from R149 million in 2016/2017), 37 judicial actions were contributed to (up from 26 in the previous year), and 149 money laundering cases were referred for investigation (up from 114 in 2016/2017).

As mentioned previously, however, these referrals come with no guarantee that any prosecutions followed. What is needed, then, is for the number of prosecutions directly resulting from the referrals to be monitored to determine whether the information provided was relevant and useful. It is clear that the FIC plays a key role in facilitating efforts against IFFs – but it cannot do so alone.

The South African Revenue Service (SARS)

The involvement of SARS is instrumental in putting an end to IFFs. A major risk that must be addressed is that posed by base erosion and profit shifting (BEPS)[xiv]. This risk is potentially heightened by the fact that South Africa’s corporate tax rate, at 28%, is higher than the world average of 22.96%[xv].

An important recent development in this regard is the introduction of country-by-country (CbC) reporting, which requires companies that operate over a number of countries to report on their activities in each country where they conduct activities. This provides vital information to authorities to assess transfer pricing irregularities and to monitor risks imposed by BEPS. This new reporting was implemented pursuant to the BEPS Action Plan, which was adopted by the OECD and G20 countries in 2013 with the aim of ensuring that all taxable profits are taxed once.

In its 2017/2018 Annual Performance Plan, SARS undertook to audit 30 BEPS in the 2017/2018 financial year.[xvi] It also recognised the threats posed by illicit trade – with the trade in cigarettes and tobacco being a notable example – and in so doing, outlined a list of ways in which SARS intends to manage these risks, including by:

• continuing to target the entire supply chain of illicit cigarette and tobacco trade, through better control of warehouses, enhancement of excise systems to improve risk detection, and increasing collaborations with key stakeholders;
• engaging with other state enforcement agencies to agree on Memorandums of Understanding for establishment of dedicated resources for fighting illicit trade;
• enhancing inter-agency co-operation in fighting tax and other financial crimes;
• building internal capacity and capability by participating in the International Academy on criminal tax investigations;
• increasing enforcement and compliance focus on high risk goods such as tobacco and its products as well as clothing and textile products and other high-risk commodities; and
• increasing control of our borders through by increasing focus on high risk flows of goods, travellers, conveyances and craft.

These steps were almost identical to those set out in the 2016/2017 performance plan. That plan had described nine ambitious actions to be taken with regard to BEPS, such as the auditing of 300 large companies and a pilot project that was due to be concluded in March 2017 “to evaluate a process to undertake legal enquiries into entities that promote tax financing structures that ultimately erode the South African tax base”. The Davis Tax Commission, in respect of these steps, made the following observation:

“Key to the success of [initiatives outlined in the plan] is the procurement, training and retention of suitably skilled resources to deal with the complex issues that give rise to BEPS. As indicated, the committee is aware of the loss of key personnel in the transfer pricing division at SARS and it is not clear whether suitable replacements have been found.”[xvii]

The problem of staffing at SARS shows no sign of abating.[xviii] Even though in December 2017 SARS downplayed the effect of the loss of staff[xix], then-Finance Minister MalusiGigaba confirmed that SARS had lost 500 employees in the first 10 months of that year, more than two-thirds as a result of voluntary resignation.[xx] In May this year[xxi], SARS Acting Commissioner Mark Kingon noted highly skilled and well-resourced teams dedicated to investigating illicit trade had been “predominantly dissolved” and “split up and scattered throughout SARS”. He also stated that “the sharp fall in the number of staff employed by the SARS had limited its ability to curb illicit financial flows”, recording that the “exodus of employees” meant that SARS’s staffing complement had declined from 14 000 in 2014 to about 12 600 now. Tackling IFFs requires highly skilled personnel of the highest calibre. Not only is a great deal of technical skill and expertise required, but staff must also demonstrate the highest ethical standards. Dealing with this issue is a significant and pressing challenge for SARS.

The good news is that efforts are already underway. The most notable of these is the Commission of Inquiry into tax administration and governance by the South African Revenue Service headed by retired Justice Robert Nugent (Nugent Commission). An account of wide-spread institutional failings at SARS to date has emerged from testimony given at Nugent Commission[xxii] and an interim report has already recommended that the suspended Commissioner Tom Moyane be fired.[xxiii]

It will be some time before processes at the Commission are completed, and only then can extensive action be taken – firstly, against those who contributed to the weakening of SARS’ operations, and secondly, towards rebuilding its structures to a point where it functions effectively. It is a somewhat beleaguered position from which to conduct battles against IFFs. Even in this state, however, SARS was able to gain some ground – in 2016/2017, it increased its BEPS capacity with the addition of 12 resources and completed 548 in-depth audits, yielding R3.1 billion including BEPS and transfer pricing.[xxiv]

What does this all mean for SARS? From a legislative and strategic planning perspective, most of the crucial aspects – such as enhanced transparency through CbC reporting, and a commitment to rooting out BEPS through in-depth auditing – are in place. What needs to be seen now is the results of implementation. Successful implementation hinges on having the necessary resources (including personnel), organisational capacity, and institutional will. In short, SARS must work hard to get its house in order – only then can we hope to see real results in the fight to curb IFFs.

Room for improvement

There is no doubt that the FIC and SARS have a vital role to play in stemming the tide of IFFs. However, their success has, to date, been limited. In some instances, this can be attributed to their own institutional shortcomings, but in others, it is the involvement of other role-players down the line that has been the weak link. Part III of this series will continue the examination of institutions tasked with fighting IFFs.

Cherese Thakur
Legal Researcher
cherese@hsf.org.za

[i] A van Wyk “Carrim calls on FIC, Hawks, SARS and NPA to stem tax losses for SA” News24 accessed at https://www.fin24.com/Economy/carrim-calls-on-fic-hawks-sars-and-npa-to-stem-tax-losses-for-sa-20180531 on 7 September 2018.