Select Committee on Public Accounts Minutes of Evidence

Examination of Witnesses(Questions 360-379)



  360. My final question is to Mr Wells just to ask you the question that Mr Davis wanted answering. What are the other companies doing which Imperial is not?
  (Mr Wells) I think the sorts of areas in which we would have particular concerns are those that, again, my Chairman—Richard Broadbent mentioned. They concern issues as to the commitment to minimise the presence of brands in the illicit market, sharing information on export sales, timeliness of information and accuracy of information on tracking and tracing procedures, commitment to terminate supplies directly or indirectly where there are concerns about customers, and willingness to share data with us on understanding of export markets and why particular volumes of exports go to particular countries. As I think I should say again, my Chairman did make clear that we do not receive no co-operation from Imperial, we simply feel that there could be more co-operation. If the sorts of trends that we have been hearing about continue we have made it clear that we are happy to review the arrangement that we have and to look at whether a Memorandum of Understanding could be signed with Imperial Tobacco as with other manufacturers.


  361. That is a fairly long list that has been read out and I think I should give you an opportunity to reply to it because that statement from Mr Wells seems to me a fairly damning statement. Do you want to reply to that?
  (Mr Davis) Yes, I would very much like to, Mr Chairman. Those particular points were raised with us as recently as 16 April when for the first time I had a face-to-face meeting with the Director of Law Enforcement. He said we were compliant but there were areas where he thought we could be more co-operative. These areas were subsequently enumerated in a letter three days later. I wrote back and said at the meeting and I said in the letter, "Now I know, there is no point in me being disappointed about perceived lack of co-operation, that is not productive for anybody. The issue, as far as I am concerned, is to make sure that co-operation takes place and the perceived weaknesses Customs see in co-operation are addressed". That particular procedure has started. None of those things causes us any particular grief or any real problem. I have a review meeting with Mr Byrne in July. I think it is fair to say John and Bruce have had two meetings with Customs so far which have been in Customs' words "open, productive and very useful". So I think there is certainly an era of greater co-operation taking place with Customs at the moment. I am sorry if they felt in the past historically that there has been a lack of co-operation vis-a"-vis other manufacturers but we cannot put it right unless we know about it. We had no meetings with Customs for 10 months.

  362. I think Customs should have to reply to that. There is an air of wounded innocence that the answer is, "I do not know why you are saying all this because we only heard about it on 16 April and we have been trying to be more co-operative ever since and what is all this about?" Do you want to reply to that? Permanent Secretaries of government agencies or departments do pick their words extremely carefully. What is your reply to this? Apparently you have only been informing them of all your difficulties in lack of co-operation since 16 April.
  (Mr Wells) Chairman, I think perhaps I can start where I left off before. My Chairman, Mr Broadbent, said on 29 April we are not suggesting that we have received no co-operation from Imperial Tobacco but rather the co-operation that has been received is less than we received from others. I think some of the things we have been talking about today, the issues with tracking and tracing, the issues around the share of the smuggled market occupied by two of Imperial's brands, the volumes of exports going to particular countries, are the sorts of areas that indicate where we have had concerns. If, as Mr Davis has said, we are able to move forward on that then I think that is exactly what we want to do. Again, as my Chairman said, we do not want to have conflict or confrontation with any tobacco manufacturer. We very much agree that the way forward is to co-operate, that is what we want to do. We would be delighted if the level of co-operation that we receive improves in the way that I have outlined and if it does we are very happy to review the situation and to move forward in a positive way.

  Chairman: Thank you. Mr Geraint Davies.

Geraint Davies

  363. Just following on from that, Mr Davis. You said earlier in this hearing that you did not know what other companies were doing, "tell us and we will do it" is what you said. You just said you only knew on 16 April what they were doing. Can I just ask again, Mr Wells, it seemed to me from reading the documentation that we were listing what Gallaher does that we think is satisfactory to provide a memorandum and you are saying, as far as you know, that Imperial did not have that list before 16 April so they did not act on it. Is that right? I am a bit confused by this. I find it very difficult to believe that we are in a hearing and have information from your Department which criticises Imperial for not doing what Gallaher does and Imperial is saying they did not know what they had to do. Is that right as far as you are aware?
  (Mr Wells) I think what Mr Davis was saying was his first meeting directly with Customs was on 16 April. We have had meetings for several years, indeed going all the way back. I think there have been ten bilateral meetings between Customs and Imperial back to 2000. Since the start of 2001 we have issued 15 red cards, one of which we withdrew and that leaves 14, we have issued 14 red cards and four yellow cards to Imperial. We have had exchanges of correspondence and we have also met bilaterally. Whereas it is certainly true to say that the first direct meeting between my Director of Law Enforcement and Mr Davis was on 16 April, there have been a great number of meetings and exchanges of correspondence.

  364. I have got the idea. That is what I thought. Mr Davis, it seemed to me the statement you made was completely incredible. I think you said "I did not know until 16 April, now we will do whatever is necessary" but the reality is executives in your corporation have regular dialogue and in the view of Customs you have been relatively unco-operative. Not you personally but corporately. Do you accept that?
  (Mr Davis) No, I think I would have to challenge the corporate—

  365. You have given an undertaking today that you will do everything that Gallaher does to co-operate with Her Majesty's Government in order to try and secure more taxation, is that correct?
  (Mr Davis) Mr Davies, when we saw the Memorandum of Understanding that was published between Customs and Gallaher, the forward looking Memorandum of Understanding, we failed to understand what the problem of co-operation was because all the things that were enumerated—

  366. So the answer is yes, you do give that undertaking today?
  (Mr Davis) Absolutely.

  367. That is very helpful. So in terms of the future perhaps it will be positive. In terms of the comments you made about the triple-whammy, the three reasons why it is not in your profit interest to manufacture all these cigarettes, the answer is that 65% of Superkings and Regal cigarettes manufactured by Imperial are in fact smuggled back. What I am interested in is, firstly, whether the profit margin on these cigarettes you are selling to Russia, Latvia, etc., is in fact more than the profit margin of these brands when sold legitimately in the UK? Is it more or less?
  (Mr Davis) Generally it was less in the sense that these were market entry strategies, as I said. We were trying to develop our business internationally and very often when you go into a market you have an investment phase where you make very little money in the first few years.

  368. Okay. You are adding in here the advertising and market development costs?
  (Mr Davis) And the pricing also.

  369. What I am asking is if it is the case that the tax in the UK is 90% on low value brands then obviously you only make 10%. If you sold a pack of cigarettes for 20% of the price in the UK shop you would get double the revenue and many, many times the profit margins. Obviously there is a lot of money to be made from selling into low tax areas and if they come back it does not matter because what they are cannibalising is a product that makes less margin. Are there examples of that anywhere?
  (Mr Davis) No, I think it is completely the other way round.
  (Mr Dibble) Yes, totally the other way round. If I may refer you to Appendix II, the profit margins are clearly set out and that only compares to—

  370. You are talking about developed Western markets in Appendix II. I was going to ask why you rip off British consumers by making 89 pence for every packet of cigarettes which generically are the same sticks on which you make 45 pence in Spain. Given the price you start with in Spain is lower because of tax, why do you not make it the same sort of margins that you are charging British people?
  (Mr Davis) That 89 pence is not just for us, that is wholesale and retail margins as well.

  371. I do not think that is completely acceptable, but anyway. Mr Dibble, you were going to explain to me how it is the case that if we are manufacturing cigarettes here and you only get 10% on the retail price, it is 90% tax, how it does not follow that if you charge the equivalent, say, 20% of that UK price in a developing market at virtually no tax you would not make much, much more money. Why is that the case?
  (Mr Dibble) I think it is not the case because we are talking percentages here and that seems to be confusing the issue.

  372. What I am saying, looking at Appendix II, is if you are selling at 89 pence that is what you get back on a packet of cigarettes sold in Britain—
  (Mr Dibble) What we and the retailers share.

  373. The question is if you sold at, I do not know, a pound a packet somewhere else which has zero tax obviously you would make more money, would you not?
  (Mr Dibble) No, we would not because it is not zero tax elsewhere. If you take Latvia, there are taxes in every country in the world. Even in the most lowest taxed country there are taxes on tobacco.

  374. What is the lowest taxed country?
  (Mr Dibble) I do not know offhand.

  375. What is the tax in Moldova? What was the tax in Afghanistan before the troubles?
  (Mr Dibble) The retail price is approximately 50 pence and the tax one presumes is approximately 30 pence.

  376. So you get 20 pence a packet?
  (Mr Dibble) And the distributors and retailers. For the sake of argument we make, say, 10 pence, which is one-ninth of the tax exclusive price in the UK. If you say the retailer is added to that, again we make four or five times more. There is four to five times more profit between us and retailers in the UK than there is in countries like Moldova.

  377. So in all these countries, Latvia, Russia, Kaliningrad, Afghanistan, Moldova and Andorra, when you sell these cigarettes you are saying you get less after tax revenue than in Western countries?
  (Mr Dibble) Much less.

  378. In terms of the brand managers of Superkings and Regal in terms of hitting their sales targets, half their production, more than half, about 65% of production, is in foreign markets and half of that is smuggled back, is it not? In fact, something like a third of the total production of these brands is knowingly smuggled. You know it is smuggled rather, we know you are making money out of that.
  (Mr Dibble) We accept large quantities are smuggled back to the UK, they are very low profit brands and even lower profit brands for us once you take off the set-up costs of starting to trade in those countries. So for many years we make nothing going into new countries, therefore when they are smuggled back that is why we are more than willing to stop supplying, it is in our economic interests.

  379. Mr Davis, one of the three reasons, and it seemed to me odd, is that you are doing enormous volumes in selling them and then saying you are not making money, that seems to be strange. Why are you doing that? It is economies of scale on production, is it not? It seems to me counter-intuitive.
  (Mr Davidson) The reason we are doing it is the future growth of the company has to come from international markets. We have a substantial share in the UK, the overall UK consumption is coming down, so—

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