Despite substantial work from the United Nations, the World Bank, the IMF, OECD, and civil society, countries have been unable to reach a political consensus on the term “illicit” in illicit financial flows (IFFs).
It is customary in policy debates to distinguish between a narrow and a broad definition of IFFs. The former requires activities that are in breach of the law whereas the latter encompasses unethical acts that are deemed lawful, if unregulated.
The distinction between the two policy camps leads to very different policy outcomes. Proponents of the narrow definition argue that transfers associated with tax evasion (illegal) qualify as IFFs while tax avoidance schemes (which comply with the law) do not even though they are unethical. In contrast, advocates of the broad definition argue that avoidance practices should still fall under the definition of illicit finance.
Tax evasion perfectly illustrates the difference between a broad and a narrow definition. This policy area is also a great example of how the narrow/broad definition is conceptually misleading. In reality, drawing the line between “illegal” and “illicit” is hard since illicit activities often involve illegal elements and require circumstantial interpretation.
Illicit finance through the lense of tax evasion and tax avoidance
Tax evasion occurs when people or businesses deliberately do not pay tax that they legally owe by underreporting income, over-reporting expenses, or simply not paying taxes. In short, tax evasion encompasses the “hidden economy” in which people “conceal their presence or taxable income” (HM Treasury 2015).
Tax avoidance involves “bending the rules of the tax system to gain a tax advantage that Parliament never intended”. The Result is compliance with the letter but not the spirit of the law. Those who engage in tax avoidance usually take advantage of technicalities for the purpose of reducing tax liability. This typically involves contrived agreements with the purpose of reducing tax.
In day-to-day reality, the distinction between tax avoidance and tax evasion is blurred as practices fall on a spectrum between tax avoidance and tax evasion. A case depend on its circumstances and legal assessment is seldom simple or obvious, which is whyit is hard to define tax avoidance as strictly illegal or illicit.
What the narrow/broad definition debate unveils is not the illegal versus illicit dilemma, but uncertainty over the legal characterisation of tax arrangements as tax law has transitioned from detailed legal drafting to broad directives such as anti-abuse rules. In addition, the debate conceals the anxiety of policy-makers about the capacity of jurisdictions to enforce tax administration and prosecution if illicit finance is narrowly defined as “illegal activities”.
A mixed approach
A broad IFF agenda could be a powerful engine for systemic change. It would likely foster regulatory coordination and counter the tendency towards legal fragmentation. However, it is important that the broad definition focuses on law rather than ethics so as to avoid “subjective” interpretations of “illicit”.
One definition that lends itself to this ojbective is “unlawful” since this encompasses legal standards that go beyond fixed rules while still allowing for circumstantial legal assessment. Taking a broad approach would help conceptualise IFFs, though, for the purpose of measuring IFFs, more narrow legal definitions that define actors, transfer mechanisms, or origin are required.
What is required, then, is a pragmatic approach that dissolves the IFF agenda into workable modules and indicators. A starting point is thematic areas set by existing IFF-related international initiatives followed by strategic alignment and collaboration between agencies.
International initiatives
There is already a rich repository of IFF-related international initiatives and strategic alignments that establish legal obligations to prevent illicit financial flows.
- United Nations Conventions against Illicit Traffic in Narcotic Drugs and Psychotropic Substances 1988 (Vienna Convention). This includes provisions on money laundering and international cooperation.
- United Nations Convention against Transnational Organized Crime 2000 (Palermo Convention). This requires countries to criminalise money laundering, and includes frameworks for extradition, mutual legal assistance and law enforcement cooperation.
- International Convention for the Suppression of the Financing of Terrorism 1999 – requires states to criminalise the financing of terrorism, and adopt powers to freeze and seize funds intended to be ued for terrorist activities. -United Nations Convention against Corruption 2003 (Merida Convention) – requires measures to revent and criminalise corruption, provide international cooperation and asset recovery on corruption cases.
- In addition a number of UN Security Council Resolutions have introduced measures to counter illicit financial flows.
- 2030 Addis Adaba Action Agenda emphasises combating illicit financial flows to safeguard public resources essential to financing Sustainable Development Goals (SDGs).
What these initiatives point to are themes of different activities that constitute illicit finance.
Activities associated with illicit finance
Below are the most frequently cited activities associated with illicit finance:
- Tax evasion
- Money laundering
- Terrorist financing
- Fraud
- Conflict financing
- Counter-terrorist financing
- Smuggling
- Trafficking drugs
- People or wildlife smuggling
- Financing of organised crime
- Counterfeitings
- Tax avoidance
Recap
The absence of an agreed defininition makes developing methodologies for monitoring and assessing illicit financial flows difficult, and where methodologies exist, disagreements and dissatisfaction with methods stem from this lack of conceptual clarity.
One policy space affected by the lack of conceptual clarity is the 2030 Addis Adaba Action Agenda and its emphasis on combating illicit financial flows to safeguard public resources essential to the financing of Sustainable Development Goals (SDGs). Without a clear definition, policy makers find it hard to set strategic objectives let alone measure “success” in safeguarding public resources.
The narrow/broad definition of illicit finance has dominated the policy debate. This distinction is alluring but misleading as activities often fall on a spectrum between illicit and illegal. Instead, the debate should focus on dividing illicit finance into modules with a broad definition for strategic definitions and a narrow definition reserved for projects that aim to measure illicit finance.