Select Committee on Public Accounts Third Report


The Committee of Public Accounts has agreed to the following Report:



1 In 2000-01 HM Customs and Excise (Customs) collected duty and VAT of £9.5 billion on the sale of cigarettes and tobacco. For that year they estimated, however, that £3.5 billion had been lost through evasion of duty and VAT on all tobacco products, equivalent to 1p on the basic rate of income tax. Some 17 billion cigarettes were smuggled into the UK in the year, with an estimated revenue loss of £2.8 billion. Most of these illicit imports were produced in the UK by three tobacco companies, exported and then smuggled back. About half were produced by the Imperial Tobacco Company. We therefore took evidence from Imperial Tobacco, and from the Chairman of Customs and Excise.

2 Tobacco and cigarette smuggling into the UK grew markedly in the mid-1990s following the removal of routine frontier controls between EU states. Customs acknowledged that they had been slow to respond to that growth, and it was only in 2000 that targets to restrict and reduce the level of smuggling were set.

3 Customs estimated in March 2000 that, without additional enforcement action, smuggled cigarettes would account for 25% of those smoked in the UK. The Government committed £209 million to slow the rate of growth, stabilise and then reduce illicit market penetration over three years. Customs were set targets to restrict cigarette smuggling in 2000-01 to 21%, and reduce it to 18% by 2004-05. Their strategy is to make smuggling less profitable, and less attractive, by increasing the chances of smugglers getting caught and securing heavier penalties.[1]

4 On the basis of a Report by the Comptroller and Auditor General on Customs' Appropriation Accounts for 2000-2001, we examined:

  • the success of the Customs' strategy for combating tobacco smuggling;

  • the co-operation they receive from cigarette manufacturers in tackling smuggling;

  • the sanctions being used to deter smuggling; and

  • the use of x-ray scanners to detect smuggled tobacco.

5 In the light of our examination, the Committee draws the following overall conclusions:

  • Smuggling of cigarettes is costing £2.8 billion a year in lost revenue (£3.5 billion if hand-rolled tobacco is included). Even if Customs meet their target for 2004-05 of limiting cigarette smuggling to 18%, there will still be a loss of VAT and duty of almost £2 billion annually. To get it down further at tolerable cost will continue to require the full cooperation of the UK cigarette manufacturers in the supply of information and in applying export policies which discourage smuggling.

  • Since 1997 there has been a marked increase in the number of cigarettes manufactured by Imperial Tobacco being smuggled back into the UK, which has coincided with a substantial increase in the company's international profits. The company acknowledged that Customs had seized large quantities of their cigarettes in 2000-01 though they disputed the precise figures. On the basis of Customs' estimates, the tax and duty lost through smuggling from the two main Imperial brands affected was some £1.4 billion in 2001-02.

  • Against this background, Customs and Excise were understandably concerned about a perceived lack of co-operation from the company in assisting with their investigations into this state of affairs. The company need to take a positive approach to preventing smuggling, notably by providing more timely responses to Customs' requests for information and by exercising greater discretion in their choice of export markets. It cannot help Imperial Tobacco's good name if there is a question mark over their attitude in this matter.

  • Customs aim to agree Memoranda of Understanding with the manufacturers. They had done so with Gallaher, and have since done so with British American Tobacco. Imperial Tobacco need to offer a similar level of assurance on their business practices, so Customs can have sufficient confidence to complete a Memorandum with that company too. Pending the completion of a memorandum, Customs should have unfettered access to relevant information held by Imperial, which should in turn be accessible to the Comptroller and Auditor General so that he can report as necessary to Parliament.

  • Customs have a difficult balance to strike in facilitating legitimate trade while at the same time deterring smuggling through seizure of assets or prosecution. Since 1999-2000 Customs have initiated fewer prosecutions, concentrating on those who smuggle significant quantities of cigarettes, while relying on seizure of vehicles and goods for lesser cases. The growing level of evasion suggests that Customs need to prosecute some of those engaged in lower level smuggling in order to emphasise the criminal nature of this offence, and act as a greater deterrence to others.

6 Our further conclusions and recommendations are:

  (i)  Customs need reliable information on the extent of smuggling to assess the success of their strategy to combat it. They are refining their methodology for calculating the level of smuggling. They should submit the revised methodology to independent expert appraisal.

  (ii)  Imperial Tobacco had been exporting cigarettes to some unusual markets, and had found it necessary to terminate these trading agreements because the cigarettes were re-entering the UK. In our view they might have foreseen that exports to such markets were likely to be diverted in this way.

  (iii)  The company drew attention to the impact of their actions in reducing the incidence of smuggling, but on the basis of limited information covering a few months only. Evidence of improvement over a longer period will be necessary.

  (iv)  In September 2000 Customs launched a campaign to change perceptions of cigarette smuggling. This campaign was targeted at drivers of Heavy Goods Vehicles and retailers but not specifically at smokers. Customs should also promote wider public awareness that purchasing smuggled tobacco diverts revenue from public services into the hands of the criminal community.

  (v)  By July 2002 Customs had introduced 12 x-ray scanning machines and ultimately plan to have 20 to cover the 43 ports and points of entry. More machines would give better coverage and reduce the need to move scanners between ports. Any such moves should be discreet and at random so that smugglers are not forewarned. The Department also need to resolve the operating difficulties associated with the scanners at some ports, and improve the scanners' throughput to the levels envisaged by the manufacturers.


7 Customs estimate that 70-80% of smuggled cigarettes are being transported into the country by organised criminals in freight, principally in deep-sea containers or 'roll on roll off' ferries. During 2000-2001 Customs made over 360 seizures from containers or lorries, each in excess of one million cigarettes.[2] Their aim is to tackle smuggling by increasing the level of checks, and to make smuggling less profitable or attractive by increasing the chances of getting caught and increasing the penalties imposed. They also aim to disrupt the activities of smugglers by confiscating assets and vehicles.

8 Customs acknowledged that measuring the extent of smuggling, and their success in combating it, was imprecise. They seized 38% more cigarettes than targeted in 2000-2001 and believe that they met their target for the year by restricting the market share of smuggled cigarettes to 21%, plus or minus 2%. They do not yet have reliable data, but believe they achieved at least the same result in 2001-2002.[3]

Figure 1: Analysis of UK Cigarette Consumption and Smuggling in 2000-01

Estimated consumption of duty paid cigarettes

56 billion

Generating £9 billion in Duty and VAT
Legitimate cross border shopping 5 billionRepresenting Duty and VAT foregone of £0.8 billion
Estimated number of smuggled counterfeit cigarettes 1.9 to 2.9 billionRepresenting a loss of Duty and VAT of between £0.3 and £0.5 billion
Estimated number of smuggled (non-counterfeit) cigarettes 14.1 to 15.1 billionRepresenting a loss of Duty and VAT of between £2.3 and £2.4 billion
Total estimated number of smuggled cigarettes 17 billionRepresenting a loss of Duty and VAT of £2.8 billion
Estimated UK consumption of cigarettes 78 billion
Note: Total cigarettes seized in the year: 2.8 billion

Source: C&AG's Report (paragraphs 5.30 and 5.31) and Customs' estimates

9 Figure 1 sets out the significant scale and financial impact of cigarette smuggling. It represented a loss to the Exchequer in 2000-2001 of £2.8 billion in VAT and Duty (£3.5 billion when hand-rolled tobacco is included), with further losses of Corporation and Income Tax because of the licit sales foregone by shops and other outlets. Customs' target has been to restrict cigarette smuggling to 18 % by 2004-05, but even if they achieve their target, the loss will still represent almost £2 billion a year in tobacco duty and VAT. Customs' acknowledged to us that the target of 18% was not particularly ambitious.[4] Their Public Service Agreement targets are reviewed annually, and since our hearing Customs have been set a new target[5] to restrict smuggling to 17% by March 2006.


10 The majority of cigarettes smuggled into the country have been manufactured here. Customs look to UK tobacco manufacturers to pursue export policies which do not encourage the re-import of smuggled cigarettes. Customs are reliant on the co-operation of the cigarette manufacturers for the supply of relevant information on the volumes they have produced and exported and on export destinations.[6] The Department have therefore sought to agree Memoranda of Understanding with the cigarette manufacturers as a framework for co-operation in combating smuggling.

11 Customs told us they had recently entered into a Memorandum of Understanding with Gallaher, and have since also reached agreement with British American Tobacco. But they had concerns about the timeliness, promptness and completeness of information provided by Imperial Tobacco. The Company had moreover been exporting very significant volumes of cigarettes to countries where they had no domestic market share.[7] As a consequence the Department had found it necessary to issue warnings on these export practices.

12 Imperial Tobacco manufacture a number of leading brands including Regal and Superkings. Customs believe that as many as 65% of the Regal and Superkings cigarettes exported by the Company were smuggled back into this country, compared with a rate for all cigarettes of only 16%. The Chief Executive of the company acknowledged that there had been a marked increase from 1997 in the number of their cigarettes being smuggled back into the UK, and that very large quantities of his company's cigarettes had been seized by Customs in 2000-2001.[8]

13 On the basis of data provided by Customs the two Imperial brands, Regal and Superkings, make up about one half of the entire smuggled market.[9] The data indicated that the illicit market for these cigarettes in this country appeared to be significantly greater than the licit market (Figure 2) yet there was little smuggling of Imperial's leading UK cigarette, Lambert and Butler. One of the main reasons appears to be that the company are restricted to exporting Lambert and Butler cigarettes to a more limited number of countries than Regal and Superkings because of trade mark ownership issues.

14 The company acknowledged holding information from which they could tell if one of their wholesale customers was selling cigarettes in a territory allocated to another of Imperial's customers, and in these circumstances they took action to terminate supply. Customs estimate that nearly 8 billion of Imperial's cigarettes are nevertheless smuggled into the UK each year.[10]

Figure 2: Regal and Superkings UK Market Share in 2001


Licit Market

Illicit Market3

% of Licit Market

No of Cigarettes

% of Illicit Market

No of Cigarettes


5. 3

3. 0 billion1

30. 1

4. 4 billion2


3. 9

2. 2 billion1

20. 1

2. 9 billion2


Approximate figures on the assumption that UK consumption of licit cigarettes is 56 billion.
2Approximate figures on the assumption that the illicit market is comprised of the 14. 6 billion non-counterfeit cigarettes estimated to be smuggled into the UK annually.
3In addition to those cigarettes successfully smuggled into the UK, Customs seized a further 1. 2 billion Regal and Superkings cigarettes in 2000-01.

Source: Customs' estimates

15 Imperial told us that the company had no incentive to encourage smuggling as it hit their duty paid sales, on which they made the largest profit margins. The diversion of cigarettes from overseas markets into the smuggled trade also affected the investment they had made in developing those markets. Moreover, the smuggling of counterfeit cigarettes depressed sales of their genuine products.[11]

16 The company said that the incidence of smuggling into this country was due to the high duty rates applied. We observed that Imperial contributed to the high cost of cigarettes, as the basic price charged by the company in the UK for its cigarettes was higher than in other EU countries. (Figure 3)

Figure 3: Variations in the basic (tax free) price of Regals across the EU

  17 The company explained that for several years their business strategy had been to increase their international business, and from 1997 the company's international profits had risen markedly. Figures for turnover and profitability are shown in Figures 4 and 5 respectively, distinguishing between United Kingdom and international business. Customs' figures indicated that the company had been sending two thirds of its exports of Regal and Superkings, totalling some three billion cigarettes, to just five locations, namely Latvia, Kaliningrad, Afghanistan, Moldova and Andorra. These locations did not seem to be among the most promising of UK export markets, and indeed the company had subsequently terminated their supply to these locations at short notice.

18 Customs had been seeking explanations for these anomalies for some time, and for information on the Company's export strategies for these brands, but without success.[12] Imperial were concerned that Customs considered the company to have been less co-operative than other tobacco manufacturers.

19 In early 2001 Customs had introduced a system of red and yellow cards to identify customers of tobacco manufacturers about whom they had serious concerns. These were based on the proportion of a particular customer's total purchases that appeared to find their way back into the UK. Cases of most serious concern were red card customers. Customs would expect a fully co-operative tobacco manufacturer to take action against such customers, and would expect yellow carded customers to be the subject of enquiries by the manufacturer. Customs had not found it necessary to issue any cards to British American Tobacco, only two to Gallaher, but 17 to Imperial.

20 Imperial considered that, in reaching a decision on terminating trading with a customer, fine judgements were required. It was not straightforward to cease trading with a customer simply because it appeared that smugglers had chosen to obtain supplies of their products from that customer. If a customer's supplies were cut off, his reputation might be damaged and infrastructure costs incurred wasted, so it was not a decision that Imperial took lightly. Nevertheless, the Company had terminated supplies to almost 30 customers since December 1999 because of such concerns. Many of these supply arrangements had been terminated before Customs had raised any concerns on them.

21 In May 2002 Imperial purchased the German tobacco company, Reemtsma, who manufacture the West brand of cigarettes. The World Customs Organisation reported that in 2000 West was the most frequently smuggled cigarette brand in Europe. Imperial's Chief Executive was however unaware of this situation, or of the criminal prosecution being brought against Reemtsma's by the German Customs authorities.[13]

1   C&AG's Report, Audit of HM Customs and Excise under Section 2 of the Exchequer and Audit Act 1921, Appropriation Accounts 2000-01, Volume 16: Class XVI (HC 335-XVI), paras 5.4-5.10 Back

2   Q 128 Back

3   C&AG's Report, paras 5. 30, 5. 33 Back

4   Q 4 Back

5   2002 Spending Review Back

6   Q 117 Back

7   Q 170 Back

8   Qq 291, 329-332 Back

9   Q 166  Back

10   Q 338 Back

11   Q 307  Back

12   Qq 220, 241 Back

13   Qq 449-461 Back

previous page contents next page

House of Commons home page Parliament home page House of Lords home page search page enquiries index

© Parliamentary copyright 2003
Prepared 10 January 2003