THIRD REPORT
The Committee of Public Accounts has agreed
to the following Report:
TOBACCO SMUGGLING
INTRODUCTION
AND
LIST
OF
CONCLUSIONS
AND
RECOMMENDATIONS
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.
EXTENT
OF
CIGARETTE
SMUGGLING
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 billion | Representing Duty and VAT foregone of £0.8 billion
|
| Estimated number of smuggled counterfeit cigarettes
| 1.9 to 2.9 billion | Representing 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 billion | Representing a loss of Duty and VAT of between £2.3 and £2.4 billion
|
| Total estimated number of smuggled cigarettes
| 17 billion | Representing 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.
CO
-OPERATION
FROM
CIGARETTE
MANUFACTURERS
IN
TACKLING
SMUGGLING
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
|
Brand |
Licit Market
|
Illicit Market3
|
|
% of Licit Market
|
No of Cigarettes
|
% of Illicit Market
|
No of Cigarettes
|
Superkings |
5. 3
|
3. 0 billion1 |
30. 1
|
4. 4 billion2 |
Regal |
3. 9 |
2. 2 billion1 |
20. 1
|
2. 9 billion2 |
1 |
Approximate figures on the assumption that UK consumption of licit cigarettes is 56 billion.
|
| 2 | Approximate 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.
|
| 3 | In 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
| 
