President Donald Trump’s Liberation Day tariff announcement rocked the world. While many had anticipated additional tariffs on China, few were prepared for the scope of the U.S. trade action. The stated purpose was to rebalance trade with each of the targeted nations. Whether the tariffs go into effect and they ultimately achieve this goal is yet to be seen. But one thing is already apparent, the uncertainty has resulted in a major unintended consequence: more bad actors in global trade.
Whether it’s fraudulent acts related to country of origin, product classifications or product value, the ramp up has been swift—even given the pause on many of these new tariffs.
A steady stream of media reports have chronicled the blatantly illegal practices cropping up in service of brands and retailers looking for a way to protect margins.
And some of these downstream partners are taking matters into their own hands. For instance, a vendor recently told HGI a client that sells in both the U.S. and Europe requested some creative accounting to sidestep tariff costs. “One of them says, ‘Please reduce your invoice to the U.S. by 10 percent and put that amount on the invoice you did for our goods for Europe,’” the vendor said.
None of this comes as a surprise to anyone who participates in global trade. Tough times, like those experienced during Covid, only increase the instances and strategies for nefarious practices. And the tariff turmoil is proving to be another one. As apparel manufacturer Leslie Jordan told The New York Times, “People can’t afford it,” she said. “They’re desperate.”
The tariff rates that range from 29 percent to 46 percent for top garment producing countries—not to mention the once 145 percent total tariff on goods from China—is reason for “significant concerns,” according to Tom Cardamone, president and CEO of Global Financial Integrity (GFI), a think tank focused on illicit financial flows.
“We do think that these new tariffs are going to exacerbate an already rampant problem in international trade,” he said. “The numbers are staggering and they’re only likely to get worse.”
Global trade fraud is costing upwards of $1.6 trillion, according to GFI.
The firm derived that number by calculating the value gaps between reported trade between 134 developing countries and their global trading partners in 2018.
“There are numerous stories of the [customs] officials that have accumulated a grotesque amount of income and wealth.”
—Iftekhar Zaman, Transparency International Bangladesh
And apparel sourcing executives expect fashion’s contribution to that number to increase further over the coming days, weeks and months.
“I believe, unfortunately, that illegal practices with regards to importation into the U.S. will be further explored,” said Guido Schlossmann, chief supply chain officer for supply chain management firm M5Groupe, immediately following the Liberation Day retaliatory tariff announcement. “I think you found it predominantly for goods out of China in the last few months or years. Now it will affect Bangladesh. It will affect Vietnam, Cambodia, in particular. We will see more underinvoicing taking place.”
The misinvoicing scheme
Underinvoicing is just one of several ways operators in the apparel supply chain can manipulate invoicing to their own benefit. More broadly misinvoicing is the practice of ticking up or down the value of goods declared at import or export to circumvent taxes and custom duties, launder money and a host of other crimes.
In its latest report, GFI stated, “Trade misinvoicing is one of the largest components of measurable illicit financial flows.”
Chart credit: GFI
Iftekhar Zaman, executive director, Transparency International Bangladesh, said the problem is “significant” in his country. And the culprit is good old-fashioned corruption. For as much as brands, retailers and intermediaries might want to defraud the government, Zaman said it couldn’t happen without the officials on the ground who receive kickbacks for manipulating documents. “There are numerous stories of the officials of these customs authority or revenue offices that have accumulated a grotesque amount of income and wealth, which is absolutely disproportionate with their legitimate source of income,” he said.
While he hasn’t seen any evidence of a surge in this activity since the tariff announcement, it wouldn’t surprise him. “The way that this sector has developed, and the way they have become addicted to this profiteering through abuse and corruption and misinvoicing and whatnot, they will take advantage of any opportunity that comes,” Zaman said.
Of course, Bangladesh is far from the only country battling these criminal actions. In fact, Cardamone speculates the reason why governments aren’t utilizing readily available tools to clamp down on trade fraud is 1) they’re embarrassed to expose the extent of their problems and 2) their own officials are participants. “Customs officials in developing countries are poorly paid, and so to get a tool that identifies every misinvoice might cut into the corruption that’s apparent in many customs departments,” he said.
But identifying misinvoicing can be tricky to do, particularly during a time when tariff rates have increased. While there’s a greater incentive for sleight of hand, fraud is not necessarily the reason for goods imported at lower-than-expected values.
“The natural economic consequence of imposing tariffs is that foreign prices should drop, and the higher the tariff, the more you would expect to see foreign prices drop,” said John M. Foote, partner at law firm Kelley Drye & Warren. “So low values [on invoices] on their own are not necessarily a sign of customs fraud.”
In fact, he said, Trump is often derided when he says foreign countries are the ones who will pay for the tariffs. But the fact is by charging U.S. partners less for goods, they are absorbing the increase.
Another reason misinvoicing continues to bedevil governments around the world because “it’s “easy to do and easy to hide,” according to Cardamone.
“There is a relatively widespread misconception that it is possible to outsource all risk associated with trade compliance to foreign suppliers.”
—John M. Foote
“When goods leave a port, there’s an export invoice. When goods enter a port, there’s an import invoice. The value on the export invoice is completely unknown to the customs officials in the importing country,” he said. “And in many instances, especially in the developing world, the methods for trying to determine the going price for a particular product are rudimentary at best.”
The lack of sophisticated tools, like blockchain, to verify the value of goods allows for rampant fraud. And it’s of no surprise, Cardamone said, that one country consistently tops the list of bad actors. In GFI’s analysis of countries with the biggest trade gaps between 2009 and 2018, China topped the list with a $445 billion trade gap. By comparison, the country with the next biggest gap was India at $68 billion. “It’s indicative of many other things that China does,” Cardamone said, characterizing the country’s actions as “a fast and loose approach to international trade.”
Data source: GFI
The transshipping conundrum
But these actions aren’t limited to China—especially these days.
Today, the retaliatory tariffs have the power to pit countries against each other. With Vietnam and Cambodia potentially as high as 46 and 49 percent, respectively, and others with just the global 10 percent tariff, it has created new hot spots and potential ports in the trade storm.
“It makes it so that there is now an economic incentive to say that your products are a product of a country with a lower assigned reciprocal tariff rate,” Foote said.
Simply stating that operations took place in a country where they haven’t is, of course, fraud. But planning for the final operations in a garment’s construction to take place in a low-tariff country could satisfy the law—with one caveat. Those goods must undergo a “substantial transformation” in that new production country. Otherwise, it is also fraud.
The problem, according to Foote, is it is “wickedly difficult” to have certainty that you’ve done so legally. According to the U.S. International Trade Administration, “Substantial transformation means that the good underwent a fundamental change in form, appearance, nature, or character.” It must also result in a “significant” increase in the product’s value.
So simply adding an embellishment, probably won’t do it—particularly with heightened vigilance from Customs and Boarder Protection [CBP] if the retaliatory tariffs go into effect. “The inherent subjectivity associated with substantial transformation analysis means that the risk of improper conduct operating under the guise of a proper substantial transformation is high,” Foote said.
Duty Liability At-a-Glance
| Legitimate practice | Illegitimate practice | |
| Country of Origin | Considering the exact manufacturing operations undertaken in different countries and to determine which satisfies the substantial transformation test | Sending goods to a new country without performing any part of the garment production there or none that satisfy the substantial transformation test |
| Product Value | Declaring a lower cost for garments because your supplier is charging you less to absorb the tariff increase | Declaring a lower cost for garments with no bearing on the actual amount that’s paid for the merchandise |
| Product Classification | Making intentional design modifications to a product so the product is classified in a provision that carries a lower duty rate | Changing the stated classification of a product with no change to the merchandise resulting in legitimate reclassification |
The siren call of fraudulent offers
Concerns over higher tariffs have also prompted some to adopt new Incoterms, or the terms that outline which party—buyer or seller—is responsible for various parts of the deal. Unlike terms like Free on Board (FOB) or CIF (Cost, Insurance and Freight), Delivered Duty Paid (DDP) is the only relationship that requires the seller to pay duties.
For that reason, DDP has become more attractive since it puts the onus of tracking which duties are in effect onto the seller. It’s also a way for buyers to make sellers responsible for paying the increase—which is legal if that’s what actually happens. If it doesn’t happen, it can ostensibly go unknown to the buyer.
That’s the crux of a lot of the tariff-free offers U.S. brands and retailers are receiving these days—often from shell companies offering to be the importer of record, according to CNBC. In this case, the ploy is basically, let us handle the tariffs (wink, wink). The problem is, while those companies can short the government and avoid prosecution by simply folding, the buyer isn’t actually off the hook.
“There is a relatively widespread misconception that it is possible to outsource all risk associated with trade compliance to foreign suppliers,” Foote said. “And I think nothing could be further from the truth.”
Even the shell companies may soon find it harder to pull this particular scam, as the U.S. considers changes to which firms can act as importers of record.
Ultimately, even if companies—in the U.S. or abroad—have successfully evaded duties in the past, they might want to think twice going forward because the climate has changed. In May, the U.S. Department of Justice outlined 10 priorities for prosecuting white collar crimes and trade and customs fraud was No. 2 on the list.
Foote anticipates the government will provide the resources to back that up.
“There are a couple of exceptions to the overall agenda to cost cutting in the federal government, and one of those is immigration, and another one is trade enforcement,” he said. “I observe CBP currently to be as aggressive as I have ever seen them in my career in enforcing U.S. trade laws.”
