Misinvoicing in the International Trade

KEY CONCEPTS

Trade misinvoicing refers to the misrepresentation or manipulation of the true or accurate value of goods sold.

TRADE MISINVOICING

In recent years, international development institutions have noted the increase in data distortion in trade invoices (trade misinvoicing)^[1] as a significant problem in international trade.

“Trade misinvoicing is a method for moving money illicitly across borders which involves the deliberate falsification of the value, volume, and/or type of commodity in an international commercial transaction of goods or services by at least one party to the transaction.”

Global Financial Integrity (GFI).^[2]

Trade misinvoicing is the largest component of illicit financial outflows, as measured by Global Financial Integrity.

Figure above illustrates the conceptual structure of international trade. In a legitimate trade transaction:

1. The invoice amount declared by the importer in the customs valuation declaration.
2. The payment made by the importer, registered by financial institutions, and reflected in the accounts.
3. The invoice amount declared by the exporter in the customs valuation declaration.
4. The exporter’s shipping document, registered by financial institutions and reflected in the accounts.
5. The true or accurate value of the goods, works, or services sold.

Entries 1, 2, 3, and 4 should correspond to the value of goods ○5. Data distortion in trade invoices occurs when the exporter, importer, or both manipulate the value, quantity, or quality of goods in the invoices and customs declarations.

CAUSES

The causes of trade misinvoicing are as follows:

• Money laundering. Companies or government officials may attempt to launder proceeds from crimes or corruption.
• Direct tax evasion and customs duty evasion. By undervaluing the goods, importers can immediately evade substantial customs duties or other taxes.
• Utilizing tax incentives. Many countries offer generous tax incentives to domestic exporters selling their goods and services abroad. Companies may attempt to abuse these tax incentives by inflating export data.
• Capital control evasion. Many developing countries have restrictions on the amount of capital that individuals or legal entities can import or export from the country’s economy. Investors seeking to circumvent this capital control often misrepresent trade transactions to obtain money out of the country.^[4]

GLOBAL FINANCIAL INTEGRITY STUDY

In 2021, Global Financial Integrity published a comprehensive study on the issue of data distortion in trade invoices based on statistical data from international trade between 2009 and 2018.^[5]

Figure below reflects the dynamics of trade imbalance (aggregate trade gap) between 134 developing countries and 36 developed economies.^[6] Over a 10-year period, the trade gap increased by USD 284 billion or 51%, reaching USD 835 billion in 2018.

Figure 3 represents the Top 10 countries with the largest trade gap in operations between 134 developing countries and 36 countries with developed economies as of 2018. The trade gap of the Top 10 countries accounts for over 70% of the total global gap, with China alone contributing more than 35%.

Figure 4 illustrates the dynamics of trade imbalance (aggregate trade gap) between 134 developing countries and all global partners, which reached 1.6 trillion USD in 2018.

Figure 5 presents the Top 10 countries with the largest trade gap in operations between 134 developing countries and all global partners as of 2018. The trade gap of the Top 10 countries accounts for approximately 70% of the total gap, with China’s trade gap also representing around 35%.

The above-mentioned indicators are absolute. To assess the integrity of countries in providing trade reporting, it is necessary to evaluate the international trade gap as a ratio to the total volume of a country’s international trade.

Figure 6 presents the Top 10 countries by average ratio of trade gap to the total volume of international trade with 36 developed economies for the period of 2009-2018.

Figure 7 presents the Top 10 countries by average ratio of trade gap to the total volume of international trade with all trading partners for the period of 2009-2018.

CHALLENGES AND COUNTERMEASURES

The problems and methods of combating trade misinvoicing represent a serious issue as it leads to the loss of billions of dollars in tax revenues from international trade. To reduce misinvoicing, governments and international development institutions employ the following measures:

• Strengthening customs and tax administration. Countries enhance their administrative systems by utilizing modern technologies, providing training to customs and tax officials, and improving coordination among various departments.
• Enhancing transparency. Governments require companies to disclose more information about their trade activities, including prices of goods and services, quantity and quality of goods, and countries involved in transactions.
• Expanding international cooperation. Countries collaborate by exchanging information and coordinating efforts to combat improper invoicing. They utilize OECD standards for automatic exchange of tax information.
• Implementing electronic invoices. Governments encourage the use of electronic invoices, which provide more accurate and transparent information about trade transactions and can reduce the risks of data distortion.
• Promoting ethical business practices. Governments should incentivize participants in international trade to adopt ethical business practices that promote transparency and fairness in trade activities. This may involve implementing internal controls, verifying business partners, and ensuring responsible supply chain management.

CONCLUSION

International trade misinvoicing facilitates the illicit movement of funds across borders and leads to significant losses in tax revenues. Unfair practices such as declaring incorrect values of goods, providing false information, money laundering, evasion of customs duties and taxes, abuse of tax incentives, and circumvention of capital controls create an unfavorable situation for the global economy.

Fighting data distortion in trade invoices is an important step towards ensuring fair and transparent international trade, contributing to sustainable economic development and the prosperity of nations. To combat data distortion, governments traditionally strengthen customs and tax administration, enhance transparency in trade transactions, exchange information, and impose stricter penalties for violators. Participants in international trade should also adopt ethical business practices, adhere to reporting rules, and responsibly manage their supply chains.

However, in recent years, the trade gap continues to grow, especially in developing countries. Therefore, the process of invoicing in international trade requires the implementation of more effective control measures. In the modern digital world, this could be achieved by transitioning to digital supranational platforms for electronic document circulation, including electronic invoicing processes.

[1] United Nations Economic and Social Council. Committee of Experts on International Cooperation in Tax Matters. 2016. “Trade misinvoicing” and its relationship to “transfer mispricing”: note / by the Secretariat.” URL: https://digitallibrary.un.org/record/839220?ln=en. Accessed: July 19, 2023.

[2]Trade Misinvoicing. Global Financial Integrity (GFI). URL: https://gfintegrity.org/issue/trade-misinvoicing/. Accessed: July 19, 2023.

[3] Illicit Financial Flows via Trade Mis-invoicing. 2018. World Custom Organization. URL: https://www.wcoomd.org/-/media/wco/public/global/pdf/media/newsroom/reports/2018/wco-study-report-on-iffs_tm.pdf?la=fr. Accessed: July 19, 2023.

[4] Trade Misinvoicing. Global Financial Integrity (GFI). URL: https://gfintegrity.org/issue/trade-misinvoicing/. Accessed: July 19, 2023.

[5] Trade-Related Illicit Financial Flows in 134 Developing Countries 2009-2018. 2021. Global Financial Integrity (GFI). URL: https://gfintegrity.org/report/trade-related-illicit-financial-flows-in-134-developing-countries-2009-2018/. Accessed: July 19, 2023.

[6] The set of 36 countries with developed economies is based on the classification of the International Monetary Fund according to a series of criteria. September 2018, International Monetary Fund: International Financial Statistics, p. VIII. URL: https://data.imf.org/api/document/download?key=62729941. Accessed: July 19, 2023.