Global Financial Integrity

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Seeking Solutions to Trade Misinvoicing in Mexico and Colombia

by Pedro Izquierdo

Addressing trade misinvoicing is a complex endeavor as it is considered one of the weakest links in the fight against money laundering, especially in developing countries like Mexico and Colombia. Trade misinvoicing is one component of trade-based money laundering (TBML) where individuals or entities falsify the quantity, price, and quality of goods to, among other reasons, launder money, claim tax incentives, or evade taxes, duties and capital controls. Corruption, lack of political will, and ineffective customs infrastructure are some of the factors that hinder anti-money laundering/counter-financing of terrorism (AML/CFT) efforts. Thus, it is necessary to take a holistic approach to facilitate effective policy solutions against this problem and mitigate the macroeconomic impacts in these two economies.

In countries like Mexico and Colombia, drug cartels frequently use low-risk, high-reward methods such as trade misinvoicing to launder money. Along with the aid of corrupt officials, businesses, and private sector employees, cartels have expanded their presence at crucial geopolitical points such as ports, airports, and border crossings, thus facilitating trade misinvoicing as well as smuggling. Because both countries are situated on the Pacific and Atlantic Oceans, it can be challenging to address TBML given the sheer size of global commerce and lack of proper infrastructure.

The Mexican government has taken deliberate legislative steps to address financial crimes and transparency in recent years. In 2019, it passed significant reforms to a federal law to fight trade misinvoicing, shell companies, and tax fraud, as well as a bill that would grant greater autonomy to the Unidad de Inteligencia Financiera (UIF), Mexico’s financial intelligence unit (FIU). Furthermore, in June 2020, Mexican President Andrés Manuel López Obrador announced that the government and the Tax Administration Service (Servicio de Administración Tributaria or SAT) would go after 43 companies and 8,212 taxpayers for invoice fraud. After analyzing 22 million allegedly false invoices dating back from 2010, the SAT determined that these companies and individuals engaged in invoice fraud worth US$2.5 billion, of which US$2 billion was from income tax and US$508.7 million came from value-added tax. The president claims that this type of tax evasion had cost the country up to 30 percent of its government income.

In April 2021, the Mexican Congress approved a law to crackdown against illicit financial flows (IFFs) with significant reforms. These include expanding the UIF’s mandate against terrorism financing as well as collecting information on beneficial ownership (BO), politically exposed persons (PEPs), and any sectors that are deemed “high-risk.” More recently, President López Obrador created the National Customs Agency of Mexico (Agencia Nacional de Aduanas de México or ANAM) which would work separately but in coordination with the SAT in an effort to tackle corruption. The problem here lies with the addition of a militarized customs institution when the country already has the General Customs Administration (Administración General de Aduanas): in addition to the fact that competent people should handle this complex work over a military likely untrained for the task at hand, this can also create administrative problems as multiple agencies try to coordinate as well as share information with each other.

However, the recently enacted reforms are expected to yield short-term results as major deficiencies and vulnerabilities persist, including the lack of prosecutions and investigations, weak infrastructural capacity, and pervasive corruption. And while the ANAM will officially be under the Secretariat of Finance and Public Credit (Secretaría de Hacienda y Crédito Público), it will be run by the Secretariat of National Defense (Secretaría de la Defensa Nacional) and the Navy, institutions with limited experience combating financial crimes like TBML and corruption. Additionally, the failure to mention TBML or trade misinvoicing in Mexico’s 2018 Financial Action Task Force (FATF) fourth round Mutual Evaluation Report (MER), it’s 2020 national risk assessment (NRA), or its 2015 customs regulations suggests that the government may not fully appreciate the vulnerability of its trade to IFFs.

Like Mexico, Colombia has also pursued legislative actions to address financial crimes such as trade misinvoicing. Under former president Juan Manuel Santos, one important measure the Colombian government took was the enactment of Customs Law No. 1762 of 2015 to strengthen the fight against money laundering, trade misinvoicing, and tax evasion by recognizing legal and institutional factors as facilitators of illicit trade and improving law enforcement activities in border areas. It also imposes heavier economic and legal penalties by strengthening the amendments to the law. In addition, the Colombian government announced a proposal in April 2021 for a US$6.4 billion tax reform to eliminate deductions and increase duties on taxpayers, which would seek to maintain the country’s credit rating and curb the practices of invoice fraud. With the reform, the country’s National Tax and Customs Authority (Dirección de Impuestos y Aduanas Nacionales or DIAN) would dissuade companies from committing fraudulent acts, with significant penalties in case of reoffending which could also proceed to criminal action. However, the tax reform was also highly regressive, mainly impacting the working class with changes such as raised VAT on basic goods, and ultimately, Colombian President Ivan Duque had to withdraw the tax reform because of nationwide protests. As of July 2021, the government proposed another, more sustainable version that maintains the same tone against invoice fraud and tax evasion but also helps hard-hit Colombians.

One shortcoming of the Customs Law of 2015 is that it does not address free trade zones, especially those in border areas, which have severe governance and institutional challenges that hinder anti-TBML efforts. The DIAN has problems of its own: as of July 2020 it has not adopted the WCO Data Model, which harmonizes customs procedures and provides for cross-border information sharing between regulatory agencies that would strengthen the institution internally and within its own customs union. Other problems include weak communication between the DIAN and the Financial Analysis and Information Unit (Unidad de Información y Análisis Financiero or UIAF), Colombia’s FIU, as the former does not have a leadership role in AML/CFT efforts. Furthermore, the country’s 2019 NRA notes “hyperregulation” in the country’s trade sector linked to the involvement of multiple government agencies with unclear responsibilities.

Transparency is an important component in the fight against financial crimes; countries should have clear BO laws so that they are able to easily identify the true owner of an entity that is engaging in illicit activity. Mexico has a general definition of BO and does require certain entities to collect BO information from their customers, but companies are still not legally required to declare their beneficial owners. However, the government has committed to creating a BO registry in 2022, overseen by the Secretariat of Civil Service (Secretaría de la Función Pública) and the UIF. The FATF recently recommended that the country be more proactive in identifying BO and having a public registry for government agencies to confirm the information. On the other end of the spectrum, Colombia has five different BO definitions which causes bureaucratic problems. As discussed in a 2019 GFI report, the Colombian government should narrow the BO definition to one, improve the verification process on an immediate basis, and create a public registry. As of August 2021, there are three different bills addressing BO which are under discussion in the Colombian senate: the July Tax Reform bill (mentioned above), the anticorruption bill, and the lobbying bill.

Corruption can play an important role in trade misinvoicing and other TBML-related schemes. Importers and exporters complicit in criminal operations can interact with corrupt public officials and other intermediaries to facilitate the money laundering process. Thus, both countries should improve anti-corruption laws and penalties against any involved actors and prioritize efforts to address corruption at customs agencies. In addition, the countries should consider studying the relationship between corruption and the sectors and industries with larger import and export value gaps. It is possible that the bigger the value gap is to the related industry, the more likely it is to be susceptible to corruption, and, therefore, the more anti-corruption efforts should be directed to that industry.

Finally, both countries should implement trade misinvoicing tools to address trade misinvoicing such as GFTrade, a risk assessment tool that provides real-time price comparisons. By comparing reported prices to average prices as reported by the trade partner country, local authorities can determine which discrepancies require further scrutiny.

Failure to adequately address TBML and trade misinvoicing not only makes global commerce more exploitable but can also help strengthen criminal financial structures. Important elements in any response would include confronting trade-related corruption, improving corporate transparency, strengthening customs legislation, and ensuring that trade-related IFFs are adequately addressed in future NRAs. Only by developing policy solutions to address trade misinvoicing and TBML, can Mexico, Colombia, Latin America, and the world work to weaken criminal financial structures and preserve the trade integrity of global commerce.

Pedro Izquierdo is a graduate student pursuing a master’s in public policy at George Mason University. and was a Spring 2021 Latin America Intern.