What is Under-invoicing in Anti-Money Laundering?

Definition

Under-invoicing is a form of Trade-Based Money Laundering (TBML) where the market value of goods or services on an invoice is deliberately reported lower than their true worth. This misrepresentation on commercial invoices allows the transfer of value (money) across borders illicitly, often involving collusion between the exporter and importer to disguise illegal financial flows while avoiding regulatory scrutiny.

Purpose and Regulatory Basis

Under-invoicing is significant in AML frameworks as it is a method for criminals to move illicit value hidden within legitimate trade transactions. It helps camouflage money laundering, terrorist financing, tax evasion, and corruption by obscuring the actual amount of money transferred across borders.

Key global and national regulations addressing under-invoicing include:

• The Financial Action Task Force (FATF) recommendations, which emphasize identifying trade-based money laundering and suspicious trade activities.
• USA PATRIOT Act mandates thorough due diligence and transaction monitoring to detect suspicious financial flows.
• European Union AML Directive (AMLD) requires member states to implement measures against trade-based money laundering, including under-invoicing.
  Financial institutions and regulatory authorities worldwide are tasked to monitor, detect, and report suspicious transactions and irregularities in invoicing as part of AML compliance.

When and How it Applies

Under-invoicing typically applies in international trade when the value declared on invoices is intentionally undervalued compared to the fair market value of goods or services shipped. This practice is used:

• To transfer undeclared funds from one country to another,
• To evade taxes, customs duties, or tariffs,
• To circumvent currency control regulations,
• To settle debts covertly between related parties,
• To move illegal proceeds through offshore accounts hidden via trade transactions.

For example, an exporter in Country A ships goods worth $1 million but invoices them at $500,000 to an importer in Country B. The importer pays the under-invoiced amount officially but secretly transfers the balance through informal channels, layering illicit funds into the financial system. The importer then sells the goods at market value, facilitating money laundering.

Types or Variants

Under-invoicing can take various forms and is often paired with other TBML methods:

• Undervaluation of goods or services on the invoice.
• Short shipment where fewer goods are shipped than invoiced.
• Partial or phantom shipments where some goods are never shipped but documented.
• Related-party transactions where affiliated companies collude to manipulate invoice prices.

Each variant serves to disguise the true financial value, enabling unauthorized value transfers and concealing the origin of illicit funds.

Procedures and Implementation

Financial institutions and regulatory bodies implement specific procedures to detect and mitigate risks related to under-invoicing:

1. Customer Due Diligence (CDD) and Know Your Customer (KYC): Comprehensive verification and profiling of trading partners to identify potential risks.
2. Trade Transaction Monitoring Systems: Automated tools analyze invoice values against market prices and historical trading patterns for anomalies.
3. Risk-Based Approach: Higher scrutiny for transactions involving high-risk countries, related parties, or unusual trade volumes.
4. Cross-agency Cooperation: Customs, tax authorities, financial intelligence units (FIUs), and banks collaborate to verify declared values against customs data.
5. Documentation and Record-Keeping: Maintenance of detailed trading records, invoices, and shipment documents to support audits and investigations.
6. Training and Awareness: Regular AML training for staff on identifying red flags and emerging typologies related to under-invoicing.

Impact on Customers/Clients

From a customer’s perspective, AML measures addressing under-invoicing might result in:

• Increased scrutiny and verification requirements during trade transactions.
• Delays due to enhanced due diligence or customs inspections.
• Restrictions or denial of transactions flagged as suspicious.
• Requirement to provide supporting documentation proving the legitimate value of goods.
  Customers have rights to transparency regarding compliance procedures but may face restrictions if their transactions involve suspicious undervaluation patterns.

Duration, Review, and Resolution

AML controls around under-invoicing involve ongoing monitoring over the lifecycle of trade transactions. Reviews include:

• Periodic reassessment of customer risk profiles.
• Continuous transaction monitoring with alerts for discrepancies.
• Investigations triggered by red flags, followed by remediation or reporting.
  Timeframes for reviews depend on institutional policies and regulatory mandates, often requiring retention of records for up to five or more years post-transaction for auditability.

Reporting and Compliance Duties

Institutions must:

• Maintain robust AML programs integrating trade finance controls.
• Report suspicious transactions to Financial Intelligence Units (FIUs).
• Document all due diligence, investigations, and actions taken.
• Cooperate fully with regulatory audits and investigations.
  Penalties for non-compliance can include fines, sanctions, reputational damage, and legal consequences.

Related AML Terms

Under-invoicing is closely linked with:

• Over-invoicing (the opposite practice, used similarly in TBML).
• Trade-Based Money Laundering (TBML) as an overall category.
• Customer Due Diligence (CDD) and Know Your Customer (KYC).
• Suspicious Activity Reporting (SAR).
• Sanctions evasion and customs fraud within AML frameworks.

Challenges and Best Practices

Challenges:

• Complexity in verifying true market prices.
• Collusion among related parties obscuring real transaction values.
• Limited access to reliable trade data.
• Evolving methods by criminals to evade detection.

Best practices:

• Use advanced data analytics and AI for anomaly detection.
• Cross-jurisdictional collaboration to track suspicious trading patterns.
• Regular updates to AML procedures reflecting evolving typologies.
• Effective staff training and awareness programs.

Recent Developments

Advancements in technology, such as artificial intelligence and blockchain, are being applied for improved detection of under-invoicing and trade fraud. Regulatory bodies are increasingly focusing on trade finance as a high-risk area, with enhanced guidelines and international cooperation frameworks emerging to counter sophisticated trade-based laundering schemes.

Under-invoicing in AML is a critical trade-based money laundering method involving the deliberate undervaluation of goods or services on invoices to illicitly move value across borders. It poses significant risks for financial crimes and requires stringent regulatory compliance through comprehensive monitoring, verification, and reporting. Understanding and addressing under-invoicing helps financial institutions and regulatory authorities safeguard the integrity of the global financial system and trade environment.