Barter Trade

The concept of value transfer goes back thousands of years, long before the modern concept of coins, paper money, monetary instruments, or electronic blips in an electronic wire transfer. Historically, all commerce is based on exchange, and originally took the form of barter. One party in a transaction traded, exchanged, or swapped an item or commodity or service for another. Bartering is perhaps the most basic form of trade. “I'll trade you flour for sheepskins.” To this day, bartering enjoys many advantages and continues to be practiced around the world—particularly in areas where money is scarce, currency is frequently devalued, there is high taxation, or there are forms of economic and political uncertainty.

Today, barter trade is also growing in developed countries. It is often facilitated by the Internet and social networking sites that readily advertise and match goods and services to exchange. Check out dozens of trading websites that entice clients: “Buy, Sell, List or Trade for FREE!” Modern bartering can be as simple as trading a box of apples for a box of oranges. One could barter a haircut for babysitting service. Somebody could barter a car for a tractor. As was the case thousands of years ago, people exchange things they might have in excess or no longer want for things they feel they need.

Low-level bartering between individuals and small businesses is often off the books. Yet for larger transactions, even though money is not being exchanged, in most jurisdictions there are tax implications for both parties. Generally speaking, the goods or services bartered are supposed to be recorded at fair market value.

The problem, of course, is that criminals also barter. When this occurs, bartering an illicit commodity and transferring value via bartering are forms of TBML. And for the most part, the bartering of illicit goods is completely off the radar screen of authorities. There is no paper trail or financial intelligence reports—our primary financial crimes countermeasure.

Many different types of illegal goods (and services) are bartered. The following are just a few examples of criminal barter trade focusing on narcotics. In some parts of the world, narcotics are not really thought of as something illicit but as simply a type of commodity that can be bought, sold, or traded:

• In certain areas of Afghanistan and Pakistan, the going rate for a kilo of heroin is a color television set.¹
• In South Africa, methaqualone, also known as mandrax (a recreational narcotic), is exchanged for diamonds.²
• In Afghanistan, warlords exchange one commodity they have—opium—for others they want such as SUVs.³
• In Canada, drug dealers use diamonds to pay drug suppliers, which are then sold to jewelry stores in small increments to avoid detection.⁴
• In a 2013 investigation in southern Indiana and western Kentucky, it was determined that narcotics obtained from sources in Texas and Mexico were brought to Indiana for distribution. The drugs were bartered or exchanged for weapons that were transported to the Cartel del Golfo in Mexico.⁵

Service-Based Laundering

Service-based money laundering is exactly what the name implies. Instead of laundering money or transferring value through trade goods, services are used. Similar to TBML, service-based laundering revolves around invoice fraud and manipulation. We are not necessarily talking about the predicate offense of fraud—for example, fraudulent Medicare billing practices—but rather, using services (real or fictitious) as a means to launder money. Many of the same techniques explained in Chapter 2 are employed. Invoices are generated and payment is made. Similar to TBML involving commodities, there could be multiple invoices generated for the same service, over- or underinvoicing, and so on. Common fraudulent service-based laundering scams include accounting, legal, marketing, and natural resource exploration fees.

I once visited Belgrade and authorities told me about a case where organized crime used fraudulent invoices generated from “music concert promotions” as a technique to send illicit funds to Cyprus. Similarly, in the State Department's 2015 INCSR country report on Montenegro, it is reported that “in some cases, off-shore companies send fictitious bills to a Montenegrin company (for market research, consulting, software, leasing, etc.) for the purpose of extracting money from the company's account in Montenegro so funds can be sent abroad. It is a form of service-based laundering.”⁶

In TBML, authorities can often track an item or a commodity. They can follow a physical trail. In service-based laundering, an invoice is presented. What authority is able to judge its validity? From an investigative standpoint, it's much more difficult to track a service. And in international transactions, there are difficulties surrounding competence, jurisdiction, and venue. I believe we will be seeing more cases of service-based laundering.

Free Trade Zones

Free trade zones (FTZs) are designated geographic areas outside of normal customs areas and procedures. FTZs and similar districts generally offer duty- and tax-free access and sometimes incorporate a number of other incentives for businesses. They provide a preferential environment for goods and services usually associated with exports.

The number of FTZs has proliferated in recent years. They are often included in economic growth plans for the developing world but are also hubs of manufacturing, trading, and innovation for developed countries. They promote trade, support new businesses, and encourage direct foreign investment. A typical general-purpose zone often provides leasable storage or distribution space to users in general warehouse-type buildings with access to various modes of transportation. Many FTZ projects allow users to construct their own facilities. Some FTZs are also located in regional financial centers and trade and transportation hubs. These features, combined with an unfortunate lack of comprehensive oversight in many of the zones, sometimes attract criminal activity. FTZs can be conducive to TBML and value transfer schemes.⁷

In 2015, there were approximately 4,300 FTZs around the world, and three out of four countries have at least one.⁸ Hundreds of billions of dollars' worth of goods are transferred through FTZs every year.⁹ In just one example, the Colon Free Zone in Panama, the world's second largest FTZ, generated approximately $31 billion in exports and re-exports in 2012.¹⁰

Although ownership of FTZs varies, oftentimes public or private corporations operate the facilities or sometimes contract for their operation.

In addition to FTZs, common terms for these areas include special economic zones, enterprise zones, freeports, and export processing zones.¹¹ Each type has distinguishing features. In the United States, Customs and Border Protection (CBP) calls these types of facilities foreign trade zones.¹²

Under foreign trade zone procedures, the usual formal CBP entry procedures and payments of duties are not required on the foreign merchandise unless it enters CBP territory for U.S. domestic consumption. While in the zone, merchandise is not subject to U.S. duty or excise tax. Certain tangible personal property is generally exempt from state and local ad valorem taxes. Domestic goods moved into the zone for export are considered exported upon admission to the zone for purposes of excise tax rebates and drawback. CBP duty and federal excise tax, if applicable, are paid when the merchandise is transferred from the zone for consumption. Goods may be exported from the zone free of duty and excise tax.¹³

The Financial Action Task Force (FATF) believes that many of the rules and regulations governing FTZs are outdated. The proliferation of FTZs has not kept up with the latest AML/CFT developments and sometimes anti–money laundering safeguards do not apply to businesses and transactions within these special areas.¹⁴

Goods introduced into an FTZ often undergo various economic modifications such as manufacturing, processing, warehousing, repackaging, and relabeling, as well as storage, marketing, delivery, and transshipment.¹⁵ Although the rules vary, generally the modifications to the product are tax free. The sheer volume in trade and the size and scope of many of the FTZs make it very difficult to effectively monitor incoming and outgoing cargo. Some shipments in and out of the zones must be turned around within 24 hours. The volume and time constraints combine to limit effective monitoring.

As we have seen in previous chapters, TBML schemes often involve false invoicing and other forms of fictitious documentation that misrepresents the contents, quality, or quantity of the goods involved. The scope of customs inspection and control over goods introduced into FTZs vary from one jurisdiction to another. I have personally visited a number of FTZs in the Middle East. I've observed that official oversight varies greatly. Yet particularly in high-risk jurisdictions, it is fair to say that lax safeguards allow opportunities for abuse, including purchases using tainted bulk cash, the processing of counterfeit goods, smuggling, black market operations, and various types of customs fraud and TBML.

The Afghan Transit Trade

The first time I visited Afghanistan in 2006, I asked a gathering of Afghan bankers, hawala brokers, and businessmen how the Taliban and warlords launder drug proceeds and finance terrorism. Without exception, they said that illicit money was laundered not via Afghanistan's licensed banks, but primarily through trade and its link to regional hawala networks. This should not be a surprise in a country where an estimated 80–90 percent of economic activity is in the informal sector, and where some 80 percent of the population is illiterate.

The heartbreaking political and social situation in Afghanistan requires no explanation. But most do not understand that TBML and value transfer help enable the corruption, poor governance, underground finance, and terror that grip the nation. Entrenched TBML and its corollaries such as underground finance have found a laboratory in South Asia, Iran, and parts of the Middle East.

Before we begin to discuss the misuse of trade and the Afghan Transit Trade and their role in TBML and the finance of terror, a brief review of the role of Afghanistan in the production of narcotics is required.

Opium is one of the few Afghan commodities that outsiders value. According to the U.N. Office on Drugs and Crime (UNODC) and the Afghan counter-narcotics ministry, in 2013 the amount of land under opium cultivation jumped to approximately 209,000 hectares (516,000 acres).¹⁶ Afghanistan produces more than 80 percent of the world's illicit opium.¹⁷ The country is also one of the world's largest suppliers of cannabis—in fact, it produces more drugs overall than Colombia, Peru, and Bolivia combined.¹⁸

There are estimates that that over one-third of Afghanistan's licit and illicit gross domestic product is derived from the drug trade,¹⁹ with some observers asserting that it makes up as much as half the country's economy. The situation will assuredly become even worse as U.S. and coalition forces complete their withdrawal from the country.

Afghan opium is refined into morphine and heroin by production labs, which are increasingly being established inside Afghanistan's borders. The drugs are often broken into small shipments and smuggled across porous borders via truck or mule caravan for resale abroad. The ancient smuggling routes follow mountainous trails out of Afghanistan into Pakistan, Iran, Turkmenistan, Uzbekistan, and other neighboring countries.²⁰

According to the UNODC, approximately 60 percent of Afghanistan's opium is trafficked across the Afghan-Iranian border. Some of the narcotics remain within Iran—a nation with one of the highest rates of addiction in the world.²¹ In order to reach lucrative markets in Europe, traditional smuggling routes continue through Iran into Turkey and the Balkans. In addition, more and more Afghan drugs are moving into the increasingly lucrative Russian market via routes that wind through many of Afghanistan's northern neighbors.

Opium gum itself is often used as a currency in Afghanistan, especially by rural farmers. Moreover, opium stockpiles are a store of value in prime production areas. As a result, a type of barter trade has developed whereby drugs are sometimes exchanged for trade goods (see above on barter trade). Although a simplistic formula, drugs are smuggled out of Afghanistan and trade goods come in. So how do many of the goods actually reach the country?

Although Afghanistan is landlocked, it has brokered favorable agreements with several neighboring countries to facilitate the movement of goods. Under a 1965 bilateral treaty with Pakistan called the Afghan Transit Trade Agreement, Afghan imports or exports moved through the Pakistani port of Karachi are exempt from Pakistani duties or customs tariffs. The treaty was subsequently expanded. In 1974, for example, Iran agreed to allow free transit through its port city of Bandar Abbas, and in 2003 it granted the same status to the port of Chabahar. Access to these port cities through rail or road gives Afghanistan direct access to the Arabian Sea and the opportunity to ship goods internationally.²²

In 2011, the Afghanistan-Pakistan Transit Trade Agreement (APTTA) expanded trade cooperation between the two countries and attempted to minimize smuggling by maximizing oversight and technical monitoring. Authorities plan on installing tracking devices on transport units and to better utilize customs-to-customs information sharing through data transfer technology. The APTTA establishes the framework in which Afghan businesses can more easily export goods through Pakistan to India, China, and beyond. Afghanistan will also be able to import goods more quickly via Pakistan. Similarly, Pakistan will also be able to export its products to Afghanistan with a streamlined customs and paperwork process. However, implementation and enforcement of the APTTA remains problematic. Massive smuggling continues as does the associated drain on customs revenue.²³

Notably, the majority of commodities that are traded and smuggled in the Afghan region—such as electronics, construction supplies, automobiles, foodstuffs, and even gold—originate from or transit Dubai. (Hong Kong, Singapore, China, and other international trading centers are used as well, but to a lesser extent.)

Many of the trade goods that enter the transit trade are broken down into smaller shipments to be distributed in Afghanistan or smuggled back into Pakistan, Iran, and other countries for resale on the black market. As a Pakistani customs official told me, “Many times the only part of the shipments that actually leaves Pakistan for Afghanistan is the paperwork.” That is, the shipping documents may indicate that the goods are destined for Afghanistan, but sometimes the cargo never actually crosses the border. Pakistani officials also related stories in which goods are taken a short distance across the border—literally just out of view of the authorities—then split into smaller loads and transported right back into Pakistan. They are then sold on the streets of Islamabad, Karachi, and other cities, including local bazaars such as Peshawar's Karkhano market.

Undoubtedly, most of the Afghan Transit Trade involves legitimate commerce. But illicit trade goods—the ones that help pay for drugs produced in the region and trafficked by terrorist-linked trading syndicates and criminal groups—also enter the subcontinent via the ATT. There are many methods of payment for these goods, including conventional bank-to-bank transfers via letters of credit and other formal financial methods. Yet a substantial percentage of tainted goods destined for Afghanistan are part of the TBML equation discussed previously in this book, including hawala (see Chapter 4).

Many elements in the trade settlement process are intermingled, including smuggling, corruption, countervaluation, legitimate commerce, and so forth. Even exchange-control credits can be used to purchase goods. For example, a trader in the region will sometimes report to exchange-control authorities that certain imports cost more (or certain exports less) than their actual price. The difference or credits can be held abroad and used to pay for additional imports. Moreover, throughout the Arab world and South Asia, cash is often accumulated and purchased by trading syndicates in the form of “guest worker” remittances. Some of the accumulated foreign exchange and currencies from various sources are used to purchase goods from souks (markets) and free trade zones in Dubai and elsewhere.

And even the new APTTA poses challenges. The increase in transit routes within Pakistan offers insurgents the ability to move materials, value, and personnel under the guise of legitimate trade transport. The designated trade routes all pass through key locations where insurgent and terrorist groups operate, particularly Karachi, Quetta, Baluchistan, Chaman/Spin Boldak, the Federally Administered Tribal Areas (FATA), Peshawar, and Torkham. It appears that insurgents are finding creative ways to utilize APTTA's new rule of being able to maintain control of a cargo truck from country of origin to cross-border destination without having to risk unloading trucks at border crossings.²⁴

In addition, since the initiation of the new APTTA agreement, it appears that organized smuggling groups have increased their use of Iranian ports of entry.²⁵ And with the phasing out of Iranian sanctions, this trend will continue to grow. Although there is little data available on money laundering in Iran, the country's underground economy is enormous, spurred in part by attempts to avoid government corruption and restrictive taxation. Indeed, capital flight via trade is a major problem for the Iran government (with Dubai a frequent destination) while currency exchange restrictions encourage the use of hawala rather than formal financial institutions. The ATT/APTTA is therefore a perfect vehicle for Iranian brokers to both circumvent currency controls and export capital by using apparently “legitimate” trade with Dubai. As one analyst noted, “Dubai is Iran's lifeline to the world. American politicians like to bray about Iran's ties to Syria, Iraq, and Lebanon's Hezbollah, but it is Dubai that keeps the ostracized nation functioning.”²⁶ Several hundred thousand Iranians reside in Dubai and more than 10,000 Iranian-run businesses operate in the city-state.²⁷ A great many are of the proverbial “import–export” variety.

The misuse of the ATT—facilitated by TBML and value transfer—has real-world political ramifications in both South Asia and the Arabian Sea area. It is one more reason why understanding TBML is essential.

Latin America's Tri-Border Area

Argentina, Brazil, and Paraguay meet at a bend in the Parana River bounded by the key border towns of Puerto Iguazu', Foz do Iguaçu, and Ciudad del Este, respectively. The Tri-Border Area (TBA) has long served as a hub of organized crime, smuggling, and narcotics and weapons trafficking. The TBA's thriving cross-border trade is estimated at approximately $5 billion per year between Ciudad del Este and Foz do Iguaçu alone!²⁸ Much of that is off the books. The commercial trade and laundering of illicit proceeds is facilitated in large part by TBML and value transfer.

The TBA first started to grow rapidly in the 1960s and 1970s when tax incentives encouraged large numbers of foreign merchants and businessmen to relocate to the region. Today, the Syrian, Lebanese, and Chinese presence is strong. (See Chapters 5 and 6.) It is believed the Shia Syrian-Lebanese community in the TBA numbers approximately 20,000 to 30,000.²⁹ Authorities claim that some of the Muslim residents give financial support to groups such as Hezbollah, Hamas, Islamic Jihad, and al-Qaeda.³⁰ It is difficult to gauge the amount of funds provided since much of it is transferred via hawala,³¹ unlicensed and unsupervised exchange houses, and trade-based value transfer. According to an official in Paraguay's antiterrorist unit, “Terrorists partly finance their operations by remitting dollars from Ciudad del Este to the Middle East.”³²

Much of the economic activity in Ciudad del Este is the “re-export” trade to Brazil. Merchants import cigarettes, clothing, electronics, and other consumer and luxury items from the United States, Europe, and increasingly China, and then sell them to primarily to Brazilians but also neighboring Argentinians. Paraguay boasts low import tariffs and free trade zones that facilitate the TBA trade.

At the lower end of the “trading” spectrum are tens of thousands of small-time sacoleiros, named for their ubiquitous overstuffed shopping bags (saco means “bag” in Portuguese). Sacoleiros account for the majority of the 30,000 to 40,000 people who cross the Ponte da Amizade (Friendship Bridge) every day.³⁶

It is surprisingly easy to move across the borders of the TBA. People and motorbikes are allowed to cross without travel documents and larger vehicles, watercraft, and smugglers can find ready ways to pass undetected. Many sacoleiros earn a living through illicit international arbitrage, buying low in Paraguay and selling high in Foz do Iguaçu. Ordinary Brazilians also flock in large numbers to the TBA as well, regularly flouting the official $300-per-month duty-free allowance to buy foreign goods in bulk.³⁷

There are also larger criminal enterprises at work in the TBA. Buyers with larger orders are sent to Ciudad del Este from far-away Brazilian cities to fulfill transactions placed on the Internet. Generally they charge a commission of 10–15 percent for their travel time and the (slim) risk of being caught by the police. There are also organized criminal networks operating in the Triple Frontier area. One of their most lucrative activities is smuggling large quantities of low-tax cigarettes (genuine and counterfeit) from Paraguay into Brazil.³⁸

In the last few years there have been attempts at transparency. In 2009, the “Unified Tax Regime” became law. The objective was to encourage Paraguayan import firms to register, systematize, and document their sales, and register vehicles used in the transport of goods. Tax and customs simplification is also part of the new trading regime. All of this information is housed in a database controlled by Brazil's Receita Federal.³⁹ However, similar to the APTTA between Afghanistan and Pakistan described above, there are problems with implementation and enforcement. The problems are particularly acute on the Paraguayan side of the border. As is the case elsewhere around the world where TBML flourishes, corruption, weak law enforcement, little regulatory oversight, and the lack of effective customs control are catalysts for criminal activity.

Carousel Fraud

Carousel fraud or missing trader fraud is the practice of importing goods from a country where they are not subject to value-added tax (VAT), selling them with VAT added, then deliberately not paying the VAT to the government. The fraudster charges VAT on the sale of the goods and instead of paying it to the government simply absconds—taking the VAT with him, hence missing trader fraud. It is a form of “carousel” or “merry-go-round” fraud when sometimes goods are cycled between companies and jurisdictions, collecting ever more fraudulent VAT revenues. Sometimes in TBML, carousel fraud also refers to the process of cycling trade goods (genuine or fictitious) in-and-out of markets in order to justify payment abroad.

Although a foreign concept to American readers, VAT is a consumption tax assessed on the value added to goods and services. In the countries that apply it, like those in the European Union, consumers pay the VAT tax every time they buy a product or service. Whether it involves a sale to a consumer or another business, VAT taxes involve a lot of paperwork as each company involved must keep track of it when it makes a transaction. It is a very important source of income for the countries involved; for example, France levies approximately 140 billions of euros with the VAT tax, or twice what French citizens pay in income tax.⁴⁰

Unfortunately, trade fraud follows VAT; Canada, Mexico, and the Ukraine are just a few countries where VAT scams regularly occur. According to a 2015 INCSR report by the U.S. State Department, “A significant facet of the grey economy in Bulgaria is large-scale tax evasion, particularly of VAT and excise duties. Proceeds from VAT fraud are significant and are largely transferred out of the country to foreign accounts held by offshore companies. They are then returned to Bulgaria and declared as loans, thus creating a legal origin for future use.”⁴¹ The State Department reports that in the Czech Republic:

[F]raud and tax evasion, especially related to the Value-Added Tax (VAT) and excise tax, are reportedly the primary sources of laundered assets in the country. A common tactic for hiding the origin of illicit proceeds is to transfer or layer funds among multiple companies, creating a system of “carousel trading,” whereby fictitious invoices, wages, and benefit payments are created. The ultimate goal of the carousel system is to benefit from an unauthorized VAT allowance.⁴²

Carousel VAT fraud in the European Union first involves obtaining a VAT registration number in an EU member state for the purposes of trade. (In general, countries that have a VAT system have a threshold or regulations specifying at which turnover levels VAT registration becomes compulsory.) Next, the same goods are traded around artificial supply chains within and sometimes beyond the EU. The goods reenter the original member state on a number of occasions with the intention of creating large unpaid VAT liabilities and associated fraudulent VAT repayment schemes.⁴³

The following is an example of a simple VAT carousel fraud operating in the EU:⁴⁴

• Company X in one EU country purchases goods from a supplier in another EU country. The VAT rate is zero.
• After acquiring the goods, Company X supplies them to Company Y, within the same country for a price plus VAT. However, X does Not pay the VAT to the EU Member State and becomes a “missing trader.”
• Company Y then supplies the goods to another EU member country and claims back the VAT that Y paid for the original purchase of the goods from Company X.

The scheme becomes more complex when Company Y adds “buffers” to the equation, distancing itself from Company X—the missing trader.

Conspirators in carousel fraud often use items that are low bulk and high value, for example, mobile phones, electronics, and computer chips. Similar to other examples of TBML found in this book, conspirators have used invoice fraud and manipulation, buying and selling goods that don't actually exist. In other cases, there have been boxes of dummy items involved.

According to a study by the FATF,⁴⁵ career criminals and organized crime groups are attracted to VAT carousel fraud because it generates large profits with a relatively low risk of prosecution. Criminal involvement is the reason why VAT carousel fraud can be considered TBML. For example, organized crime groups in the United Kingdom have conducted violent armed robberies at freight forwarder premises to steal mobile phones for use in carousel fraud. In other cases, criminals hijacked and “stole” their own goods in order to make fraudulent insurance claims, which were then used to finance further carousel fraud. Moreover, illicit proceeds—including those from narcotics trafficking—have been invested in carousel fraud.

Although some governments are addicted to VAT because of the revenue it generates, the VAT tax system is complex, invites fraud, and costs a lot of money to administer. And rising VAT rates have encouraged some companies to avoid the tax rather than pay it. As per Chapter 7, some companies seek to avoid taxes by relocating their headquarters to Luxemburg, for example, where the VAT rate is lower.⁴⁶

Case Studies