A working session for Ministry of Finance, Tax Policy Unit
This handbook teaches what illicit financial flows are, where they hide, and how the largest of them, the commercial and tax-related flows, are spotted. It then turns to your craft: how to draft law that stops transfer pricing abuse and trade misinvoicing, with model provisions and a drafting trial to attempt yourself.
Start here
Naming a problem is easier once you have seen it. Read these three before any theory. Each moved value across a border in a way that was wrong, and each points to one of the three families we study.
A copper mine sells almost all its output to its own trading arm abroad, at prices below what independent buyers pay. Its local accounts show almost no profit.
Real profit, earned at home, priced away to a low-tax affiliate. The largest category, and the focus of this session.
Gold is dug at unlicensed pits, sold for cash, carried over the border and flown to a Gulf hub, where it enters the legal market. None of it appears in export records.
Dirty from the start. Illegal extraction and smuggling, then laundering, often through informal value chains.
A minister approves inflated invoices for a road barely built. The surplus is wired to a company he secretly controls, then buys an apartment abroad in a relative's name.
Public office and public money turned private, then hidden offshore. The smallest channel by value, the most visible.
The idea
An illicit financial flow is money that is illegal in its origin, in its transfer, or in its use, and that crosses a border. That is the agreed definition, and the word that matters most for policy is or.
A flow is illicit if it is illegal at any one of three points: where the money is generated, how it is moved, or how it is finally used. It need not be illegal at every step.
To regulate a flow you first say where the illegality enters. The origin is where the money is generated. The transfer is how it moves and is disguised. The use is where it rests and what it then does. A single tainted step taints the whole flow.
Illegal at the origin. The money is dirty from the start, such as the proceeds of smuggling or theft. Lawful origin, illicit transfer. Real income moved out illegally, by underpricing a related-party sale or falsifying an invoice. Lawful origin and transfer, illicit use. Income earned and moved within the law, then hidden from tax once abroad, or used to finance crime.
Many real flows combine two of these. The framework does not force one label. It tells you where to look, which is the first thing any drafter needs to know.
The sums are not marginal. Africa loses about 88.6 billion dollars a year this way, and between 2000 and 2015 the cumulative loss exceeded the continent's external debt, which makes Africa a net creditor to the world rather than its debtor.
The map
The 2015 African Union panel led by Thabo Mbeki weighed the field and gave proportions that still anchor the debate. Commercial and tax abuse is about 65 per cent, criminal activity about 30 per cent, corruption about 5 per cent.
Commercial. Real businesses shifting real profit out through pricing and structuring. Criminal. The proceeds of crime laundered and moved. Corruption. Public office and public money turned to private gain.
Public attention inverts this order, fixing on corruption because its cases are vivid, while the largest channel moves quietly through company accounts. Aim your scarce enforcement where the money truly sits.
Two worlds
Illicit flows travel through two very different worlds, and they need different tools.
Registered companies, banks, invoices, treaties. The money is recorded, but disguised in the pricing. Most commercial flows live here.
Met with: transfer pricing rules, country-by-country reporting, audit. The data exists; the task is to read it correctly.
Cash, informal money transfer such as hawala, smuggling, artisanal and small-scale mining, unrecorded cross-border trade. The money never enters the system.
Met with: customs valuation, registration and formalisation, beneficial ownership, value-chain monitoring. The task is to make the invisible visible.
This session now follows the largest and most drafting-rich of the two, the formal-sector commercial flows, because that is where careful law does the most work.
Examples from the field
Illicit value rarely announces itself. Two examples from customs work show how far concealment goes, and why an officer cannot rely on the paperwork alone.
Customs officers in Bhutan found travellers carrying gold not as bars but as parts of ordinary objects. The metal had been cast into the buttons of shirts and into the internal handles of travel bags, then painted over so it read as plastic or cloth. The value walked across the border in a form no scanner was looking for.
Criminal · informal smuggling and concealment to evade duty and tax
A stone-crushing machine was declared broken and shipped back to its country of manufacture, China, for repair. Wedged inside was a large rock that would not come loose. The rock held precious minerals the operators had found and wished to move out of the source country without declaring them or paying any tax.
Criminal and commercial · disguised export, non-declaration and tax evasion
Both schemes defeat a desk that checks documents. They are stopped by physical inspection, by valuation and reference-price powers, and by the duty to declare, which is why the law you draft has to reach the goods and the substance, not only the invoice.
This short lesson follows the gold trade and asks why a country like Mali, producing billions of dollars of gold, keeps so little of it. Watch it, then answer the two questions below.
By Lyla Latif for TED-Ed · running time about five minutes
1. In 2020 Mali produced over 71 tonnes of gold, worth billions of dollars. About how much did Mali itself receive?
2. According to the lesson, why do gold-rich African states keep so little of their gold wealth?
The deep dive
A commercial flow starts with a real business earning real profit inside the country. Then pricing and structuring make that profit appear somewhere with little or no tax, so the local base is stripped before it can be assessed.
Transfer mispricing. Companies in one group trade with each other at prices set to move profit, not to reflect the market. A subsidiary sells to the parent's offshore arm below the price an independent buyer would pay, so the profit lands offshore.
Trade misinvoicing. The declared value on an invoice is inflated or understated. Over-invoicing an import, or under-invoicing an export, shifts value across the border.
Intra-group debt. A parent lends to its local subsidiary at a high rate. The interest is deducted at home and paid to a low-tax affiliate. Service fees and royalties. The local company is charged steep management fees or royalties for assets held offshore. Treaty shopping. Investment is routed through a country chosen only for its tax treaty, to cut withholding tax.
The arm's length principle. Would unrelated persons, dealing independently, have agreed this price? If not, the profit can be re-allocated and taxed. This single idea is the backbone of the law you will draft.
The incentive is straightforward. Tax is lower in another jurisdiction, and transactions inside one corporate group let profit be moved there. Secrecy hides the move, and advisers make it routine. The opening is institutional as much as it is greedy: transfer pricing rules may be weak or absent, audit teams thin, and the information needed to challenge a price sits with the firm, not the authority. Each of those openings is a drafting target.
Mispricing is worth policing because of arithmetic. Tax falls on the profit margin, and the margin is a thin slice of the price, so a small cut in the declared price produces a large cut in the tax. Move the slider and feel the effect, using published figures from a Zambian copper study.
Tax falls on the thin profit margin, not the whole price, so a small cut in the declared price produces a large cut in the tax. That is the mathematics every mispricing scheme relies on, and the reason a strong transfer pricing rule is worth the effort.
Detection starts from one question. Does the reported profit match the economic reality? A firm with real production and persistent losses, whose sales go to related parties and whose profit is booked where almost no one works, is showing you the pattern. Benchmark related-party prices against independent ones, read country-by-country data, check production volumes, and compare the two sides of the border.
In one year Zambia's records showed about 3.9 billion dollars of copper exported to Switzerland, while Swiss records showed no matching copper arriving. The contract said Switzerland; the metal went elsewhere. A steady, one-directional gap between the two sides of a border is a signal worth following.
The Zambia Revenue Authority audited Mopani Copper Mines, a Glencore subsidiary, for selling copper to its Swiss affiliate below arm's length prices, which reduced the profit taxable in Zambia. Using the Comparable Uncontrolled Price method, comparing the related-party price to sales to independent buyers, and years of patient capacity building, the authority won in the Supreme Court of Zambia in 2020 and recovered about 13 million dollars.
Benchmarking and documentation, backed by trained teams, beat the scheme. The tax rate was never the problem. The law and the capacity to enforce it were what mattered.
Your craft
Spotting a scheme is half the work. The other half is a rule a court can apply and an officer can enforce. Strong drafting follows a sequence, whatever the mischief. Learn the sequence once, then apply it to transfer pricing abuse and to trade misinvoicing.
The mischief is profit shifted out by mispricing transactions inside a group. The principle is arm's length. The rule re-prices the transaction to what independent persons would have agreed, the method names how, the documentation puts the burden on the firm, and a cap on base-eroding payments such as interest and royalties closes the common back doors. Here is what a strong provision looks like.
Arm's length pricing of transactions with connected persons
The mischief is value shifted by falsifying the price or quantity declared at the border. The principle is the transaction value under the customs valuation rules, the rule scrutinises related-party prices, reference prices give the authority a benchmark for commodities, mirror-trade data lets it test the declaration against the partner's records, and a reassessment power with penalties does the rest.
Valuation of imported goods and false declarations
Run any draft against these hallmarks before it leaves your desk. A provision that carries all of them is hard to defeat.
Your turn
Now you draft. Pick a brief, read the facts, and write a provision in the workspace. When you are ready, reveal a model answer and check your draft against it. Your work stays in your browser; use the copy button to keep it.
Your task. Draft a short provision to stop this practice. A strong answer names the mischief, defines connected persons, states the arm's length principle, gives the Commissioner an adjustment power, requires contemporaneous documentation, addresses the royalty, and sets a penalty for non-documentation.
Did your draft include each element? Tap to tick.
Evidence base
Every figure and model clause is drawn from the record below. The model provisions are teaching drafts that follow these instruments; they are a starting point for your own drafting, not finished legislation.