Capital flight in trade payment

Given that known sources of illicit financial flows are tax evasion, the proceeds of criminal activities and bribes, the task of combatting those flows appears to fall to tax authorities, the police and financial regulatory institutes. Customs authorities have been supporting the fight against illicit financial flows at borders by cracking down on smuggling in cash or gold. However, in response to the emerging risk of illicit financial flows disguised as legitimate trade payments or receipts, customs authorities should play a leading role in the fight against them via trade misinvoicing.

Overview of the risk

Every trade transaction has two official records: one recorded by the importing country and the other by the exporting country. Existing literature suggests that discrepancies between the importer’s and exporter’s reports may be an informative indicator for assessing the risk of trade misinvoicing. An overview of the trade discrepancy ratio for the period from 2011 to 2015 reveals that the worldwide risk of illicit financial flows through trade misinvoicing was consistently significant, and that the risk in imports from developing countries made by members of the Organisation for Economic Co-operation and Development (OECD) was even higher than that in trade between developing countries.

Border controls

What exactly has distracted customs authorities from detecting trade misinvoicing at borders? When it comes to auditing the value of traded goods, most customs authorities focus solely on ‘under-invoiced imports’, in line with their traditional mandate of securing customs duties. Even the World Trade Organization’s Valuation Agreement (formally known as the Agreement on Implementation of Article VII of the General Agreement on Tariffs and Trade) sets out customs valuation standards for imported goods only, and not for exported goods. Consequently, over-invoiced imports (intended to disguise capital flight as trade payments), under-invoiced exports (intended to conceal trade profits abroad, such as in tax havens) and over-invoiced exports (intended to transfer illicit proceeds to domestic financial accounts) have not been the chief concern of customs authorities. This may have resulted in trade transactions suspected of involving illicit financial flows not being properly checked at borders.

Policy recommendations

As requested by the G20 Hangzhou Summit in 2016, the World Customs Organization has prepared a report on trade misinvoicing, which explores the trail of illicit financial flows by analysing customs trade data. It presents policy recommendations based on certain best practices by customs authorities.

An indispensable prerequisite for tackling illicit financial flows through trade misinvoicing is ensuring that customs authorities have a sufficient mandate and resources. In particular, customs authorities should be instructed to examine both over-invoicing and under-invoicing, as well as irregularities in export declarations and import declarations alike. By way of example, in 2013 Korea revised its customs act to criminalise the manipulation of invoices (values), irrespective of the impact on customs revenue. This revision encouraged customs officers to examine misinvoicing more comprehensively. Based on the results, this year the Korea Customs Service increased the number of its divisions specialising in investigating illicit financial flows. Allowing customs authorities to access the financial records of traders for the purpose of comparison with trade records is also highly recommended. Additionally, in 2017 Germany restructured its financial intelligence unit and transferred it to the General Customs Directorate.

Enhancing partnerships involving national customs authorities, tax authorities, financial intelligence units, police and customs authorities of trading partners is also essential, so that all these parties can obtain and share timely information and data to detect illicit financial flows concealed in trade.

New technology, such as blockchain, could potentially provide a solution to preventing and detecting any fraudulent manipulation of trade transactions and related financial transactions, by sharing information in a trusted and secure manner.

Providing capacity building, including financial and human resources, is essential for customs authorities to combat illicit financial flows through trade misinvoicing. When managing human resources, customs authorities should enhance integrity, as this is a prerequisite for the effective and efficient operation of a customs administration and, as a corollary, is essential in combatting illicit financial flows.