Strategies for Addressing Capital Flight, Part 3

James K. Boyce and Léonce Ndikumana

This is part 3 of a five-part series, drawn from Political Economy Research Institute (PERI) working paper No. 361, “Strategies for Addressing Capital Flight,” by James K. Boyce and Léonce Ndikumana, available here. The paper is forthcoming in Capital Flight from Africa: Causes, Effects and Policy Issues, S.I. Ajayi, and Leonce Ndikumana, eds. (Oxford University Press, 2014), accessible here.

Curbing trade misinvoicing and transfer pricing

A substantial amount of capital flight from African countries occurs through the underinvoicing of exports and the overinvoicing of imports (Ndikumana et al., 2014). When a firm understates the price and/or quantity of exports on invoices submitted to the African authorities, it can retain abroad the difference between the true value and the declared value, rather than surrendering the full amount of its foreign exchange earnings to the central bank in return for local currency. When a firm overstates the true value of its imports, it can obtain extra foreign exchange to send abroad, and again retain the difference in foreign accounts.

Strategies to curb trade misinvoicing must include interventions on both sides of trade transactions; that is, both in Africa and in trading partner countries. African governments need to strengthen trade regulation and exchange control mechanisms to better track international trade. The governments of Africa’s trading partners need to cooperate in enforcing transparency in international trade and combating corporate sector corruption. The automatic sharing of invoice data submitted to trading partners’ customs authorities would make it possible to identify discrepancies in the prices and quantities recorded on both sides of trade transactions. In addition, the African trader who files a falsified invoice often has a cooperating partner overseas who may corroborate inaccurate information and remit the hidden funds to designated accounts. Africa’s trading partners can assist the continent by establishing and enforcing regulations and laws that make such complicity costly.

Transfer pricing poses a different set of challenges, since it cannot be detected by the comparisons of invoices submitted to the customs authorities of the originating and receiving countries. Instead, the same fictive price is recorded at both ends of the transaction, so as to relocate profits to low-tax or no-tax jurisdictions, thereby lowering the firm’s overall global payments of taxes.

Transfer pricing vs. trade misinvoicing

In Africa, as elsewhere, transfer pricing by multinational firms is a ubiquitous tax-avoidance practice. Transfer pricing is the manipulation of prices assigned, for accounting purposes, to intra-firm trade in goods and services so as to park corporate profits in low-tax (or no-tax) jurisdictions.

Transfer pricing is sometimes confused with trade misinvoicing, but the two are quite different. Trade misinvoicing can be detected by comparing the invoices submitted to customs authorities in the exporting and importing countries on either side of a given transaction. In principle, the quantity and value of the goods should match on both invoices, after adjusting for the costs of freight and insurance, so that country A’s recorded exports to country B are the same as country B’s recorded imports from country A. In practice, however, there are often systematic discrepancies between the two, as discussed by Ndikumana et al. (2014). Exporters may understate quantities or values, or importers may overstate them, as a means for capital flight. In other cases, importers understate quantities or values to evade customs duties.

Transfer pricing, in contrast, does not entail the submission of different information to the exporting country and the importing country. The same quantities and the same values— computed on the basis of the same transfer prices—are invoiced at both ends of the transaction. But the prices assigned for this purpose differ greatly from those that would have been paid in an arms-length transaction between different firms.

Four of the main strategies that have been advanced for combating transfer pricing

1) Since transfer prices differ from the prices that would apply in market transactions between independent firms, one strategy is for tax authorities to develop a more realistic set of prices and to apply these alternative prices in tax assessments.

2) A second strategy, known as “global formulary apportionment,” is to allocate the worldwide profits of multinational firms across the jurisdictions in which they operate on the basis of a formula based on the distribution of the firm’s assets, sales, employment, or other operational indicators.

3) At present, multinational enterprises are not required to disclose, in their audited annual reports, their total profits and taxes paid in all the jurisdictions in which they operate. This lack of information makes it much more difficult for tax authorities to detect tax avoidance and tax evasion. Country-by-country reporting, the third strategy for combating transfer pricing, would require the firm to report for each country in which it operates

4) A “thinly capitalized” firm is one that relies heavily on debt, as opposed to equity, for its capital. Whereas returns to equity are taxed as profit, interest on debt is deducted as a business expense, and interest payments can be channeled to subsidiaries in locations where they are subject to low taxes or none at all. To combat this problem, thin capitalization rules put a ceiling on the amount of interest payments that can be deducted for tax purposes (OECD, 2012).


Ndikumana, L., Boyce, J. K. and Ndiaye, A. S. (2014). “Capital Flight from Africa: Measurement and Drivers.” In S. I. Ajayi and L. Ndikumana (Eds.), Capital Flight from Africa: Causes, Effects and Policy Issues. Oxford: Oxford University Press (Forthcoming).

OECD. (2012). Thin Capitalization Legislation: A Background Paper for Country Tax Administrations. Paris: OECD.

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