Illicit financial flows (IFFs) have been an issue of increasing concern over the past two decades, with many discussions, raising questions on what IFFs include, what we know about them, and how they can be measured.

Estimates of the scale of the phenomenon have played a key role in attracting attention and building political momentum. For example, Global Financial Integrity, a non-governmental organization (NGO), which was created “with the aim of quantifying and studying the flow of illegal money while promoting public policy solutions to curtail it,” published figures estimating that annual IFFs from developing countries were in the order of one trillion US dollars.

The NGO defines an IFF simply as “funds [that] are illegally earned, transferred, and/or utilized.” The Organisation for Economic Co-operation and Development (OECD) defines an IFF as any financial flows ”generated by methods, practices and crimes aiming to transfer financial capital out of a country in contravention of national or international laws.” Other organizations have their own definitions as well. While there is a fair degree of convergence between these definitions, some fuzziness does remain.

Delegates attending the Conference on Illicit Financial Flows and Trade Mis-Invoicing that was organized by the WCO on 23 May 2018 did not discuss the definition of an IFF and figures related to the scale of the phenomenon at length. They mainly examined how to better identify illegal transfer mechanisms of money via commercial transactions, deliberated on the organizational and operational aspects of the Customs response to the issue, and looked at the potential offered by technologies such as blockchains.

Trade mis-invoicing is a form of Customs and/or tax fraud involving exporters and importers deliberately misreporting the value, quantity, or nature of goods or services in a commercial transaction. The motive governing such transfers ranges from:

• the evasion of taxes and tariffs;
• the payment of bribes and kick-backs;
• the avoidance of trade regulations;
• the exploitation of trade incentives;
• the evasion of capital controls.

Trade mis-invoicing can be related to, but does not precisely correspond to, trade-based money laundering (TBML). Rather, trade mis-invoicing is a mechanism that can be used to engage in TBML.

The principle areas where trade mis-invoicing, as a channel for IFFs, have been observed include the over-invoicing of imports intended to disguise capital flight, the under-invoicing of exports intended to conceal trade profit abroad (in a third-party country such as tax havens), and the over-invoicing of exports intended to bring illicit (concealed) proceeds into the domestic legal financial system.

The Conference provided the WCO with an ideal opportunity to present to participants the main findings of the WCO Study Report on Illicit Financial Flows via Trade Mis-invoicing, which the Organization was commissioned to undertake by the G20 leaders.

This Study Report, which is the culmination of many months of empirical analysis and collaboration between Customs administrations, the WCO Secretariat and other experts, provided a narrative background to the Conference, and the WCO was pleased to welcome many of the co-authors of the Report to present their research, thanks to funding provided by the Korea Customs Service.

The Report discusses the two methods that could be used to effectively detect trade transactions presenting a risk, highlights recommended practices, and introduces specific mechanisms developed by some administrations, notably those from Italy, China, Korea and Norway, some aspects of which will be presented later in this article. In addition, the Report lists a number of recommendations inviting countries in particular to:

• ensure that Customs has a sufficient mandate and the resources necessary to tackle not only under-invoiced imports, but also over-invoiced imports, under-invoiced exports, and over-invoiced exports;

• allow Customs to access foreign exchange transaction databases, and equip Customs with a mandate to examine whether financial transactions between traders correspond to the declared value of traded goods;

• facilitate inter-agency cooperation among Customs authorities, Tax authorities, Financial Intelligence Units and other agencies availing of information-sharing, joint investigation teams, joint intelligence centres, secondments and co-location of personnel, and joint training programmes.

The Report is a “living” document that will be shared with Members of the WCO for their comments and input, before being considered for approval by the WCO Council, the Organization’s highest decision-making body, in June 2018. An excerpt of the Report will be presented to the G20 for their consideration too.

As IFFs via trade mis-invoicing are concealed across countless trade transactions, it is impossible to directly measure the magnitude of them. Different methods have been developed by researchers to estimate the volume of the trade transactions, chief amongst them are the Partner Country Method (PCM), which compares the trade value of one country to the corresponding trade value of a partner country (i.e. the comparison of bilateral trade data), and the Price Filter Method (PFM), which uses price filters to detect suspicious transactions with abnormal prices.

Three researchers presented the work carried out to demonstrate the usefulness of the PCM and PFM in managing trade mis-invoicing risks. Matthew Salomon, Senior Economist at Global Financial Integrity, presented a case study where data on importations from South Africa from 2010 to 2015 was used. The objective of the study was to examine how the PCM and PFM compare in identifying potential import under-invoicing. The principal findings of the study were that the PCM and PFM yielded very different estimates of the magnitude of trade mis-invoicing (which is not surprising as the data and metrics were different), but largely identified the same risks of potential under-invoicing of South African imports.

Philipp Hong from Central Michigan University and Simon Pak from Pennsylvania State University, in their research presentation, compared both methods using data on United States imports and exports in 2016. Their findings show that the two methods estimate quite different magnitudes of trade mis-invoicing, and identify a different list of potential high-risk transactions.

Yeon Soo Choi from the WCO Research Unit presented research where datasets of three countries were examined. As demonstrated by other research, the researchers found that estimates of trade mis-invoicing were very different according to the method used, but that cross-referencing both methods – i.e. using both methods and selecting transactions flagged by both for further investigation – can be one of the useful mechanisms to manage the risk associated with suspicious trade transactions.

Moving from the academic realm to the practitioner’s perspective, the second session of the Conference showcased best practices with engaging presentations featuring representatives from the Korea Customs Service (KCS) and the Nigeria Customs Service (NCS), who advocated for a shift in the focus from undervaluation to overvaluation.

Adewale Adeniyi from the NCS highlighted the pressure that his administration is put under to reach unrealistic revenue targets as well as the high level of non-compliance existing in the country, with 20% of trade estimated to be compliant. Recently, the NCS had started working more on data analysis, with patterns suggesting the emergence of a high degree of mis-invoicing. Transactions of low duty items were found to present some risk of over-invoicing, while transactions of high duty items were found to be undervalued.

He also pointed out the need for more awareness about over-invoicing, the adoption of a “data culture” and of efficient reporting procedures on inspection results to enhance risk management, and the development of analysis capacity among officers as well as the use of analytical tools.

Matthew Joo from the KCS started his intervention by stating that Customs is in the right position to address IFFs as it was able to monitor trade and financial transactions at the same time. He explained that his Administration had acquired investigative authority on foreign exchange (FX) transactions related to cross-border trade in 1999. In practice, KCS investigators initiate investigations through cross-referencing Customs declaration data (on transferring of goods) and FX transaction data (on payment for goods).

Moreover, in 2013, the speaker added, the Korean Customs Act had been revised to criminalize the manipulation of prices of goods, irrespective of whether the evasion of taxes was involved. Indeed, as Customs duty has dramatically decreased around the world, criminal traders have less incentive to declare undervalued prices of traded goods to Customs, and instead have sought to overvalue imported goods in order to evade corporate income tax or embezzle government subsidies.

Mr Joo continued by outlining the structure of his administration, which established financial investigation units dedicated to fighting illicit FX transactions in 2000. Today, there is one unit housed within Customs’ Headquarters and three units in local Customs houses, with a total number of 80 financial investigators. Beside trade and FX transaction data, they also receive reports from the Tax Service and the Immigration Bureau, as well as suspicious transaction reports (STRs) and currency transaction reports (CTRs) related to cross-border trade from Korea’s Financial Intelligence Unit that includes Customs officers among its staff.

Last but not least, the speaker gave examples of cases of overpricing, highlighting the critical need for access to financial transaction information to efficiently tackle mis-invoicing and related IFFs.

Some participants then took the floor. A representative of Brazil explained that a Joint Task Force to study IFFs had identified that the main conduit of IFFs is the under-invoicing of exports, the magnitude of which, according to the representative, is huge. Money flows, in particular, to countries offering high banking secrecy or tax havens, where under-invoicing is used by companies to shift profits and reduce their tax liabilities in Brazil.

She then called on the WCO to encourage multilateral cooperation and the automatic exchange of transaction-level trade data, an exchange which is already in place among Mercosur countries, as it is a key measure that enables real-time risk management models to counter IFFs through mis-invoicing.

A representative from the Russian Federation reminded participants that copies of two important model agreements developed by Russia to formalize cooperation with foreign countries had been made available: the agreement on information cooperation during cross-border transportation by individuals of cash and/or monetary instruments; and the agreement on preventing, detecting and suppressing the commitment of suspicious financial transactions by participants in foreign economic activities.

He then stated that his country is particularly confronted with the overvaluation of high-tech goods that were exempt from duty. Exchange of information between countries was, therefore, critical in order to check import declarations and the existence of destination companies, or just the fact that it is a registered importer. In one case alone, the price declared was 900 times higher than the “normal price.”

The panel discussing recommended practices also included speakers from the Financial Action Task Force (FATF) and the Organisation for Economic Co-operation and Development (OECD). Derek Leist from the FATF outlined practical policies that Customs could implement in order to facilitate the sharing of information, such as standardizing data formats and centralizing data for operational use, while Melissa Dejong from the OECD spoke about the necessity to adopt a whole-of-government approach in order to develop a coherent strategy and to avoid a scenario whereby agencies operate in silos. Inter-agency cooperation is the subject of an entire chapter of the WCO Study Report, and its chief recommendation in this respect is that inter-agency cooperation is paramount in the fight against IFFs.

Ms Dejong also highlighted the work being done under the OECD Global Forum on Transparency and Exchange of Information for Tax Purposes to make available information on companies and beneficial ownership. 150 jurisdictions have committed to implementing the international standard on exchange of information on request (EOIR), and over 100 countries and jurisdictions have committed to implementing the new standard on automatic exchange of financial account information including the official owner of the accounts. The latter will enable recipients to receive real-time information that they may not have requested, and uncover facts that they were unaware of.

The WCO Study Report also advocates for Customs to take full advantage of the potential offered by new technologies, such as blockchains, to prevent any fraudulent manipulation of trade transactions, and to allow the sharing of relevant information in a trusted and secure manner.

Jeffrey Owens from the Institute for Austrian and International Tax Law at Vienna University of Economics and Business acknowledged that the WCO was one of the only international organizations seriously examining blockchains, and presented an overview of the principle features of the technology; the fact that it allows for the creation of immutable records and the decentralization and distribution of ledgers, in addition to a potential increase in transparency, would make it a very attractive option for Customs, particularly those wishing to engage in information-sharing with other agencies such as tax authorities.

Yao-Hua Tan from Delft University of Technology outlined the principle features and benefits of a pilot project undertaken in the Netherlands by Maersk and IBM with the cooperation of Dutch Customs; an example of cooperation and collaboration across industries and agencies, which enabled all stakeholders to leverage knowledge from the supply chain.

All panellists of this last session agreed on the importance for the WCO and Customs to keep abreast of the changes in a rapidly-evolving technological realm.

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