Illicit Financial Flows: Concepts and Definition

While “Illicit Financial Flows” (IFFs) have received considerable attention by virtue of Sustainable Development Goal (SDG) target 16.4, which aims at reducing IFFs, consensus on the boundaries of the concept remain elusive. In their latest article, Dr. Irene Musselli and Dr. Elisabeth Bürgi Bonanomi review and challenge some of the key tenets of the debate. They deconstruct the concept by challenging the distinction of ‘illegal’ and ‘illicit’, diffusing the tension between ‘development’ and legal approaches, and reconciling aggregate and disaggregate approaches.

The World Bank’s definition of IFFs (cross-border movement of money and assets associated with illegal activity) continues to be the most conventionally accepted in the policy and advocacy domain. However, this definition loses its appeal in a more operational setting due to its inherent ambiguity in defining the types, nature and consequences of activities which could fall under the purview of the IFFs agenda. We believe the potential for discord in policy-setting necessitates the need for a clear advancing of the debate by defining the boundaries of what IFFs should encompass. Our analysis tackles three contested areas in the debate: the distinction between illegal an illicit (unethical, but legal) financial flows, tension between ‘development’ and ‘legal’ approaches to IFFs, and aggregate versus disaggregate approaches under the IFF agenda.

We posit that the current debate on the definitional aspects of ‘illicit’ versus ‘illegal’ is, to a significant extent, misleading, since it mischaracterizes the legal terrain. In real life, it is hard to draw a line between ‘illegal’ and ‘illicit’ activities: so-called illicit activities often involve illegal elements. In particular, the legal assessment of tax avoidance practices involves a circumstantial process of interpretation and constant adjustment, in a dynamic and adaptive regulatory environment. This also reflects the increased pace and breadth of regulatory reform in tax law over the past years, as well as the shift in tax law from detailed legal drafting towards broad, open-textured standards (such as general anti-abuse rules). Note also that public discourses tend to conflate illegality and criminality, which unduly restricts the legal domain – some actions may be unlawful even if they are not criminal. Eventually, what is genuinely at stake, today, is not the illegal versus illicit dilemma, but some uncertainty over the ex-ante legal characterisation of tax arrangements. The focus on the illegal versus illicit distinction conceals something else: capacity gaps regarding tax administration and prosecution, particularly in resource-strained jurisdictions. These considerations show the need to move beyond simplified distinctions (illegal versus illicit) that fail to bring clarity to the debate. Against this background, we suggest that the definition of IFFs should be anchored in law (unlawful), rather than ethics (illicit), to give precise and objective contours to what constitutes ‘illicit flows’. Yet, the legal assessment should be broadly encompassing. It should include legal standards that go beyond bright-line rules, allowing scope for principled decisions, balancing tests, and circumstantial assessment. Furthermore, the legal definition of IFFs should not be specific to jurisdictions, but rather comparatively refer to and evolve in conjunction with major legal developments in other jurisdictions and at the international level. This could level the playing field between countries with different regulatory and enforcement capacities.

Furthermore, we take due cognizance of the ‘development approach’ to IFFs which can be critical in legal interpretations in complex socioeconomic contexts. This definition’s flexibility stems from its focus on the question of whether or to what extent IFFs damage the development of poor countries, irrespective of whether the flows are legal, illegal, or fall in a grey area. From a development perspective, the reach of the IFF agenda would expand to include such issues as business tax incentives, price unfairness, and the allocation of taxing rights under double-tax agreements, to the extent that they have negative net impacts on sustainable development. At the same time, the development definition of IFFs excludes flows that, although in breach of some laws, have no negative net impacts on sustainable development – for example, informal value transfers, or flows associated with unreported artisanal mining, if pro-poor. A development or revenue–impact approach offers a useful policy orientation to the IFF debate. We argue that it is compatible and can be reconciled with a legal definition of IFFs that fully acknowledges the role of standards and balancing in lawmaking and law implementation. We believe that integrating this approach by using a ‘particularization’ legal stance, that is, by weighing and balancing multiple socioeconomic factors in deciding whether an activity falls under the IFFs ambit, would act as a crucial bridge between the legal and economic understandings of the concept.

Lastly, we advocate for a broad IFF agenda that fosters regulatory coordination across a range of interventions. As outlined above, by benchmarking illegality against legal standards that have attracted wide international acceptance, the IFF debate would remain anchored in law. At the same time, it would integrate evolving elements and level the playing field across countries with different lawmaking and law-enforcement capacity. Such an approach houses different but interconnected modules and concepts that lie within the framework of IFFs. However, for specific policy and research purposes, it remains necessary to add granularity to the legal definition of IFFs, with a clear elucidation on the country and context-specific actors, transfer mechanisms, or origins to be considered. Our research highlights the need for operational flexibility when it comes to creating or refining indicators that measure IFFs, where there remains a need to structure indicators that are tailored to specific domains of activity and align with reform measures in the same. It is important in this respect to consider regulatory developments and administrative frameworks that generate new data on IFFs, and use this data to structure indicators in a way that informs and guides policy reform. For instance, the establishment of multiple transparency and exchange-of-tax-information frameworks generate new types of data that enable more precise measurement of different aspects of IFFs. At the same time, there are built-in limits within these frameworks, such as confidentiality agreements and data safeguards, which would require conforming to established economic standards even on a national basis. 

Read full article here.

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