UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE To be published as HC 126-i

House of COMMONS

MINUTES OF EVIDENCE

TAKEN BEFORE

TREASURY COMMITTEE

(TREASURY SUB-COMMITTEE)

 

 

EXCISE DUTY FRAUD

 

 

Wednesday 8 December 2004

MR P SCULLY, DR D LONG, MR I GOOD, MR G HEWITT and MR I SHEARER

Evidence heard in Public Questions 102-260

 

 

USE OF THE TRANSCRIPT

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Oral Evidence

Taken before the Treasury Committee Treasury Sub-Committee

on Wednesday 8 December 2004

Members present

Mr Nigel Beard

Norman Lamb

Mr John McFall

Mr George Mudie

Mr Robert Walter

 

In the absence of the Chairman, Mr McFall was called to the Chair

________________

 

 

Examination of Witnesses

 

Witnesses: Dr David Long Director, Brewing and Mr Peter Scully Interbrew, The British Beer and Pub Association (BBPA) and Mr Ian Good, Chairman, Mr Gavin Hewitt, Chief Executive and Mr Ian Shearer, Director of Operations and Technical Affairs, The Scotch Whisky Association (SWA), examined.

Q102 Mr McFall: May I open the meeting by welcoming you to the sub-committee and, for the sake of Gurney's shorthand writer, starting with Mr Scully would you identify yourselves please?

Mr Scully: My name is Peter Scully and I am here representing the British Beer and Pub Association, although I work for Interbrew UK.

Dr Long: I am Dr David Long; I am Director, Brewing, of the British Beer and Pub Association.

Mr Good: I am Ian Good, Chairman of the Scotch Whisky Association and also Chairman of the Edrington Group.

Mr Hewitt: Gavin Hewitt, Chief Executive of the Scotch Whisky Association.

Mr Shearer: And I am Ian Shearer, Director of Operational and Technical Affairs at the Scotch Whisky Association.

Q103 Mr McFall: Thank you and welcome. May I start off with Mr Good. According to Customs, most spirit fraud involves the sale of the genuine product on which duty has been fraudulently evaded through licence outlets at full or above the normal retail price. Now you say in your submission that the industry has always been committed to working with the government in tackling alcohol fraud, and I quote, "... as it hurts brands just as much as it impacts on government revenue". How does alcohol fraud hurt brands?

Mr Good: Probably the best way to answer that is to talk about the personal experience that we have. Our company owns brands such as a Famous Grouse, Macallan, Highland Park, premium brands. If we do not have control over their promotion, their positioning, then we lose control over one of the main assets of our business, that is the brands. Therefore anything that is done in the marketplace which is detrimental to the positioning of our brands is detrimental to our company and latterly to industry.

Q104 Mr McFall: Does any fraud take place with your brands, and if it does, where do you as a company think it takes place and what are you trying as a company to do about it?

Mr Good: The first thing is that there is a lot less fraud now than there was. Our experience is that with our brands there is still fraud, but it is on a much lesser scale than it was. I believe there are many reasons why that situation exists: one is that there has been a tremendous amount of work done between our industry and Customs and Excise to try to stamp out fraud. Fraud is detrimental to the government, is detrimental to our industry, is detrimental to our brands and we are determined to stamp it out as much as we can. As far as our brands are concerned, what we do is try to ensure that it is sold only to legitimate traders; traders who are bona fide, traders who have taken out Customs and Excise guarantees. In other words, it is sold between companies who are legitimate.

Q105 Mr McFall: Have you as a company undertaken any investigations? What has it uncovered, as regards fraud? What have any investigations that you as a company have undertaken, you have a famous brand, Famous Grouse, produced as regards fraud? Where is it taking place?

Mr Good: I think probably, again using the example, what we found was that we sold our goods to company X. Company X then in turn sold it onto company Y. We found, for example, that our sales to company X increased significantly and in relation to the size of company X, it seemed unreasonable that they were taking so much of our product. We then traced that, because we can trace every bottle; we have lot codes on every bottle, and we can trace that to when it was shipped, who it was shipped to, etcetera. We found that what that company X was doing was selling it onto company Y. Company Y was not as scrupulous as company X and that was where we found the fraud.

Q106 Mr McFall: Did you report company Y to Customs?

Mr Good: Not only did we do it, but we found in talking to other companies that they were finding the same problem. We took a dossier to Customs and Excise on that specific occasion.

Q107 Mr McFall: What percentage of the brands of your company alone do you think are subject to fraud?

Mr Good: Our belief is that the figure is extremely small now; probably less than two per cent.

Q108 Mr McFall: So in terms of working with Customs and the government, is it worth the candle, doing all this stuff with tax stamps?

Mr Good: Absolutely. We would argue ---

Q109 Mr McFall: There is a brouhaha about tax stamps, but it seems to me that everybody is working well together now. When I ask government they say everything is fine. When I ask industry they say it is very important that everybody works together. I just wonder how we got this split in the first place, but over to you.

Mr Good: I think you have to go back over history. We would argue that if you look at the, the change from, let us say 1993 to 1998 and then subsequently, the amount of work that was being done between the industry and Customs and Excise has increased dramatically in that period. We have a memorandum of understanding, we have joint task force. These things were not in existence before. You talk about the brouhaha over tax stamps. One of the reasons we were opposed to tax stamps initially was that we believed that the steps which were being taken by the industry and Customs and Excise to reduce fraud were in fact working. Now there was some debate on the figures which suggested it was not working. We argued that it was and there is some evidence now that maybe the figures that were being quoted before were exaggerated.

Q110 Mr McFall: Now you have a memorandum of understanding with the government and the government informs us they are setting out plans to provide duty stamps for spirits and confirming the implementation of further regulatory changes, there are announcing the creation of a new Customs intelligence unit, they are setting out proposals for Customs to build on existing work with the spirits industry, these are all things that you welcome.

Mr Good: Yes; absolutely.

Q111 Mr McFall: What I am trying to say is that I just cannot understand where the split came from. You say this is vital now, but at the time you were saying a lot of this was unnecessary. It does seem to be necessary now and you have come together with the government to work constructively, is that correct?

Mr Good: We did say it was necessary and we felt that the steps we were taking with the MoU and the joint task force was actually providing results.

Q112 Mr McFall: Yes, but you did not say tax stamps were necessary. Do you still think they are necessary now, given that the government have modified the proposals, putting it on bottles? Are you happy with that?

Mr Good: Tax stamps provide a check.

Q113 Mr McFall: Which must be good.

Mr Good: Which is good. But the various steps that we have talked about, the MoU and the joint industry task force, get to the root of the problem and prevent the problem happening rather than, if you like, check what has happened after the event.

Q114 Mr McFall: Are you happy that the government is opposed to tax stamps at the moment?

Mr Good: We think it is an improvement, a considerable improvement. What we have to make sure is that it is proportionate to the size of the problem. If there is any suggestion that the cost to the industry is going to be disproportionate to the size of the problem, then it is going to make our industry uncompetitive and that would be bad news for UK PLC, given the size of export earnings from the industry. Anything that makes our industry less competitive is bad for the industry.

Q115 Mr McFall: But the big ones in the industry that I spoke to, felt there was not going to be a problem with tax stamps. The issue was for small companies and therefore it was important to impress upon the government that you had to work with small companies. I note from the Memorandum of Understanding that the government will make targeted exemptions from the duty stamps regime; specifically goods sold by registered mobile operators and export shops will be exempt from the requirement to bear duty stamps. That must be a good thing and that must show that constructive dialogue and engagement are taking place between the industry and the government on a subject which both of you think should be tackled because there is still fraud at the moment. Is that correct?

Mr Good: Absolutely. I would argue that the situation has changed significantly from the original announcement on tax stamps. That is an example again of the two parties working together to get the correct solution.

Q116 Mr McFall: Exactly. But what we were all saying at the time was that negotiation is very important. You should not stand off. As you know, a number of us were involved with you and the Treasury in trying to get to that stage. So everything is hunky-dory now and you are working along.

Mr Good: Things are a lot better. To say it is hunky-dory ...

Q117 Mr McFall: We can never get heaven on earth, but we are getting there.

Mr Good: You never get heaven on earth.

Q118 Mr McFall: Okay; we are getting there. Now on the issue of the Customs' estimates for spirits fraud, their latest figures were in the Pre-Budget Report (PBR). Their estimates of fraud for 2001-2002 will be reduced from £600 million to £450 million and their figures for 2002-2003 show a fall to £250 million. They describe these as the most robust and up-to-date estimates presently available. Do you agree with that statement?

Mr Good: Yes. We have some very detailed sort of information on that. Gavin, do you want to start and then Ian?

Mr Hewitt: First, I think it is highly significant that the figure we now have for fraud in 2002-2003 is seven per cent, £250 million as you say. That is a very big reduction from the revised figure of 13 per cent for the previous year, which was previously 16 per cent and £600 million; and they have revised the figures back down the line. What we have always said, and Ian Shearer can elaborate on this if you are interested, is that effectively the data set, the figures which Customs and Excise have been using to produce their fraud figures, are wrongly based. We started off from that and we say that there are some market realities to show that they are actually wrongly based. They have used one set of ONS statistics. We showed, and it is attached behind the PBR statement, that there is another set of statistics which show a very different story about the level of fraud. When we take our statistics and our data set, which are government statistics, and put them together with the market reality, we believe very strongly that it is our statistics which are right and Customs which are wrong.

Q119 Mr McFall: So you think the seven per cent figure is not correct.

Mr Hewitt: I believe that the seven per cent will be further revised.

Q120 Mr McFall: To what?

Mr Hewitt: ONS is doing work at the moment.

Q121 Mr McFall: What is your figure?

Mr Hewitt: We gave a figure, for example, for 2001-2002 where we said the figure for fraud, using the NAO work which looked at it, was between £10 million and 180 million. That was the spread when the NAO looked at our figures, which were worked on the General Household Survey. That compared with the figure, when they corrected it, which was £330 million and £1,080 million for the Customs figures. So our figure is substantially lower. We believe, if the ONS look and come out with the right data set, which is what they are working on at the moment, we may well see some figures changing yet again.

Q122 Norman Lamb: With those ranges is it not the truth that nobody knows how much fraud there is?

Mr Hewitt: We do believe we know the truth, but the government has actually chosen statistics which do not tell the truth. We believe the figures are very close, much closer to ours, because we have the reality of the market to prove them.

Q123 Mr McFall: How come you have the Holy Grail and the government does not have it?

Mr Hewitt: I am afraid we have a very expert statistician who has worked very hard on it.

Q124 Mr McFall: Mr Shearer, welcome. You tell us, educate us all here.

Mr Shearer: What has happened is that Customs and Excise have used one survey set for the consumption of spirits, but there are other ONS survey sets out there and we believe that there is a need for a reality check to be introduced on which set of figures accords most closely with reality. Interestingly, the government actually also published our alternative figures last week in an annex to the Pre-Budget Report. They did publish the alternative survey estimates and by those figures, which are based on the work that we did, the illicit market share in 2000-2001 was six per cent, in 2001-2002 it was three per cent, it compared with the government's estimate, which I think was 13 per cent, and in 2002-2003 the level of illicit market was minimal, possibly less than two per cent, compared with the government's estimate of seven per cent. Now why do I talk about reality checks? One needs to look not just at the theoretical debate which tends to create this kind of fog of uncertainty, but you also need to look at some reality checks on the figures. The first one is market disruption and Ian spoke in his introduction about the kind of market disruption which he experienced on his brands in the 1990s. There was evidence that some of his brands were getting into cash-and-carries and that they were definitely being illicitly traded. At the present time, he is not experiencing that, so the industry is not experiencing the market disruption that it used to. The second reality check is actually the revenue that the government is getting. If you look at the revenue figures for spirits, they have gone up continuously since 1998; they have actually gone up by 35 per cent since 1998 which is an increase of about £600 million. You will remember that the £600 million was the original speculation as to the size of the fraud problem, but the revenue has actually gone up by £600 million since 1998. If revenue is going up, that suggests that fraud has been going down.

Q125 Norman Lamb: Or consumption is going up.

Mr Shearer: Well that is the third reality check. The third reality check is consumption and the Customs estimate is based on an estimate of consumption. However, their estimate of consumption is so huge, that it does not tally with the experience of sales and marketing people as to what the level of consumption really is. Also, as I said, there are other ONS surveys on spirits consumption which show a totally different trend from the consumption trend which is shown in the original Customs' survey that they have relied on. So there are two different pictures of consumption there. A couple of other very brief reality checks. One is: what are Customs actually seizing and detecting in terms of fraud? If you look at their seizures, the stuff which comes in through the ports, these have considerably fallen. They have gone down by 57 per cent between 2000-2001 and 2002-3. If you looked at the outward frauds that they are detecting and asked them now what hard evidence there is that there are now currently major outward frauds going on, they are quite reticent on the subject because there is not much hard evidence at the moment of outward fraud. The third sort of thing is that if seven per cent of the market were illicit, that would be about 80,000 bottles a day. Now if that kind of fraud were being found in the marketplace by Customs' investigators, Ian's company and other companies would be expecting phone calls from Trading Standards' and Customs' officers around the country on a regular basis saying "Can you tell us about this bottle and this lot code? What is the history of this lot code? Should it be in the UK market at all?" and we are just not getting that volume of calls. I think in Ian's company he has had about one call in the last year.

Mr Good: One in the last year.

Mr Shearer: The final reality check is, if you do an analysis of the market by sales channels, how much the average consumer spends in the supermarket on spirits, how much they spend in off-licences and how much they spend in independent corner shops on spirits, this seven per cent figure which the government quotes is equivalent to just about half of all corner shops in the UK. When they said it was £600 million, that would be every bottle in every corner shop in the UK. We assume there is no fraud in supermarkets and off-licences, by the way, because those have very secure supply chains, but the current figure is equivalent to probably about half of all corner shops in the UK and every bottle in that share of the market. I put it to the Committee that that is slightly implausible.

Q126 Mr McFall: So we are talking about the level of fraud here, and you are arguing about the range. Is that right. Fraud still exists but we are arguing about the range.

Mr Hewitt: Yes.

 

Mr Shearer: But we think it is not just a picture of uncertainty. You can do these reality checks which either back up, or do not, one set of figures.

Q127 Mr McFall: Why can you not sit there with Customs? I would expect that if Customs and yourselves sat down and presented us with a common theme here, we would chip away. It is like a marshmallow here. Why is this?

Mr Hewitt: You know how far we have actually argued. When the Chancellor last year, on 10 December, came out and proposed tax stamps as a solution to fraud, we actually seriously criticised and continue to criticise the figures. We have shown time after time after time that the figures which Customs and Excise are using are wrongly based. We have been consistent in this. Our persistence led to the NAO looking at the figures, looking at our figures and looking at the government's figures. They made comments when the NAO report was produced to the Committee of Public Accounts. The Committee of Public Accounts looked at them and asked the ONS to go away and look at the data sets. Why did the government's own data sets, the different ones, produce such different figures? That is the work the ONS is now dealing with and we are looking forward to the results of their inquiries.

Q128 Mr McFall: And that famous NAO survey showed the range was between £150 million and £1,050 million.

Mr Hewitt: Precisely so.

Q129 Mr McFall: Not very precise is it?

Mr Hewitt: They did a very good job in the time available, but when they did that report, and they admitted this themselves, they were not able to apply the market reality checks which Ian has just set out.

Q130 Mr McFall: Right; so we have got it then that you are working well with the government and this is a common theme and we are going to have tax stamps and we are going to crack down on fraud. The government thinks there is big fraud and you think it is medium or wee fraud. Is that right?

Mr Hewitt: Yes.

 

Mr Good: It is certainly not significant.

Q131 Mr McFall: Dr Long, welcome. Dr Long, you said in your memorandum that duty fraud, and I quote "is damaging the UK beer market". Illicit beer sales will damage pubs and other retail outlets, but what effect does beer fraud have on brewers if it is UK brands or overseas brands brewed in the UK under licence that are involved? What is the scene?

Dr Long: I think the picture is very much as described by The Scotch Whisky Association, that the differential in excise duty as between the UK and France and other countries within continental Europe is driving fraud. This is damaging to the beer market and it is damaging to brands, both those produced in the UK as UK brands and those produced under licence from brewers overseas. I think this is a straight matter of economics in the market: if the price of the product is undermined this will damage the product in the market.

Q132 Mr McFall: Customs have not been able to estimate the excise duty losses on beer or wine from smuggling. How significant is duty fraud in these areas and do you have any estimates of the sums involved?

Dr Long: When we talk about fraud, we have to be clear that we are talking about a number of aspects here. We are talking about smuggled beer; we are talking about outward diversion fraud, inward diversion fraud and drawback fraud. Fraud is notoriously difficult to measure but for the last ten years The British Beer and Pub Association has been carrying out surveys and one of the surveys is in relation to the so-called white van trade. This is a highly visible form of smuggling of beer into the UK and over the last ten years we have been measuring this and we have very robust figures which now show that that van trade is at an extremely low level. We have down-played the amount of work that we are now carrying out in Calais on that work. There is no doubt that some of that smuggled beer will be diverted into, displaced into other areas, maybe into larger-scale smuggling, but that is extremely difficult to measure in terms of trailers.

Q133 Norman Lamb: Do you mean high value consignments which are diverted?

Dr Long: I am talking about trailer-loads of beer which could be coming in, but we have no means of measuring that.

Q134 Norman Lamb: What happens? Does it pull up in a lay-by on a motorway or whatever and get off-loaded before it ever gets to its destination?

Dr Long: That is precisely what happens. This is either beer which has paid French duty, and remember that the French duty comparison for a five per cent ABV product would be five pence, UK duty would be 35 pence, so we are talking about that sort of differential or ---

Q135 Norman Lamb: Or movement between two warehouses.

Dr Long: --- moving between two warehouses it never reaches the destination, but fraudulent paperwork suggests that it has. This is then diverted onto the UK market, having either paid no duty at all or having paid French duty.

Q136 Norman Lamb: Do you have no estimate at all about how much of that is going on?

Dr Long: We have no estimate, but, again, we rely on information which we have from the market, which suggests that the level of fraud is in fact at a low stable level and it is that residual level of fraud that we are trying to tackle. We have some evidence that we presented in our written paper to the Committee which looks at the difference, the discrepancy, between import and export data between the UK and France. There will be statistical differences of course between different fiscal authorities in different Member States, but we believe that this discrepancy is too large to explain by a statistical difference. It would indicate a level of fraud which, again, is relatively low and relatively stable.

Q137 Mr Walter: May I go back to Mr Good? It seems quite clear from what you have already said that nobody really knows what the extent of this situation is, in terms of excise duty fraud or duty foregone by purchases either legally or illegally outside the UK net. You have said that the Customs' figures for the levels of fraud are inconsistent with your own knowledge. I wonder whether you could just give us some idea of exactly how much of your information is available to Customs. Do you share every piece of information that you have with Customs authorities?

Mr Good: Absolutely. Part of the joint industry task force and the memorandum of understanding is that if we have any questionable transactions or changes in pattern of sales through warehouses that we do not know, we will notify Customs immediately. For example, if we found that there was an increase in sales to one particular warehouse, to one particular customer using this warehouse, and he in turn did not seem to be selling the product, or it was not apparent on the shelves as we might have expected, we then found that he had sent it on to warehouse Y, we would tell the Customs that and the Customs would investigate warehouse Y. It would be as transparent as that.

Q138 Mr Walter: Why could you not ensure that duty was paid at a level at which you control? If it is going to go out to all these different distributors it is supplied duty paid.

Mr Good: I would suggest you ask the Chancellor why 74 per cent of every bottle of whisky is duty and VAT.

Q139 Mr Walter: To what extent is what we are looking at excise fraud and to what extent is what we are looking at the consumer buying, quite legitimately, products outside the UK? I cannot remember the last time I have purchased a bottle of whisky for my personal consumption UK duty paid. Perhaps I should not admit that. I do buy Speaker Martin's ten-year-old malt but that is usually for draw prizes. I am not alone in that. To what extent is that the problem and to what extent is the fraud, is the conspiracy to defraud the reason?

Mr Good: There is a complete difference between what I would call legitimate buying of product at airports or wherever and also, I would say, retailers who are reducing their prices to what you might say are almost VAT-free or whatever prices. That is normal commercial business. What we are talking about is where people are not paying duty by fraudulent means and that is what we want to stamp out because that affects our brands.

Mr Hewitt: In the Pre-Budget Report papers, page 12, these are the figures of statistics and spirits estimates, together at the back with our own calculations, you have cross-border shopping, which is the stuff you are talking about, buying legitimately in France or Germany and bringing it in, at £150 million, but that is not fraud, that is legitimate purchasing in another tax regime and bringing it in. They calculate then the illicit fraud, that is the fraud in smuggling, at £250 million. So legitimate trading, people bringing goods in but having paid the tax in another regime or in the duty-free shop if you are outside the EU, is £150 million, fraud is £250 million. Those are their figures. Our figures are £150 million legitimate trading in another tax regime and effectively zero, because they say the figures, and they accept this, do not produce a meaningful result, that is basically it is very, very small.

Q140 Mr Walter: I am just trying to get a handle on the figures. To what extent is this excise duty fraud totally domestic? Is any of it totally domestic?

Mr Good: What we are talking about principally is domestic duty; it is where duty is not being paid in the UK market. What probably would be happening would be that someone would sell, let us just take our company, we would sell to another company in warehouse X. That would be sold without paying duty. The expectation would be that when that company were putting it onto the shelves, they would pay duty and that would be gathered in the normal way. The problem would tend to be where that company, not necessarily that company, but a company in that warehouse, was selling onto another party who was not paying duty and was perhaps saying "I'm now selling it to France" and it was coming back in without duty being paid.

Q141 Mr Walter: So basically you as an industry are losing control of the goods.

Mr Good: Correct. That is one of the reasons why we are as keen as the Customs and Excise and the government to stamp out fraud.

Mr Shearer: The big frauds of the 1990s were the so-called outward frauds where it started in a warehouse, a third party warehouse, and then it went off to the continent allegedly, but disappeared into the UK market.

Q142 Mr Walter: It never actually went to the continent.

Mr Shearer: It never actually got there. Then huge controls were put in place around about 1998 to stop that type of fraud and we believe that those controls were largely effective, though there have been one or two instances ---

Q143 Mr McFall: Give us a flavour of those controls.

Mr Shearer: The warehouse controls were significantly improved. In the mid-1990s Customs had possibly been approving one or two people as warehouse keepers whom they perhaps should not have been approving and they clamped down on looking at what these warehouse keepers were doing in their warehouses. It is really just all about effective oversight of the warehouse.

Q144 Norman Lamb: Are you talking about the London and City Bond?

Mr Shearer: There have been one or two well-known cases.

Q145 Norman Lamb: That is still in place and still doing business.

Mr Shearer: It is a very large and successful third party warehouse and it is still widely used. I do not think there is any suggestion that it is fraudulent at the moment. But anyway, when that fraud was stopped, there was a risk of this other type of fraud called inward fraud where the stuff goes out to the continent, then comes back in again and then disappears. Customs picked up on that in around about 2000-2001 and the secret to that is just putting more intelligence-based controls at the ports. John Rocks, who investigated all this in about 2001, said the only way to do this was to put controls at the ports. Customs have done that; in around about 2001, they put a whole lot more people in the ports. We help those people because they phone us up and say "What do you know about this brand or that brand". That has led to this decline in seizures at the ports that I reported, so we think the lid is on that type of fraud as well.

Q146 Mr McFall: It was John Rocks who suggested duty stamps, was it not?

Mr Shearer: It was among his recommendations.

Q147 Mr Walter: May I just get a quantification? May I just look at the, if you like, cross-border fraud and try to get a quantification on that and the white van trade and so on? How much of that is through the corner shop as you have described it and how much is off the back of a van or through unofficial networks and so on? I have heard evidence, not in your industry but in the tobacco industry and we are going to hear evidence from the tobacco manufacturers later in this inquiry, that in terms of hand-rolling tobacco most of this is out of the back of a van on a Friday night. How much of that is there in the spirits industry?

Mr Hewitt: You need to look at where the spirits are sold in the UK. About 70 per cent is in the supermarket, the big supermarkets where the supply chains are very tightly controlled between the producers and appearing on the shelf. Fifteen per cent is in the controlled off-licences, the off-licences which are controlled by the big companies and where the supply chain is very, very tightly controlled. We do not believe that there is very much fraud at all within those tight supply chains. That leaves, at maximum, 15 per cent for the corner shop. As Ian said before, on the figures which they produced last year in the PBR at 16 per cent of £600 million, every single bottle sold, and that was the equivalent of 200,000 bottles a day, was going to have to be illegitimate in the corner shop, that is had escaped duty.

Q148 Norman Lamb: What about sales to pubs and clubs? Does that not happen?

Mr Hewitt: This is another form; there are other problems associated there.

Mr Good: That is the difference between the on and the off trade. Gavin is talking about the off trade. There is the on trade, which is selling to the pubs and that would tend to be done through wholesalers, cash-and-carries.

Q149 Mr Beard: What steps do you take in the industry to vet the people who are driving the lorries or running the warehouses, to make sure they are bona fide people? In the London bonded warehouse which has just been referred to, some of the people involved there had criminal records.

Mr Hewitt: Companies who have controlled supply chains know exactly who it is they are using, whether it is Edrington, Diageo or Allied.

Q150 Mr Beard: In the past they have not done, have they?

Mr Hewitt: They do.

Q151 Mr McFall: Could you tell me, when you lose control, at which stage you lose control? I think that is what Nigel is getting at.

Mr Good: When you say lose control, we always know the bottle, because it has a lot code number on it. On the back of the label there will be a lot code number which will say when that was bottled, the time it was bottled, that would lead to a case and the case is then controlled. So we can control the bottle. What we cannot do is control it once it goes from our warehouse or our distribution company's warehouse to the third party. At that point, the third party can either quite legitimately put it onto its shelf, quite legitimately sell it onto another party. There is nothing to stop him doing that, but what we have to hope is that when he sells it on to another party, if he is selling it duty paid there is not a problem, if he is selling it under bond, we need to be sure that the warehouse that he is selling it to has the same controls as the original warehouse.

Q152 Mr Beard: If we are just talking about when it is under bond, it would not take a lot to vet the people properly who are handling it.

Mr Good: Let us talk about guarantees.

Mr Hewitt: What we as the industry had proposed to Customs was that most of the fraud was coming and produced out of third party warehouses, not out of the primary producer and the distributor. Those third party warehouses, in our view, were not being adequately controlled by Customs.

Q153 Norman Lamb: Were not or are not?

Mr Hewitt: They were not being adequately controlled and we still believe there are aspects which are still not being adequately controlled. I use one example and this is within the last year, a Liverpool bond third party warehouse where I have been told that one of the directors of that company has a criminal record for fraud and that bond is still operating.

Q154 Norman Lamb: Outrageous, is it not?

Mr Hewitt: That is a fact and that is a question of control by Customs.

Q155 Mr McFall: Yes, but is it not a question for the industry as well, for the industry to alert Customs to check what is happening?

Mr Hewitt: Yes; absolutely.

 

Mr Good: I think the other thing is that legitimate companies, the Allieds, the Diageos, the Pernods, the Edringtons, the Grants, these kinds of people know that because we have intelligence on which warehouses we would not send our goods to and we would not think of sending our goods to that warehouse.

Q156 Norman Lamb: There was a period in the 1990s, which went on for quite a long time, when we knew that massive frauds were going on and yet the products were still going through those warehouses.

Mr Good: Yes, but they were not going direct to those. That was the point. We were selling it.

Q157 Norman Lamb: I appreciate that, but you could see what was happening, because you were tracing your goods.

Mr Good: Yes.

Q158 Mr Walter: I just want to try and get a quantity. We have talked about the measurable fraud, but what is the black market? How do you know how big that is of the people who are either selling direct to the consumer into the back door of a pub or a club or the restaurant or whatever? How big is that market?

Mr Hewitt: It goes back again to the estimates of fraud and the basis on which you calculate that fraud and there are different data sets which have produced different figures.

Q159 Mr Walter: What do you think it is?

Mr Hewitt: We think the figures, obviously working on the GHS, the General Household Survey, together with the consumption, together with the clearances, taking all that together, indicate that fraud at the moment is in the region probably of two to three per cent maximum. Maybe even less, but I am willing to accept that there is fraud and let us put it at that. We believe that it is not even at seven per cent. That is because we are looking at an official government set of statistics, using that in exactly the same way as Customs and Excise are using a different set of statistics, hence the ONS study of which is the right data set to use. We are in a difference now between a very low percentage figure, let us accept two to three per cent or less, and the seven per cent which Customs are now using.

Q160 Mr McFall: We are focusing on the supply chain. Let us keep going on that.

Mr Hewitt: May I answer one question? You say we were aware of fraud going through. May I just remind you of what was going on in the London bond which was that Customs admit they were allowing fraud to run? Now those figures are therefore being used against us.

Q161 Mr Beard: The first part of it in the London bond warehouse was that there was a lot of smuggling. There was another case where they allowed the fraud to run and lost £670 million in the process, but the fraud was there to start with.

Mr Hewitt: The fraud is there, but it is the third party warehouse. Now let me just support controls. We brought that to the attention of Customs. We have suggested, very strongly to Customs that they should tighten up the process of guarantees of third party warehouses, that is a warehouse guarantee should not be used where they do not know the owner of the goods.

Q162 Norman Lamb: Explain how a guarantee works.

Mr Hewitt: A guarantee is required for all movement and holding of excisable goods under bond. Edrington has a guarantee, Diageo has a guarantee, all the way through the supply chain people have guarantees.

Mr Good: That would be financed by a bank and there would be a significant cost in doing that. It is a legitimate business transaction which people would need to enter into and therefore the bank would investigate the bona fides of the person who was looking for guarantees.

Mr Hewitt: These third party warehouse guarantees were being used to allow movements out of the bond, out of the third party warehouse, and then they disappeared. The point was that the owner of the goods, the person who was transporting, taking those goods out, was not at risk himself. He had no guarantee against these goods and so effectively he was able to escape, sell the goods into the market and escape without penalty. We, as the industry, suggested that did not make sense. The guarantee should be provided by the owner and therefore, in a sense, that owner, Mr X, who is rather suspect, rather fraudulent should be required to come back into the banking system and actually raise a guarantee of his own. If he is fraudulent and the banks check him out, he probably will not get a guarantee, which means that those goods will not move from the third party warehouse because there is no guarantee.

Q163 Mr McFall: Looking at your responsibility in this, how far can you take it along the supply chain and guarantee that the people who are in the bonded warehouses are bona fide? That is what we are actually interested in today, where you lose control, where fraud takes place.

Mr Good: To answer that, the easiest thing to say really is where fraud is most likely to take place. It is after it has left what you call the legitimate trade. If, for example, we were selling under bond to a large supermarket chain, we would not think twice about that because that would be totally controlled. If we were selling to a chain of cash-and-carries, we would need to be sure that they were going there and they were definitely going into those cash-and-carries. Because of the buying patterns of the cash-and-carries, they could be buying for a whole range of smaller cash-and-carries and that is when it can start. If they are selling it from that warehouse to another bonded warehouse, who in turn are then selling it on to another bonded warehouse, which is quite legitimate, it is each time it goes through a bonded warehouse that there is a likelihood of fraud.

Q164 Norman Lamb: How long have you been able to trace your bottle all the way through?

Mr Good: Since the 1990s.

Q165 Norman Lamb: The scandal is that in that period of the 1990s, well over a billion pounds of duty was lost to the Exchequer. You were able to trace the bottles and yet it was happening. What I want to know is how on earth it was allowed to happen. Customs and Excise are in the dock clearly, because they were allowing these frauds to continue, but what about your responsibility? You knew it was happening, what were you doing about it?

Mr Good: Well, again I can give you an example. There was one particular case where we were selling to warehouse X. He was in turn selling on to another company. That company was then distributing it without paying duty. It was being sold in a number of cash-and-carries. Legitimate cash-and-carries came back to us and said "Why is cash-and-carry A able to sell Famous Grouse at that price?".

Q166 Norman Lamb: What date are we talking about?

Mr Good: That would be 1996. We checked with the then United Distillers, with IBV, with Allied and we found that they were having the same problems with this particular customer. The four companies gathered the evidence and took it to the Customs in 1996 and said "We believe that this particular company is perpetrating very significant fraud".

Q167 Norman Lamb: Was action taken?

Mr Good: Yes.

Q168 Norman Lamb: Then that company clearly was replaced by lots of other companies because the frauds persisted.

Mr Good: The fact is that was 1996 and that was when we as an industry were getting extremely concerned that the control over our brands was being seriously hampered by this fraudulent business.

Q169 Norman Lamb: Was there a prosecution in that case?

Mr Good: Yes.

 

Q170 Norman Lamb: Is it one of the ones which is going to fall?

Mr Good: I do not know what has happened in that particular case. They certainly were prosecuted.

Q171 Norman Lamb: But once that fraud was sorted out, it was replaced by loads of others, because fraud was continuing throughout the late 1990s and well beyond 2000.

Mr Good: I think what you would see, subsequent to that type of liaison with Customs, was that there was a much more formal link between the industry and Customs to try to eradicate this fraud.

Q172 Mr Beard: Why could you not ensure that the duty is paid at a level which you control? If it is going to go out to all these different people it is provided duty paid.

Mr Good: I would suggest you ask the Chancellor why 74 per cent of every bottle of whisky is duty and VAT.

Q173 Mr Beard: That is not the question I am asking.

Mr Good: I know that, but the point is that it has such a significant cash flow impact on our industry.

Q174 Mr McFall: Let us make it easy for you then, dead easy. Let us pay the duty when the product leaves production, then everything is fine after that, because you have paid at that level. What is your problem with that?

Mr Hewitt: The Government would be in contravention of EU law.

Q175 Mr Beard: Why?

Mr Hewitt: Because under EU law duty suspension is allowed for legitimate traders, any trader, right through to the point of consumption and you only pay tax at that point.

Q176 Mr McFall: Is there no chance of getting around that?

Mr Hewitt: It is not we who control that.

Q177 Mr McFall: I am sad for you: you are frustrated, you want to pay it at the factory level ---

Mr Hewitt: Have I misunderstood?

Mr Good: Let us come back. Let us have a reality check. The impact that would have on the industry would be catastrophic.

Q178 Mr McFall: It could be phased in.

Mr Good: How would we be able to develop our business overseas if we were being hammered by the UK government in terms of the cash flow of our industry?

Q179 Mr McFall: If I were the Chancellor, what I would say to you guys would be "Wait a minute. Okay, if you say it is EU law, let us debate that and I'll get my lawyers to go and see whether it is EU law". You have to keep a tab on it the whole way along the line and not lose control of it. I think this is the issue here which we are highlighting. At the moment, at some stage, you lose control of it and we want you to retain that control and then it would make it simple for everyone in the production. I just think this is an elaborate ---

Mr Good: The point we are making is that when there is so much money involved, you will inevitably get people who try to defeat the system. What we are saying is that the system has been tightened very significantly; the controls are much better than they ever were and therefore the quantum of fraud is very low now. You will never eradicate fraud.

Mr Hewitt: May I make the point that the government is interested in the competitiveness of British industry.

Q180 Mr McFall: I understand that.

Mr Hewitt: If you apply duty at the point of production and the companies who produce have to pay that duty, they are seriously disadvantaged vis-à-vis foreign spirits' producers who are allowed to operate under EU law. There is allegedly a single market within Europe and we must have a single rule.

Q181 Mr McFall: Why do we not all unite in a campaign to see whether we can get the law changed and have it paid on production?

Mr Hewitt: It is open to the Chancellor to campaign for that.

Q182 Mr Walter: We could almost suggest a single rate of duty, but we will not go down that route. I want to move on to beer and wine, but wine obviously is a different kettle-of-fish. Customs told us that they are continuing 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". Dr Long, in your evidence to us you said "Over the last five years, UK trade figures indicate that over 1.1 million hectolitres of beer was exported to France that has not been accounted for in French import statistics. In the same time period French trade statistics also show nearly 1.7 million hectolitres of beer exported to the UK that does not appear in UK import statistics". Are you involved in trying to find ways of actually estimating the exact level of cross-border fraud in this area?

Dr Long: We were interested to read in the document which accompanied the pre-budget report (PBR), Measuring and Tackling Indirect Tax Losses 2002, that mention was made of supplementing information with periodic testing. We are not sure what that means. This is a Customs and Excise initiative. We stand ready to talk with Customs and Excise in whatever way we can assist them in developing such methodologies. We have been engaged for ten years in measuring the fraud which we know is visible and easily measurable. It is that hidden fraud which is very difficult to measure. The figures we refer to are indicative of irregularities. I would not claim that these are a robust measure of fraud, but we feel that they are worthy of further investigation. Customs and Excise have been advised of these data. They carried out their own assessments and they believe that they are not in fact robust measures. They have set those aside and they have not put any estimate of fraud into the document which accompanied the PBR and have made mention of this additional statistical analysis that they wish to carry out.

Q183 Mr Walter: Could you just give the Committee a ballpark idea of what you think the quantum is of diversion fraud and what the quantum is of large-scale smuggling?

Dr Long: In terms of smuggling, the data we have presented in the written evidence would suggest that the value of smuggling into the UK in van trade would be in the order of £2 million.

Q184 Mr Walter: What is that as a percentage of consumption?

Dr Long: Duty is in the order of £3 billion, so it is an extremely small figure. We have been talking about spirit fraud, but we should emphasise that we are talking about orders of magnitude less. We are talking about very small levels of residual fraud in the beer trade, about which we are not complacent. We wish to drive that down and work with Customs and Excise, but it is a matter of scale. This is very small-scale fraud that we are talking about.

Q185 Mr Walter: And diversion?

Dr Long: Outward diversion is very well controlled. We have no accurate measure for inward diversion fraud.

Q186 Mr Walter: What about wine? What sort of quantum are we looking at there?

Dr Long: I am afraid I am not able to comment on that.

Q187 Mr Walter: The only information which was available related essentially to cross-Channel smuggling. You have stopped your surveys which you used to conduct on that, basically those on heavily laden vans, because the smuggling has dropped significantly. Customs have also stopped their cross-Channel smuggling survey. In the absence of this information, how are we going to know whether this is going up or down?

Dr Long: That is not quite correct in fact. We have reduced the level of surveillance in Calais now to a very low level, because that van trade has all but collapsed. We have in fact carried out two exercises in the current year, very low level surveillance, to see what sort of activity there is around the cash-and-carry areas in Calais. We would stand ready to reactivate those surveys to the level at which they were formerly conducted, if there were any indication that had risen, perhaps as a result of a relaxation of Customs activity. It seems to us to be very clear that the enhancement of Customs activity in 2000 had a direct impact on that level of smuggling. Perhaps if Customs are challenged in the European Court on the level of activity in channel ports, there could be a resurgence of activity and that is why we have maintained that low level of surveillance.

Q188 Mr Walter: Do you think the decrease in this has been because of the level of Customs' surveillance rather than because the Chancellor has the relative levels of duty about right?

Dr Long: I would say very much the former.

Q189 Mr Walter: I thought you might.

Dr Long: Yes, there was a direct impact on this highly visible trade across the Channel and this was entirely due to the level of activity in the Channel ports.

Q190 Mr Walter: Is there any discernible problem in terms of cross-border trade between Northern Ireland and the Republic of Ireland?

Dr Long: This is not marked, but we would see this whole area as actually a European issue. The Chancellor repeats the mantra of fiscal sovereignty and we understand that. However, the UK is not alone in having a problem; in fact the degree of cross-border smuggling is relatively low in the UK. When we looked, for example, in Sweden, the amount of beer which is consumed in that country which has not paid Swedish duty is about 33 per cent and all this is because of cross-border differentials. It is a domino effect. If the duty rate in the UK were reduced, then there would be an immediate problem in southern Ireland. We would talk about approximation of duties, rather than harmonisation of duties and we believe that would be achieved, not by increasing the low duty rates in those countries with low levels of excise duty, but by starting a process of reducing the high level of taxation, particularly in northern European countries. When the single market opened in 1993, a target level of excise duty was set. The levels of excise duty have moved generally downward towards that target level or below. The UK stands alone in moving away from that target level of duty and in fact exacerbating the problem that we have.

Q191 Mr McFall: I want to look at the memorandum of understanding. In that memorandum of understanding the government clearly believes that duty stamps can work provided the trade can demonstrate a clear commitment to supporting them in other ways. The trade and Customs working together is extremely important. It is important that progress is made in signing this memorandum of understanding, but given that some trade bodies have been in discussions with Customs for over three years it does not look very encouraging. How can you zoom into that?

Mr Good: Ian Shearer has some grey hairs but that is one of the things which has been giving him ---

Q192 Mr McFall: How can you get that speeded up and get something done?

Mr Shearer: In the Budget 2002 the Chancellor set up this body called the Joint Spirits Fraud Task Force. One of the objectives was to improve all the channels of communication between us and Customs on all sorts of things. After a while we decided to try to formalise that in a memorandum of understanding. That was negotiated during 2002-2003 where we tried to capture all the things the task force was doing. If there were any delays in that process incidentally, it was not entirely our fault that there were some delays during the negotiations. We were just about to sign this and we were about to launch it at a seminar in Glasgow last December and the Pre-Budget Report announcing tax stamps was the previous day.

Q193 Mr McFall: Come on, we are beyond that now. Let us get going.

Mr Shearer: We are beyond that. The memorandum of understanding is still on the table and we will have to ---

Q194 Mr McFall: Give us some hope on that.

Mr Hewitt: This is certainly something which would be a visible indication of our serious desire to co-operate intimately with Customs. I want to see the whole of the debate on tax stamps behind us. We will not necessarily wait for the debate to be behind us but I would hope that we should be able to say - remember it is not just the SWA, it is the gin, vodka, the wine and spirits ---

Q195 Mr McFall: The trade bodies are negotiating.

Mr Hewitt: All the industry, all the trade bodies. There is a very important thing too. There is another memorandum, to which you may not have seen reference, which is one with the warehousemen. That is one which is probably the most important of them all. It is not the producers who have been creating the fraud, it is further down the line. I believe that we should be able to come and agree. A lot of what we are talking about on tax stamps is already reflected in the memorandum of understanding.

Q196 Mr McFall: So we could be talking about six months at the most before a memorandum is signed. Is that correct?

Mr Hewitt: As the representative of The Scotch Whisky Association it has to be signed and agreed by all my member companies and on that basis I certainly will want to go ---

Q197 Mr McFall: Will you take that to your next meeting then?

Mr Hewitt: It is not on my agenda for tomorrow, but this is certainly something I want because we want to discuss it with Customs and Excise at our next meeting with Customs and Excise in January.

Q198 Mr McFall: Could you envisage it being on your agenda the day after tomorrow?

Mr Hewitt: Do you want me to call them all together specially? I do not think that this is an issue. The industry is ready to co-operate totally and fully with Customs and Excise.

Q199 Mr McFall: But government and Customs see it as an issue, so it is important, if this co-operative spirit is to be maintained, to get that memorandum signed as quickly as possible. Do you agree?

Mr Good: The principle is absolutely right. We want the MoU. That is the piece of paper which says "We want to work together and make sure we stamp out fraud". In the PBR the Chancellor recognised that the industry and Customs had been working together. What we are saying is that he has recognised it, we want to do it, there are still one or two issues outstanding, let us get them out.

Q200 Norman Lamb: Is the memorandum containing the package of measures which you put forward as the alternative entirely different?

Mr Hewitt: No, the memorandum predates the package of measures we put forward before the budget. Can I also emphasise that we have been producing more measures. We have given all sorts of ideas to Customs and Excise which they can put in place. The memorandum of understanding is not signed because effectively they took the carpet from under us last December when we were ready.

Q201 Mr McFall: They are bad people, these Customs and Excise, are they not?

Mr Hewitt: I had a signature from nearly all the companies of our membership to go and sign it. That was one of my very first duties.

Q202 Mr McFall: We have moved on from that. You are the Chairman of The Scotch Whisky Association, so you can have chairman's prerogative and put it on the agenda, can you not?

Mr Good: Absolutely. For the avoidance of doubt, there is no suggestion of people dragging their heels. Quite frankly we are trying to get the whole question of how we best stamp out fraud and that has to be a combined effort. We want to do it.

Mr McFall: And do it quickly.

Q203 Norman Lamb: Are you saying the warehouse ownership is ---

Mr Hewitt: No, we do not. This is the warehouse association. It is separate.

Q204 Norman Lamb: Sure, but you said a few minutes ago that you think they should be signing up their own shortly.

Mr Hewitt: They have negotiated. It is absolutely crucial that they should sign too.

Q205 Norman Lamb: They have negotiated, have they?

Mr Hewitt: They have negotiated a text. They are in the same state as we are, as I understand it.

Q206 Mr McFall: Can you give us a date?

Mr Shearer: No. Can we reassure you about the controls in these third party warehouses, back to an earlier thing of yours about the loss of control in these third party warehouses, as well as the memorandum which they are negotiating? I would give Customs a lot of credit. Since 1997 and all these huge problems which occurred, a series of new controls has been introduced at these third party warehouses. It is really the job of Customs.

Q207 Norman Lamb: You have just given evidence about a man with a conviction for fraud in charge of a warehouse in Liverpool now.

Mr Shearer: I cannot comment on that.

Q208 Norman Lamb: You just have done; or your colleague has.

Mr Hewitt: Presumably they are satisfied that the two other directors are legitimate.

Q209 Norman Lamb: You clearly criticised that.

Mr Hewitt: I did; correct.

Q210 Norman Lamb: Is that part of your package of measures which ought to be taken?

Mr Hewitt: We would argue with Customs that if they find there is an irregularity the licence to trade under duty suspension should be withdrawn. End of story.

Q211 Norman Lamb: A warehouse which has a director with a conviction for fraud ought not to be capable of this.

Mr Hewitt: Basically has not passed the test of being a fit and due person to carry out the job.

Q212 Norman Lamb: Is that the test?

Mr Hewitt: That must be the test.

Q213 Mr McFall: That could be in the memorandum of understanding of the warehouse people. We did mention that a major part of this fraud problem is the ability of fraudsters to acquire goods from unknowing legitimate traders, producers or warehouse keepers. What can be done by Customs to stop that happening? You have said there is work to be done with Customs to stop that happening and you have indicated in the past few years there has been progress there but maybe more could be done. Duty stamps are obviously a major part of that. What more could be done across the industry to reduce the scope for such acquisitions to happen? For example, would the trade consider more radical voluntary action selling duty paid to customers about which it has doubt and could that feature in that memorandum of understanding?

Mr Good: That happens. It does not happen so much now but as has happened in the past, where there has been any question that someone would sell on or some question about whether they were bona fide, then one route is to sell duty-paid.

Q214 Mr McFall: If that were included in the memorandum of understanding ---

Mr Hewitt: It is.

Q215 Mr McFall: If it is signed, then that is going to happen. Surely that step in itself, which is quite radical, must help reduce fraud?

Mr Good: The only issue I am querying is the question of "radical". We have been doing it and we would do it, because we want to stamp out fraud.

Q216 Mr McFall: But Norman talked about guys from Liverpool and elsewhere screwing the system.

Mr Hewitt: We do not trade with them.

Mr Good: Our company would not trade with that warehouse.

Mr McFall: Somebody must be trading with them.

Q217 Norman Lamb: Who is trading with them then?

Mr Good: These are third party warehouse people trading between themselves.

Q218 Norman Lamb: Which is where the fraud is perpetrated.

Mr Hewitt: Most of the fraud.

Q219 Mr McFall: You guys could stop it by getting the duty paid, asking them to pay it because there has been a question mark over them.

Mr Hewitt: May I just explain? May I take Edrington's as an example? They pass it on to the distributor. That is under duty suspension. The distributor passes it on to another legitimate trade who is at that point a third party warehouse; again, known to their distributor. That third party warehouse then can trade to another person. That is well understood. That is not in Edrington's control at any moment.

Q220 Mr McFall: I understand that. What I am saying to you is that what is in Edrington's control is that you are supplying to people. If you have doubts about them, then you ask them to pay duty. That is the point.

Mr Good: Exactly and that is what we do; that is what we have done.

Q221 Mr McFall: What is the problem then? This should be a land free of fraud then, if that happens.

Mr Good: The point I was making earlier was that we have had one call in the last year from Customs and Excise with even a question mark over fraud of our products.

Q222 Mr McFall: I would put it back to you that maybe a quality control exercise should be instigated by yourselves with your own companies looking at things like that to verify the veracity of the people down the line.

Mr Good: We have a team of people; Diageo have a team of people; Allied have a team of people. Their job is security. That is to make sure that we are not trading.

Q223 Mr McFall: There is a dislocation here. You are here because there is fraud. You have said that we cannot stop fraud, but we are trying to eliminate it and we want more radical steps to eliminate that. You have already admitted that in Liverpool and elsewhere you have it. If you have doubts about this step, asking for duty to be paid, surely to goodness that must eliminate fraud quite a bit. Would you not agree?

Mr Shearer: The big companies do look at this.

Q224 Mr McFall: But others do not, is that correct?

Mr Hewitt: Yes.

Mr Good: Yes.

Q225 Mr McFall: How can we get to the others who do not?

Mr Good: Some of the companies you say do not are small companies and they do not have the resource effectively to have a protection department; they do not have anything like that. They may legitimately sell ---

Q226 Mr McFall: So we have identified a black hole here; we have identified a black hole.

Mr Good: There are areas ---

Q227 Mr McFall: No, no; we have identified a black hole.

Mr Good: That is why there is fraud.

Q228 Mr McFall: How do we ...?

Mr Hewitt: May I say how we do it? We have suggested to Customs that those companies allowed to trade under duty suspension should be registered and there should be a known register of companies which are totally approved by Customs to operate under duty suspension, to trade under duty suspension.

Q229 Norman Lamb: A fit and proper person test of some sort.

Mr Hewitt: It is the job of Customs to make sure that each company is legitimate, has a good track record on paying tax.

Q230 Mr McFall: So you are discussing this with Customs, there is a memorandum of understanding coming. What is your suggestion? Would you agree that memorandum of understanding can take us a long way? Is that right?

Mr Hewitt: We should like Customs to do that, but Customs say they have a problem because they cannot stop people trading. I am sorry: that is not an acceptable response.

Mr McFall: There is an industry responsibility here. You should have accepted that industry responsibility and seen it and that black hole which was described.

Q231 Mr Walter: Are you saying that there are warehouses, there are traders who are what one might call bonded traders, who are trading, yet Customs and Excise do not approve or register or have any control or any means of checking what is in those warehouses, what is bonded, what is duty paid?

Mr Hewitt: No. Technically every person who is trading in bonded goods is checked by Customs and they do have, and they say and they claim they have, an assurance and they check to make sure they are legitimate traders. If they have done enough checks, we will not have leakage from these people. If they are leaking, they are not legitimate traders and they should not be on the register. Hence the point I made about one bond which we know has a director who has a criminal record for fraud.

Mr Shearer: One example of a very new control which has just come in is that all these warehouses now have to do electronic mandatory warehouse returns. Monthly they have to submit detailed information about what is in their warehouses and the idea is that Customs can then do trend checks on this. This is one example of the kind of controls where I think they have been very successful. I really believe that the level of fraud has come down significantly and it is a story of success.

Q232 Norman Lamb: It did come down.

Mr Shearer: Since 1997 all sorts of new controls have been put in place and one has to give Customs credit, they are policing this system more effectively.

Q233 Mr Walter: You are saying that it has come down, but that does not alter the fact that the system still operates whereby somebody can operate duty free in the UK and Customs are happy for them to operate duty free, yet Customs themselves admit that this is open to abuse. Let me give you a parallel. I used to have a farm and a Customs and Excise man would come to check my VAT returns and he would be more interested in the level of my phone calls. Yet here we are talking about millions and millions of pounds, to which they seem almost to have turned a blind eye in the past.

Mr Hewitt: That is exactly the point we are making. It seems to me that like a football referee, if someone gets it wrong there is a yellow card, if someone gets it wrong twice there is a red card on the basis that the first time it might have been a mistake, but with two mistakes where you are cheating the system you should not be let off.

Q234 Mr McFall: I would be the last to divide you, but I think Ian Shearer has a different view on that in terms of Customs.

Mr Shearer: It is very interesting to see that you are in the Thatcher Room. If we go back to Mrs Thatcher, in those days there used to be a Revenue officer in every bonded warehouse. They were taken away during the 1980s and this was great for blue chip companies, because there was no Revenue officer watching everything they were doing. Blue chip companies were trusted to police themselves effectively. It did open up opportunities for the unscrupulous in these third party warehouses. I believe that by policing these properly ---

Q235 Norman Lamb: Hang on. We have already established that Customs and Excise were allowing the frauds to continue; they were aware of it happening. Whether you have a bloke there or not ---

Mr Shearer: I do not know whether that was before these new warehouse returns or not.

Q236 Norman Lamb: It was in the 1990s.

Mr Shearer: With these new warehouse returns and other effective controls, if you watch, where is the stuff going that these warehouses are sending? Is it going abroad? Why would a warehouse in Liverpool be exporting one of Mr Good's brands? Surely an intelligent use of warehouse returns would mean that Customs would be phoning up and asking whether this stuff should be going abroad. You can police this system effectively if you study the warehouse returns properly. This system has just come in and I believe that it will be very helpful in trying to police the system more effectively.

Mr Hewitt: There are still gaps, but they are doing better.

Q237 Mr McFall: There is still a black hole and there is responsibility on both sides.

Mr Hewitt: Yes.

Mr Good: Absolutely.

Q238 Mr McFall: Is there any scope for a more consistent standard of vigilance across the industry to reduce fraud? Are some traders more careful than others to whom they sell? If so, is there anything the trade as a whole can do to ensure more rigorous checks?

Mr Good: A lot of it comes back to scale. Small companies will not have the resource to put in the policing which the larger companies do have. Some of the smaller companies will not be trading with what you might call international brands and therefore perhaps would be less concerned, not about fraud, but less concerned about where their goods end up. For example, if we sold our goods to a warehouse in the UK and they legitimately sold it on to a warehouse in France, we would be concerned because in fact our distributor in France was getting goods coming in from the UK and could disrupt the market. The question of control over brands is perhaps much more legitimate in terms of the bigger companies than a smaller company which is not developing brands, but is perhaps developing a secondary brand. They would not have the resource and they may be vulnerable to the person who just wants to trade a bottle of whisky rather than a brand.

Mr Hewitt: Additionally, in the 17 proposals we put forward before the Budget, there was a very important proposal and I touched on it already. It was that warehouses, particularly now we are talking about third party warehouses, should not have their guarantee used for the movement of goods under bond. It is the person who owns those goods who should actually be liable for that guarantee. If that owner is a fraudulent person, he will find it very difficult to get that guarantee. It is a fundamental change of where you get the guarantee for moving and holding.

Q239 Norman Lamb: Is it perfectly possible to implement that? No problem with European law or anything like that.

Mr Hewitt: Nothing. There is no difficulty whatsoever.

Q240 Norman Lamb: What is stopping you doing it?

Mr Hewitt: I think Customs are looking at it and I think they may well change the process.

Q241 Norman Lamb: How long have they been looking at it?

Mr Hewitt: We put it on the table at the start of this year.

Q242 Mr Walter: So you are saying that a legitimate trader, a bonded warehouse, can sell the goods which somebody else is going to ship, even if that person may not be a fit and proper person to take those goods without them having paid duty.

Mr Hewitt: Yes, unfortunately at the moment they can use the warehouse guarantee. I own a lorry-load of whisky. I have it parked in warehouse X. I then move that to another third party warehouse, as the owner. At the moment the warehouse guarantee is being used, very often, to ship from that warehouse to the other warehouse, for the movement. I as the owner am not liable for duty; it is the warehouseman. Off that owner goes, he may slip away, not pay the duty, divert it onto the market. He has escaped because he has not put down any guarantee; he is not liable for anything, the warehouseman is and they are not his goods. Effectively, if you put the responsibility to put the money up front on ---

Q243 Norman Lamb: Does the warehouseman avoid having to pay up on his guarantee?

Mr Hewitt: At this point Customs have a difficulty. Effectively, technically, the warehouseman is liable, but of course it is not the warehouseman who is responsible for the diversion.

Mr Shearer: Warehouse keepers are already very careful about whom they allow to use their guarantee, for obvious reasons. What they are talking about is a further code of practice or something where they would be even more careful about who uses their duty guarantee.

Mr Hewitt: If you create the system that the guarantee against fraud by movement is the owner, then you will indeed tighten this system very much.

Q244 Norman Lamb: Dr Long, you note that there are several regulatory measures to reduce beer fraud which have not been progressed because Customs' attention has been focused on the tax stamp issue. Could you just set out what measures you have in mind?

Dr Long: These were regulatory options which were actually discussed during the course of the past year, but were not progressed because of the attention which was understandably focused on the higher risk issue.

Q245 Norman Lamb: What are they?

Dr Long: We discussed issues such as the curtailment of movements in duty suspension. The Committee has talked about this. We were very opposed to this as an idea: the simple idea that if you do not have a duty suspense system, then you do not have a problem because you do not have diversion. In fact we made very strong representations about this, as did The Scotch Whisky Association and that idea was dropped. Several measures have now been carried forward into the business briefing which was issued with the PBR last week, things like notification of cash transactions and advance payments, real-time notification of excise movements, civil penalties for wholesalers and retailers. These are the sorts of issues which were being discussed. There was also a suggestion for beer and wine that there would be discussions on documentation and guarantees. In fact we have not had such discussions because resource has been drawn into the area of tax stamps.

Q246 Norman Lamb: You suggest that Customs adopt a risk-based approach to fraud which concentrates on movements to third party warehouses, what we have been talking about today. Why is this the area of greatest risk? I think we know why it is the area of greatest risk, but do you think enough is being done to tackle fraud at that point? When you put forward the recommendation that they should adopt this risk-based approach, the suggestion is that they are not really doing this at the moment.

Dr Long: That is absolutely right. We have said as an industry for a long time now, that there really is not a robust risk-based assessment. The legislation is applied as a blanket and this will affect the legitimate trader and very often actually not target the fraudulent trader. For example, in the case of the brewing industry, we would estimate that there were something like 150,000 duty suspended movements between the operating sites within the same company ownership. There is a huge movement of beer for onward packaging and packaging back to another brewery.

Q247 Norman Lamb: Do you suggest that number of movements implies that quite a proportion of those is fraudulent?

Dr Long: What I was coming on to say is that we take those 150,000 out of the picture. We would imagine the creation of a virtual brewery with movements, regardless of distance, which are controlled within the same computer system, which are extremely low risk to the Revenue; in fact I would say zero risk. I know of no fraudulent activity within that company curtilage. Then there are 25,000 movements which are outside that ring, which are moving down that chain of third party warehousing which has been described. It is those multiple movements, where the original despatcher of the goods is not aware of where those goods have actually ended up, and it is from there that there is a danger of a diversion fraud. What we are saying to Customs and Excise is that there should be a robust modelling of risk in order that we can help in saying let us take these low risk movements out of the picture and let us focus down on where there is fraud. Let us put that precious Customs and Excise resource into tackling where we all know the fraud is likely to be.

Q248 Norman Lamb: Is the guarantee point which we have been discussing part of that?

Dr Long: Absolutely right. We think that there should be a hierarchy of guarantees, that in fact in those low-/no-risk movement areas a guarantee is irrelevant. In those higher risk movements which are outside the virtual brewery, then there ought to be a higher requirement for a guarantee. We also believe that there should be a guarantee applying to the haulier, because in the majority of instances the diversion fraud which would occur would be with a complicit haulier. Finally, just going back to this point, given that we have suffered a loss probably of billions of pounds in duty, where does the fault lie for that staggering and outrageous loss? I appreciate that we are talking about organised crime, so that is where the fault ultimately lies, but why was it allowed to continue for so long? Did Customs fail to keep their eye on the ball?

Mr Hewitt: You have to understand that in the development of the single market and the development therefore of an EU duty suspension regime ---

Q249 Norman Lamb: It created the opportunity.

Mr Hewitt: --- it created the opportunity for people to move in.

Q250 Norman Lamb: Why take so long to get it sorted?

Mr Hewitt: If I may say so, I do think at that point - and I do support what Ian said, that things are getting better and that we have successes on both sides, but at that point - the eye was taken off the ball, what was happening was not seen and then we found ourselves caught up in very substantial fraud, culminating in 1997-1998, which was the high year.

Mr Shearer: The eye was very much back on the ball from then.

Q251 Norman Lamb: You have made your point.

Mr Hewitt: There was a time when they just did not see what was happening.

Q252 Mr McFall: You are the defender of Customs and Excise. Two or three points for the record. You have been opposed to the government's proposal to introduce tax stamps, but last week the government announced a number of changes to the proposals, including targeted exemption. I note they are talking about goods sold by registered mobile operators such as ferries and airlines and export shops which will be exempt from the requirement to bear duty stamps and the exemption of liqueurs as a class can be achieved in a way which avoids complexity. Uncertain of the degree of new risk, the government is attracted to the case for doing so. What is your view on that and on these changes in particular? Have they alleviated your main concerns, given the seeming progress which has been made here?

Mr Good: We have made a lot of progress since a year ago. There is an understanding now that both sides really do want to stamp out fraud. There was a feeling before that the industry could have done a lot more. Now there is a recognition that the industry has done an awful lot and that Customs are now seeing that the more we can work together, the better it is going to be. I think we have moved a long way.

Q253 Mr McFall: On the issue of compliance costs and I know that is a big issue for the smaller companies, as mentioned earlier, do you agree that the proposals coming forward from the government will significantly reduce the compliance costs of the schemes which were originally envisaged.

Mr Good: Oh, yes; the compliance costs will be reduced. One thing we do have to bear in mind is that while the compliance costs have been reduced, they are ongoing. They are something which are going to be a cost, particularly to smaller companies; it is going to be a cost to them for ever and a day. It is not just going to be a one-off and then they get back to normal.

Q254 Mr McFall: You say that the benefits of the package of measures suggested to the industry in response to the Chancellor's challenge to find a better way of tackling fraud than tax stamps, in your words, "... could remove at least 50 per cent of spirits fraud" and provide "--- more enduring effectiveness". Is it the case that these measures could and should be implemented anyway, regardless of any decision on tax stamps?

Mr Hewitt: Yes; absolutely. We think that many of the measure which we included in our 17 measures before the Budget are highly applicable, could be introduced very quickly and can be introduced almost within a matter of months.

Q255 Norman Lamb: Are these measures largely which have to be introduced by Customs and Excise?

Mr Hewitt: These are measures which largely have to be introduced, but it is the whole question of change in the process of guarantees, change in controlling warehouses a bit more efficiently.

Q256 Norman Lamb: They are not initiatives within your area of responsibility, but things for Customs and Excise.

Mr Hewitt: We have to co-operate with whatever it is they are going, but we are very happy to do it and we believe that it would actually massively improve the control of fraudulent activity.

Q257 Mr McFall: If I might sum up, we agree that we will never eliminate fraud, wines, spirits, beer, whatever else it is, but alcohol fraud has come down significantly, particularly since the 1990s; that is what we have been told. However, there is still a black hole somewhere, Mr Good and I agreed on that. The main issues or the main risks are through third party traders and maybe corner shops, off-licences. Am I correct in saying that?

Mr Good: Yes.

Q258 Mr McFall: You also accept the need for greater controls and working along with Customs and Excise you will be pushing for this memorandum of understanding to be implemented pretty soon.

Mr Good: As quickly as possible.

Q259 Mr McFall: Maybe creeping into that memorandum of understanding will be the issue of duty paid to customers, about which you have doubts. Or am I going too far there?

Mr Good: That is in it.

Mr Shearer: It is in it. A lot of the things in the MoU, including that one, are already happening. The MoU is an expression of all the things which are already happening.

Q260 Mr McFall: Yes, but there is still a way to go on taking account of the black hole.

Dr Long: May I just mention two points quickly, which perhaps we have been concerned about in our dealings with Customs and Excise? One we have mentioned, which is the beer fraud task force, in which we stand ready to play our full part. The other one is something which we have raised on several occasions and which we think could have a very dramatic effect on reduction of fraud. This is what we call simplification and modification or modernisation of the system. When we look at the complexity of the legislation we have and the way that companies operate, not only producing beer, but producing ready-to-drink ciders, etcetera, we believe there is great scope for simplification of the system by having a single registration, for example, of multi-site operations for provision of financial security for duty suspended movements, etcetera. The idea that we have presented is of utilising modern IT in order to track goods and ascribe the appropriate level of liability at the start of the movement, verifying the warehouse automatically. When the movement has been completed and the duty has crystallised then that is signalled, again electronically. We have mentioned this on many occasions to Customs and Excise and we have made presentations to the joint alcohol and tobacco consultation group. As yet it is disappointing that they have not taken those matters forward, particularly since we have offered one man day per month of logistics, of financial expertise, to act as a sounding board for Customs and Excise.

Mr McFall: What we will do is bring the minutes to the attention of Customs and Excise in the next few days and if you have any short-term problems with Customs and Excise, see Mr Shearer. Thank you for your attention.