Over- and under-invoicing
Also written Over-invoicing · Under-invoicing
Misstating the price of goods or services on an invoice to move value between importer and exporter — under-invoicing moves value to the importer, over-invoicing to the exporter.
In plain language
An invoice is a statement of what goods are worth. Change that number, and the money paid for the goods stops matching their value — the difference is value that has crossed a border without anyone calling it a transfer.
The workbook calls over- and under-invoicing one of the oldest methods of fraudulently transferring value across borders, and says it remains a common practice today. Its key element is simple: misrepresentation of the price of the good or service to transfer additional value between the importer and the exporter.
The only thing to get right in an exam is the direction. That is where almost every wrong answer comes from.
How it works
The two directions (Chapter 8, section 8.6.2(a)).
| Technique | Invoice price vs fair market price | Who pays what | Value moves to |
|---|---|---|---|
| Under-invoicing | Below fair market price | Importer pays less than the goods are worth when sold on the open market | Importer |
| Over-invoicing | Above fair market price | Importer pays more than it will receive when the goods are sold on the open market | Exporter (the exporter receives value from the importer) |
Where it sits. It is the first of the four basic TBML techniques, alongside multiple invoicing, over- and under-shipments, and falsely described goods and services.
The same trick for a different purpose — capital flight. Companies and individuals shift money between countries to diversify risk and protect wealth against financial or political crises, and a common technique to circumvent currency restrictions is to over-invoice imports or under-invoice exports. The mechanism is identical; the difference is that capital flight usually involves legitimately earned funds, while TBML involves proceeds of crime.
Tax motive. Differing tax rates give corporations an incentive to shift taxable income from high-tax to low-tax jurisdictions — the related, but separate, activity of tax avoidance and evasion.
Detection. Studies analyse whether reported import and export prices reflect fair market values; one method being explored uses statistical techniques to detect discrepancies in shipping documents. False descriptions of services — financial advice, consulting, market research — are harder, because their fair market value is itself difficult to establish.
The formula
Value transferred = |Fair market value − Invoice value|
- Invoice value below fair market value → value transferred to the importer
- Invoice value above fair market value → value transferred to the exporter
A worked example
Illustrative amounts.
An exporter ships 10,000 units of machine parts with a fair market price of USD 50 each.
Fair market value = 10,000 × USD 50 = USD 500,000.
Case 1 — under-invoicing. The invoice shows USD 20 a unit.
- Invoice value = 10,000 × 20 = USD 200,000
- The importer pays USD 200,000 and can sell the parts for USD 500,000
- Value transferred to the importer = 500,000 − 200,000 = USD 300,000
Use: an exporter holding criminal proceeds in its own country moves USD 300,000 of value to an importer abroad.
Case 2 — over-invoicing. The invoice shows USD 80 a unit.
- Invoice value = 10,000 × 80 = USD 800,000
- The importer pays USD 800,000 for goods worth USD 500,000
- Value transferred to the exporter = 800,000 − 500,000 = USD 300,000
Use: an importer holding criminal proceeds moves USD 300,000 of value to the exporter, and the exporter's receipt looks like sales revenue.
What an IFSC Banking Unit can see. Financing the Case 2 import, a bank that knows these parts ordinarily sell near USD 50 sees a unit price 60% above it — (80 − 50) ÷ 50 = 60% — with no quality or specification difference in the documents. That price discrepancy is the red flag the workbook's statistical detection methods are built to find.
Why NISM asks about it
Chapter 8 (Financial Action Task Force and Its Recommendations), section 8.6.2(a), explains the technique and its two directions; section 8.6.1(b) ties the same device to capital flight; and Chapter 1, section 1.2.2, lists it first among the basic TBML techniques. Expect a direction question ("invoicing below fair market price transfers value to whom?") and a question distinguishing capital flight from TBML.
Common exam traps
- Under-invoicing transfers value to the importer; over-invoicing transfers value to the exporter. Reverse this and you lose the mark.
- The key element is price. Changing quantity is over- or under-shipment; changing the description is falsely described goods.
- Capital flight uses over-invoicing of imports or under-invoicing of exports — and usually involves legitimate money, not proceeds of crime.
- It is one of the oldest methods, and the workbook says it remains common today.
- Services are harder to value than goods, which makes false descriptions of services difficult to detect.
Check yourself
1.The process of disguising the proceeds of crime and moving value through the use of trade transactions is better known as:
- a)Trade-based Money Laundering
- b)Bulk cash smuggling
- c)Cheques and wire transfers
- d)All of the above
Show the answer
Answer: (a) Trade-based Money Laundering
Trade-based money laundering is defined as the process of disguising the proceeds of crime and moving value through the use of trade transactions in an attempt to legitimise their illicit origins.
Options B and C name the other two channels, not this one. There are three main methods by which criminal organisations and terrorist financiers move money for the purpose of disguising its origins and integrating it into the formal economy:
i. The first involves the movement of value through the financial system using methods such as cheques and wire transfers;
ii. The second involves the physical movement of banknotes using methods such as cash couriers and bulk cash smuggling; and
iii. The third involves the movement of value using methods such as the false documentation and declaration of traded goods and services.
The third is trade-based money laundering — so option D is wrong because the three are distinct methods, not synonyms.
Why the third has grown. In recent years, the Financial Action Task Force has focused considerable attention on the first two of these methods. By comparison, the scope for abuse of the international trade system has received relatively little attention.
In 2003, the FATF significantly toughened the standards that apply to the financial system and various non-financial intermediaries. Two years later, it extended these standards to cover the activities of cash couriers.
And criminals move to whatever remains easiest: when governments take action against certain methods of money laundering or terrorist financing, criminal activities tend to migrate to other methods.
The four basic techniques: over- and under-invoicing of goods and services; multiple invoicing of goods and services; over- and under-shipments of goods and services; and falsely described goods and services — though all of these techniques are not necessarily in use in every country.
Where this is taught
Free preparation for NISM Series IFSCA-01Related terms
- FATF StandardsThe FATF Recommendations together with their Interpretive Notes and the applicable Glossary definitions — the international AML/CFT/PF standard that more than 200 jurisdictions have committed to implement.
- Money launderingTurning the proceeds of a crime into money that looks legitimate — classically in three stages, placement, layering and integration — and a standalone offence under section 3 of the PMLA.
- Proceeds of crimeUnder section 2(1)(u) of the PMLA, any property derived or obtained, directly or indirectly, from criminal activity relating to a scheduled offence — or its value, or equivalent property where it is held abroad.
- Trade-based money launderingDisguising the proceeds of crime and moving value through trade transactions to legitimise their illicit origin — by misrepresenting the price, quantity or quality of imports or exports.
- Capital flightCompanies and individuals shifting money from one country to another to diversify risk and protect wealth against financial or political crises — usually with legitimately earned funds, unlike money laundering.
- Phantom shipmentThe extreme form of over-shipment: the exporter ships no goods at all and colludes with the importer so that all shipping and customs documents are routinely processed and paid against.
- Black market peso exchangeThe complex trade-based laundering arrangement the workbook names: it combines drug smuggling, laundering through the financial system and trade laundering, and needs no collusion between importer and exporter.