Select Committee on Treasury Written Evidence


Memorandum submitted by Philip Morris International

  Philip Morris International[15] welcomes this opportunity to comment upon current strategies for tackling tobacco smuggling in the UK. We will address each of the issues upon which the Committee has invited comment.

1.  THE LEVEL OF FRAUD AND HOW IT HAS BEEN ESTIMATED

  1.  By its very nature, the level of excise duty fraud is incapable of precise definition. Because illegal tobacco sales take place outside legitimate sales channels, there is no reliable way to calculate their exact volume. This problem is exacerbated further in the case of the UK because genuine non-domestic products found in the UK market but emanating from other EU Member States may or may not have been imported legally, depending on where and under what circumstances they were purchased, and by whom they were ultimately consumed.

  2.  There are several different methodologies for attempting to measure the level of illegal tobacco products in a domestic market.

    (1)  Market surveys based on the collection of cigarette packs. These can confirm the existence or non-existence of genuine non-domestic products or counterfeit products in the relevant market at a particular point in time. However, it is only through repeated surveys in the same area and under the same conditions that trends—upward or downward—can be detected. Even then, the level of illegal products cannot be determined with precision, since it depends upon the extrapolation of data from a sample and its application to the entire market. In our experience, depending in part on the underlying methodology and the collection techniques, these extrapolations can generate unreliable conclusions.

    (2)  Consumer surveys are subject to the obvious and inherent bias that accompanies asking a consumer whether they have purchased cigarettes illegally. For this reason, consumer surveys have extremely limited utility in determining the size of the illegal market.

    (3)  Seizure statistics. Again, these statistics can provide an indication of the presence of illegal products entering the UK. They can also be very useful in ascertaining trends—for example, the changing routes that smugglers use to gain access to the UK market—which can then be used to focus the resources of customs and police authorities more appropriately. However, absent some reliable ratio for the volume of seized products versus the volume of illegal products that escape seizure—a ratio that is constantly changing—it is impossible to use seizure statistics to measure the size of the illegal market.

  3.  In fact, none of these methodologies can account for the impact of legal intra-EU sales on the UK market. It is extremely difficult in practice to determine whether genuine products from other EU Member States that are found in the UK have been purchased in accordance with the relevant rules on free movement of intra-EU goods, or have been imported illegally from other EU Member States for re-sale on a commercial basis. There are other factors which have the potential to affect the size of the legitimate market such as declining smoking incidence and more people purchasing their cigarettes legally abroad, both of which would account for fewer legitimate sales of UK tax-paid products.

  4.  In short, we do not believe that there is any way of calculating the precise size of the illegal tobacco market in the UK. Each method suffers from one or more flaws, although taken together, they can provide information upon which to base a very general estimate. HMCE's estimate of 18% of the cigarette market and 51% of the hand rolling tobacco market is such an estimate, and on that basis we do not disagree with its figures.

  5.  What we can say with some certainty is that the UK is one of the most attractive markets in the world for the illegal cigarette trade. This is the unfortunate consequence of the high retail price of cigarettes in the UK, which provides an economic incentive for the diversion of genuine products from other countries where the price is lower, or for the manufacture of counterfeit cigarettes for sale in the UK. A pack of cigarettes can be purchased at retail in some other countries, after the payment of taxes, for between a tenth and a twentieth of the cost in the UK. Even within the EU, the price can vary significantly, from just over

2 a pack in Portugal to over

7 per pack in the UK. In addition, we have seen multiple examples of our products being counterfeited in China with UK Duty Paid markings, clearly intended for export to the UK, and have been notified of such products being seized by HMCE in Britain. Sadly, so long as these huge price differentials with other countries remain, there will always be an economic incentive for the smuggling of cigarettes and other tobacco products into the UK market.

2.  THE STEPS TAKEN AND PROPOSED TO REDUCE THE LEVEL OF FRAUD

  6.  Absent some significant change in tax policy which would reduce the economic incentive for tobacco smuggling, we believe it is more constructive for us to discuss other possible measures to reduce the volume of illegal tobacco products reaching the UK market.

  7.  To date, the main thrust of the effort to reduce excise fraud has been enforcement action by HMCE, consisting of seizures in ports and in the domestic market, combined with aggressive prosecution of offenders. HM Customs has also expanded its efforts to include communications campaigns, aimed at educating consumers about the consequences of purchasing tobacco products in the illegal market. We welcome these initiatives, which we believe will go at least some way towards reducing the demand for these products. However, while HMCE's efforts have met with success in the past several years, with increased seizures and prosecutions, the sheer scale of the problem means that, by HMCE's own admission, the majority of smuggled and counterfeit products are still reaching the UK domestic market, and the price differentials mean that demand for these products will continue to exist. Thus, while we agree that increased resources will help HMCE to stem the tide of illegal products even further (in particular, for equipment such as fixed and mobile container scanners which have quickly proved self-financing in many European ports), we also believe that action on a policy level is necessary.

A.   A Secure Distribution Network for Tobacco Products

  8.  Philip Morris International believes that the first step in preventing illegal tobacco products reaching the market is the creation of a secure distribution network. That is why we support the licensing of tobacco product manufacturers, importers, exporters, warehouse proprietors, transporters, distributors, and retailers. Any person trading in (or storing or transporting) cigarettes without a license would be subject to severe penalties. Any licensed person trading in genuine non-domestic or counterfeit cigarettes upon which UK taxes have not been paid should be subject to the same penalties, as well as forfeiture of their license.

  9.  Such a system, properly enforced, would see the elimination of the "unofficial" outlets—the street corners, the pubs, the flea markets, etc—through which contraband and counterfeit cigarettes are sold, and would ensure that the legitimate distribution channel is the only place where cigarettes can be purchased. A more detailed version of our proposal for securing the legitimate distribution channel is available on our website at: www.pmintl.com/global/downloads/OBE/Confronting_contraband.pdf.

B.   Intra-EU Sales of Tobacco Products

  10.  We also feel it would be helpful, in the context of the Committee's inquiry, to examine the EU Commission's recent proposals amending Directive 92/12, published in COM(2004)227 on April 2, 2004, which deal with the very complex issue of cross border sales.

  11.  We believe that these proposals have to be viewed from two different perspectives that are readily distinguished in addressing the internal market for excise goods, particularly cigarettes. Directive 92/12 and the proposals made by the Commission address two distinct aspects of the internal market: (1) rules applicable to manufacturers and traders on the holding and movement of excise goods for commercial purposes; and (2) rules applicable to consumers purchasing goods within the European Community. In assessing the effectiveness and efficiency of the current directive and the Commission's proposals in relation to tobacco products, we come to very different conclusions with respect to those measures applicable to manufacturers and traders and those applicable to consumers. We think it is appropriate to view these distinct aspects of the market differently because of the unique nature of tobacco products and the tensions that need to be accommodated between public health goals pursued by the Commission and Member States in relation to these products and the desire to promote a single internal market.

  12.  Philip Morris International believes that the rules on the internal market for tobacco goods cannot be viewed in isolation, but must be seen in the larger context of regulations that exist and are being developed to achieve Government policy objectives to protect and grow excise revenues, to fight against fraud, and to reduce the harm caused by tobacco consumption. Indeed, we note that the Commission has acknowledged this reality in making proposals that treat cigarettes differently in relation to distance selling "on public health grounds".[16] We believe it is appropriate to review Directive 92/12 and the Commission's proposals from the perspective not only of the internal market, but also in the broader context of achieving appropriate policy goals in relation to revenue protection, fraud prevention and the promotion of public health. We also believe that Directive 92/12 cannot be viewed in isolation in the framework of the Excise Duty Directives. On the contrary, we think that the discussion on, for example, indicative limits is intrinsically linked to the discussion on structures and rates (for which a review is planned for 2006). Our views seek to build a bridge to those important policy considerations and the EU Tobacco Excise Review 2006.

  13.  In our experience, the internal market for manufacturers is generally working well. We are able to manufacture cigarettes in any of our EU factories for any of the EU Member States, using the duty suspension procedures prescribed by the Directive, ensuring payment of the excise tax where due under EU principles. The procedures designed by the EU need to balance security and control of excise revenues with efficient and practicable operating procedures. We believe that such balance is best achieved by setting very high standards for licensed operators, whilst introducing new technology—such as the Excise Movement and Control System (EMCS)—such that these reliable operators are able to work in an efficient way. We believe that Directive 92/12 accomplished that objective and we see the proposed technical improvements to articles 7 and 10 of the Directive as sound measures to further secure that balance and to enhance the efficiency and security of the internal market and we thus fully support this part of the Commission proposals.

  14.  On the other hand, we believe that the internal market for consumers is not yet functioning as originally intended by the EU because the original goal of excise duty harmonization has not yet been achieved. For consumers able and willing to travel abroad, there is, depending on their country of residence, an imperfect internal market that is hampered by the inconsistency of rules and procedures applying indicative limits and the uncertainty and confusion for consumers that results from the concept of indicative limits.

  15.  In short, we feel that the EU rules for consumers are confusing and discriminatory. For policy makers we believe that it is appropriate today to decide, in relation to tobacco products:

    —  whether the promise of the internal market can be achieved at this moment in time, consistent with the necessity of preserving the policy goals in those other areas we have referenced (ie, revenue protection, fraud prevention and the promotion of public health); or

    —  whether the objective of an internal market for consumers of tobacco products should be temporarily suspended until the duty levels on tobacco products within the EU-25 have reached a sufficient level of harmonization.

  16.  A truly functioning internal market requires abolishing the indicative limits—as is proposed by the EU Commission—but in all respects. In such case, the internal market should enable mail order and distance selling with payment of excise duties in the country of origin as was proposed for alcohol. However, until tobacco duty harmonization is achieved, such an approach for tobacco products could have very significant consequences that are likely to raise grave concerns for the UK in relation to its desire to protect revenue, prevent fraud and promote the reduction of tobacco consumption. If history is any guide, it will likely lead to further displacement of duty paid sales towards those countries with the lowest excise rates.[17] Such inevitable displacement of duty paid sales within the EU has very significant implications for individual Member States:

      1.  Countries with high excise taxes would suffer substantial revenue losses as consumers could legally—and not hampered by current restrictions—buy their cigarettes where taxes are lowest.

      2.  Illegal cross-border sales, where a resale of product occurs in the country of destination without payment of the appropriate excise tax, would become difficult to detect and fight.

      3.  It would become difficult for individual Member States to achieve public health objectives, as national excise tax policy—as a key tool for revenue generation and harm reduction—would be significantly undermined.

  17.  Therefore, we recommend changing the current unsatisfactory situation by proposing measures aimed at substantially reducing cross-border shopping of tobacco products in the European Union until the tax levels (excise and VAT) have come to a reasonable degree of harmonization.

  18.  We believe that an array of technical solutions and legal measures could be developed, which, taken as package as opposed to being used in isolation, could enable Governments to achieve effective enforcement in their objective of significantly reducing cross-border sales of tobacco products. In our view, the package of measures should cover the following four areas:

    —  Introduce clear rules for consumers

        The current system of indicative limits is not clear for consumers. Some EU Ministries of Finance have indicated to us that—in their opinion—the existence of clear, simple rules, adequately communicated to consumers, in itself would help to reduce cross-border sales. Their view is that the large majority of consumers will follow unambiguous and mandatory rules, without any active enforcement in place. This view has for instance been expressed in several Nordic countries. Changing the indicative limit into a fixed limit—until duty harmonization takes place within the EU—seems also to be the position of France's Minister of Finance.

    —  Introduce measures at retail level

        The idea is to prevent retailers from selling to "unlicensed" private individuals quantities of cigarettes that cannot normally be assumed to be for private local consumption but are more likely to be used for cross-border supply. In practice it could mean that retailers can not sell more than, for example, 200/400/800 cigarettes in a single time period (eg day) to a consumer—and not following this rule could lead to withdrawal of the retail license. Such a rule already exists today in Spain—albeit for a higher limit.

    —  Introduce rules on unlicensed possession of excessive quantities

        The idea is to introduce a simple rule that makes it unlawful for private ("unlicensed") individuals to possess cigarettes in excess of a certain quantity. The relevant quantity may differ near the border or elsewhere. Such rule already exists in some EU Member States requiring certain fiscal documents to transport or hold cigarettes in excess of 2,000 cigarettes (within 30 km of the State border) and 10,000 cigarettes elsewhere.

    —  Introduce measures to address mail-order, including mail-order by digital means

      The idea is to require a license for sending cigarettes by mail from one country to another. As part of such license, a number of administrative measures should be implemented as part of the conditions for the license (eg financial bond for any applicable taxes; a quarterly tax return, etc). Any cigarettes sent by a non-licensed retailer would be seized. In addition, it could be made unlawful for any post office or courier service to accept for "mailing" any cigarettes shipped by any person who has not registered in the country of deposit and the country of destination.

  19.  The quantities of the specific limits, ie number of cigarettes, applicable for measures in these different areas need to be determined by the ECOFIN Council of Ministers, but should depend on the particular behavior sought to be affected. Obviously, Governments are most interested in regulating commercial, as opposed to truly individual, behaviour; and, accordingly, the rules should focus on that type of behaviour, whether undertaken by individuals or entities.

  20.  We feel that our proposals could clarify for consumers and the retail trade what is allowed and what not. These rules are also easier to interpret for customs officials or other law enforcement agents, who today are forced to judge whether cigarettes are carried "for own use" or "for commercial purposes"—often not a clear-cut matter. With the disappearance of borders in the Schengen area, cross-border sales are anyway difficult to monitor, indicating that a new and comprehensive approach such as the one we suggest, may be preferable. This will gain further importance after the entry into Schengen of the new EU member states.

  21.  We should stress that these ideas require further thought and refinement, but we hope that sharing them with the Committee now may help to highlight some areas in which progress can be made, and move the debate forward in line with key Government policy objectives to protect and grow excise revenues, to fight against fraud, as well as to improve public health.

3.  THE IMPACT THESE STEPS HAVE HAD ON THE LEVEL OF FRAUD AND ON COMPLIANCE COSTS

  22.  HMCE estimates suggest that the level of illegal products entering into the UK has stopped increasing, which represents a significant success in itself for which HMCE should be commended. However, as noted previously, the sheer scale of the problem mandates additional action. The proposals we make here are not without cost in terms of compliance. For example, our proposed licensing system would impose some additional administrative burdens on the appropriate government agency and members of the legitimate trade. However, we believe that these incremental burdens are minimal when compared to the threat posed by the smuggled and counterfeit cigarettes. In our view, the benefits for all concerned—the Government, legitimate traders and consumers—far outweigh any possible disadvantages.

  Thank you for the opportunity to comment on these important issues. We would be happy to provide further input or clarification concerning our positions on the issues should the Committee deem it necessary.

9 November 2004








15   Philip Morris International Management S.A. is responsible for the administrative functions of the tobacco businesses of affiliates of Philip Morris International Inc. including in the United Kingdom. Back

16   European Commission Press Release, IP/04/452, 2 April 2004. Back

17   Although such displacement could be prevented through a full EU harmonization of tobacco excise rates, we do not believe that this is economically and politically feasible in the next decade. Just to illustrate our point: today the excise duty level per thousand cigarettes varies between Euro 16 in Latvia and Euro 268 in the UK. Although taxes in Latvia are to increase significantly over time to meet EU minimum rates of Euro 64 level by the year 2010, this will still leave a significant gap between different EU Member States. Back


 
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