Memorandum submitted by The Scotch Whisky
Association
EXECUTIVE SUMMARY
1. Fraud, by its nature, is difficult to
estimate and seeking ways to tackle it is complex, but The Scotch
Whisky Association (SWA)[34]
does not accept that the Customs estimates of fraud are accurate.
It believes that the combined efforts of the spirits trade and
HM Customs and Excise 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.
2. 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 co-operation 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 co-operative approach has had no impact. It
is also inconsistent with the market reality.
3. 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.
4. An analysis by the SWA has shown that
official statistics do demonstrate the falling trend in fraud.
As a result there is an urgent need for a reality check to be
introduced to the Customs methodology and estimates of fraud.
I. THE
LEVEL OF
SPIRITS FRAUD
AND HOW
THIS HAS
BEEN ESTIMATED
5. The UK spirits market suffered rising
fraud and disruption from 1993 to 1998. Since that period there
has been a significant decline in fraud, leading to evidence of
major fraud from inward and outward diversion being relatively
scarce for at least the last year.
6. Rising fraud meant falling revenue. In
1997-98, spirits receipts fell to a low of £1.55 billion.
Since then legitimate duty-paid clearances of spirits[35]
have risen continuously, by a total of 35%[36]
since the trough of 1997-98, delivering excise revenues up by
nearly £600 million to £2.13 billion.[37]
7. Producers, importers, distributors, warehousekeepers,
wholesalers and retailers all shared this experience of the rise
and fall of fraud. Thus the Customs estimates of the level of
fraud for 1999 to 2002, and the suggestion of a still rising fraud
trend, reaching a claimed £600 million revenue loss in 2001-02,
are not consistent with the industry's experience and market disruption
that flows from fraud, or with other published data. There
is growing evidence that both the estimates and the trend are
incorrect, and based on a flawed calculation of the total
consumption of spirits.
8. A conclusion that the industry does
not take fraud seriously would not be supported by the history
of its full commitment to efforts to stop fraud. Steps taken
by the trade, and in partnership with Customs and others, are
cited in Section II. While there is disagreement over the estimates
of fraud, and some methods of tackling it, there is no disagreement
as to the seriousness of the impact of and the need to drive out
real fraud. Officials and Ministers have praised the industry's
commitment in this regard.
9. The background to the fraud estimates
is given in Annex 1.[38]
It describes the signs of inconsistencies in the figures published
with the Pre-Budget Report of 2001 (PBR01) and PBR02. Although
concerns at the methodology were raised, Customs continued with
their approach. In PBR03, estimated losses for 1999-2000 were
again revised, and with the benefit of hindsight marked downwards
to £350 million; those for 2000-01 were also revised downwards
to £450 million; yet, new estimates published for 2001-02
showed a jump to £600 million, or circa 16% of the market.
This was greeted with widespread surprise. Estimates for 2002-03
using this methodology have not yet been disclosed.
10. 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.
11. 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 (ONS) 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.
12. Explaining all the trade's work on the
estimates is difficult without going into statistical detail,[39]
but the key points were as follows:
— The Customs figures were inconsistent
with the trade's knowledge of consumption trends, with much reduced
levels of market disruption compared with the 1990s, with steadily
rising excise revenue receipts, and with an analysis of the UK
spirits market by sales channel: they implied that almost every
bottle sold in independent (ie not supermarkets or multiple
chains) off-licences across the UK was illicit
— When Customs used an identical methodology
to estimate beer and wine fraud, they abandoned it as unreliable
as "it does not generate meaningful results"[40]
— Both the trade and outside observers
such as John Roques, the National Audit Office and the Hon Mr
Justice Butterfield were aware that Customs had taken some effective
steps from 1997-98 onwards to curtail diversion fraud
— Yet the Customs figures would imply
that fraud levels had been immune to all the enquiries and many
other measures and increased resources allocated to Customs since
1997-98
— The trade estimates were plausible,
consistent and compatible with Customs' seizure and detection
rates, and with the results of enforcement initiatives such as
an inter-agency assurance exercise in London in 2003.
13. The Public Accounts Committee asked
the National Audit Office (NAO) to study the differences in the
estimates. The NAO, with advice from the London School of Economics
(LSE), reported[41]
that the new trade method was reasonable, but "it was
difficult to accept that both methods are reliable when they result
in such widely different estimates of consumption . . . Great
care is needed in determining what reliance is to be placed on
the results at present available". Working to a tight
timescale and narrow remit, the NAO did not get to the bottom
of the matter.
14. The Public Accounts Committee agreed[42]
it was "clear that further work needs to be done by the
Office for National Statistics . . . to explain why there are
such different estimates for consumption and therefore alcohol
fraud". Since then, the ONS has put much expert time
and effort into understanding how Customs used ONS survey data
to give a picture of spirits consumption and trends which differs
from other evidence and surveys. We understand the ONS will
report soon. The strategy for tackling spirits fraud should
and will be assessed in the light of the ONS report and the most
robust available further information and advice on fraud levels
and trends. The control strategy of Customs, and the trade,
over the last five years may yet be shown to be a story of laudable
success in driving down fraud.
15. If measurements of leakage are "key
measures of the effectiveness of the Department, and the key driver
of requests for additional resources",[43]
we suggest that measurements of leakage should be assessed
by an independent expert body. Whilst they are one important indicator
of performance, they should also be balanced by measuring the
revenue, economic and trade benefits of efficient facilitation
and control of the legitimate trade.
16. The Scottish Affairs Committee also
examined the differing results to emerge from the analysis undertaken
by the SWA and the Customs estimates. In its report the Committee
commented "For any government to introduce important measures
which could have major implications for industry and employment,
based on what could be inaccurate figures, might be considered
precipitate to the point of being reckless."[44]
II—THE
STEPS TAKEN
AND PROPOSED
TO REDUCE
THE LEVEL
OF FRAUD
17. The rise of fraud in the 1990s, and
the involvement of organised crime, caused concern across the
legitimate trade. Our members' brands and distribution channels
were undercut and undermined. The good reputation of Scotch Whisky
and other spirits was threatened. Wholesalers and retailers clamoured
about illegal competition. Targeted initiatives were taken
across the supply chain to address the problems urgently. Among
the actions taken by our members were:
— Companies monitored unusual sales
patterns to particular warehouses/outlets, exchanged information
on this with HM Customs and Excise and in several cases took steps
to protect their products from being diverted onto the UK illicit
market by restricting supplies to certain customers, or only supplying
duty-paid;[45]
terms and conditions of sale were amended to reserve the brand
owner's rights if there was any suggestion of fraudulent misuse
of products
— Four major manufacturers representing
50% of the market share for wines and spirits joined with the
Customs National Intelligence Division in preparing a strategic
threat assessment and contributed commercial data to highlight
suspicious factors and trading patterns[46]
— A working group developed industry
guidance, "Preventing Duty Fraud—Tightening Security",
advising on ensuring the security of high-value consignments in
transit, whilst safeguarding against exposure to duty loss resulting
from criminal activity; it covered the three main areas of customer
knowledge, movement of goods, and documentation
— Workshops were organised with Customs
officials to drive home the message about fraudsters' activities
and risk indicators.
18. Wholesalers also formed a duty fraud
action group. It worked with the authorities to isolate and close
off the illicit alcohol suppliers.
19. A great deal of effort, creativity
and management time have been devoted by dedicated trade people
to most of the following reviews:
1997—Alcohol and Tobacco Fraud
Review
1999—Treasury Sub-committee Enquiry
2000-01—Roques review and report
2001—NAO Review: Losses to the
Revenue from Frauds on Alcohol Duty
2003—Butterfield Review of Criminal
Investigations and Prosecutions
2003—Consultation on Reducing
Opportunities for Alcohol Fraud
2004—Scottish Affairs Committee
Inquiry into the Proposed Whisky Strip Stamp.
20. These and other exercises led to
many improvements, controls and other measures to detect,
prevent and prosecute fraud, including:
1998—Excise Warehousing (Etc)
Regulations
1999—Warehousekeepers and Owners
of Warehoused Goods Regulations
2000-01—Restructuring of HM Customs and
Excise
2001-02—146 more Customs and Excise warehouse
assurance officers
—New policies on warehouse
approvals
—Excise Duty Points
etc Regulations
—New National Discreditation
Team at ports
—Tougher action on
vehicle seizures
2002-03—Excise Goods (Accompanying Documents)
Regulations
—Joint Spirits Fraud
Task Force (with a range of new initiatives)
—New initiatives on
transporters
—New mandatory monthly
warehouse returns.
21. There has also been the commitment of
many Customs officials, inland and at the frontier, trying to
beat the fraudsters, and learn from experience built up in investigating
methods of fraudulent activity.
22. The Customs estimates imply that,
unfortunately, none of the above has made any impact in reducing
the levels of spirits fraud. This is not credible (see Section
I), but is also a disservice to the people involved.
23. Following the Budget 2002 decision to
postpone tax stamps, The Scotch Whisky Association, Gin and
Vodka Association and Wine and Spirit Association put major effort
into establishing with Customs the Joint Spirits Fraud Task Force
(JSFTF), whose creation was announced by the Chancellor. Its
terms of reference are given at Annex 2.[47]
24. The industry's long-standing belief[48]
is that close co-operation between Customs and the legitimate
trade is the best way to identify, isolate and prevent the fraudster.
The JSFTF is acknowledged by both sides to have been a highly
valuable and effective partnership, bringing all relevant divisions
of the Department together with industry to implement joint mechanisms
and to exchange information, intelligence and ideas. Its impact
has yet to feed into published fraud estimates, which to date
cover a period before the Task Force's creation.
25. A detailed Memorandum of Understanding
(MoU) between the associations and HM Customs and Excise was drawn
up to formalise all the new areas of action and co-operation in
the JSFTF, and was all but agreed. Our MoU was on the point of
being launched in Glasgow in December 2003 when PBR03 was delivered
the preceding day, announcing the imposition of tax stamps. In
view of on-going discussions on the nature of the tax stamp regime
since then, the draft MoU remains on hold.
26. The announcement at the same time that
the government was after all 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 from which Scotch Whisky contributes
more than £2 billion to the balance of trade. International
experience has shown tax stamps are of limited effectiveness in
combating fraud. Therefore the industry associations and member
companies submitted a comprehensive joint trade submission[49]
before the 2004 Budget, containing a package of 17 alternative
measures—summarised in Annex 3[50]—but
regrettably this was rejected.
27. Long negotiations have continued since
the 2004 Budget about the implementation of tax stamps. We welcomed
government amendments to the Finance Bill which allow greater
flexibility in selecting the form of the stamp—providing
for the possibility that stamps could be incorporated into the
back labels of bottles. Progress has been made on this and other
aspects of the regime, including the important financial arrangements.
All details are still uncertain but are understood to be close
to decision.
28. Both the regulatory options on which
the Government consulted in 2003, and the tax stamp proposals,
may entail a belief that it is the system of duty suspension in
which alcohol is traded that is the basic problem; but suspension
of duty, with the duty not paid until the point of release for
consumption, is a fundamental legal principle and right under
the EU system.
To apply a stamp saying "duty paid"
at the start of the supply chain, at the point of production,
within a system where duty is not paid until the final point of
release for consumption, often by a different trader, gives rise
to complex issues with which Customs and the trade are grappling
in the negotiations. Customs state that the stamp represents an
amount equivalent to the duty, and not the duty itself.
29. The system of warehousing for alcohol
and other goods, in which customs or excise duties can be "suspended",
dates back to the early 19th century. It particularly alleviated
the difficulties of smaller traders who would otherwise have been
compelled to pay large sums of duty before the goods were sold.
It is possible to control such a system for spirits without much
diversion fraud occurring, as happened for most of its history.
Comparisons with the payment of duty by the tobacco and oil industries
"at the factory gate" are inappropriate. They have far
fewer traders. Much longer distribution chains, and the rich diversity
of products, including fine wines and spirits, also distinguish
the alcohol trade.
30. In 1999,[51]
we welcomed the EU's proposals to replace the existing paper-based
system for the movement of excise goods with a computerised system
of documentation and control, and explained its potential benefits.
Insufficient priority and attention have been given to this. The
EU is now consulting on its functional specifications. It will
secure further the duty suspension system.
31. Anti-fraud measures should in our
view follow these principles:
— Revenue and enforcement controls
should be targeted towards criminals, and the areas and traders
of highest risk
— Legitimate traders with good compliance
history, low risk, and high levels of responsibility and co-operation,
should be facilitated and subject to lighter levels of control,
creating wider economic benefits
— Blanket regulatory approaches
which catch everyone in the same level of burdens, bureaucracy
and trade barriers are not the right approach if similar or greater
revenue objectives could be achieved by other focused methods
which are less burdensome.
Section III—The impact of steps taken,
and proposed, on fraud levels and on compliance costs.
32. Steps taken so far have been a success
in reducing fraud levels without excessively burdening or obstructing
legitimate trade (see Section I above). While sporadic instances
of fraud may continue, it is an inevitable feature of any tax
system—the general picture is of significant improvement.
33. In its Regulatory Impact Assessment[52]
(RIA), the government "cautiously estimates that the anti-fraud
impact of tax stamps will be £160 million during their first
year of introduction".[53]
Customs' calculation of this is proportional to revenue losses
immediately prior to the introduction of stamps (by this method,
revenue gains will be circa 27% of those losses), and assumes
such losses will be £600 million, the same as the estimate
for 2001-02. For the reasons set out, in our view this assumption
is not justified.[54]
34. Estimates of revenue loss are "not
necessarily equal to the additional revenue that the Government
would gain if fraudulent activity was mitigated, as the relatively
low prices of illicit goods mean that some illicit consumption
may represent additional consumption as opposed to displacement
of UK duty-paid consumption . . . Some estimates of revenue evaded
may overstate the revenue gain that would result from eliminating
fraudulent activity".[55]
This may also reduce the revenue gain of tax stamps (or other
measures) to some extent.
35. The Government's implementation
costs, including for all offsetting measures, should be subtracted
from estimated gains.
36. MPs may be aware of fraud in their constituencies
from reports of alcohol being sold in and around pubs, clubs,
street markets and car boot sales. Tax stamps do not prevent
this type of fraud, known as "hawking", and may
encourage it, as well as theft of stamped products. Customs therefore
exclude hawking from the 27% of losses they say tax stamps will
recover. Stamps also do not prevent the practice of substitution
from illicit bottles on optics in the on-trade, or cross-channel
smuggling.
37. Under compliance costs, trade costs,
and knock-on costs to the economy and other tax revenues if other
countries are encouraged by the UK precedent to adopt tax stamps
have not been taken into account. The RIA[56]
uses pan-industry estimates of compliance costs as £23 million
one-off costs and £54 million a year of ongoing costs, adding
a conservative estimate of around 15-20 pence on the average shelf
price of a bottle. For SMEs this could be significantly higher.
This estimate is based upon conventional strip stamps with up-front
payment. (As the cost of offsetting measures should be subtracted
from the government's estimate of revenue benefits, so must any
trade benefit from offsets be subtracted from compliance costs).
The trade welcomes Ministers' commitment to reduce these compliance
cost figures. Allowing different forms of stamp, and avoiding
up-front payment, could offer considerable reductions but quantifying
these is difficult until final details are known.
38. Following the passing of the Finance
Bill, the industry has been working constructively with the government
to try and ensure that any tax stamp regime involves the minimum
of cost and disruption being placed upon legitimate traders. However,
concerns over the methodology that lies behind the estimates of
fraud, and the trade's experience of falling market disruption
and increasing revenue receipts mean that the revenue benefit
estimated to flow from the proposed policy reaction to the fraud
estimates must be questionable. The Sub-committee's Inquiry will,
we hope, lead to greater clarity and understanding of this complex
issue.
November 2004
34 The SWA is submitting this report on behalf of
the spirits trade associations (SWA, Gin and Vodka Association,
Wine and Spirit Association) on the Joint Alcohol Tobacco Consultation
Group (JATCG) which represents the industry from producer through
to retailer. Back
35
Excluding ready-to-drink (RTD) products. Back
36
Provisional clearance figures for September 2003-August 2004
of 1,091,169 hectolitres of pure alcohol [Source: HM C&E
Spirits Bulletin, pub. Oct. 2004]. Back
37
VAT receipts from spirits will be additional to the figures quoted. Back
38
See Ev 96 Back
39
An SWA paper (11 pages plus appendices) will be made available. Back
40
PBR 2003, "Measuring and Tackling Indirect Tax Losses",
p. 19-20. Back
41
http://www.parliament.uk/documents/upload/PACspiritsmemo.pdf Back
42
http://www.parliament.uk/parliamentary_committees/committee_of_public_accounts/pac110304_a.cfm Back
43
John Roques-see Annex 1, para. 2. Back
44
Select Committee on Scottish Affairs, Third Report. The Proposed
Whisky Strip Stamp 28 April 2004. Back
45
Roques Report s.5.3.2.2. Back
46
Report of the Alcohol and Tobacco Fraud Review, Jan. 1998,
para. 5.3.6. Back
47
See Ev 97 Back
48
See also 1999 written evidence, para. 47. Back
49
Not printed. Back
50
See Ev 98 Back
51
1999 written evidence, para. 37 and Annex 4. Back
52
HM Customs and Excise, "Tacking Spirits Fraud: Regulatory
Impact Assessment", 8 April 2004. Back
53
p 5. Back
54
JATCG submission before Budget 2004, Section 4. Back
55
"Measuring Indirect Tax Losses", HM Customs
& Excise, PRB01, para 2.6. Back
56
RIA, p 36. Back
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