Trade-Based Money Laundering (TBML) explained

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By Najib Shah/Deccan Herald

A short trader with no pretensions to have public interest brought the Indian markets to a crash with allegations against a major conglomerate. Everybody from the Supreme Court to Parliament to the regulators is currently seized of the issue. Many a term, circular trading, round-tripping, trade-based money laundering (TBML), lexicon previously restricted to financial investigators, are rolling down the tongues of ordinary citizens and occupying newspaper space.

So, what really are these terms, what are their implications and how do we address the problem?

The UN Convention Against Illicit Traffic in Narcotics Drugs & Psychotropic Substances 1988, was the first to recognize the problem of money laundering as a critical cog in drug trafficking. It highlighted the need to ‘arrest the attempt to convert or transfer property which are the proceeds of crime’. As any investigator would tell, follow the money trail to get at the crime, and if you dry up the money, you can also tackle the crime.

It was recognized that the proceeds of crime need not necessarily be generated only from narcotics.

The next big step in the fight was the establishment of the Financial Action Task Force (FATF) in 1989. FATF has issued 40 recommendations designed to target  proceeds of all crime. This was a clear recognition of the fact that ‘the primary motivation in committing crime is to make money and that money laundering is accordingly a feature of many types of crime’.

FATF has defined money laundering as the processing of criminal proceeds to disguise their illegal origin and to legitimize the ill-gotten gains. The World Economic Forum has estimated the size of the illicit market at about US $ 2.2 trillion or about 3 percent of the world’s GDP.

In the context of India, Prof. Arun Kumar, who has done extensive work, has estimated that the illicit economy is about 62 percent of GDP-generating at (2016-2017 prices) about Rs. 93 lakh crore of revenue. Money, which is outside the tax net or Black money, is of little use if it cannot be used. Not all proceeds need be laundered, it can be used for financing other criminal activities where cash is king. But a good amount needs to be laundered. To escape the clutches of the tax administrators, the next step of disguising criminal proceeds commences; or in other words, the process of laundering the criminal proceeds, begins.  

The first step is to ‘place’ the money by using various techniques in the financial system. The next step is to ‘layer’ or conceal the criminal origin of proceeds. Then comes the critical step of ‘integration,’ – creating an apparent legal origin for the proceeds.

Laundering has become increasingly sophisticated-from the use of cryptocurrencies to creation of offshore accounts, to the use of professional enablers and intermediaries. And where trade is used as means of laundering, we enter the world of Trade-based Money Laundering or TBML.

TBML is the process of disguising the proceeds of crime and moving value using trade transactions to legitimize their illicit origin. With volumes of trade dramatically increasing (UNCTAD estimates that current trade levels to have crossed US$ 28 trillion) this is becoming easier. This is possible by misrepresentation of price, quantity or quality of imports or exports. What this means is that the price of the goods or services is falsified to transfer additional value between the importer and exporter.

By invoicing the good or service at a price below the correct price, the exporter can transfer value to the importer. The payment obviously will be lower. However, the remaining value is retained abroad. By invoicing the good or service at a price above the correct value, the exporter can receive a higher payment than what is due. The methodology works for both imports and exports. In either case, trade becomes a means of transferring or receiving money over and above the actual value.

A key element in all such transactions is that there necessarily must be a nexus between the exporter and importer. Invariably, both the exporter and importer are controlled by the same entity. Again, invariably, the exporter or importer is located in a tax haven; the conduit of trade is also one such ‘friendly’ location. There is a strong possibility of corruption too, of collusion between the importer/exporter and officials.

Every over and under-invoicing of exports and imports has significant tax implications. When over-valuation of exports takes place more foreign exchange is earned which is nothing but laundered proceeds. However, significantly, the exporter also gets additional export incentives which governments extend to genuine exporters. Similarly, an importer who under-values pays lesser import duties. The settlement takes place by either under valuation of exports or overvaluation of imports. Over-invoicing of imports could result in more duty being paid, but the larger purpose of over invoicing is to transfer funds.

When this money makes its way back to the origin country in the form of investments or proceeds of trade, you have round-tripping. Circular trading occurs when the same goods go back and forth; the purpose is to manipulate prices and transfer funds, noticed in India in the context of diamonds.

Trade-based money-laundering avoids the vulnerabilities of hawala transactions and is thus more challenging to detect. Peeling off the veneer of legitimate trade calls for coordinated action between multiple agencies-in the context of India. This would mean, the Customs, the Enforcement Directorate, the Financial Intelligence Unit, the Income Tax authorities, the market regulator, and the Central Bureau of Investigation. Unfortunately, such a coordinated response does not always happen.


Najib Shah is a retired Chairman of the Indian   Central Board of Indirect Taxes and Customs.

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