4 Tackling alcohol fraud
52. The movement of alcohol under duty suspension
facilitates the legitimate trade by avoiding the need for fiscal
controls at frontiers, and the vast majority of these movements
arrive safely. However, most spirits fraud is perpetrated through
the diversion onto the UK market of product which is being moved
under duty suspension ostensibly between excise approved warehouses,
often involving traders in different Member States of the EU.
This can happen on import or export. Consignments of spirits,
on which no tax has been paid, are obtained and diverted by fraudsters
who cover their tracks with forged or duplicated paperwork. This
illicit spirit is then sold mainly through licensed outlets at
full (or close to) normal retail price. Neither the consumer,
nor the honest trader, can distinguish illicit from licit goods.[55]
53. Inward diversion occurs when duty suspended product
is imported, ostensibly for a UK warehouse, but is diverted en
route and placed on the UK market without duty payment; outward
diversion occurs when product described as destined for exportation
never in fact leaves the country and is diverted onto the UK market.
There are other types of fraud, but according to Customs these
account for a small proportion of the total tax losses.[56]
54. Customs' strategy for tackling alcohol fraud
has centred on operational activity to identify and tackle the
fraudsters responsible for alcohol fraud. Customs consider that
introducing measures through legislation that narrow the scope
for fraudsters to exploit weaknesses in the system is key to maximising
operational effectiveness. The Chancellor's announcement in December
2003 that he would introduce tax stamps on spirits from 2006 is
a key part of Customs' strategy, the fundamental principles of
which are to:
- make it as difficult as possible
for a fraudster to deal with—and hide amongst—the
legitimate trade, at all points along the supply chain;
- make it easier for Customs, the trade and the
public, to identify and trace illicit product; and
- substantially drive up the costs—and thereby
significantly reduce the profits—of being involved with
spirits fraud.[57]
Estimating the level of alcohol
fraud
55. Customs' estimates of the revenue lost through
fraud and smuggling for spirits, the corresponding illicit market
shares, and how these have changed are noted in table 4 below.
Customs have not published regular estimates of the level of fraud
for other alcohols such as beer and wine.[58]Table
4: Spirits revenue evaded through fraud and smuggling and illicit
market share (%)
| 1999-2000
| 2000-01 | 2001-02
| 2002-03 |
| PBR2001 | £450m 15%
| - | -
| - |
| PBR 2002 | £500m 15%
| £550m 15% | -
| - |
| PBR2003 | £350m 11%
| £450m 14% | £600m 16%
| - |
| PBR 2004 | £350m 11%
| £450m 13% | £450m 13%
| £250m 7% |
Source: HM Customs and Excise, annual publication
on Measuring (and Tackling) Indirect Tax Losses, November 2001,
November 2002, December 2003, December 2004
56. In contrast to the position on tobacco, Customs'
published estimates of the level of spirits revenue evaded have
showed a scale and trend of fraud that are disputed by the industry.
The published figures have also been subject to significant revisions
in subsequent years.
57. The Scotch Whisky Association, in evidence submitted
on behalf of the Gin and Vodka, and Wine and Spirit Association,
told us that it did not accept that Customs' estimates of fraud
were accurate. It believed that:
"the combined efforts of the spirits trade
and [Customs] have resulted in a major reduction of fraud in recent
years, a downward trend that continues to this day. Whatever the
level, the industry has always been committed to working with
the government in tackling fraud, as it hurts brands just as much
as it impacts on government revenue. Following the accepted significant
levels of fraud around 1997-98, measures taken to reduce illegal
activity have delivered results. However, the Customs methodology
for estimating revenue losses from fraud continued to suggest
a rising trend into 2001-02. This ignores major cooperation between
industry and Customs, steps taken by the industry and importantly,
the success resulting from the considerable additional resources
given to Customs to tackle the problem. Surprisingly, it implies
that this combined and cooperative approach has had no impact.
It is also inconsistent with the market reality. The official
fraud estimates suggest that legitimate sales and revenue should
have been falling. This is contrary to the measurable market reality.
Traders have seen a drop in market disruption caused by illegal
sales. The government has benefited from rising revenue receipts.
This points to successes in fighting illegal activity."[59]
58. In December 2003 Customs published their first
estimates of spirits fraud for 2001-02, which showed revenue losses
had increased to £600 million. The Scotch Whisky Association
noted that:
"the whole trade immediately questioned
the new figures. Both the scale (equivalent to 200,000 bottles
every day), and especially the new suggestion of an upward trend
in 2000-01, so contradicted market experience that, on behalf
of the whole joint alcohol trade, the Scotch Whisky Association
examined the basis for the methodology and figures in much greater
detail. This work quickly threw up a number of anomalies which
were reported to Treasury and Customs. Other survey data on spirits
consumption from the Office of National Statistics emerged and
contradicted the survey data relied on by Customs in both scale
and trends. An alternative gap analysis, using this government
data, suggested that the revenue gap was at its greatest in 1997-98
and then reduced significantly, that losses for 2001-02 could
be less than a quarter of the official estimates and, importantly,
on a downward trend."[60]
59. A National Audit Office memorandum, published
in March 2004, examined the significant disparities between Customs'
estimate of spirits fraud of some £600 million for 2001-02
and that produced by the Scotch Whisky Association of some £100
million to £150 million for the same year. The National Audit
Office calculated that Customs' estimate of £600 million
should more properly have been presented as a range between £330
million and £1,080 million. Likewise the National Audit Office
calculated that the Scotch Whisky Association estimate of £100
million to £150 million lay between £10 million and
£260 million.[61]
The National Audit Office concluded that the different methods
used by Customs and the Scotch Whisky Association were "reasonable
to professional statisticians. But it is difficult to accept that
both methods are reliable when they result in such widely different
estimates of consumption. It is therefore clear that further work
needs to be done by the Office for National Statistics, with Customs
and the Scotch Whisky Association, to explain why there are such
different estimates for consumption and therefore alcohol fraud."[62]
The Office for National Statistics are currently conducting work
to explain and reconcile the differences between the different
estimates of alcohol consumption. The outcome of this review has
not yet been published.[63]
60. In December 2004, Customs published their latest
estimates of spirits fraud which revised the figure for revenue
losses for 2001-02 downwards from £600 million to £450
million and showed estimated losses for 2002-03 of £250 million.
In accordance with one of the recommendations made by the National
Audit Office, Customs noted that the figure for 2002-03 of £250
million fell statistically within a range of minus £150
million to plus £650 million, illustrating the level
of uncertainty attached to this estimate.[64]
61. The British Beer and Pub Association observed
that Customs were "unable to accurately measure the amount
of large-scale smuggling/diversion fraud for beer. This is a concern
for the industry and must be a concern for the Government."[65]
Customs told us that they "continue to explore alternative
methods to estimate the overall scale of beer and wine fraud.
Although a robust quantification of the problem is not yet possible,
the available operational evidence gives no clear indication that
revenue losses resulting from beer or wine fraud are as substantial
as those from spirits."[66]
Asked about the lack of any estimate for beer and wine fraud,
Customs noted:
"we have not been able to manage to do the
sort of gap analysis of the illegal market in beer and wine because
the numbers are small. […]Basically, the market is so much
larger and the problem so much smaller that it is very difficult
to get a precise figure, but we think that the illicit market
in beer, for example, is less than 4% of the market and the basic
gap analysis would suggest they are collecting more tax than beer
is actually consumed, which probably is a bit unlikely. We are
fairly confident that this is a very small market."[67]
62. We
recognise that estimating the level of spirits revenue evaded
through fraud and smuggling is difficult. But confidence in Customs'
estimates of spirits fraud is undermined by a number of factors.
The figures are disputed by the industry, whose alternative estimate,
showing fraud to be much lower, is equally valid statistically.
The level of uncertainty attached to Customs' estimates is such
that their latest figure for fraud, of £250 million a year,
falls statistically within a range of minus £150 million
to plus £650 million. And if the methodology used for estimating
spirits fraud is applied to beer, it produces a result that suggests
more tax is collected than beer is consumed.
63. Given these
factors, we conclude that specific estimates for spirits fraud
can only be viewed with caution. We look to the review being undertaken
by the Office for National Statistics to result in more accurate
estimates being produced. We expect this to be completed and published
promptly.
64. Excise duty
receipts on beer, wine and other alcohol products were some £5
billion in 2003-04, substantially more than the £2.4 billion
collected on spirits. We note Customs' evidence that the level
of fraud is much lower in this area, but it is of concern that
there are no reliable estimates to support this view. We look
to Customs to provide robust estimates of the level of fraud in
all areas where significant revenue streams are at risk.
Tax stamps on spirits
65. In 2002 Customs undertook a consultation on a
proposal to implement a tax stamp system for spirits. Customs
told us that the consultation established that tax stamps would
have the advantage of allowing enforcement staff, the trade, and
the public, to distinguish between legitimate and illicit spirits
at the point of retail sale. The presence of a tax stamp would
prevent the distribution of unstamped spirits at full market value
and would increase the risks taken by anyone dealing in illicit
spirits. The impact on fraud would be significant.[68]
But others argued that tax stamps were not the best way to combat
fraud, expressing concern that employing a strip stamp across
the top of the bottle was an old fashioned and ineffective solution
that would require bottlers to buy new machinery, that tax stamps
would be easy to counterfeit, and that they could make counterfeit
spirits appear genuine. These matters were considered by the Scottish
Affairs Committee in its report on the proposals in April 2004
and the arguments for and against tax stamps as a means of tackling
fraud are set out in the Committee's report and the Government's
response to it. We have not duplicated this work, concentrating
instead on the strategic case for a tax stamp regime.[69]
66. The Government decided not to proceed with tax
stamps in 2002, but asked Customs to work with the industry to
tackle fraud and to explore alternative means of making progress
in reducing the illicit market share.[70]
In 2003 the Government consulted on a range of alternative options
for reducing the opportunities available to commit fraud through
the framework for holding and moving alcohol in duty suspension.
According to Customs, responses "indicated that, while some
of the measures would be acceptable to the industry and would
have a small further impact in reducing fraud, the most significant
proposals—radically to restrict the circumstances in which
alcohol could be moved and sold in duty suspension—would
not deliver an anti-fraud benefit that was proportionate to its
compliance cost to the industry. The Government therefore concluded
that tax stamps were the only way to combat spirits fraud effectively—both
today and in the future."[71]
67. In the 2003 Pre-Budget Report the Government
announced the intention to implement tax stamps, but "gave
industry a final opportunity to put forward an alternative measure
that would be as effective in tackling spirits fraud. The trade's
alternative proposals took the form of a package of proposed new
controls on the alcohol supply chain, but [the Government] concluded
that the proposals would be significantly less effective in tackling
fraud than tax stamps. The Chancellor therefore confirmed in the
2004 Budget that tax stamps would be implemented early in 2006-07."[72]
68. The Scotch Whisky Association told us that the
announcement in the 2003 Pre-Budget Report that the Government
was proposing to introduce tax stamps on spirits "was both
a surprise and a blow to the entire spirits industry. Tax stamps
are a barrier to free intra-EU and international trade and unhelpful
to UK efforts to oppose trade barriers in some 200 markets worldwide
[…] International experience has shown tax stamps are of
limited experience in combating fraud. Therefore the industry
[…] submitted […] a package of 17 alternative measures
[…] but regrettably this was rejected."[73]
69. When the Chancellor confirmed in Budget 2004
that tax stamps would be implemented, Customs' latest estimate
of the losses from spirits fraud was £600 million for 2001-02.
That figure was subsequently revised down to £450 million
in the Pre-Budget Report 2004, which also provided the first estimate
for 2002-03—a further fall in the level of losses from spirits
fraud to £250 million. We asked the Economic Secretary whether,
given that losses had declined significantly without the introduction
of tax stamps, it was still necessary to go ahead with the scheme.
The Economic Secretary told us that a level of fraud which resulted
in an illicit market share of 7% still needed to be tackled and
that:
"[…] it would be irresponsible of us,
as a Government, not to take action to deal with that and I think
it would be unfair on those legitimate businesses that do pay
their tax to have their own products and their markets undermined
in that way, which is, in the end, why the industry is so strongly
with us on the commitment to tackle fraud. They do not like tax
stamps but they accept it and they now believe […] that these
can be introduced as a result of the detailed discussions we have
had with them in a way that will work, and they can be introduced
in a way which makes the costs that are imposed on industry proportionate
to the problem that we face."[74]
The Economic Secretary confirmed that he was resolute
in his determination to introduce tax stamps. Discussions with
the industry "simply did not throw up any other credible
alternatives that would allow us to deal with this spirits fraud.
In those circumstances, we took the decision--and this is the
position we are in--that tax stamps can be introduced, they need
to be introduced and we will introduce them in a way that balances
our ability to tackle fraud with not imposing unnecessary costs
on the industry in doing so."[75]
Legislation for the introduction of tax stamps was included in
the Finance Act 2004.[76]
70. The Government announced a number of measures
to offset and mitigate the impact of compliance costs of tax stamps
on the industry. The 2004 Pre-Budget Report noted: "in addition
to freezing spirits duty for the remainder of the Parliament and
meeting the additional printing and distribution costs entailed
by duty stamps, the Government:
- has decided, based on industry
proposals, to make targeted exemptions from the duty stamps regime;
- has decided to adopt the industry's proposal
to allow duty stamps to be incorporated into bottle labels, and,
subject to further work with the industry on detailed stamp design,
is inclined to allow additional flexibility in the format of stamps;
and
- believes there is a case for not attaching a
financial liability to duty stamps, and will work further with
the industry to examine the implications of this for the impact
of duty stamps on both fraud and compliance costs before making
a final decision.
As a result of incorporating these features into
the planned duty stamps system, overall compliance costs—at
the time of the Budget estimated by the industry at £23 million
start-up and £54 million a year ongoing—could be reduced
to £7 million start-up and £5 million a year ongoing
based on the industry's estimates. This means duty stamps remain
a proportionate measure […]." [77]
71. The
Government is convinced that tax stamps on spirits bottles are
required to tackle alcohol fraud. Following lengthy and detailed
consultations with industry, which have resulted in a number of
changes to the proposals to minimise compliance costs, a tax stamp
scheme is to be implemented early in 2006-07. The decision to
proceed with the scheme was made when losses were estimated to
be some £600 million a year. But estimated losses have fallen,
without a tax stamp regime being in place, to £250 million
a year, a figure which on past experience could well be revised
downwards.
72. The decision to implement tax
stamps should be based on accurate and up-to-date assessments
of the level of fraud, and of compliance costs, in order to determine
whether the expected benefits outweigh the costs. Customs' estimates
of fraud contain a significant level of uncertainty, and the most
recent figure is for the year 2002-03. We expect this estimate
to be revised as new information is available, either from later
figures, or as a result of the review being undertaken by the
Office for National Statistics. But as the latest estimate of
fraud (£250 million a year) is of a different order of magnitude
from the estimated compliance costs (£7 million start-up
costs and £5 million a year thereafter), we conclude that
the latest proposals for tax stamps cannot be considered a disproportionate
response to the problem.
55 Ev 88, paras 70, 71 Back
56
Ev 89, para 72 Back
57
Ev 90, paras 81, 82 Back
58
Range figures for beer and wine were published with PBR 2002 (see
Measuring indirect tax losses, Nov 2002), but have not
been repeated in later years. Back
59
Ev 91, paras 1-3 Back
60
Ev 92, paras 10, 11 Back
61
Estimating the level of Spirits Fraud, Memorandum by the
Comptroller and Auditor General, 10 March 2004, para 6 Back
62
ibid, para 10 Back
63
Ev 88, para 66 Back
64
Measuring and Tackling Indirect Tax Losses - 2004, Dec
2004, Tables 3.1 and 3.2 Back
65
Ev 61, para 1.1 Back
66
Ev 88, para 69 Back
67
Treasury Sub-committee, Minutes of Evidence, Wednesday 21 July
2004, HM Customs & Excise Spring Departmental Report 2004,
HC 908-i, Q 34 Back
68
Ev 90, para 84 Back
69
Scottish Affairs Committee: Third Report, Session 2003-04, The
Proposed Whisky Strip Stamp (HC 419), and Second Special Report,
Session 2003-04, Response by the Government to the Third Report
(HC 822) Back
70
Ev 90, para 84 Back
71
Ev 91, para 85 Back
72
Ev 91, para 86 Back
73
Ev 94, para 26 Back
74
Q 393 Back
75
Q 411 Back
76
Ev 91, para 88 Back
77
Pre-Budget Report 2004, Cm 6408, paras 5.96, 5.97 Back
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