Vol 2: Navigating the intersection of tariffs and money laundering risks

Navigating the risks of tariffs and money laundering, exploring how trade policies can inadvertently facilitate illicit financial activities.

Co-authored by:

• Krutika Sequeira, Senior Manager, Financial Crimes, Risk Consulting
• Nathalie Rahil, Manager, Financial Crimes, Risk Consulting

In Volume 1 of Canada’s response to proposed US tariffs, we discussed the impacts on and considerations for Financial Transactions and Reports Analysis Centre of Canada (FINTRAC) reporting entities. In Volume 2, we’ll take a deeper look at how the current tariffs in effect and the threat of future ones can create opportunities for bad actors to launder illicit funds.

Tariffs are a tool of economic policy that has historically been used to regulate trade between nations. When used strategically and responsibly, they have the potential to provide economic benefits such as increased government revenue, protection of domestic industries and encouragement of local investments.

However, tariffs can have unintended consequences, one of which is facilitating money laundering. As complex international trade networks evolve, identifying money laundering activities becomes a significant challenge for reporting entities.

Tariffs and trade-based money laundering

Tariffs can impact money laundering in several ways. When tariffs are high, the cost of goods increases, creating opportunities for criminals to over- or under-invoice shipments. Over-invoicing involves exaggerating the value of goods to move larger sums of money across borders. Under-invoicing does the opposite, allowing criminals to evade taxes and tariffs while moving funds covertly.

Criminals may declare a higher value for goods than their actual worth. By doing so, they can transfer large amounts of illicit money disguised as payment for imports. This excess money is then laundered through the financial system, appearing as legitimate business transactions. Conversely, under-invoicing involves stating a lower value for goods to reduce the payable tariffs and taxes, which is a tariff evasion technique. The difference between the actual value and the declared value is often paid through informal channels, facilitating money laundering and tax evasion.

Scenarios of how tariff and sanctions evasion can lead to money laundering

Scenario 1: False declarations

A company imports high-value electronics but declares them as low-cost accessories to evade tariffs. The difference in value, which represents the true cost and the illicit funds, is settled through underground banking channels. This method allows the company to launder substantial amounts of money under the guise of legitimate trade. False declarations of goods is a tariff evasion technique that could become more prevalent given the current global trade environment.

Scenario 2: Ghost shipments

A company may create fictitious invoices for goods that never actually ship. These “ghost” shipments are billed at inflated prices, and payments are processed through international banks. The money transferred for these nonexistent goods is effectively laundered as legitimate business expenses, bypassing tariff regulations entirely.

Scenario 3: Misclassification of goods

Another method involves misclassifying high-tariff goods as lower-tariff items. For instance, luxury watches could be imported and declared as generic wristwatches. The payment for the luxury watches involves illicit funds, which are then integrated into the financial system, masked by the lower-tariff classification.

Scenario 4: Routing goods through free trade or lower-tariff zones

A shipment of luxury cars might be routed through a free trade zone in a third country before reaching its final destination. During this transit, the goods are re-invoiced at significantly reduced prices, taking advantage of the lower or nonexistent tariffs in the intermediary region. By the time the luxury cars arrive at their final destination, the declared value is much lower than the actual worth, allowing the company to pay minimal tariffs.

The difference between the declared value and the actual value can be settled through illicit funds. This process not only evades tariffs but also launders money by integrating the illicit funds into legitimate trade channels.

Scenario 5: Exploiting loopholes in tariff regulations to trade with sanctioned entities

Some businesses may exploit exemptions or loopholes in tariff regulations to continue trading with sanctioned entities, geographies and people. This could involve claiming that goods are for humanitarian purposes or that they fall under specific exemptions. Companies involved in global supply chains may unknowingly face indirect sanctions exposure if their suppliers or subcontractors engage with sanctioned entities.

For example, a manufacturing company sourcing raw materials from a supplier that has trade relations with a sanctioned country can indirectly be affected. These risks are much harder to detect and mitigate, but can result in disruptions to the supply chain, legal risks and reputational damage.

Scenario 6: Smuggling of goods across borders

Goods may be smuggled across borders to avoid tariffs altogether. This can involve concealing goods to evade customs border searches or falsely filling out customs declarations. This illegal activity can undermine legitimate businesses and create safety and security risks.

Stay alert, rely on alliances and strengthen compliance monitoring

Efforts to evade tariffs represent not only a compliance problem – it’s everyone’s problem. They undermine global trade, financial integrity and supply chains, leading to volatile markets and strained international relations, ultimately harming both domestic economies and the global trading system as a whole.

Whether or not you are a FINTRAC reporting entity, every organization must stay vigilant on potential tariff and sanctions evasion techniques. Organizations should lean on alliances with technology partners, regulatory and law enforcement agencies, trusted advisors, supply chain partners and banking partners to collectively combat the very real threat of money laundering in Canada. There’s power in numbers.

You should continuously reassess your organization’s money laundering and sanctions controls across people, process, technology and governance to understand the implications of tariffs. This may include:

• Increasing oversight from governance functions such as the board and compliance officers.
• Enhancing transaction and customer monitoring by refining transaction monitoring rules, updating investigation templates and checklists, and incorporating machine learning to achieve continual optimization.
• Updating your enterprise-wide risk assessment.
• Implementing increased customer due diligence measures on a risk-based approach, for example focusing on manufacturers, shipping companies, commodity traders, and global importers/exporters.
• Providing ongoing and targeted training to your compliance department on what to look out for.

Conclusion

While tariffs serve potential benefits to economic policies, they also present risks by enabling trade-based money laundering schemes. Through enhanced monitoring, education and cooperation, businesses and authorities can work together to combat money laundering, allowing trade to serve its intended purpose as a force for good in the economy.

Fighting money laundering and organized crimes requires all hands on deck. By understanding the mechanisms at play and staying alert to potential abuses, we can help protect Canada’s financial system and maintain the integrity of trade practices.