Documents considered by the Committee on 29 November 2017 Contents

13EU budget: fight against fraud

Committee’s assessment

Politically important

Committee’s decision

Not cleared from scrutiny; further information requested; drawn to the attention of the Public Accounts Committee and Treasury Committee

Document details

Report from the Commission: Protection of the European Union’s financial interests—Fight against fraud 2016 Annual Report

Legal base

Report issued pursuant to Article 325(5) TFEU

Department

Treasury

Document Number

(38939), 11503/17 + ADD1–6, COM(2017) 383

Summary and Committee’s conclusions

13.1The European Commission publishes an annual report on the steps it has taken, in cooperation with the Member States, to protect the EU budget from fraud and other irregularities. Its latest report, published in July 2017, shows that the Commission received nearly 20,000 reports of fraudulent and non-fraudulent irregularities relating to the EU budget in 2016.166 These reports involved total sums of approximately €2.97 billion (£2.66 billion), of which €391 million (£350 million) were alleged instances of fraud.167 The vast majority of the reports received related to the expenditure side of the EU budget.

13.2From the UK’s perspective, the most important element of the Commission’s Report is its description of a two-year investigation into HM Revenue and Customs by the EU’s anti-fraud body OLAF. It concluded in March 2017 that HMRC had enabled importers of Chinese textiles and footwear to evade customs duties totalling €1.87 billion between 2013 and 2016. In response to these findings, it asked HMRC to take “all necessary actions” to stop the fraud from reoccurring, and to take “all appropriate measures to recover the customs duties evaded to the extent possible”. Separately, the European Commission has asked the Government to compensate the EU for the loss of these customs duties (which, as so-called “Traditional Own Resources”, are an important source of revenue for the EU budget). We have summarised the facts of the investigation, and the implications of customs fraud for the EU budget, in more detail in “Background” below.

13.3It is not apparent from the information currently available to what extent the Government accepts OLAF’s factual findings in relation to how this particular type of customs fraud was perpetrated in the UK, or what steps have been taken to put a stop to it. However, HRMC has said that it “does not agree [with] the calculations or recognise the conclusions drawn”. The Chief Secretary to the Treasury has also stated that the Government “[does] not recognise OLAF’s estimate of alleged duty loss”. The Commission has publicly warned that the UK may face an infringement procedure before the European Court of Justice for its failure to apply EU customs law and compensate the EU for the customs duties that were allegedly evaded.

13.4In view of the background to the allegations against HMRC set out in paragraphs 13.13 to 13.29, the potential implications of this dispute for the UK’s public purse (including any compensatory payments into the EU budget for the missing customs duties), and setting it in the wider context of possible negotiations on a new UK-EU customs partnership (see paragraph 0.31 below), we are asking the Minister to clarify the following matters:

Collection of TOR by HMRC

Further contributions to the EU budget

Implications of Brexit

13.5In anticipation of the Minister’s reply to our questions, we retain the document under scrutiny. We also draw it to the attention of the Treasury Committee and the Public Accounts Committee.

Full details of the documents

Report from the Commission: Protection of the European Union’s financial interests—Fight against fraud 2016 Annual Report: (38939), 11503/17 + ADD 1–6, COM(2017) 383.

Background

13.6The European Commission and the Member States have a shared responsibility to protect both the revenue and expenditure sides of the EU budget from being affected by fraud and other financial irregularities. As part of this process, the Commission reports annually on how it has worked with the Member States to protect the EU’s financial interests in its PIF Report.168

13.7The PIF Report for 2016, published in July 2017, shows that the Commission received nearly 20,000 reports of fraudulent and non-fraudulent irregularities relating to the EU budget last year, involving total sums of approximately €2.97 billion (£2.66 billion). Most of these reports concerned the expenditure side, mainly under the Common Agricultural Policy and the Cohesion Fund.169 A minority of 1,400 of these reports involved allegations of fraud, in relation to sums amounting to €391 million (£350 million) across both revenue and expenditure. The Commission has noted elsewhere that in 2016, the total financial corrections and recoveries for undue or irregular payments from the EU budget amounted to €3.4 billion (£3 billion).170

13.8The Chief Secretary to the Treasury (Elizabeth Truss) submitted an Explanatory Memorandum on the PIF Report on 10 October.171 From the UK’s perspective, the most important element of the PIF Report relates to its description of customs fraud at the EU’s external border. Evasion of customs duties affects the EU budget as such duties, alongside levies on imports of sugar, make up the EU’s “Traditional Own Resources” (TOR).

13.9The Report refers to the serious allegation—which the Government disputes—that HMRC allowed importers of Chinese textiles and footwear to evade customs duties totalling nearly €2 billion between 2013 and 2016, and that no measures have been taken to date to put a stop to the problem despite concerns being raised as far back as 2014.

13.10Given the financial and political implications of this allegation about HMRC, especially in the context of our EU withdrawal negotiations on both the financial settlement and the future trading relationship, we have further assessed the consequences of this dispute in some detail below.

Collection of Traditional Own Resources

13.11The revenue which funds the EU budget consists primarily of its so-called Own Resources, of which the one relevant to the PIF Report is the Traditional Own Resources (TOR).172 This refers to all customs duties and sugar levies collected by the Member States on imports from outside the EU; these are passed on to the European Commission, minus a 20 per cent collection cost which is retained by the collecting Member State. TOR are a substantial contribution to the EU budget: in 2015, the EU’s revenue from customs duties was €18.6 billion (£16.6 billion), or 12.7 per cent of its total income.173

13.12The European Commission checks annually whether the national authorities are correctly applying EU customs legislation, and collecting the right amount of customs duties. Failure to comply with these rules may require a Member State to make additional contributions to the budget, including a penalty in the form of interest.174

Customs fraud and collection of TOR

13.13The vulnerability of the EU’s revenue from TOR to evasion of customs duties has long been recognised. In its 2012 Annual Report on the EU budget, the European Court of Auditors expressed concerns about “deficiencies in national customs supervision related to post-clearance audits and risk analysis”, warning that “there is an increased risk that the amounts of TOR collected are inaccurate”. It therefore recommended to the Commission that it should “encourage Member States to strengthen customs supervision” to maximise the amount of TOR collected.175

13.14In 2014, the European Commission, Member States and China’s Government carried out a joint customs operation (“Operation Snake”), targeting the undervaluation of imported Chinese goods. It uncovered “major undervaluation hubs” in five EU countries, including the UK.176 OLAF requested that Member States take the necessary measures to stop the fraud from occurring. The media subsequently reported that HMRC “initially complied with these requests”, but introduced the new risk assessment tools only for the four-week duration of Operation Snake.177

13.15In January 2015, OLAF formally opened an investigation in the UK due to concerns that HMRC was still allowing large volumes of undervalued Chinese imports to enter free circulation onto the EU’s Single Market, in violation of EU customs law. Over the course of 2015 and 2016, OLAF also held four bilateral meetings with British officials “where the magnitude of the fraud scheme and the related risks were drawn to the UK’s attention”.178

13.16In November 2016, the European Commission’s annual inspection on TOR in the UK also found “significant weaknesses in the management and control of undervalued imports of textiles and footwear”.179

13.17While the OLAF investigation was on-going, the French customs authorities conducted “Operation Octopus” in the first half of 2016. This operation specifically targeted organised criminal networks which imported textile and footwear from China into the EU via the UK. The Operation concluded that substantial undervaluation was still taking place during customs clearance in the UK,180 further exacerbated by non-payment of VAT in both the UK and the EU countries to which the goods were subsequently shipped.181

13.18OLAF concluded its investigation into HMRC in March 2017, as reported in the press at the time.182 It effectively confirmed the findings of Operation Octopus, namely that HMRC was still allowing large volumes of undervalued Chinese imports of textiles and footwear to enter free circulation onto the EU’s Single Market “even after repeated warnings”. For example, OLAF found that the HMRC had cleared imports of women’s trousers from China valued at €0.91 per kilogram, even though this value was less than 5 per cent of the average customs valuation for such products across the EU (and, indeed, lower than the price of world market price of raw cotton at the time).183

13.19Following its investigation, OLAF issued two recommendations to the UK authorities:

Impact on the EU budget

13.20As customs duties are normally levied ad valorem or by weight, an underreporting of either the value or weight of an imported good means that the amount of TOR it generates for the EU budget will be correspondingly lower.

13.21OLAF estimates that the customs fraud that occurred in the UK resulted in a loss to the EU budget of €1.57 billion (after deducting the UK’s share of the collection costs)185 between 2013 and 2016.186 The Commission’s annual TOR inspection in November 2016 also found that the UK had “wrongly cancelled customs debts amounting to £357.1 million” in relation to undervalued imports. The Commission is due to assess the amount of customs duties potentially evaded in the UK in 2017 at a later stage.

13.22The OLAF investigation also revealed evasion of VAT on Chinese imports routed through the UK for sale in other Member States. This fraud was facilitated by an abuse of the suspension of the payment of VAT under the so-called customs procedure 42.187 Effectively, VAT was not paid in the UK and the companies receiving the goods elsewhere in the EU were systematically wound up before they could pay VAT. As a result, other EU countries—in particular France, Spain, Germany and Italy—were deprived of an estimated €3.2 billion in VAT for the period 2013–2016.188

13.23The level of VAT evasion will also have had a small, indirect impact on the EU’s revenue, as the Member States transfer a fixed percentage of their VAT base to the budget (this “call rate” is fixed at 0.3 per cent for most countries). Similarly, the underpayment of customs duties and the evasion of VAT will have increased the GNI-based contributions all Member States make to the EU budget, as it is the balancing factor which is increased or decreased depending on the other sources of revenue to ensure the EU can meet its expenditure commitments. It is not clear whether—should some of the customs duties evaded in the UK subsequently be paid—Member States’ GNI contributions for the affected years may be retrospectively decreased.

13.24Based on its findings, OLAF recommended to the European Commission that it should ensure the recovery of the evaded customs duties, and assess whether it should bring infringement proceedings against the UK for the latter’s failure to comply with EU budgetary and customs legislation. The European Commission’s Director-General for the Budget subsequently wrote to the Government on 24 March, inviting it to:

13.25In the absence of evidence that the amount of customs duties evaded is different from the total calculated by OLAF, the Commission said it would be “obliged to call on the UK to make available an amount in traditional own resources corresponding to the losses identified by [the investigation]”. EU budgetary legislation also provides for the accrual of financial penalties in the form of interest on late payments into the budget.189 In the meantime, the Commission entered a formal reservation into its annual activity report on the budget for 2016 to note the inaccuracy of the TOR amounts transferred to the EU budget by the UK since 2013.190

The Government’s response

13.26From the documentation made available by OLAF and the European Commission, it appears HMRC was warned repeatedly from 2014 onwards about the weaknesses identified in the valuation of imports from China without the necessary measures being taken to address the problem. In March 2017, a spokesperson for OLAF said that:

“Despite repeated efforts deployed by OLAF, and in contrast to the actions taken by several other Member States to fight against these fraudsters, the fraud hub in the UK has continued to grow.”191

13.27The Commission in July 2017 again warned that “in the event the UK does not take appropriate corrective action” the Commission will take “all appropriate measures to protect the financial interests of the Union including, where appropriate, the legal action envisaged by the Treaties”.

13.28It is unclear what the Government’s view is of the deficiencies in the UK’s customs administration identified by OLAF, other than to dispute the amount of customs duties that may have been evaded. In her Explanatory Memorandum on the PIF Report, the Minister notes that the Government “has made clear to the European Commission that we do not recognise OLAF’s estimate of alleged duty loss”, and that it is “taking this matter forward with the Commission”. HM Revenue and Custom’s Annual Report, published in July 2017, states:

“HMRC is closely investigating the allegation by OLAF (…), in their report of March 2017, of undervaluation of imports of Chinese textiles into the European Union. HMRC is analysing the detail of the report but does not agree the calculations or recognise the conclusions drawn by OLAF and will respond to this report in due course.”192

13.29We are not aware of further action taken by HMRC to address the incidence of undervaluation fraud, or of any agreement between the Commission and the Government with respect to additional payments by the Treasury into the EU budget to make good any liability that arose because an incorrect amount of customs duties were collected.

Our assessment

13.30The PIF Report itself is a straightforward factual summary of steps taken by both the Commission and the Member States to protect both the expenditure and revenue sides of the EU budget from fraud and irregularities.

13.31However, we consider that the concerns raised by OLAF and the European Commission with respect to the collection of customs duties are serious enough to warrant the request of further information from the Minister for a number of reasons:

13.32Given the above, we have decided to retain the document under scrutiny while we await further information from the Minister on the matters raised by OLAF’s allegations.

Previous Committee Reports

None.


167 The total EU budget for payments in 2016 was €143.9 billion (£128.3 billion).

168 From the French, “Protection des intérêts financiers”.

169 The total budget for payments in 2016 was €143.9 billion (£128.3 billion), although irregularities reported are often in in relation to payments made in previous years.

170 These sums are given for information only as they do not necessarily relate to reports of fraudulent or non-fraudulent irregularities made in 2016. See COM(2017)351 for more information.

171 Explanatory Memorandum submitted by HM Treasury (10 October 2017).

172 The other two elements of the Own Resources are a share of each EU country’s VAT base, and a GNI-based contribution which is directly proportional to each Member State’s economic size.

173 See the European Commission’s Financial Report for 2015. The sugar levy charge paid by sugar importers accounts for a much smaller amount of TOR (€124 million in 2015).

174 Chapter 12, article 1.2.0 Customs duties and other duties referred to in Article 2(1)(a) of Decision 2014/335/EU, Euratom.

175 European Court of Auditors, 2012 Annual Report on the EU budget.

176 The others were Malta, Portugal, Slovakia and Spain.

177 Politico, “UK faces €2 billion EU tab for China fraud“ (7 March 2017).

178 Idem.

180 French customs concluded that the goods’ values declared on importation into the United Kingdom, on the basis of false invoices, were 5 to 10 times lower than those declared for similar goods elsewhere in the EU.

181 OLAF, “La douane et l’OLAF présentent les résultats de l’opération OCTOPUS“ (28 September 2016; accessed 18 October 2017).

184 Among OLAF’s recommendations to HMRC—and EU customs authorities more generally—were the inclusion in its risk management system of EU-wide risk profiles based on ‘clean average prices’; systematic challenges of potentially undervalued goods detected by means of risk profiles; and a policy of refusing to release goods unless the declarants of potentially undervalued goods had removed the HMRC’s “reasonable doubts about the accuracy of the declared value”, or provided a guarantee to fully cover any customs debt incurred.

185 The total amount of customs duties estimated to have been evaded is €1.87 billion (£1.72). The current collection cost retained by Member States is fixed at 20 per cent of the total customs duties collected. However, prior to 2014 it was 25 per cent.

186 The total amount of customs duties lost was calculated to be approximately €1.87 billion between 2013 and 2016. By comparison, the UK’s actual net payment of TOR in in 2014 was €2.7 billion and 2015 was €3.2 billion.

187 Customs procedure 42 provides for non-EU goods to be released into free circulation in an EU Member State exempted from import VAT on the condition that these goods will be transported to another Member State due to an intracommunity transaction. [If you import goods from outside the EU, you normally have to pay VAT as if you had bought them in the UK. In some circumstances you may be able to obtain relief from import VAT by claiming Onward Supply Relief (OSR).OSR lets you import goods from outside the EU specifically to forward them on to another EU country without paying UK VAT on them. Instead, the VAT is accounted for in the destination country.]

188 After clearing customs in the UK, the goods would be shipped to companies set up for that purpose and subsequently dissolved before any VAT was paid.

189 Article 12 of Regulation 609/2014 specifies that, for non-Eurozone countries, the interest rate on late payments into the EU budget will be equal to the rate applied by their Central Bank plus 2.5 percentage points. This rate is increased by 0.25 percentage points for each month of delay.

190 See https://ec.europa.eu/info/sites/info/files/file_import/aar-budg-2016_en_2.pdf. This document is not ordinarily deposited for scrutiny.

193 The European Commission has taken the position that the ECJ should continue to have jurisdiction over the UK for all relevant cases pending on “Brexit day”. The Government has been more ambiguous, although the Prime Minister told the House on 11 October that the “implementation period” she is seeking for a two-year period after March 2019 “may mean that we start off with the [Court] still governing the rules we are part of for that period”.

195 Post-Brexit, when the abolition of customs controls under the Single Market no longer apply to UK-EU trade, goods exported from the UK into the EU could face a higher level of checks to establish their provenance and true value, leading to delays and costs for exporters.




1 December 2017