How Pakistan's Elite Use Trade Misinvoicing to Launder Money
By Riaz Haq
CA
Pakistan's exports have declined significantly since former Prime Minister Nawaz Sharif's PML-N party assumed power in 2013. They are down from about $25 billion in 2013-14 to about $20 billion in 2016-17.
At the same time, the nation's imports have jumped to $47 billion during this period, widening the trade deficit to a record $27 billion. Overvaluation of the Pakistani currency and CPEC-related imports are often cited as a reason for this situation.
The other, probably more important reason, may be the increasing misinvoicing of trade facilitated by the people in power. Trade misinvoicing is the largest component of illicit financial outflows from developing countries, according to the Washington-based Global Financial Integrity (GFI) which tracks such flows.
Trade Misinvoicing
Global Financial Integrity (GFI) defines trade misinvoicing as "fraudulently manipulating the price, quantity, or quality of a good or service on an invoice submitted to customs" to quickly move substantial sums of money across international borders.
How does trade miscinvoicing work? Here's an example:
Let's say an exporter in Pakistan exports goods worth $1 million to a foreign country and invoices it at $500,000 through an offshore middleman. The middleman invoices and collects $1 million from the end customer, sends $500,000 to Pakistan and deposits $500,000 in an offshore account. The result: Pakistan is deprived of $500,000 in foreign exchange.
Similarly, imports of goods worth $1 million to Pakistan are overinvoiced at $1.5 million through an offshore middleman and the difference is kept in an overseas account. The result: Pakistan loses another $500,000 in foreign exchange. Meanwhile, the Pakistani traders and officials facilitating misinvoicing together pocket $1 million or 50% on the two trades. Pakistan's trade and current account deficits grow and the foreign exchange reserves are depleted, forcing Pakistan to go back to the International Monetary Fund (IMF) for yet another bailout with tough conditions.
Terror and Drug Financing
It is not just greedy politicians, unscrupulous businessmen and corrupt officials in developing countries who rely on fraudulent manipulation of trade invoices; all kinds of drug traders, terrorists and criminals also use what is called TBML (trade-based money laundering).
John A. Cassara, former US intelligence official with expertise in money laundering, submitted written testimony for a US Congressional hearing on “Trading with the Enemy: Trade-Based Money Laundering Is the Growth Industry in Terror Finance” to the Task Force to Investigate Terrorism Financing Of the House Financial Services Committee February 3, 2016. Here's an except from it:
"Not long after the September 11 attacks, I had a conversation with a Pakistani entrepreneur. This businessman could charitably be described as being involved in international grey markets and illicit finance. We discussed many of the subjects addressed in this hearing including trade-based money laundering, terror finance, value transfer, hawala, fictitious invoicing, and counter-valuation. At the end of the discussion, he looked at me and said, ‘Mr John, don’t you know that your adversaries are transferring money and value right under your noses? But the West doesn’t see it. Your enemies are laughing at you.’ "
Foreign Residency(Iqama)
Assets held by people in offshore tax havens are tracked by their country of residence, not by their citizenship, under OECD-sponsored Agreement On Exchange of Information on Tax Matters. Pakistan is a signatory to this international agreement. When Pakistan seeks information from another country under this agreement, the nation's FBR gets only the information on asset holders who have declared Pakistan as their country of residence. Information on those Pakistanis who claim residency (iqama) in another country is not shared with the Pakistan government. This loophole allows many Pakistani asset holders with iqamas in other countries to hide their assets. Many of Pakistan's top politicians, bureaucrats and businessmen hold residency visas in the Middle East, Europe and North America.
Loss of Tax Revenue
Customs duties in developing countries often make up a huge chunk of tax revenue collected by the government. Trade Misinvoicing not only increases current account deficits but also worsens budget deficits by cutting tax receipts. Raymond Baker, author of Capitalism's Achilles Heel, has made an important observation:
"The Pakistan government's largest source of revenues is customs duties, and therefore evasion of duties is a national pastime. Isn't there to tap into this major income stream, pretending to fight customs corruption and getting rich at the same time? Of course; we can hire a reputable (or disreputable, as the case maybe) inspection company, have the government pay the company about one percent fee to do price checking on imports, and get multi-million dollar bribes paid to us upon award of the contracts. Societe de Generale de Surveillance (SGS), headquartered in Switzerland, and its then subsidiary Cotecna, the biggest group in the inspection business, readily agree to this subterfuge. Letters in 1994 promised "consultancy fees", meaning kickbacks, of 6 percent amd 3 percent to British Virgin Island (BVI) companies, Bomer Finance Inc. and Nassam Overseas Inc., controlled by (Benazir) Bhutto and (Asif) Zardari. Payments of $12 million were made to Swiss bank accounts of the BVI companies."
Aid in Reverse
Some have called London the "Money Laundering Capital of the World" where corrupt leaders from developing nations use wealth looted from their people to buy expensive real estate and other assets. Private individuals and businesses from poor nations also park money in the West and other off-shore tax havens to hide their incomes and assets from the tax authorities in their countries of residence.
The multi-trillion dollar massive net outflow of money from the poor to the rich countries has been documented by the US-based Global Financial Integrity (GFI). This flow of capital has been described as "aid in reverse". It has made big headlines in Pakistan and elsewhere since the release of the Panama Papers and the Paradise Leaks which revealed true owners of offshore assets held by anonymous shell companies. Bloomberg has reported that Pakistanis alone own as much as $150 billion worth of undeclared assets offshore.
Impact on Economic Growth
There's a direct relationship between investment and GDP. Flight of capital reduces domestic investment and depresses economic growth in poor countries. Lower tax revenues also impact spending on education, health care and infrastructure, resulting in poor socioeconomic indicators.
In Pakistan, for example, it takes investment of about 4% of GDP to grow the economy by 1%. Lower levels of investments in the country have kept its GDP growth below par relative to the rest of South Asia. Any reduction in the outflow of capital to offshore tax havens will help boost economic growth in Pakistan to close the gap with its neighbors, particularly Bangladesh and India whose economies are both growing 1-2% faster than Pakistan's.
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