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Op-Ed: Overcoming Under-Invoicing Amid Higher Tariffs

Let’s be honest—higher tariffs are a problem only for companies that pay them. A number of competitors, however, will choose to fight the new trade wars with an old evasive tactic: under-invoicing.

Falsifying documentation has been the bane of customs officials practically since the advent of ad valorem taxes. Since the amount owed is based on the value of the underlying goods, imposing new customs duties or raising rates also increases the incentive to misrepresent an item’s price.

At base, the practice of under-invoicing is rather straightforward: the invoice provided to government officials specifies a lower amount than what the purchaser actually paid. To see how this works, we need only look to recent court cases. For example, dividing single shipments into multiple smaller shipments under the import duty threshold led to Pure Collections agreeing to pay over $900,000 in a False Claims Act action settled earlier this year.

Notations, a Pennsylvania wholesaler, allegedly benefited from under-invoicing by its Chinese partners, and as a result it ended up paying $1,000,000 in a 2017 settlement. Similarly, a 2014 case involved a double-invoicing scheme in which the lower-priced shipping invoice was supplemented with an invoiced amount paid directly to the supplier. In addition, it is also not uncommon for corporate affiliates to allocate—or manipulate—pricing across related entities in order to exploit varying tax rates in different countries.

Mismatches between the reported values of exports and imports around the world indicate that countries are losing billions of dollars each year, with apparel and footwear being particularly problematic sectors.

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A recent Pakistan Business Council report, for example, indicates that the reported cost of textiles imported to Pakistan from China is roughly one-fourth of their actual value, and the May 2018 report of the U.S.-China Joint Commission on Commerce and Trade (JCCT) blames “intentional under-invoicing” for a growing disparity between the two nations’ trade data.

The harmful effects, of course, go beyond statistical accuracy and lack of tax revenue. Law-abiding brands are themselves victims, as they find themselves at a competitive disadvantage compared to scofflaws not paying as much tax. What’s more, under-invoicing by third-party suppliers at distant points in the supply chain exposes even the most scrupulous U.S. importers to potential risk, just as the use of falsified invoices in money laundering—especially for terrorism and the illicit drug trade—can lead to heightened scrutiny of legitimate transactions, not to mention the risk of delays and even seizure of funds.

As much as the damage to both governments and fashion brands makes solving this problem a joint priority, for the most part enforcement strategies have done little to adapt to what the JCCT describes as the exponential growth of invoicing fraud over the past decade. On occasion, law enforcement officials try to discourage under-invoicing by touting the latest court case or settlement, and from a certain angle these prosecutorial press releases can indeed seem persuasive. Although threats can incentivize customs compliance, they also illustrate why efforts to curb under-invoicing have been unable to stem the under-invoicing tide.

A systemic problem faced by customs officials is their lack of direct access to a considerable amount of data outside the shipping process. The growing reliance on the False Claims Act lawsuits, which are filed by whistleblowers who stand to receive part of the recovered amount, is itself a product of officials’ own inability to spot side-transactions without outside help. Upward of a 30 percent bounty might sound like a lot, but success in these lawsuits is by no means guaranteed and can take a considerable amount of time to conclude; in fact, the court case against the Chinese suppliers involved in the Notations settlement is still ongoing despite having been set in motion nearly eight years ago.

Technological solutions are underway, from India’s new effort to use data mining to identify invoice fraud to the electronic trade data exchange being implemented by Pakistan and China. Nonetheless, these are at best slight improvements on the current system of enforcement, and if history shows us anything, it’s that improvements in detecting fraud tend to be outpaced by the technology of evasion.

Perhaps the time has come for a different approach. Instead of merely imposing penalties or streamlining compliance, governments should also reduce customs duties in exchange for expanding the scope of voluntary disclosure. This is where emerging technologies are particularly promising. In addition to more traditional forms of data transfer, a blockchain-based approach could award Bitcoin-like tariff credits for data entry that in turn could be sold in a secondary market, akin to the markets for carbon offsets or India’s export duty credit scrips.

Under-invoicing may be inevitable in a world without global free trade, but if protectionist tariffs are going to be in our future, we might as well make compliance more attractive by lowering their cost.

Jeff Trexler is an attorney and associate director of the Fashion Law Institute.