Trade-based money laundering (TBML) is defined by the Financial Action Task Force (FATF) as the process of disguising the proceeds of crime, and moving the money into the formal economy through the use of trade transactions in an attempt to legitimize its illicit origins. In practice, this can be achieved notably through the misrepresentation of the price, as well as the quantity or quality of imports and/or exports.

In Malawi, the Financial Intelligence Agency (FIA) cites TBML as the main source of Illicit Financial Flows (IFFs) out of the country. Malawi Customs has, therefore, an important role to play in the fight against IFFs, as it can identify trade anomalies, which may cover financial flows out of Malawi to a foreign country through the undervaluation of exports and the overvaluation of imports.

In this article, I will focus on overvaluation of imports as this type of fraud receives less attention than the undervaluation of exports, which often has a greater impact on the controls of Customs and financial institutions in developing countries owing to its implications on state revenue and on foreign exchange reserves, although overvaluation of imports also has an effect on the latter – a country’s ability to import is limited by the foreign exchange it earns from its exports, or from what is called the “current account,” unless it chooses, as some often do, to finance its deficit through borrowings.

The little prominence on overvaluation is due to the fact that Malawi, as a least developed country (LDC), relies heavily on Customs revenue as a source of state revenue and it accounts for about a third of total tax revenues. When goods are overvalued, the tax burden on the importer is high, and so is the amount of duties and taxes that are collected and thereafter paid into the fund for state revenue.

In a study which I conducted, I used the mirror analysis method to identify potential fraud and offences in the transactions of various commodities that Malawi traded with its major trading partners in East and Southern African in the year 2015. I discovered several overvaluation cases, which shows that through such practices unscrupulous traders may be sending capital outside the country, taking advantage of the laxity in controls.

By definition, overvaluation or over-invoicing consists of deliberately and fraudulently inflating the price of goods, and involves collusion between the importer and exporter. Once the goods have been successfully imported, the exporter/supplier then returns the overpayment to an accomplice in some other form that could include cash or other benefits. The ultimate motivation of overvaluing imports is to shift funds from the importing country, otherwise known as capital flight, which may result in three crimes: Customs and tax fraud (export subsidies), income tax evasion, and money laundering.

Let’s take a simple example: supplier X from country A spends 1 million US dollars to purchase razor blades at five cents each and exports 20 million razor blades to importer Y in Malawi for 30 cents per unit. The total cost of the consignment is six million US dollars, which the importer pays, thereby shifting about five million US dollars out of Malawi in a single transaction.

Identifying, tracing and prosecuting overvaluation is difficult as it requires access to complex trade documents, and is made even more difficult due to the collusion between traders. However, there are a number of ways of flagging risky transactions, such as:

• conducting a mirror analysis, i.e., comparing domestic and foreign import/export data to detect discrepancies in unit prices, trade values, and weights;
• undertaking a unit price analysis to compare the average unit price for a particular commodity, and identifying traders who are importing commodities at a substantially higher or lower price than the world market;
• analysing financial information to identity the parties to these transactions, as well as potential third parties;
• looking for inconsistencies in trade transactions, for example between the type and size of the commodity being imported and the usual business of the importer.

Malawi’s FIA admits that the country is at the risk of overvaluation fraud, which bleeds the country of significant capital and potential revenue in the sense that the externalized capital could have generated profits that could have been taxed in Malawi. As a result, Malawi Customs has been implementing various measures to fight fraud and IFFs through overvaluation.

Valuation Control

In line with the Practical Guidelines for Valuation Control, a tool contained in the WCO Revenue Package, Malawi Customs’ Valuation Unit developed a valuation control module for its Customs system in order to identify transactions where the declared value may be in doubt. The Automated System for Customs Data (ASYCUDA World) software was enhanced and a valuation database functionality integrated into it, which allows for the automatic and post-clearance control of values during declaration processing.

The valuation database records a Tariff Specification Code (TSC) for every brand of product for which a maximum and minimum value are set. The database is used only as a risk assessment tool and is regularly updated. It is integrated into the risk management module that automatically flags problematic transactions during clearance processing.

In 2016, the valuation database was put into service and its deployment coincided with an unprecedented increase in revenue collection for the 2016/17 financial year, which exceeded targets by about 15%. In addition, using the database as a risk assessment tool has proved to be a success, evidenced by the following example where the system flagged a case in which an exporter had presented forged Customs documents to a bank in order to externalize funds.

Inter-agency cooperation

In 2007, the Government of Malawi established the FIA, which is responsible for identifying illicit proceeds, and combating money laundering and terrorist financing activities. The FIA works with other agencies such as the Anti-Corruption Bureau (ACB), the Director of Public Prosecutions (DPP), the Fiscal and Fraud Police Unit (FFU), the National Intelligence Service (NIS) and, most importantly, the Malawi Revenue Authority (MRA).

For a while, investigations of suspected offences relating to TBML, like overvaluation, were difficult to initiate because the MRA lacked inter-agency backing and the legal muscle to prosecute such cases. Nowadays, although the MRA cannot directly investigate cases of overvaluation because the revenue implications are not imminent, inter-agency coordination fills this gap.

In an effort to ensure coherency in the different entities’ approach as well as more effective coordination when it comes to fighting IFFs, the MRA intends to conclude a Memorandum of Understanding (MoU) with the country’s central bank, namely the Reserve Bank of Malawi (RBM), with the FIA, as well as with the ACB. The MoUs are expected to be ready and operational in 2018. Coordination will involve joint investigations and prosecutions, as well as seamless exchange of information and intelligence among the agencies.

Mirror analysis and data analytics

Risk management is at the centre of all Customs’ activities. It is, therefore, imperative for Customs to strengthen its capacity to use the huge chunks of data that it collects on a daily basis. The Malawian study using mirror analysis that I conducted is a very good start towards ensuring that Customs operations are risk based and intelligence driven, and that Malawi Customs leverages the power of data in its operations. One key deliverable of the study is a fraud control plan, which will significantly help in reducing revenue fraud, and most importantly, capital flight through overvaluation.

According to the plan, Malawi Customs’ Business Analysis Department in conjunction with its Risk Management Unit will have to routinely conduct fraud analyses using the mirror analysis technique. A Customs officer will be appointed at head office to audit the declarations entered in the Customs automated system and to analyse the mirror analysis results as a means of identifying potential revenue fraud, including possible cases of overvaluation. This officer will also be trained to conduct joint audits and investigations with colleagues from the MRA’s investigative body as well as with staff from external agencies such as those working for the FIA. The plan aims at ensuring that Customs is proactive and goes beyond traditional revenue collection activities to play a part in the fight against other types of fraud that could result in revenue leakages.

Import Documents Verification Facility

The introduction of ASYCUDA World in 2016 enabled better control of import payments. An electronic interface called the “Import Document Verification Facility” connects ASYCUDA World to the computerized systems of commercial banks, allowing the banks to verify the authenticity of Customs documents that are presented to them when applications for foreign currency are submitted.

Before the banks make payments to foreign suppliers, they use the interface to check that the documents which have been presented to them are compliant. The verification and authentication of documents are done using a quick response (QR) code that is visible on MRA documents. After bank personnel scan the code, the QR application displays the URL where a document’s details stored in the Customs system may be viewed. This new process helps in abating foreign currency externalization through overvaluation.

It is high time Customs realized that overvaluation fraud is as serious as other Customs offences like undervaluation, as it deprives countries of much needed capital and may result in money laundering. By virtue of its mission, Customs ought to play a significant role in pinning down and flagging TBML in cross-border transactions. To achieve this, providing Customs officers with tailored training programmes on financial and trade data analysis, promoting a culture of intelligence, as well as effective information exchange among all agencies involved at the national and international level is of paramount importance.

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fkalizinje@yahoo.co.uk