House of COMMONS
MINUTES OF EVIDENCE
TAKEN BEFORE
TREASURY COMMITTEE
Wednesday 12 January 2005
MR BEN STEVENS, MR NIGEL NORTHRIDGE, MR GARETH DAVIS and MR DAVID DAVIES
Evidence heard in Public Questions 261 - 373
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Oral Evidence
Taken before the Treasury Committee (Treasury Sub-Committee)
on Wednesday 12 January 2005
Members present
Mr Michael Fallon, in the Chair
Mr Nigel Beard
Mr Jim Cousins
Norman Lamb
Mr John McFall
Mr Robert Walter
________________
Examination of Witnesses
Witnesses: Mr Ben Stevens, Regional Director Europe, British American Tobacco, Mr Nigel Northridge, Chief Executive, Gallaher Group Plc, Mr Gareth Davis, Chief Executive, Imperial Tobacco Group Plc, and Mr David Davies, Senior Vice-President, Corporate Affairs, Philip Morris International, examined.
Q261 Chairman: May I welcome you to the Sub-Committee this afternoon, to help us in our inquiry? A key element of the strategy to reduce tobacco smuggling is reducing the supply of cigarettes that are available to smugglers. As I understand it, Customs have signed a Memorandum of Understanding with the three major UK tobacco manufacturers. How is that working in practice?
Mr Davis: From our point of view, it is working very well. It is something that obviously will continually be revisited in the regular meetings, so that it can be maintained as the cutting edge of best practice. I would elaborate a little more and say that it is working so well that we have also signed Memoranda of Understanding with another six European nations' customs authorities, and we are in discussion with a further 12 customs authorities in Europe and beyond.
Mr Northridge: From our perspective, I would reiterate what Mr Davis has said. I feel that it is working exceptionally well. We have seen a reduction in the non-UK-duty-paid volume from around 25 billion to 20 billion cigarettes in the last five years. There are three sources of illicit volumes that are still coming into the UK: one relating to outside Europe; second, counterfeiting; third, people going to Europe itself, which I am sure we will talk about later on. We would still like greater resource put into Customs, but the Memorandum of Understanding, as a principle, has been very useful. We were the first to sign it, and we are equally looking to use this technique in other parts of Europe and also farther afield.
Mr Stevens: We are very happy. We have always co-operated with Customs anyway, so the Memorandum of Understanding just takes us to a new level of that co-operation. We are very happy with the way things are going. I think that Customs are very happy too.
Q262 Chairman: How does Philip Morris work this? You are not a UK company. Have you signed a similar agreement, or has anything been proposed with Philip Morris?
Mr Davies: No, we have not. We do work closely with the UK Customs and Excise. Our products are sold here. They are imported from our factories in Germany and Portugal. As you know, we have signed an agreement with the European Commission and ten of the Member States that is very extensive and constitutes a commitment on our part, and a commitment on the part of the European Commission and the ten signatory Member States, to co‑operate together to fight illegal trade of all forms; and, for us, particularly to focus on the alarmingly increasing trade in counterfeit goods. That agreement has very extensive compliance protocols, customer oversight provisions, product tracking and tracing provisions, as well as a commitment by us to contribute a substantial amount of money - over a billion dollars - to the European Commission over the next 12 years, in order to enhance their efforts to do everything they can to prevent the growing trade in illegal and, particularly, counterfeit products.
Q263 Chairman: Is the UK one of those ten states?
Mr Davies: The UK is not a signatory to that agreement. It can, if it wishes, sign the agreement and become a party to it.
Q264 Chairman: What is preventing you signing an agreement with the British Customs?
Mr Davies: We are more than happy to have the UK sign the European agreement. It is far more extensive in its provisions, its scope and extent than any Memorandum of Understanding that exists with our company and other governments, or other companies and the UK government or other governments.
Q265 Chairman: Has the UK Government or Customs proposed a Memorandum to you?
Mr Davies: No, they have not.
Q266 Norman Lamb: Why do not the UK Government sign up to this, in your view?
Mr Davies: I think that is a question you have to ask your Government.
Q267 Norman Lamb: But your view of this? You must have talked to them.
Mr Davies: No, I have not talked to the UK Government about that. I think that it is a question you have to put to the Government, as to why they do not wish to sign on to this agreement.
Q268 Chairman: The other three of you, do you regard the European Union agreement as stronger than your Memorandum of Understanding with the British Customs?
Mr Davis: I do not particularly, Mr Chairman, no. I think that our Memorandum of Understanding is ----
Q269 Chairman: Because you have signed one with other EU Member States.
Mr Davis: We have signed separate Memoranda with other European states, yes. The difference I would see is that there was also litigation, or contemplated litigation, involving the EU and the ten Member States and Philip Morris. We are not involved in any form of litigation related to smuggling and we see the Memorandum of Understanding as more appropriate. It is extremely comprehensive. It not only covers illicit trade into the UK, ex-UK manufactured product, but it covers all our factories in other parts of the world and it comprehensively covers counterfeit, which has been the growing problem over the last couple of years. I would therefore argue that ours is a very comprehensive document with Customs and is working very well.
Q270 Chairman: Since you last appeared before the Public Accounts Committee, I think it is true to say that seizures of your brands have actually declined. Is that right?
Mr Davis: Since 2001 - which predated the PAC, which I think was in June or July 2002 - at the time we came to the PAC, seizures of our products were already down 40 per cent in the prior six months; but since 2001 seizures of genuine Imperial product are down by 92 per cent. It is fair to say that, in the four months ending September 2004, in total three million cigarettes of Imperial's were seized.
Q271 Chairman: To what do you attribute that step change? It is not just the Memorandum, is it?
Mr Davis: No, I think that a lot of the activity was taking place before the Public Accounts Committee meeting, but since that time, working strongly in association with Customs, we have obviously made very significant inroads into the problems of smuggling of genuine product into the UK - or our product. The sad thing to reflect is that, I would not say there has been an exact mirroring, but there has been a very significant uplift in the amount of counterfeit product coming into this country, and I think that is the major challenge we now face.
Q272 Chairman: With Gallaher the story is not quite as good, is it? Customs told us that, for 2003-04, 74 per cent of all the cigarettes they seized in that year were two of your brands.
Mr Northridge: Yes. Unfortunately, it all relates to one particular distributor, who has responsibility for about 12 territories. Having signed the Memoranda of Understanding, and being the first company to so do, we felt it was correct to introduce that customer to Customs before we gave him the contract in 2002. Initially, things seemed to go very well. There was no sign of product coming back. Then, at the end of 2003, beginning of 2004, product started returning. We subsequently withdrew the brand of Sovereign, despite the fact that the packaging of that brand had been designed to be completely different from that in the UK in the first place. We withdrew that brand in June of last year and we have not sold cigarettes of our brands to that individual since. We have effectively suspended the contract.
Q273 Chairman: For all brands?
Mr Northridge: For all brands, to all those territories, to that distributor - because it is clear to us that he is unable to exercise the control we need within our international trading policy to ensure that that product remains in the markets it was destined for.
Q274 Chairman: How does that happen? Do you not vet a distributor?
Mr Northridge: Absolutely. We go to huge lengths to understand not only his intent but the guiding minds of the owners of the company, his experience, his knowledge of the tobacco industry, his sub-distributors. Unfortunately, further down the chain, it would appear that there are people who have been able to get their hands on this stock and return it to the UK. We therefore have no other methodology, other than to withdraw the brand and to discontinue the trade.
Q275 Chairman: So it was the control procedures that were at fault? It was his control procedures that were at fault?
Mr Northridge: It is his control procedures that are at fault. However, we appointed him and so we are not blameless in that sense. It is wholly unacceptable, and that is the reason we have withdrawn business, or suspended trade.
Q276 Mr Walter: I wonder if I could follow up on that one point. In the case of that particular distributor, are you physically delivering the stock to him in that territory, or is he taking possession of the stock in this country and exporting it himself?
Mr Northridge: We mark the product with the destination market, the distributor, and the time and place of manufacture. In some cases, we ship directly to market. In some cases, we ship to his warehouses and then we follow up by visiting the markets that he subsequently ships to.
Q277 Mr Walter: Is there any possibility that those cigarettes never actually left this country?
Mr Northridge: I do not believe so, no.
Q278 Mr Walter: I wonder if I could go on more generally to the evidence that you have submitted. I think that all of you basically suggested that the whole area of tobacco smuggling grew exponentially in the 1990s. One of the figures that stands out to me when I look again at the Gallaher evidence is that you say, "By the end of the 1990s, the Tobacco Manufacturers Association estimated that some 78 per cent of UK consumption of hand‑rolling tobacco was sourced abroad. In other words, four out of five hand-rolled cigarettes smoked domestically have no UK duty paid on them". This enormous increase - does this imply that Customs and Excise had taken their eye off the ball in that period?
Mr Northridge: I think that it is very easy with hindsight. At the time, I think that we were also taken a bit by surprise. Despite the fact that in the late 1990s we were developing relationships with Customs, we were shocked by the increase. We started restricting our supply to Belgium on that basis. However, it became very clear, with a tax-driven differential of over £5 for one 50 gramme pouch, and very easy to pack and to take this product across - and I think that it coincided with the price war battle with the ferries, so that for a couple of years you could get across to Belgium and to Adinkerke and back for £1 - during that period it became a business which grew at a huge rate of knots. I would not want to blame Customs in that sense. I think that it was driven by a period of significant price increase, driven by a tax increase of five per cent plus inflation, and we were all caught a little bit by surprise, to be honest with you.
Q279 Mr Walter: I do not know whether others have a comment to make on that?
Mr Davis: With roll-your-own tobacco, in some ways it is a smaller problem, in that it only represents ----
Q280 Mr Walter: The whole market grew.
Mr Davis: It only represents about 12 per cent of total UK consumption. Paradoxically, however, it is a more difficult one, because the vast majority of roll-your-own tobacco that comes into this country is EU duty paid; i.e. it has borne duty in another EU Member State. Basically, the inflow is largely dominated by cross-border shopping and/or what we would call bootlegging, which is product which has attracted duty in the intended country, the destination market, but has been brought back in quantities for the purpose of illegally reselling. In roll-your-own tobacco, the vast majority of it has borne duty in some country of the EU. With cigarette it is somewhat different, in that there is a much wider field, as it were.
Q281 Mr Walter: This trade was, if you like, the white van trade. What were Customs doing? In your opinion, what were Customs doing in this period? Obviously not stopping it.
Mr Davis: The thing that kicked it into life was very much the entry into the Single Market in 1993. That is when it took off. As my colleague said, it perhaps caught everyone a little by surprise and it took some time to catch up with that. I think that the difficulty Customs have had - and it has been a real difficulty - is the growth in indicative allowance limits for British citizens exercising their free will as EU citizens to travel to another Member State to purchase goods, et cetera, and the difficulty in being able to differentiate between the legitimate cross‑border purchaser and the bootlegger. As we know, the UK Government has taken a fair amount of stick in recent years from the EU Commission, in terms of the enforcement and the seizure regime that we have had at the ports. I think that Customs have had to bear a lot of unfair criticism in trying to control what is a particularly difficult area.
Q282 Mr Walter: Mr Stevens, do you have a view on that?
Mr Stevens: Yes, I concur with what Mr Davis and Mr Northridge have said. Smuggling of BAT brands into the UK has never really been a problem, I have to say. The amount of BAT product that has been seized, as a percentage of the total seizures, is less than a third of one per cent. So it is a very small problem.
Q283 Norman Lamb: Why is it different between different companies?
Mr Stevens: I have no idea why it is different between different companies. I can guess. BAT was not really in the UK market before 1999. It was only when we merged with Rothmans that we entered the UK market. We have a very low market share in the UK anyway. Our market share is below six per cent. When people do cross borders to smuggle brands, they tend to smuggle market-leading brands. So the smaller manufacturers tend to fall off the end of the equation - would be my guess.
Q284 Mr Walter: The estimate of non-UK-duty-paid share of total UK cigarette consumption peaked in the year 2000 at 31 per cent - which, if I were in the Treasury, I would be somewhat concerned about. It seems to have slipped back now to about 27 per cent. Mr Gareth Davis, perhaps I could put this to you, because this was in your submission. In terms of the smuggled element of that, based on your pack collections you showed that cigarette smuggling had slightly increased in 2003 to 18 per cent, whereas Customs estimated it had fallen to 15 per cent. Have you looked at those figures with Customs, to see why not only are your figures different but your trends are different?
Mr Davis: The answer is yes. We discuss the figures at our regular meetings with Customs. The important thing is that, while there may be slight differences over the estimates and the components of the non-UK-duty-paid segment, directionally we broadly agree the way things are going. Estimates of this nature in this type of trade are incredibly difficult to attain, and it is very difficult to verify their accuracy in total; nevertheless, they are estimates. Basically, we establish our figures by three routes: via sales to trade in the UK; via market research; and via pack collection exercises, where we collect discarded packs. We collect around 10,000 packs a quarter from pubs, clubs, football grounds, racetracks, et cetera, and analyse those. There is a slight difference in the estimated size of total consumption between the TMA, ourselves and Customs and Excise. I think that they are largely about collection period, timing differences. The other difference is that in our figures we take the Customs number for what we would call official/legal cross-border purchases. If we apply that figure of Customs to our total estimate, we are left with a derived figure, which would suggest 18 per cent on our data, rather than the 15 per cent of Customs. However, overall, directionally, in macro terms, we would agree with Customs that things are moving very much in the right direction.
Q285 Mr Walter: Why do you think that is?
Mr Davis: If we look at the point you made, Mr Walter, over the period that we are talking about the trend has come down from 31 per cent and we are in the mid-twenties somewhere. Whether it is 24 or 26 or whatever, it is definitely moving down. Certainly in the latest 2004 data from Customs, it has moved down again to the figure they quote as around 15 per cent. We would not really take issue with it. We think that estimates are notoriously difficult. The timescales and the periods of measurement are somewhat different between some of the manufacturers and Customs, and I think that accounts for most of the differences. Directionally though, we do not disagree.
Q286 Mr Walter: Can I go back to the Gallaher statement to us and quote? You say, "Taken alone, Customs and Excise analysis of seizures suggests that contraband cigarettes appear to be almost entirely sourced from outside the EU. By contrast, the pack surveys and our analysis of pack discards indicate that around 60 per cent of non-UK-duty-paid cigarettes come from markets inside the EU". What leads you to this view, which seems to be in total contradiction with the Customs' view?
Mr Northridge: To be honest with you, Mr Walter, it may be confusing in the way we have articulated it, because I would not disagree with what Mr Davis was saying or, indeed, indicatively with what Her Majesty's Customs have been saying. We believe that the UK non‑duty-paid element in the UK market is somewhere around 25 or 26 per cent, which is very similar. We think that there are three sources to that. The thing that has changed in the last five years is the source of that change. Originally, some 80 to 90 per cent of seizures were tobacco or cigarettes coming in from outside Europe. That is now between 20 and 30 per cent. In terms of the huge growth in the UK non-duty-paid portion which is coming from Europe, it is impossible for us to ascertain, or indeed Customs, to what extent that is based on people legitimately going and buying cigarettes for their own consumption as opposed to bootlegging. We believe that an increasing portion of that element is being bootlegged, as opposed to people buying for their own consumption. We have a concern that, going forward, that may increase, unless we can work together with Customs to try to reduce that potential. Anecdotally, I read in a newspaper over the Christmas holiday that a plane from Tenerife landed at Newcastle Airport on Christmas Day; they did not expect there to be Customs officials around on Christmas Day, and there were. They walked through the airport, leaving their bags, and there were two million cigarettes left on the carousel. Those are examples of what can happen - with the realisation and the knowledge that if you only buy the 3,200 indicative allowance and you sell those cigarettes on, you can, at full retail differentials, make £500. That will pay for your weekend trip to Spain. I think that there is a real need, if we can, to get the whole of Europe to apply a fixed limit which you are allowed as an individual to have in your possession. I understand that the French authorities are debating at the moment whether that should be, for example, 1,000 cigarettes. If we had tax harmonisation, this issue would not arise. Without that, with differentials - for example in Spain, Portugal and Greece, where people are increasingly travelling to on budget airlines -they can acquire cigarettes at full retail price at less than half the price of the UK. Without any indication as to what limit they are allowed to bring back, I think that increasingly people will be tempted to bring back more than they are going to consume themselves, and find a business. The problem with that is that it opens up illegal channels; it does not have the same control, in terms of access to children; and the third is counterfeit, which we have all mentioned, which is a very big and growing problem for all of us. However, to me, it is still nowhere near the size of the bootlegged issue, which is probably of greater concern because those products have been manufactured by people who we have known ----
Q287 Mr Walter: So you stick by your view that 60 per cent of the non-UK-duty-paid cigarettes come from within the EU?
Mr Northridge: Absolutely, but I do not know what portion of that 60 per cent are legally being purchased by people, as opposed to being bootlegged.
Q288 Mr Walter: I appreciate that.
Mr Northridge: That is the differential. I do not believe that Customs or my competitors here would greatly disagree with that number. It used to be about two-thirds coming from outside Europe; now it is 60 per cent coming from within Europe, but maybe only half of that is bootlegged - maybe not even half of it. We simply do not know. I do not believe that Customs could possibly know, because it is very difficult. There are 45 million trips by British people across to Europe every year. That is a huge opportunity for people, with one little carrier bag, to bring back more cigarettes than are for their own consumption.
Q289 Mr Walter: But Customs' estimate is that only 15 per cent is smuggled.
Mr Northridge: Yes, but that is 60 per cent of the 22 per cent or the 25 per cent. In and of itself, it is about 15 and then you have to add the small portion of cigarettes that are still coming in from outside Europe, but that is declining very quickly. So, in all, the numbers are not dramatically different. We just wanted to bring attention to the fact that we, at Gallaher, would very much like there to be some fixed limit, so that consumers themselves knew what they were entitled legitimately to bring back into the UK, as opposed to indicative figures - which were 800 and then went to 3,200, and which I think has led to a growth in this bootlegged business. Unfortunately, I cannot prove it to you, other than anecdotally, reading newspaper articles, and our sales force - 300 people - going to a shop where suddenly the business is decimated, and we think that it is maybe because of a car boot sale, or a pub next door, or a house on a housing estate where somebody is travelling weekly. I think that increasingly they will go to the accession countries, where you can buy cigarettes fully duty paid for less than £1. You are only supposed to bring 200, but if you think that there is a pretty good chance that you will be able to get an easyJet or a Ryanair flight and walk through without being stopped, I think that increasingly they will do so. If you see Customs, I think that is a pretty big deterrent.
Q290 Norman Lamb: Do you all agree that there should be a fixed limit rather than indicative levels?
Mr Davis: I would like to put one further dimension on that. I think that the idea of a fixed limit is laudable, but ----
Q291 Norman Lamb: Is it lawful?
Mr Davis: That is the problem as I see it. We then have to look at the pragmatic aspects of it. In fact, the current debate in the EU Commission is to abolish indicative limits, and it just becomes a free-for-all. So that would be very much contra to the way the EU is thinking. I do not think that the problem is with indicative limits; it is lack of adherence to the indicative limits which is the problem. I think that is what we have to do.
Q292 Norman Lamb: Other than equalising tax rates, which is unlikely to happen given the political debate, what else could be done to tighten it up? Are you talking about much better Customs controls?
Mr Davis: I think that there are a number of things in terms of recommendations. We very much believe in closer frontline co-operation with Customs. We do not think that the problem is just about container scanning or that type of trade - the container trade coming in. We also think that there is still a cross-Channel activity that needs to be controlled, with closer frontline co-operation and resources.
Q293 Norman Lamb: Are there things that Customs are not doing that you think they ought to be doing?
Mr Davis: There are a couple of things that would very much help us and Customs in the activities. We are promoting two of those things with Customs. One is the ability for them to seize genuine product, where it has been diverted by a third party - which they can do perfectly legally from the country of destination, with correct paperwork, and the Customs cannot seize the product. We have just undertaken two cases in Holland and Belgium where, paradoxically, we have used intellectual property law in order to seize that product in those countries.
Q294 Norman Lamb: This requires a change in the law.
Mr Davis: Whether it be law or the rules of engagement, I am not quite sure where it falls. Certainly, if our Customs and indeed other countries' customs authorities could have that power of seizure, and then when they have seized it destroy it, where it has plainly been mis‑declared or is an illegal movement of product, that would help.
Q295 Norman Lamb: You said there was another one.
Mr Davis: Extending the concept of the European transit guarantee bond to a worldwide basis would help, whereby monetary guarantees were put in place with the various fiscal authorities throughout the world. That would flag up suspicious movements much more clearly to the various Customs authorities.
Q296 Norman Lamb: Have you proposed this to Customs?
Mr Davis: Yes, we are in discussion with Customs on that. Obviously, it is not entirely within their bailiwick. A lot of this would involve international customs authorities. However, we would certainly be promoting it through those where we have an MoU.
Q297 Norman Lamb: So that I understand the scale of it in pounds, the 18 per cent of the total UK market which is smuggled - what is that in pounds, in lost duty?
Mr Davis: In lost duty, I think the latest figure is around £3 billion.
Q298 Norman Lamb: Per year?
Mr Davis: Yes.
Q299 Mr Cousins: I wonder if I might ask Mr Davis for some comments on the questions which have just been raised by my colleague.
Mr Davies: May I first say that indicative limits are a matter of great concern, but it cannot be looked at in isolation. Several governments in Europe have expressed the view to us that if one had clear rules about what one could purchase and what one could bring home, that, in and of itself, would reduce the amount of illegal cross-border selling. There is a great deal of confusion about what one is allowed to do and what one is not allowed to do. Looking at fixed limits alone, however, leads one to miss opportunities. The first place one has to start is the establishment of a secure distribution network for cigarettes throughout the supply chain - from manufacturers to logistics providers to wholesalers and to retailers.
Q300 Norman Lamb: With traceability.
Mr Davies: With traceability and with enforcement, because once you have established that distribution chain and one attaches to that requirements through licensing, for example, then you have to protect the legitimate supply chain. That requires enforcement, obviously. However, there are measures. If one had that, one could, for example, make it unlawful for a licensed retailer of tobacco products to sell more than a certain quantity of cigarettes on any given day to an unlicensed purchaser. That system actually does exist in Spain, for example. If one is selling more than, shall we say, 1,000 cigarettes on a daily basis to a purchaser, there is ample reason to suspect that is not for personal consumption. If one were to make the possession of a licence dependent on commitments and responsibilities to sell responsibly and not to sell irresponsibly, I think that would do much to address the problem of the losses to revenue that this government and other governments suffer as a result of the confusion around cross-border sales. Yes, one has to harmonise government policy in relation to protection of the internal market. However, today in Latvia the tax is 16 euros per 1,000 cigarettes and here in the United Kingdom it is 263. If one were to have a pure internal market for cigarettes, no one would buy cigarettes in the United Kingdom; they would buy them all in Latvia. That does not promote policy within the UK for revenue protection, the prevention of fraud, or the promotion of public health policy, in terms of using taxation as a measure to reduce consumption of cigarettes. So I think that you have to look at the issue holistically; not seize on one issue. You have to look at how one can accomplish a secure distribution network, with obligations attached to every player within the supply chain, which will ensure that there is no infiltration of that network; that there is no diversion from it and no circumvention of it.
Q301 Mr McFall: In your submission, Mr Davies, you said that we need "the creation of a secure distribution network". That is why Philip Morris support "the licensing of tobacco product, manufacturers, importers, exporters, warehouse proprietors, transporters, distributors and retailers. Any person trading...without a licence would be subject to severe penalties. Any licensed person trading in genuine non-domestic or counterfeit cigarettes upon which UK taxes have not been paid should be subject to the same penalties, as well as forfeiture of their licence". On a superficial basis, that looks very much like a watertight situation. First of all I would ask why we have not moved to that and, second, would everyone at the table agree that we should have such a licensing system? Mr Davies, could you answer first?
Mr Davies: It is a solution but it also requires enforcement, obviously. That is why we advocate, as part of the structure of a secure distribution network, the issuance of licences, with severe penalties attached for violating conditions. Conditions can include an obligation to maintain appropriate records; an obligation to permit government to audit movement of goods and to audit shipments to customers; an obligation on retailers not to sell product that is not lawfully tax-paid product; an obligation on retailers not to sell to young people. There is a whole range of measures, but it clearly requires enforcement. Smuggling depends on a willing marketplace and a distribution network. To the extent you have an unregulated distribution network, you are encouraging and facilitating smuggling.
Q302 Mr McFall: But if I could take Mr Northridge's point, from what you said earlier on it was the breakdown of the distribution network that caused the problem. So if we had a licensing system which included proprietors, transporters, distributors and retailers, that would be an almost foolproof system, and the problem that arose with Gallaher would not arise in the future.
Mr Northridge: I would not disagree at all, Mr McFall. I just do not believe that, while that is a fantastic vision, in a practical or administrative sense you would be able to get to it. As Mr Davies said, it requires huge amounts of buy-in from everybody, right across the whole of Europe. We cannot get tax harmonisation at the moment. To ask for this kind of vision would be even more difficult that getting tax harmonisation.
Q303 Mr McFall: So it is a pipe dream then?
Mr Northridge: No. It is a new concept to us. I have only heard of it in the last few weeks. I just believe that it would be very difficult. I believe that the BAT-driven initiative of the export bond guarantee is a step in the same direction, without the same degree of difficulty. It will not be easy because, again, it will require a lot of government and Treasury buy-in but, ultimately, I think that it is a more practical solution.
Mr Stevens: There are a number of different issues that we are talking about here. I think that licensing the supply chain can help in some circumstances. For example, if you are trying to stop traders selling products to children, then licensing them and withdrawing the licence can be very helpful. The situation in the UK is slightly different. The majority of the smuggled product being sold in the UK, as far as I am aware, is sold in pub car parks and car boot sales. It is bought, duty paid, in other European markets. A licensing system will not really help you there. That is the problem we have with it. On the other hand, it could cause the most enormous administrative burden. To license the entire supply chain across the whole of Europe, which is what you would be talking about, would be extremely difficult. Therefore, I think that there are advantages in having licensing, but I am not sure that we will solve the problem we are debating today with it. That is my concern.
Q304 Mr Walter: Perhaps I could come in on Mr Davies's point. We do not need a licensing system, because any legitimate retailer is already subject to all that kind of audit from Customs and Excise in his VAT return. We all know what his turnover is - unless he is committing fraud. So we do not need to go down the licensing route. Mr Stevens has a very valid point there: that it is the people who are selling outside the legitimate chain who we have a problem with.
Mr Davies: I think that we have to create consequences. A licensing mechanism provides a unique opportunity to create very serious consequences. I should also say this. Let me come back to the issue of whether it is a pipe dream and whether administratively the burdens can be overcome. I do not think that it is a pipe dream - if there is a real commitment on the part of government and on the part of those involved in the trade to solve the problem, which is hurting all of us. The Government is losing hundreds of millions of pounds. We are losing hundreds of millions of euros in lost sales. If there is a real commitment, it can be made to happen, and it can be self-financing.
Q305 Norman Lamb: Just explain how you are losing your sales.
Mr Davies: Because every time someone buys illegal product - ours, for the most part, it is counterfeit product - we are losing sales. Not only that, we are putting our brand equity at enormous risk, because the quality of those products does not match ours. Let me just say this by way of analogy. The port of Rotterdam invested 14 million euros in a scanner. Within the first six months they had recovered 20 million euros in lost duties. A licensing scheme, taking the same sort of approach, can be self-financing in terms of the recovered losses to both the government, manufacturers, and others involved in the distribution chain.
Q306 Norman Lamb: Is there any precedent for this in other products or other jurisdictions?
Mr Davies: Spain has a licensing scheme, which includes limitations on the quantities of products that retailers can sell. They enhanced those provisions in the late 1990s. As this Committee is probably aware, through a combination of significantly increased enforcement efforts and these changes to the licensing system in Spain, we have seen a very dramatic reduction in the levels of illegal sales of cigarettes within the kingdom of Spain. I think that is a very good example.
Q307 Norman Lamb: Mr Northridge, you refer in your submission to further research by Customs and Excise in conjunction with other EU customs authorities, "to help to establish more accurately the scale of smuggling from other EU countries, thereby enabling supply routes to be focused upon and controls to be put in place". Have you suggested this to Customs? Is this something that is likely to be taken up?
Mr Northridge: Yes. With the opportunity of meeting Customs at every level and with policy every six months or so, they are aware of and they share our concern.
Q308 Norman Lamb: Because there is clearly a lack of intelligence, is there not, about what is actually happening?
Mr Northridge: Yes, and I think that the intelligence that existed for the tobacco products being brought in from outside Europe allows us to turn our attention to within Europe.
Q309 Norman Lamb: According to Customs, large-scale, organised smuggling gangs, who supply most of the illicit market, have increasingly switched their attention to counterfeit product. As a result, there has been a significant increase in the volume of counterfeit cigarettes seized, which we have heard about. Do you measure the volume of counterfeit cigarettes in the market, using your pack surveys, and what is your estimate of the level of counterfeiting?
Mr Northridge: We started our pack survey in 1998, where we interview - perhaps "interview" is too strong a word - we get 500 or 600 people every month to contribute towards that survey. It suggests that somewhere around 21/2 per cent of the market - say, two to three billion cigarettes currently being consumed in the UK - are counterfeit, and it is growing.
Q310 Norman Lamb: Is that an estimate that you share?
Mr Stevens: Of the BAT product that is seized and given to us by Customs to look at, 80 per cent is counterfeit. So it is very significant.
Mr Davis: For us it is 93 per cent that are now counterfeit, and we go to some pretty grotty places to do pack collections. We would estimate a little higher than Mr Northridge: probably somewhere nearer to the Customs' estimate. I think that their mid-range estimate is about four billion cigarettes.
Q311 Norman Lamb: According to your submissions, the root cause of tobacco smuggling is the fact that the UK has the highest taxes on cigarettes in the EU, but the UK retail price net of taxes is also the highest in the EU. In the UK it is £1.05, compared to 68p in France and 54p in Spain. Do you accept that your own pricing policies are also contributing to the problem?
Mr Davis: No, I do not. If you look at the tax-exclusive prices in the UK as a percentage of the retail price, you find the UK is one of the lowest in Europe at about 22 per cent.
Q312 Norman Lamb: Because the tax is so high.
Mr Davis: If we look at Sweden, it is 30 per cent; Germany and Italy, 26 per cent; the Netherlands, 29 per cent. It is only France, at 20 per cent, that is lower.
Q313 Norman Lamb: Just going back to the figures I quoted you ----
Mr Davis: The absolute cash amount.
Q314 Norman Lamb: Why £1.05 in the UK, 54p in Spain? You are making a lot more profit here than in Spain.
Mr Davis: There are also some significant differences in the market. In the UK, we have 191,000 points of sale to service. In Spain - one of my colleagues may correct me if I am wrong - I think that it is around 40,000. This is obviously higher absolute prices, so we have higher retail margins - because of the higher insurance costs, because of the higher tax-driven prices, higher property costs. Also in this country, ourselves and the retailers have the cost of discounting - which does not take place in other countries. If we put all those ----
Q315 Norman Lamb: So you are saying the figures that I quoted do not include what is happening in terms of discounting?
Mr Davis: No, that takes place after, as it were.
Mr Northridge: An interesting point, I believe, is if you look over the last decade and strip out inflation and the excise increases, in total the price of Gallaher cigarettes over that ten years, on a volume-weighted basis, has only increased by 5.7 per cent. Not per annum: in total, over ten years.
Q316 Norman Lamb: But you are still making more here.
Mr Northridge: Our margins have increased because we have been able to take out costs, and we have economies of scale; but, from a consumer perspective, it has not had a huge effect.
Q317 Norman Lamb: You are still making more on your packet of cigarettes here than you are in Spain.
Mr Northridge: We are. Absolutely, yes.
Q318 Norman Lamb: Substantially more - double.
Mr Northridge: At the premium end, yes. On our biggest selling brand in the UK, Mayfair, we do not. It is about the same as we make in continental Europe, but on the premium brands we do make more. But we have invested far more, over many years, and they have a higher cachet in that sense. We tend at Gallaher to be in the value end in Europe and in the premium end in the UK, so we would expect the margins to be higher. The important thing from the tax-driven, smuggling perspective is that the retail price differential - stripping out inflation and tax - has increased by only six per cent. Even if you took just the taxed price in the UK of, say, Benson and Hedges at £3.77, it is still more than double the full margin price in Spain. Even if we made them, sold them and distributed them for free, it would still be more than double.
Norman Lamb: I am sure that you will not do that.
Q319 Mr Beard: You have supplied us with written evidence, setting out what you are doing to combat this illicit trade in both genuine and counterfeit products. Can you give us an idea of what resources you are devoting to combating cigarette smuggling, say in terms of the number of people you have involved in this sort of exercise? Mr Northridge?
Mr Northridge: We have a specific brand detection team of around seven or eight people. The point I have tried to make, more importantly than that but in that context, is that we have a sales force of 300 in the UK and a global sales force of 2,500 people, and our international trading policy, in our submission, is really a way of life. It is implicit in the way in which our commercial people do business. Everybody is charged with ensuring that that policy is enshrined in the way they act, feeding that information back up through the brand enforcement team, through internal audit - which is good risk assurance - to the board, where we identify it on a quarterly basis and debate it, and then give all that information back to Customs. That, I believe, is more relevant than the specific eight or nine people who are in that brand detection squad. If you take that, plus the market research, plus the external agencies that we also use, plus witness statements, attending court sessions, et cetera, we estimate that we spend in excess of £1 million in that area. However, I want to reiterate the point I have made. It really is a way of life. Everybody who is employed at Gallaher at the commercial end understands that it is their responsibility to do everything in their power to bring these people to justice or to eradicate that business. In that sense, therefore, they are all whistle-blowing.
Mr Davis: I concur with what Mr Northridge has said. It is very much embedded throughout all of our sales organisations worldwide.
Q320 Mr Beard: How many people do you have?
Mr Davis: On top of that, on the specific brand integrity side, as we call it, we have got a fixed staff of 25 people worldwide who are liaising with the various Customs Authorities, getting involved in co-operation with other manufacturers with raids on counterfeit factories, and what have you. I would estimate our ongoing overhead, as it were, on top of what is embedded throughout the sales organisations to be between £5 million and £6 million, something like that, with some of the fees we pay as well.
Mr Stevens: We have probably nearer 100 people involved in brand enforcement, either directly or indirectly, looking at counterfeit or smuggling, costing tens of millions of pounds. That involves going into China and trying to stop the manufacture of counterfeit products in China. It is a very significant operation for us.
Mr Davies: We have a brand integrity group staffed by approximately 55 people. In addition, there is a group within our packaging department that is dedicated to exploring ways in which we can effectively counter the efforts of those criminals engaged in counterfeiting our products. The brand integrity group conducts investigations, gathers information and works with law enforcement authorities in over 60 countries. For example, in 2003 we were responsible for providing information that led to 350 successful raids on counterfeiting operations and the seizure of over a billion cigarettes. In addition, we work with Customs Authorities to provide them with information and training. In 2003 we conducted more than 70 training sessions with Customs Authorities in more than 25 countries. On these efforts we spend somewhere between $30 million and $40 million each year. As I said earlier, we have made a commitment to the European Commission to fund their efforts to crack down on illegal trade over the next 12 years with a commitment to pay more than $1 billion.
Q321 Mr Beard: There is quite a range of effort in every case but it is really quite a small proportion of your turnover, is it not? You would not say you were breaking the bank in the effort you are devoting to counteracting smuggled products, would you?
Mr Stevens: For example, last year alone in China we had 400 factories raided and 350 cigarette making machines seized. That is a significant amount of effort to cause that to happen.
Q322 Mr Beard: A key element of the Customs' strategy is to reduce the supply of cigarettes available to smugglers and this relies to a large extent on controls over who you will do business with. You note in your submission that you will, if necessary, terminate your relationship with distributors you believe are acting improperly. How many distributors have you ceased trading with on those grounds over the last three years?
Mr Northridge: In the case of Gallaher I think it is around 12 and also we have developed a list of around 50 people that we would not be prepared to do business with that we have picked up in our conversations with Customs.
Q323 Mr Beard: What sort of people are the 12?
Mr Northridge: They are distributors in places around the world. I could not name them, Mr Beard, they are all over the place.
Q324 Mr Beard: I am not asking you to name them.
Mr Northridge: They are just distributors we have been dealing with who we do not believe are able to exercise the control and the rigour we require within the international trading policy which is enshrined within the Memorandum of Understanding for the UK, but equally it applies to lots of other countries.
Mr Davis: Since the last three years, I am not sure of the absolute number, since late 1999 we have terminated 30.
Q325 Mr Beard: Between 1999 and now?
Mr Davis: Between the end of 1999 and the current date.
Mr Stevens: We have rationalised our number of distributors since merging with Rothman's in 1999, so we have taken out a considerable number of distributors. Asking our guys before I came here, they reckon about 30/35 would have been terminated on the grounds of being unsure where the product was going to end up.
Q326 Mr Beard: That is out of how many? How many would you be dealing with, just roughly?
Mr Davis: I can say intuitively it is a fairly small percentage if we look on a worldwide basis.
Q327 Mr Beard: What would be the number of people you are dealing with comparable with these you have suspended?
Mr Stevens: Something over 1,000 for BAT.
Q328 Mr Beard: Over 1,000. What about you, Mr Davis?
Mr Davis: Probably somewhat less than that. In our case, I would think probably 500 or 600, something like that.
Q329 Mr Beard: Mr Northridge?
Mr Northridge: I would guess around 100 but I would need to check that, Mr Beard, I do not have that figure.
Q330 Mr Beard: All three of you in those companies have laid quite an emphasis on this Memorandum of Understanding, a new dawn has come and you have got the Memorandum of Understanding. What are you doing differently now, having signed the Memorandum of Understanding, compared with what you were doing before you signed it? Mr Northridge?
Mr Northridge: I cannot think of anything. We had written the international trading policy about a year before we signed the Memorandum of Understanding and we saw the Memorandum of Understanding as simply enshrining what we were doing at that time. I cannot think of any significant difference in our trading policy as from beforehand.
Mr Davis: Not in our trading policy but it cements the commitment where we go way, way beyond the law. Basically we are looking at the cutting edge of best practice on illicit trade prevention and detection. We are very much looking at it on a much more international scale with UK Customs and what can be done as regards the sources and routes, et cetera, but also very much emphasised over the last year or two a huge amount of liaison on counterfeit and basically liaising on unsolicited approaches that we get from distributors and things like that, the enormous amount of witness support that we give. As Mr Northridge says, we have been doing a lot of these things for decades and they are enshrined. The Memorandum goes beyond those things and it is really a state of mind. Wherever we can mutually help each other we do, and that is the absolute norm. The one last point is that the interaction is almost on a daily basis. Yes, there are significant meetings at various levels of management on a regular basis but the interaction is very much daily.
Mr Stevens: We have always co-operated with Customs. The Memorandum of Understanding takes us well beyond what we are required to do by law.
Q331 Mr Beard: What does it include that you were not doing before?
Mr Stevens: I think we were always doing stuff before, we are just doing more of it. We are doing much more communication with Customs, we are doing some training with Customs, and we provide witness statements with Customs. It is more development of the relationship rather than a list of the activities that are done now that were not done before.
Q332 Mr Beard: This is very puzzling because we heard that the figures were not good and now we have got the Memorandum of Understanding, and you have mentioned it now and have mentioned it in your submissions, and Customs and Excise have mentioned it, it is a new dawn, yet when I ask you what has changed, nothing has changed.
Mr Stevens: The figures were always good for BAT, so there has never been a smuggling problem for BAT. There has always been good co-operation between Customs and BAT.
Q333 Mr Beard: What sounds very strange to people looking in from outside is that you are all subject to the law of the country and then you sign a Memorandum of Understanding that transforms things and you say you are going to co-operate. That is how the message is coming over to us and that sounds very strange because you are subject to the law anyway.
Mr Stevens: I can only answer that question from BAT's perspective. We have always co-operated with Customs in BAT and the Memorandum of Understanding demonstrates and lays out how we co-operate with Customs. Customs have never had a problem with smuggling of BAT product into the UK and it has never been a significant issue.
Q334 Mr Beard: Where is the Memorandum likely to have its biggest impact, on product that is yours that has been returned to the United Kingdom or on counterfeit product?
Mr Davis: I think increasingly it will be on counterfeit. Under the latest Customs' figures we are seeing about 54 per cent of the illicit market is counterfeit, so it is bound to be more down the counterfeit route I suggest, Mr Beard.
Q335 Mr Beard: One of the things puzzles us, again, is we have heard this story about Andorra, for instance, importing so many cigarettes that the population could not possibly have smoked them all if every man, woman and child had smoked from breakfast time to bedtime until they died. Your brands were amongst those going to Andorra in this ridiculous farce. Why did you not stop this and why did you not do something about it when it was spotted?
Mr Northridge: If I can speak for Gallaher, Mr Beard. Clearly we were aware of the huge sales growth, obviously, and we alerted Customs to it and they were aware of it too, but those cigarettes were duty paid and they were being purchased by people who, in the main, we felt were buying for their own consumption at the time.
Q336 Mr Beard: On that scale?
Mr Northridge: We then voluntarily significantly reduced supply to Andorra and subsequently we have reduced supply - I can think of two examples - to Luxembourg and to Gibraltar and, indeed, to Belgium in conjunction with Customs because we do not believe that market requires that amount of stock.
Mr Davis: Looking at the Andorra situation, it is a market, as I understand it, of about two to three billion cigarettes a year and we sell about 40 million cigarettes a year in Andorra, which is about two per cent. I think it peaked at 140 and something million. I think Spanish and French Customs also took action in that situation. Andorra is a very significant shopping place for people, not just for cigarettes but for white goods, everything, it is that sort of place.
Q337 Mr Beard: I am not focusing on Andorra but on a situation where they were plainly importing cigarettes out of any scale to what the population could consume. Plainly there was some funny business going on and you did not seem to do anything about it.
Mr Davis: I think there was something done about it, Mr Beard. There are time lags and one of the things we have learned about is time lags. If I look at the seizures of genuine Imperial products in the year ending 2004, I think it was a total of 66 million with three million in the last four months. By far and away virtually all of that relates to product which was actually sold in 1999, so there is a big stockpiling and time lag effect on these things.
Q338 Mr Beard: Have you anything to add to that, Mr Stevens?
Mr Stevens: I think Customs would confirm that this was never an issue for BAT.
Q339 Mr Beard: You refer again in your submission to the codes you place on cigarette packets and cartons. Do those not enable you to determine to whom each packet was supplied? Is that information that you supply to Customs so that they can trace smuggled cigarettes to the purchaser?
Mr Stevens: Yes, we share all of that information with Customs.
Q340 Mr Beard: Is that tracing done?
Mr Stevens: Yes.
Q341 Mr Beard: Is it being acted on?
Mr Stevens: Yes.
Q342 Mr Beard: According to British American Tobacco, China is the main source of counterfeit British American Tobacco products and most counterfeit cigarettes, including many of those coming into the UK, do originate from China. Do the other companies represented here share the view that China is the biggest source of counterfeit cigarettes?
Mr Davies: Certainly it is one of the largest. The world Customs organisations estimated that in 2002 there were 190 billion cigarettes counterfeited in China alone but, having said that, it is true that there is counterfeiting that occurs in Europe, in other parts of Asia and in Latin America. The trade in counterfeit cigarettes is huge. The counterfeit cigarette business is our fourth largest competitor now. China is working very, very hard to address the problem, and last year the Chinese Government prosecuted more than 150,000 cases against counterfeiting operations. By its very nature it is extraordinarily difficult, it needs the concerted efforts of governments across the world, of those involved in the trade, our suppliers, our business partners, and that is why we believe that the agreement that we have entered into with the European Commission will be a very, very effective tool because they are committing in that to join with us, not only within Europe but to reach out to governments across the world, to fight this problem.
Mr Davis: To echo what Mr Davies has said, China, Russia and the Balkans seem to have been the main areas, but China has dominated, I think. Certainly in conjunction with BAT, with Philip Morris and Japan Tobacco we have participated in many activities that in the last year have closed down 31 illicit factories, 11 illicit warehouses, 20 illicit printing factories, and we have seized around 750 million cigarettes in these types of activities as well. Much of that, particularly in China, has been with the full co-operation of the Chinese tobacco monopoly and Chinese Customs. I think it is a problem that the Chinese are very aware of and we are all working very hard on it, but the scale of the problem, as Ben outlined, is so enormous that it is a bit like the Forth Road Bridge.
Q343 Mr Beard: To tackle this problem a coalition was established by a number of international cigarette manufacturers and the Chinese authorities to identify and de-commission the factories, as you were mentioning. The other companies represented here, Mr Northridge, are all part of that coalition, but why are you not?
Mr Northridge: We have not suffered to the same extent as my competitors over the last two or three years, but during the last 12 months we have and we have been contributing informally where there has been product that was clearly destined for the UK counterfeit from China or elsewhere. I do not think it will be very long before we formally join and, in fact, we are in negotiation at the moment.
Q344 Mr McFall: Mr Davis, you mentioned your anti-counterfeiting operations against criminals with the UK as the target market and mentioned closing 31 counterfeit factories. Where were these located?
Mr Davis: The majority were in China.
Q345 Mr McFall: Were any UK based operations?
Mr Davis: We have had a couple of occasions when these have not been what I would call illicit factories but of the back street type in a garage type of counterfeit operations. We have found some in the UK and obviously we were straight on to Customs as soon as we were informed.
Q346 Mr McFall: Where in the UK, can you tell us?
Mr Davis: If my memory serves me correctly, I think one was in the North East but I do not know the exact location.
Q347 Mr McFall: If you can send us a paper on that.
Mr Davis: Certainly our people will do so. Just to add to this, one of the issues is one of the resources that we do have is that the component supply industry to the tobacco industry is actually quite concentrated, there are not that many printers and suppliers of filter tow, that manufacture filter tips. More and more manufacturers are engaging with the supply chain to actually get more control from their point of view over where their products go because these counterfeiters do need to source these components from somewhere. I think if we move down the chain, and we are doing this very much in association with Customs, this is one significant area where we can make a lot of progress.
Q348 Mr McFall: Yet Gallaher's and Imperial Tobacco have mentioned about the need to tackle counterfeit cigarettes and prevent the materials necessary for cigarette manufacturing being obtained. Can I ask how practical a proposition that is? What type of material do you have in mind? How many suppliers of these are there worldwide? In other words, is it a sophisticated technology or if you do not destroy your surplus machinery, as Imperial Tobacco said, can others make it at the drop of a hat?
Mr Northridge: From Gallaher's perspective I think you have raised two points, Mr McFall. In terms of trying to bring suppliers of raw materials into the whole network of trying to prevent counterfeiting I would reiterate what Mr Davis said, that the tow manufacturers are the most obvious people because really the components of cigarette packaging are paper or cardboard, foil, and then when it comes to the cigarette itself the tobacco, and there are only six or eight worldwide suppliers of tow, so I think that would be a good source. In terms of machinery, the Gallaher policy is that if we are not going to use it ourselves and if we cannot sell it back to the manufacturer then we will destroy it.
Q349 Mr Walter: What about the tobacco?
Mr Davis: Paradoxically that is probably the easiest thing for a counterfeiter to obtain. It is of questionable quality, one would have to say, but that is probably the easiest of all the components to obtain because a lot of it is domestically grown.
Q350 Mr McFall: In a sense, the proposition is not as practical as it would appear.
Mr Davis: No, I think there is a lot of mileage and a lot of merit in it because a cigarette without a filter is not going to be terribly attractive for anyone to buy given the tobacco types that they are using. I think the issue with counterfeit is that a lot of the punters who buy counterfeit tobacco are not sure when they buy the carton. The printing looks very good, it looks to be a bona fide carton, but it is when you open it and smoke it that you realise you have been had, or doubly had.
Q351 Mr McFall: A last one from me. ASH has sent us a briefing on this, no doubt friends of yours. How many of you smoke, by the way? Three out of four. It is three gold ambassadors for your companies. You are the odd man out, Mr Stevens. ASH has referred to the legal agreement between Philip Morris and the EU on smuggling as the gold standard by which all cigarette manufacturers attempting to control excise tax frauds should be judged from now on. What they are asking us to do is to urge Customs and Excise to renegotiate the Memorandum of Understanding that it has with tobacco companies up to the Philip Morris standard and to sign up to the PMI agreement. Would you be happy to enter into negotiations with Customs and Excise to do that?
Mr Northridge: Do you mean to the extent of paying a fine? In what sense? We are not a signatory to the Philip Morris agreement.
Q352 Mr McFall: Mr Davies is the expert on this. What should your competitors sign up to here?
Mr Davies: I think that is a question that really is better addressed to them.
Q353 Mr McFall: What you are doing that they are not doing?
Mr Davies: We believe that the measures that are embedded in that agreement are going to be extraordinarily effective in addressing the illegal trade, particularly this growing counterfeit trade. To the extent that anyone who is involved in the cigarette business chooses to take the same approach, I think we would all benefit. Whether they should sign up to it is a question that has to be addressed to them and not to me.
Q354 Mr McFall: I understand. Would you be willing to enter into negotiations? Customs and Excise are sometimes behind the curve, we find, and we have got to prepare the ground carefully for them. If you say that you would be willing to enter into negotiations today, maybe in our submission we will ask Customs and Excise to have a little chat with you on it.
Mr Northridge: I am very happy to talk to Customs and Excise on any subject as we see them so regularly.
Q355 Mr McFall: You must know what this agreement is about yourselves.
Mr Northridge: The background to the agreement is to clear up an historic litigation issue, to which we were not a party.
Q356 Norman Lamb: Can you summarise what the litigation issue was so we understand what we are talking about?
Mr Davies: Several years ago, the European Commission filed a lawsuit in the United States of America in a federal courthouse in Brooklyn. Principally it was brought against three entities: Philip Morris, Japan Tobacco and RJ Reynolds. The essence of the claim that was being made was that the defendants had facilitated the smuggling of cigarettes leading to lost revenues within the European Union. The lawsuit was dismissed by that court. An appeal was taken by the European Commission, which was unsuccessful. It was following the conclusion of that appeal, flowing out of the discussions we had been having with them, that we began the negotiations towards this agreement. This agreement as we characterise it and, indeed, as the European Union characterise it, is a commitment to co-operate. It makes sense because what we came to realise, both we - Philip Morris International - and the European Commission and the ten member countries involved, was that we had a shared problem. We had a shared problem of illegal trade that was causing damage to government revenues, causing damage to our revenues, harming our consumers, harming society in Europe as a whole, and we realised that the best way to address this shared problem was to have a shared solution and by working together we could accomplish more than we could working separately. That is why it is called a co-operation agreement and that is why it is focused on measures on their side and measures on our side that we believe will be effective in fighting illegal trade.
Q357 Mr McFall: Given that is the gold standard then, and the legal case is in the past, in a sense would you all be willing to enter into negotiations with Customs and Excise to get to this gold standard? Mr Stevens first. Just quick answers.
Mr Stevens: As far as I understood it the billion was the cost for settling the cost of the court case with the EU and we do not have a court case with the EU.
Q358 Mr McFall: As Mr Davies said, this illegal trade is harming consumers and it is harming society. On the basis of that criteria, are you willing to enter into negotiations?
Mr Stevens: I think there are bits of the agreement that we would support and there are bits that we would not support. The bits that we would not support would be voluntarily paying the excise on product that other people had smuggled, frankly I think that would be ridiculous. I think some of the tracking and tracing bits in the Philip Morris agreement are, to quote HMC, "missing the point" in terms of controlling smuggling because Philip Morris has talked about being able to identify the first customer and where there is a problem with the second customer, but by the time the product gets smuggled it has probably gone through ten or 12 customers, so I do not think that is going to create a great benefit either. I can understand why Philip Morris would like this to become an industry standard because they have spent a lot of money putting it together but I do not think it is going to solve the problems. I think bits of it we would support, but not all of it.
Mr McFall: But you would be willing to negotiate that.
Norman Lamb: Mr Northridge's body language is that it is not that simple.
Q359 Mr McFall: We will come to him. Mr Davis?
Mr Davis: I would take issue that it is actually the gold standard because I do not think it is at all. I can understand ASH saying it is the gold standard because anything that increases the cost of our licence to operate they would support, but they would, would they not? I do not think it is the gold standard, I think the gold standard is the sort of things that we are currently doing.
Q360 Mr McFall: Would you be willing to look at measures like that?
Mr Davis: I am always willing to discuss anything with Customs, but it has to be on an equitable basis.
Q361 Mr McFall: Mr Northridge?
Mr Northridge: Mr Lamb is right. I agree with 99 per cent of what Mr Stevens said. I think the gold standard is the Memorandum of Understanding.
Q362 Mr McFall: You are a bit naïve and a bit of a soft touch, Mr Davies?
Mr Davies: I do not think I would characterise it that way. I do not think the European Commission or OLAF or any of the ten Member States would characterise it that way.
Q363 Mr Beard: Mr Northridge, how can you say that when a few minutes ago you were saying that you had not really changed very much from what you were doing as a result of the Memorandum of Understanding, so why is it the gold standard?
Mr Northridge: Because it has worked, but we were doing that before.
Q364 Mr Beard: What does "worked" mean if you are doing the same afterwards as you were doing before?
Mr Northridge: It is about better collaboration, it is about more focus, more regular meetings. In our case, all the MoU did was to formalise what was in existence beforehand, but it has led to much closer co-operation.
Q365 Mr Beard: From what we have heard this afternoon it sounds as though before you were not really co-operating and now you are. I attribute the unworthy motive that now you see looming on the horizon a threat from counterfeit cigarettes that do touch your turnover, whereas the previous round-trip cigarettes did not and, therefore, you were not all that bothered about co-operating.
Mr Northridge: I disagree with you, Mr Beard, and I would like to think that Customs would agree with me that our relationship with them before the MoU was as it is after the MoU.
Q366 Mr Cousins: I think we should remind ourselves that we are talking about an illegal trade which supports petty criminal networks which reach every neighbourhood in this country. Mr Northridge, you have made reference to the incident that occurred at Newcastle Airport over the holiday season and, for whatever reason, Customs, who are not normally present at Newcastle Airport, were present. A large number of bags were left on the conveyor belts and they contained between 2 million and 3 million of cigarettes. There is no reason to suppose that the people concerned were coming to Newcastle. The fact is we have a large number of airports in this country now which support charter and cheap flights to an increasing range of destinations at which Customs are not routinely present. The Newcastle incident that was picked up might be repeated every day of the week in any of the airports in Britain outside of the big ones with a permanent Customs presence. Do you feel that the optimistic picture given by Customs in their evidence to the Committee on counterfeit cigarettes is borne out by your own reference to the Newcastle incident, which demonstrates that the lack of presence by Customs officers at this increasing range of airports may be one of the sources of our difficulties?
Mr Northridge: I believe that there will have been an excellent return on the investment in 2000 in an extra 1,000 Customs officers, as evidenced by the reduction in non-UK duty paid from around 25 million to 20 million. I believe that same investment would get a good return again in the next five years if that was able to be achieved. I think greater presence at airports, at ports, and helping and encouraging them to work together on counterfeit would get fantastic returns.
Q367 Mr Cousins: I wonder if I could ask Mr Stevens, you were an advocate of the Export Bond system in your evidence to the Committee. What reaction have you had from Customs to the idea of an Export Bond system which is internationally validated and which, of course, the Government would have to take up with other jurisdictions?
Mr Stevens: The Export Bond is pretty much rolling out what currently happens in the EU around the rest of the world.
Q368 Mr Cousins: Beyond the EU?
Mr Stevens: Beyond the EU. The Export Bond itself would not solve some of the problems of smuggling into the UK because where smugglers go and hoover up duty paid stock around Europe ----
Q369 Mr Cousins: Do forgive me, Mr Stevens, the Committee is short of time. I am not asking for a rehearsal of what the Export Bond is, that is in your evidence and we are grateful to you for it. What I am asking you is what is your perception of the energy and enthusiasm and commitment that our Customs Authorities are putting into getting that kind of international agreement beyond the EU that the Export Bond system needs to be put into effect. That is my question.
Mr Stevens: I think we have had good discussions with Customs and Excise and we are not at the stage yet of rolling it out worldwide, but it is something that we think would make a difference.
Q370 Mr Cousins: You have had discussions with them and you both agree it is a nice idea. What evidence do you have of the energy with which Customs has taken this up with other jurisdictions?
Mr Stevens: I cannot answer that off the top of my head.
Q371 Mr Cousins: Thank you. Mr Davies, I think in response to a question from me, you set out very, very clearly your suggestion of a licensing system and, as our Chairman has referred to, we have had other evidence about your agreement with the EU. What reaction have you had from our governmental authorities, from Customs and Excise, when you have discussed these issues with them? Have they been enthusiastic? Have they said, "Well done, what an interesting idea, there are bits here we want to look at"? How have they reacted?
Mr Davies: We have had no discussions with the Customs and Excise Authorities here directly concerning the agreement. We have had numerous discussions with them in relation to the issues addressed by the agreement. I thought initially that they viewed the concept of securing a distribution network through means such as licensing had some appeal. I was rather surprised to read in the transcript of their testimony before this Committee the comment that it rather misses the point, because I do not think it does. I think it misses the point not to realise that the heart of controlling the issue is to secure and protect a legitimate supply chain.
Q372 Chairman: Thank you all very much indeed. Mr Davis, I think you promised a note on something that Mr McFall asked you.
Mr Davis: Yes.
Q373 Chairman: If the Committee could have that reasonably quickly.
Mr Davis: Indeed.
Chairman: Thank you all very much.