Select Committee on Scottish Affairs Memoranda

Memorandum from HM Customs and Excise

Letter to the Clerk of the Committee from the Parliamentary Clerk, HM Treasury

  Thank you for your letters of 18 and 24 July about your Committee's plans for completing their inquiry into the drinks industry in Scotland.

  I enclose, as requested, a revised and updated memorandum[1] by Customs and Excise.

  This updated memorandum addresses each of the points raised in your letters. Specifically:

    —  European Commission review of minimum rates of duty: no report has yet materialised (see paragraph 5 of the memorandum).

    —  Commission study on competition: Customs Associates reported in February 2001[2]. This is a very lengthy report, the executive summary and contents pages of which I enclose (also paragraph 5).

    —  Roques report[3]: you already have copies (see paragraphs 31 and 32).

    —  IPS survey: (see paragraph 22).

    —  NAO study on losses and weaknesses[4]: a copy is enclosed (see paragraph 33).

    —  Customs' own survey: (see paragraph 22); and

    —  New registration scheme for owners of goods in warehouses: (paragraphs 38 to 40).

HM Treasury

September 2001



  This memorandum explains the United Kingdom's alcohol excise duty structures with particular emphasis, as requested by the Committee, on beer and spirits; the European dimension; and cross-border activity. The memorandum comprises the following main headings:

    —  Section 1: Alcohol excise duties—general.

    —  Section 2: Alcohol excise duties—spirits and beer duty.

    —  Section 3: Cross-border shopping, smuggling and fraud.


  1.  Excise duties provide an economical means of raising revenue and the United Kingdom is a strong proponent of their use. The price elasticities of demand are relatively low for beer and wine, and in many cases expenditure on alcohol is of a discretionary kind. In the financial year 2000-01 alcohol duties raised £6,664 million and total tax receipts, including VAT, came to £11,660 million. Receipts (£ million) for each category of drink since completion of the Single Market are shown in the following table:

1993-941994-95 1995-961996-97 1997-981998-99 1999-20002000-01p
Spirits1,7071,776 1,6531,5931,546 1,6431,8041,842
Beer2,2822,534 2,6422,6292,696 2,7022,8132,850
Wine1,0821,139 1,1871,2741,363 1,4811,6571,814
Cider101112 134135137 140155158
Total duty5,1725,560 5,6175,6315,742 5,9666,4296,664
VAT*3,6303,820 3,8804,1404,340 4,4604,8505,000
Total tax8,8009,380 9,5009,77010,080 10,43011,28011,660

The introduction of end product duty for beer in 1993-94 led to a reduction in receipts of approximately £200 million in that year.

Estimate of VAT based on data from Office for National Statistics for household expenditure on alcoholic drinks.

p—provisional figures

Note: Due to rounding of figures, components may not sum to the totals shown.

EU Directives

  2.  The structures and rates of excise duty on alcohol and alcoholic beverages are set down in European legislation[5]. The Structures Directive defines the various categories of alcohol and alcoholic beverages (ethyl alcohol, spirits, beer, wine, etc), the method for establishing duty and makes provision for certain special cases, for example exemptions for specified purposes (eg denatured alcohol, medical purposes, etc). The Rates Directive sets down the minimum rates of duty that Member States are required to apply to each category of alcohol or alcoholic beverage. Details of the minimum rates are shown in Annex A.

  3.  The Rates Directive provides that Member States are free to set excise duty rates at levels they feel are appropriate to their own particular circumstances, subject only to the agreed minimum rates. (This was tested and effectively confirmed in the Shepherd Neame judicial review case[6].) However, as a result of a 1983 ruling in the European Court, the duties on beer and table wine are linked in a broad ratio of 3:1, by volume, or 1:1 on a unitary taxation basis. Further, under the terms of the Rates Directives the Commission is required every two years commencing 31 December 1994 to examine the minimum rates of duty and report to Council and, where appropriate, make proposals for change. The first report, which appeared in 1995, made no proposals for change but merely analysed the position highlighting potential problems and concluded that detailed consultation with national administrations and others was necessary to allow more detailed analysis of all the relevant issues and the implications of any adjustments.

  4.  As part of the consultation process an EU-wide conference took place in Lisbon in November 1995 where the UK argued that the immediate way forward should be to allow Member States a continuation of fiscal sovereignty, but underpinned by a regime of sensible and realistic minimum rates (including the abolition of the zero rate on wine); the UK also argued that the present minimum rate for spirits was too high compared with the rates for other drinks and that effectively acted as a discriminatory barrier to EU trade in spirits. It should be noted, however, that the Commission failed to come forward with either its 1996 or 1998 reviews. At the ECOFIN in March 2000, the Commission gave a commitment to undertake both a study on the competition aspects between the various categories of alcoholic drinks and a consultation exercise and promised to produce a report by the end of 2000.

  5.  The consultation exercise has been carried out and the competition study report has been produced by the UK consultancy; Customs Associates Ltd (February 2001). The Commission's report of their review has still not been published and is now not expected until the autumn.

  6.  The consultation questionnaire was grouped around four themes: the proper functioning of the internal market, competition between the different categories of alcoholic drinks, the real value of the rates of duty and the wider objectives of the Treaty. The questionnaire also covered the alcohol structures. While not required under the terms of the Directive, the Commission felt that possible problems related to the classification of products in one or other category could not be dissociated from the rates issue.

  7.  We understand that trade involvement in the review was through the European trade associations.

UK and EU Member States alcohol excise duty rates

  8.  Current UK excise duty rates and the incidence of tax (duty and VAT) on various items are shown in Annex B. Comparative excise duty rates for beer and spirits (in sterling) for each EU Member State are shown in Annex C.


Spirits duty

  9.  Spirits are the most heavily taxed of the alcoholic drinks. However, in recent years the real value of duty on spirits has fallen almost continuously, including as a percentage of the retail price. Duty freezes in the last four Budgets were cuts in real terms. The real value of tax (duty and VAT) on a (nominal) 70cl bottle of whisky at 40 per cent strength has fallen from £8.11 (at April 2001 prices) in January 1989 to £7.23 in April 2001. As a percentage of the retail price this represents a fall from 66 per cent in 1989 to 61 per cent in April 2001[7].

  10.  Spirits are the most price sensitive of the alcohols. Research suggests that the own-price elasticity of demand for spirits is about -1.4[8][9]. The elasticity, plus what we know about the proportion of price accounted for by duty, determines whether an increase in the duty rate will increase or reduce revenues.

Beer duty

  11.  Beer duty is based on the quantity and alcoholic strength of the beer and the rate of duty applicable when released for consumption. Compared to duty rates in June 1993 excise duty on beer has fallen in real terms by 6 per cent. In addition, the proportion of tax (duty and VAT) to the cost of a pint has also fallen. In 1993 tax on a pint of bitter in a pub represented 32 per cent of the retail selling price. As at April 2001 this has dropped to 29 per cent.

  12.  Research suggests that the own-price elasticity of beer is -0.59. This means that a 1 per cent increase in the price of beer reduces demand for beer by 0.59 per cent.[10]


  13.  The following tables show recent trends in clearances of beer and spirits for the UK as a whole:

1991-921992-93 1993-941994-95 1995-961996-97 1997-981998-99 1999-20002000-01p
2,5192,4182,353 2,4152,4622,432 2,4802,4382,477 2,353

p—provisional figure

1991-921992-93 1993-941994-95 1995-961996-97 1997-981998-99 1999-20002000-01p
888863850 887814823 810840926 937
p—provisional figure

  14.  The brewing industry dominates the UK alcohol market although its share has been in gradual decline for many years, principally as a result of changing consumer tastes and social trends. Beer currently accounts for about 48 per cent of all clearances, measured in terms of pure alcohol content.

  15.  Total spirits clearances have also fallen over the same period (and for the same reasons) and now account for about 19 per cent of all clearances measured in terms of pure alcohol content. Holding the greatest single share of the domestic spirits market, consumption of whisky had been declining until recently. However, clearances have actually increased by around 2 per cent in the 10 years to 2000 (inclusive). White spirits, vodka in particular, although not immune to the long term consumer trend away from spirits are, however, enjoying a period of relative growth.



  16.  Within the brewing sector, 33 of the 478 breweries registered for excise purposes in the UK are located in Scotland. Between them, in the financial year 2000-01, they paid approximately £407 million in excise duty (about 14 per cent of total UK beer duty receipts).

  17.  The UK spirits industry is highly concentrated with some 95 per cent of total potable spirits currently being produced in Scotland. Within the sector, whisky makes a significant contribution to both the regional economy of Scotland and to the national economy, including to the UK's balance of payments; nearly 90 per cent of whisky sales are for export. In the financial year 2000-01 domestically produced whisky (including Northern Irish whiskey) accounted for some £625 million, or 34 per cent of UK spirits duty receipts.



  18.  Until the completion of the Single Market on 1 January 1993, cross-border traffic was regulated by a strictly enforced system of frontier controls for both personal and commercial importations of excisable goods, supported, in the case of goods for personal consumption, by objectively defined limits. Within these limits excisable goods could be imported free of duty and tax; above the limits goods could be imported in unlimited quantities provided, of course, that UK duty and tax were paid. These limits applied to both goods purchased duty-paid abroad, and those bought duty-free.

  19.  The Single Market brought with it the abolition of routine frontier controls over both private and commercial traffic and of the strict personal allowances for intra-EU travellers. Since then there has been a rapid rise in both legitimate cross-border shopping and cross-Channel smuggling of excise goods.

Legitimate cross-border shopping

  20.  Since completion of the Single Market, travellers have been allowed to bring back to the UK quantities of excise goods, duty and tax paid in the Member State visited, without incurring any charge to UK duty and tax provided that the goods are for the traveller's own consumption and are personally transported by the traveller. To assist the tax authorities in determining whether the goods are for "own consumption", the European Council of Ministers agreed to the adoption of "guidance levels" (also referred to as "minimum indicative levels"). These are set out in Annex D. Below the levels, the goods are presumed to be for the traveller's personal use unless the authorities can demonstrate otherwise; above them, the onus is on the traveller to demonstrate (if asked to do so by the authorities) that he or she has no commercial intentions with regard to the goods. If he or she cannot do so, the goods are liable to payment of duty in the country of importation or seizure, subject to the normal appeal mechanisms.

  21.  The Government of the day recognised that these new rules would lead to an increase in cross-border shopping and, for the first full year (1993-94) made Budgetary provision for an additional revenue loss from legitimate cross-border shopping of £250 million for alcohol and tobacco, over and above the existing revenue lost. Estimates of actual revenue losses for the three years to 1998 are shown in the following table. Figures for 2000 are not yet available.

Revenue lost through cross-border shopping (£ million)
Product type1996 19971998 1999
Beer4550 5560
Wine100140 180220
Spirits4550 5090
Tobacco Products5060 85220
Total235305 375590

Figures have been independently rounded to £5 million. Components may not therefore sum to the totals shown. The figures shown for revenue lost use Customs' assumption that between 70 per cent and 80 per cent of all alcohol purchased abroad substitutes for similar purchases in the UK (100 per cent assumed for tobacco products).

  22.  The cross-border shopping estimates are based on Customs' own analysis of the International Passenger Survey (IPS). The IPS is a continuous survey of international passengers at various seaports and airports conducted by the Office of National Statistics. Customs sponsor a question on the IPS asking about expenditure on alcohol (and tobacco) purchased duty-paid in other EU states by UK residents. These expenditures are then grossed up to produce the National totals once any potential smugglers have been removed from the dataset.

Cross-channel smuggling and fraud

  23.  The loss of alcohol revenue is currently from two distinct sources: (a) the inward diversion of duty suspended product, mostly spirits, moved in freight and (b) the cross-channel smuggling of duty paid product, mostly beer and wine, moved in light vehicles. Customs currently believe that the former is the most significant threat in the alcohol sector.

  24.  Customs estimate that in 1990-2000 the revenue lost (duty and VAT) to all forms of alcohol smuggling and fraud was around £800 million. Of this, the largest losses were in respect of spirits, estimated at £500 million. Losses from wine and beer smuggling were in the region of £100 million and £200 million respectively.

Cross-channel smuggling

  25.  The principal risk for the illicit supply of beer and wine is through cross Channel smuggling in private and light goods vehicles—classically known as "bootlegging". The table below details our estimates of the revenue (duty and VAT) evaded and lost from cross-channel smuggling (£ million):
1997 1998 1999 2000
EvadedLost EvadedLostEvaded LostEvadedLost
Beer150110 200150190 140245185
Wine6045 655045 306550
Spirits3525 403020 151515
Total240180 305230255 190325245

Figures are independently rounded to £5 million and therefore may not sum to the totals shown. The 1999 figures are revised to take account of the latest ONS International Passenger Survey data. Customs assume between 70 per cent and 80 per cent of alcohol purchased abroad substitutes for similar purchases in the UK—hence revenue lost is deemed to be less than that evaded.

  26.  Estimates for revenue evaded from cross-channel smuggling are based on Customs own survey of ferry and shuttle passengers conducted in June each year. Returning UK passengers are challenged at random. The results are then grossed using overall annual passenger figures to produce the national estimates.

  27.  Cross-channel smuggling, and the associated law and order problems for the channel ports, is being addressed in parallel with the tobacco strategy. The tobacco strategy provides for an additional 170 officers specifically to target all kinds of cross-channel smuggling and aims to reduce overall the revenue loss from cross-channel smuggling of all excise goods by 10 per cent annually.

Diversion Fraud

  28.  Diversion fraud is very different to smuggling, and has a variety of forms. Inward diversion involves ostensibly legitimate freight consignments of duty suspended spirits being imported from duty suspended warehouses in the EU, but which never arrive at the intended UK duty suspended warehouse. Instead the goods are diverted for sale on the UK illicit market without payment of duty. Unlike smuggling, concealment is not necessary, and, if challenged by Customs prior to the diversion, criminals can use the supporting paperwork to claim legitimacy.

  29.  Customs estimate that the vast majority of illicit spirits are supplied through diversion fraud and freight smuggling. In response Customs have put in place a number of initiatives to tackle the problem. These include:

    —  increasing freight challenges at the channel ports in order to increase detections of illicit alcohol loads;

    —  establishing a specialist team at Dover to scrutinise and discredit the false paperwork accompanying illicit duty suspended movements of alcohol;

    —  a tough new HGV seizure policy to impact on those hauliers who allow their vehicles to be used in alcohol fraud and smuggling;

    —  stronger warehouse assurance controls in support of the increased frontier activity, and to prevent and detect outward and domestic diversion frauds;

    —  enhanced overseas intelligence activity targeting the EU warehouses from which illicit loads are sourced; and

    —  focussing investigations on disrupting the organisers of the frauds at the earliest opportunity.

  30.  Customs are currently looking at the costs of implementing a full scale strategy and its likely effectiveness at reducing the fraud.

Excise diversion fraud: independent investigation

  31.  The report of the independent investigation into the collection of excise duties in HM Customs and Excise, conducted by Mr John Roques, was published in July 2001. In the report, Mr Roques outlines the system for the holding and moving of excise goods in duty suspension and the evolution of Customs' controls of that system since the advent of the Single Market on 1 January 1993. He examines the activities of the National Investigation Service arising from excise diversion and considers action for prevention and detection of losses from excise diversion. The report contains 65 recommendations designed to improve controls and the way fraud is tackled by Customs. The Department has accepted, wholly or in a modified form, 62 of the 65 recommendations made.

  32.  Customs did not accept one recommendation, (15), because it is contrary to our EU Treaty obligations and a further two are likely to take longer to research and, if appropriate, implement fully. These are:

    —  Recommendation 8 (parts a and d). A requirement that warehouse-keepers give Customs prior notification of excise goods entering and leaving warehouses and a requirement for warehouse-keepers to notify Customs of goods not delivered to warehouses within 24 hours. The benefits of applying these requirements in a blanket fashion to all warehouse-keepers are not clear, and careful work needs to be done to balance the costs and the deliverable benefits. We also need to look closely at EU law in this area; and

    —  Recommendation 27. The introduction of tax stamps for spirits. Work has begun with the trade to produce a firm cost/benefit analysis for fiscal marking of spirits and other drinks. The Government is approaching the exercise with an open mind and decisions on the future introduction of fiscal marks will not be made until the compliance costs and benefits have been established.

  33.  The National Audit Office report "Losses to the Revenue from Frauds on Alcohol Duty", published July 2001, said that the level of revenue evaded from alcohol diversion from 1993 to 1999 was £668 million, 1.4 per cent of the total revenue from alcohol duty over that period. The NAO acknowledge that Customs' efforts to address the deficiencies in the system, through a combination of fraud investigations and tightening of controls, led to a significant fall in the level of outward diversion fraud after 1997-98.

  34.  Diversion fraud is very different from smuggling, and has a variety of forms. Inward diversion involves ostensibly legitimate freight consignments of duty suspended spirits being imported from bonded warehouses in the EU, but which never arrive at the intended UK bonded warehouse. Instead the goods are diverted for sale on the UK illicit market without payment of duty. Unlike smuggling, concealment is not necessary, and, if challenged by Customs prior to the diversion, criminals can use the supporting paperwork to claim legitimacy.

Alcohol and Tobacco Fraud Review

  35.  The measures announced in the March 2000 Budget follow on from the recommendations of the Alcohol and Tobacco Fraud Review (ATFR) undertaken in the second half of 1997-98. The ATFR recommendations were aimed principally at tackling cross-Channel smuggling and internal (paper-based) diversion fraud involving alcohol. The outcome was announced in July 1998 and the Comprehensive Spending Review provided for £35 million over the three years to March 2002 to implement the recommendations of the ATFR. Money was also made available in 1998-99 so an immediate start could be made on implementation. Measures implemented include:

    —  the allocation of an additional 145 staff, the majority of which are front line anti-smuggling officers—all the front line staff were in post at the Channel ports and inland by the end of November 1998 and beginning of April 1999 respectively;

    —  a new registration system for owners of goods in warehouse which became operational on 1 October 1999;

    —  a revised prosecution policy for excise smugglers and fraudsters. Customs now urge the courts to use all sanctions available against offenders, including driving disqualifications, compensation orders and, when appropriate, confiscation orders; and

    —  new rules on the treatment of seized vehicles. Offenders now face losing their vehicles even for first offences.

  In addition:

    —  Customs are working even more closely with other agencies (Police, Benefits Agency; Traffic Commissioners; Local Authorities; Trading Standards and Inland Revenue) to develop further a national task force approach involving closer working to bring the full weight of all available sanctions to bear against smugglers and fraudsters; and

    —  as a result of guidelines set down by the Court of Appeal on sentencing in excise fraud cases custodial terms are now awarded for revenue evasion of even a few thousand pounds with higher sentences tiered upwards.

  36.  As at April 2000 more than half the 90 or so recommendations had been implemented. Work on most of the remaining recommendations is well advanced[14].

Other initiatives

  37.  The ATFR measures aimed at tackling diversion frauds complement Customs' IMPEX (IMPort and EXport) initiative which began in April 1997. The initiative consists of converged, multi-functional teams, with Customs and Excise, VAT, Intelligence and Investigation resources working closely together to combat non-compliance and fraud in relation to imports, exports and movements of excise goods. There is evidence that this strategy has been successful in disrupting the activities of the internal diversion fraudster. The fraudsters' modus operandi appears to have moved whereby the goods are actually exported before being smuggled back into the UK. This increases costs to the fraudster and the risk of the goods being detected on their return to the UK. However, Customs are still investigating the extent to which our strategy has been the key contributory factor.

  38.  To implement ATFR recommendations 30, 31 and 32, Customs introduced The Warehouse-keepers and Owners of Warehoused Goods Regulations 1999 (WOWGR) on 1 October 1999. Under WOWGR, warehouse-keepers, owners of goods under duty suspension and duty representatives (who hold goods on behalf of owners without a UK base) are required to be registered by Customs. Applicants must meet certain criteria before they are registered and Customs can attach additional conditions on the registered persons. This system of registration has allowed Customs greater control over traders dealing with duty suspended goods. It ensures that there is always someone with duty liability for warehoused goods up to the point of removal, and requires that a person with duty liability is UK based.

  39.  Following legal advice, Customs were unable to include transporters in the new regulations because this was seen as a restriction to trade, especially to foreign hauliers, and would therefore not be supported under EU law. However, Customs are currently working on a public notice that sets out the legal responsibilities of hauliers and transporters.

  40.  Customs have also recently improved their controls over the registration of warehouse-keepers and owners of warehoused goods as part of their strategy to improve compliance in the holding and movement regime. Prior to authorisation, Customs will undertake rigorous credibility checks and will only register suitable people. Where Customs think it appropriate, they will attach additional conditions upon authorisations or will refuse applications.

  41.  Customs also work closely with the trade in tackling smuggling and fraud. For example, Customs regularly meets with the "Excise Alliance" (which is made up of members of the alcohol and tobacco trades), both nationally and regionally, to share information on excise fraud and smuggling and to update members on successes in combating excise fraud. Members include the Scotch Whisky Association and the Scottish Licensed Trade Association.

1   See also HC 114-v, pp 268-276. Back

2   "Study on the Competition between Alcoholic Drinks". Customs Associates Ltd, February 2001. (Not herewith printed.) Back

3   See website: Back

4   "Losses to the Revenue from Frauds on Alcohol Duty". NAO July 2001. Back

5   Council Directives 92/83/EEC ("Structures Directive") and 92/84/EEC (the "Rates Directive") respectively. Back

6   The Queen v HM Treasury, Commissioners of Customs and Excise, The Attorney General-Ex Parte Shepherd Neame Limited. Queens Bench Division CO/3259/97 and Court of Appeal QBCOF 98/0394%5 FC3 98/6724/4. Back

7   This is based on the average price for a bottle of whisky in April 2001 of 11.78 which is calculated using specially collected ONS information on alcohol price movements. Back

8   Consumers' Demand and Excise Duty Receipts Equations for Alcohol, Tobacco, Petrol and DERV" by Marcus J Chambers, University of Essex November 1998 (Revised August 1999)-Government Economic Service Working Paper No 138 (November 1999). Back

9   HM Customs and Excise is currently reviewing its elasticity of demand estimates. Own price elasticity of demand measures the responsiveness of demand for a particular product to changes in the price of that product. Thus in the case of spirits, a 1 per cent increase in price should result in a 1.4 per cent decline in demand. Back

10   No copy Back

11   ie quantities released for domestic consumption. Back

12   The Drink Pocket Book 2001. Back

13   As a percentage of market share (pure alcohol). Back

14   The subject of alcohol and tobacco fraud and smuggling was included in the terms of reference for the Treasury Sub-Committee inquiry into Customs and Excise towards the end of 1999. As part of the inquiry the Sub-Committee requested a report on the implementation of each of the ATFR recommendations. A summary of progress, as at 30 November 1999, was produced and included in the minutes of evidence taken before the Committee on 3 November 1999. Back

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