11UK customs controls and the EU budget
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Committee’s assessment |
Politically important |
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Cleared from scrutiny; further information requested; drawn to the attention of the International Trade, the Public Accounts and the Treasury Committees |
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Document details |
(a) Report from the Commission: Protection of the European Union’s financial interests—Fight against fraud 2016 Annual Report; (b) European Court of Auditors Special report No 19/2017: Import procedures |
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Legal base |
(a)—; Report issued pursuant to Article 325(5) TFEU; (b)—; Report issued pursuant to Article 287(4) TFEU |
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Department |
Revenue and Customs AND Treasury |
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Document Numbers |
(a) (38939), 11503/17 + ADDs 1–6, COM(17) 383; (b) (39360),— |
Summary and Committee’s conclusions
11.1Customs duties collected by EU Member States are used to finance the EU budget.106 In a July 2017 report on fraud affecting the EU budget (the so-called PIF Report),107 the European Commission repeated allegations by the EU’s anti-fraud body OLAF that HM Revenue and Customs (HMRC) had enabled importers of Chinese textiles and footwear to evade customs duties totalling €1.98 billion (£1.76 billion)108 between 2013 and 2016 by declaring fraudulently low values.109
11.2The Commission argues that, as a consequence of this undervaluation fraud, the EU budget received €1.57 billion (£1.4 billion) less in customs duties than should have been the case over this period.110 It has therefore called on the UK to compensate the EU for the customs duties that were allegedly evaded. The Government disputes the estimated amount of duty loss, and is currently engaged in talks with the Commission to settle the matter.
11.3The Committee first considered the PIF Report in November 2017.111 The Explanatory Memorandum submitted by the Chief Secretary to the Treasury (Elizabeth Truss) did not make clear whether the Government accepted OLAF’s findings, or what steps had been taken to put a stop to undervaluation fraud at UK ports.112 The European Commission, in a document dated 30 November 2017, stated that the fraud “has not been stopped to date”.113 Given the potential implications for the public purse and in the context of negotiations on the UK’s cooperation with the EU on customs matters after it leaves the Customs Union, the Committee retained the report under scrutiny and asked the Minister to clarify the Government’s position on OLAF’s allegations.
11.4Shortly after we considered the PIF Report, the European Court of Auditors produced a special report on import procedures at EU ports.114 This corroborated the findings of the OLAF investigation in respect of widespread undervaluation of Chinese imports at UK ports, and questioned the effectiveness of the UK’s import control procedures more generally (see paragraphs 11.18 to 11.22 below). In particular, the auditors expressed concern that HMRC does not apply risk thresholds to imports based on an independent calculation of the “fair price” of the good in question, or release goods which could have been undervalued with a request for a guarantee which would facilitate recovery of potential duty loss afterwards. The Court of Auditors concluded this “has led to traffic diversions”, with “imports of significantly undervalued Chinese goods coming in transit from other Member States [to the UK for customs clearance] which (…) are [then] transported back to continental Europe”.
11.5The Chief Secretary to the Treasury (Elizabeth Truss) provided further information on the Government’s position on the dispute concerning undervaluation fraud at UK ports by letter of 22 December.115 In summary, while not disputing (widespread) undervaluation fraud at UK ports, the Government does not recognise OLAF’s estimate of total customs duties evaded but is unable to provide a different estimate until “individual cases” have been pursued “to their conclusions based on their own facts”. The Minister also argues that the dispute will not have an impact on any forthcoming negotiations with the EU on a post-Brexit customs partnership, as it relates to “historic transactions”.
11.6We thank the Minister for her response to our questions on OLAF’s allegations. It still leaves questions unanswered about the scale of undervaluation fraud on imported goods at the UK border. We are also concerned that the European Commission by November 2017 was still of the view that widespread undervaluation fraud at UK ports had not been addressed. The Court of Auditors also found that HMRC’s approach to Chinese textiles imports had led to trade diversion, apparently to benefit from the opportunities to avoid duties when seeking customs clearance at UK ports.
11.7As we have noted before, the dispute could give rise to a considerable payment from the UK public purse to the EU budget to compensate for the duty loss. In addition, after the UK leaves the EU Customs Union and ceases to make direct contributions to the EU budget, undervaluation of imports would present a direct loss to the Exchequer as customs duties collected by HMRC would be retained entirely by the Government. It is unclear to what extent undervaluation fraud at UK ports has been able to take root precisely because the fiscal losses accrue to the EU budget, and not the UK Exchequer.
11.8We consider these findings of OLAF and the European Court of Auditors are more appropriately a matter for the Public Accounts Committee and the Treasury Committee given that they relate to the domestic activities of HM Revenue and Customs. We are therefore drawing this Report to their attention. We also consider the International Trade Committee may have an interested in the context of its inquiry into the Trade Bill.
11.9We now clear the PIF Report and the Court of Auditors report from scrutiny, but ask the Chief Secretary to keep us informed of progress in negotiations with the European Commission on resolving the matter of TOR losses to the EU budget as a result of undervaluation fraud at UK ports.
Full details of the documents
(a) Report from the Commission: Protection of the European Union’s financial interests—Fight against fraud 2016 Annual Report: (38939), 11503/17 + ADDs 1–6, COM(17) 383; (b) Special report No 19/2017: Import procedures: shortcomings in the legal framework and an ineffective implementation impact the financial interests of the EU: (39360),—.
Background
Report on protection of the EU’s budget
11.10The revenue which funds the EU budget consists primarily of its so-called Own Resources, including the Traditional Own Resources (TOR).116 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 2016, the EU’s revenue from customs duties was €20.1 billion (£17.9 billion), or 14 per cent of its total income.117
11.11The 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. The Commission also publishes an annual report (the so-called PIF Report) on the steps it has taken, in cooperation with the Member States, to protect the EU budget from fraud and other irregularities.
11.12The latest iteration of that Report, published in July 2017, described a two-year investigation into HM Revenue and Customs by the EU’s anti-fraud body OLAF.118 It concluded in March 2017 that HMRC had enabled importers of Chinese textiles and footwear to evade customs duties totalling €1.97 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 net loss of these customs duties to its budget (estimated at €1.57 billion).
11.13HMRC stated in its 2016–17 Annual Report 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 UK may face an infringement procedure before the European Court of Justice for its failure to apply EU customs law, and have to compensate the EU for the customs duties that were allegedly evaded.
11.14When the Committee considered the Commission report in November 2017, it was unclear whether the Government accepted OLAF’s factual findings in relation to how this particular type of customs fraud was perpetrated in the UK, or what steps had been taken to put a stop to it. In March 2017, OLAF had stated the “fraud hub” had “continued to grow”.119 Given the potential implications of these events for the public purse and in the context of negotiations on the UK’s cooperation with the EU on customs matters after Brexit, the Committee retained the report under scrutiny and asked the Minister to clarify the Government’s position on OLAF’s allegations.120
The European Court of Auditors Special Report
11.15The week after the Committee considered the Commission document, the European Court of Auditors produced a special report on import procedures, entitled “shortcomings in the legal framework and an ineffective implementation impact the financial interests of the EU”.121 It was deposited for scrutiny on 18 December 2017, and an Explanatory Memorandum was submitted by the Financial Secretary to the Treasury (Mel Stride) on 11 January.122
11.16The UK was one of five EU countries audited for the purposes of the report. Overall, the auditors found that there is no harmonised and standardised application of customs controls by the Member States, meaning anti-competitive behaviour at the EU’s various points of entry and exit cannot be effectively prevented. The Court of Auditors also argues that Member States’ customs authorities may be disincentivised from properly applying customs controls, as any errors detected would result in that country being liable to make up the resulting loss to the EU budget from its public resources.123
11.17Based on their findings, the Court of Auditors called on further support for EU customs authorities and exchange of information between them under the next Multiannual Financial Framework; recommended several targeted amendments to EU customs legislation, including a legal basis for financial corrections for Member States which are not adequately addressing the risks and possibly encouraging “import point shopping”;124 and called for additional efforts to tackle evasion of customs duties and VAT on goods bought online.125 In response, the European Commission has rejected the need for any new legislation, except a change to make the indication of the consignor on customs import declaration compulsory in all Member States.
Court of Auditors’ findings in the UK
11.18The Court of Auditors includes in its report several findings on the operation of customs controls by HM Revenue and Customs specifically, which are relevant to the allegations of widespread evasion of customs duties at UK ports:
- nearly nine out of ten of all import declarations submitted to HMRC are cleared under a simplified procedure126 without any documentary and physical inspections before release;127
- where documentary controls are applied by HMRC to verify the origin of a good during release controls,128 original proofs of origin and the experimental “ConTraffic” database129 are not checked. The auditors note this “calls into question the effectiveness of release controls in the UK”;
- HMRC does not include insolvent traders when targeting post-release controls (as any error in the amount of customs duties could only be collected from these traders with difficulty or not at all, the resulting shortfall to the EU budget would have to be paid from the public purse);130
- the UK does not apply risk thresholds based on estimates for “fair prices” for imported goods;131
- HMRC does not request a guarantee for the release of goods declared with a potentially undervalued customs value, which would facilitate recovery of possible duty loss. The auditors concluded that lack of request for a guarantee “has led to traffic diversions”, with “imports of significantly undervalued Chinese goods coming in transit from other Member States [to the UK for customs clearance] which (…) are [then] transported back to continental Europe”; and
- HMRC is not using the current version of TARIC 3, the EU’s database of all tariff measures, because the earlier TARIC 1 is the only version that the HMRC’s electronic release system is capable of applying.132
Undervaluation of Chinese textile imports by HMRC
11.19The report also highlights the practical consequences of HMRC’s practices, corroborating the alleged findings of undervaluation fraud perpetrated at UK ports detailed in the European Commission’s July 2017 report (see paragraphs 11.10 to 11.14 above):
“We also found that Member States which carry out fewer customs release controls attract more imports. This is particularly evident in the case of controls related to undervaluation of textiles and footwear from China, where Member States which do not carry out customs release controls attract traffic from other Member States.”
11.20In particular, the auditors concluded that improved release controls by national authorities for textiles and footwear from China were inversely correlated to decreases in such imports into those countries. Of the five Member States audited, the UK was the only one where the medium price per kilogramme of imported textiles and footwear from China was lower in 2016 than it was in 2007.133 As a result, the report says, the volume of imports into the UK increased by 358,000 tonnes and it decreased in the other four Member States by 264,000 tonnes in total.134
11.21The Court of Auditors concluded that the lack of request for a guarantee in the UK in respect of potentially undervalued goods has led to traffic diversions, with imports of “significantly undervalued” Chinese clothing being cleared for free circulation by HM Revenue and Customs. They also found evidence of abuse of customs procedure 42, which allows VAT to be suspended for imported goods which are immediately shipped from the EU point of entry to another Member State.135 In many cases, the goods would disappear onto the black market after clearing UK customs control, thereby leading to evasion of VAT in addition to the duty loss linked to undervaluation.
11.22The Court of Auditors report does not independently arrive at an estimate of the scale of duty loss, but refers to the €1.97 billion figure used by OLAF and the European Commission.
The Minister’s letter of 22 December 2017 and Explanatory Memorandum of 11 January 2018
11.23The Chief Secretary to the Treasury responded to the Committee’s questions on OLAF’s allegations against HM Revenue and Customs by letter of 22 December 2017.136 In summary, her reply states:
- the Government does not recognise OLAF’s estimate of alleged duty loss, as it believes OLAF’s approach of aggregating duty losses across a variety of individual cases cannot accurately estimate the cumulative scale of the fraud;
- however, the Minister does not dispute that (widespread) evasion of customs duties did occur at UK ports in the 2013–16 period. Given the individual circumstances of each case, the Minister cannot provide a different or more precise estimate as “it is only possible to get an accurate figure of suspected duty loss by pursuing individual cases to their conclusions based on their own facts”;
- nevertheless, the Minister argues that HM Revenue and Customs have taken “reasonable and appropriate steps to address suspected fraud”, including “Operation Breach”, which focused on post-clearance checks where there is suspected undervaluation or onward supply relief VAT fraud;137
- the Government remains in correspondence with the European Commission about the evasion of customs duties in the UK, and hopes to “resolve this matter as swiftly as reasonably possible”. It is also ready to discuss “with the Commission where there may be genuine concerns”;
- with respect to £357 million of customs debts which the European Commission alleges were wrongly cancelled by HMRC, a review by the latter is on-going but the Minister states that “the cases in question were withdrawn on the basis that, at the time, there was not enough evidence to maintain them under the Customs Code as replacement values could not be established to the requisite level of proof”; and
- in the context of the Brexit negotiations, the Minister is confident that the OLAF investigation will not have an impact on any forthcoming negotiations with the EU on a post-Brexit customs partnership as it relates to “historic transactions”.
11.24The Financial Secretary’s subsequent Explanatory Memorandum on the Court of Auditors report reiterated the Government’s position that it has taken “reasonable and appropriate steps” to address undervaluation fraud at UK ports. It also notes that HMRC will be able to use the latest TARIC system from July 2018 as part of the new Customs Declarations Service, but confirms that, at present, “HMRC ensures compliance with EU customs tariff information by manually keying the tariff measures, duty rates and data on to the system”.
11.25With respect to the Court of Auditors’ concerns about the effectiveness of HMRC’s release controls of goods presented for inspection, the Minister argues that the UK’s approach “strikes an appropriate balance between facilitating importations by genuine traders and targeting error and fraud by means of effective risk based checks”:
“Simplified declarations are scrutinised by the import declaration system, CHIEF, for matches against its risk parameters and consignments are selected for documentary or physical examinations as a result. Businesses that import high risk goods under simplified procedures are required to provide additional data to support CHIEF profiling.”
Our assessment
11.26The Committee remains concerned about the allegations of widespread undervaluation fraud on the calculation of customs duties at UK ports, which have now been highlighted in a series of documents issued by OLAF, the European Commission and the European Court of Auditors.
11.27There appears to be a widespread view within the EU institutions that HMRC may still not be adequately assessing the risk related to potential undervaluation of imports, particularly for Chinese textiles and footwear. The Court of Auditors in its recent report made several observations relating to the apparent lack of use by HMRC of “fair price” risk assessments and guarantees to cover potentially duty losses for goods suspected of undervaluation, which appear to have contributed to the scale of the problem.138 As a result, the auditors concluded that goods arriving elsewhere in the EU from China are sent onwards to the UK only for clearing customs at fraudulently low values, evading the correct level of customs duties before the goods are shipped back to the continent.
11.28With respect to the total amount of customs duties evaded in recent years, the Minister says the Government does not recognise OLAF’s estimate of €1.57 billion in net duty loss to the EU budget. However, she is unable to provide a different estimate for the total evaded customs duties, and also does not state the evasion was categorically of a smaller scale than alleged by OLAF and the Commission.
11.29As we have noted in our previous Report on this matter,139 this debate is not purely academic, as customs duties evaded represent a direct loss to the EU budget for which the UK may have to pay from the public purse (potentially including penalty interest). Moreover, after customs duties are no longer passed to the European Commission to finance the EU budget following the UK’s withdrawal from the EU, any losses from incorrect or lax application of customs legislation by HM Revenue and Customs would result in a direct loss to the UK Exchequer.140 It is therefore imperative that this matter is resolved as quickly as possible, and any shortcomings in the UK’s customs operations remedied without delay. It is unclear to what extent undervaluation fraud at UK ports has been able to take root precisely because the fiscal losses currently accrue to the EU budget, and not the Exchequer directly.
11.30The Committee also remains to be convinced that the dispute over the evasion of customs duties will not complicate the Government’s negotiations on a future UK-EU customs partnership, after the UK effectively leaves the Customs Union.141 The Minister says that the OLAF investigation “relates to historic transactions” and will therefore will not have an impact on the negotiations about a future partnership. However, it is clear from the Minister’s own letter that the matter has not yet been resolved with the European Commission. Moreover, in March 2017 OLAF stated publicly that, in its view, the scale of customs evasion in the UK was continuing to grow. A Commission document dated 30 November 2017 also states that “losses to the EU budget are still on-going since this fraud has not been stopped to date”.142
11.31We have asked the Minister to keep the Committee informed of progress in its discussions with the European Commission on resolving the matter of duty loss and the UK’s contributions to the EU budget.
Previous Committee Reports
Third Report HC 301–iii (2017–19), chapter 13 (29 November 2017).
106 Customs duties are known in this context as “Traditional Own Resources” (TOR).
107 From the French, “Protection des intérêts financiers”.
108 £1 = €0.87985 or €1 = £1.13655 as at 30 November.
109 The existence of widespread undervaluation of Chinese imports at UK ports was first uncovered by Operation Snake, a joint customs operation carried out by the European Commission, Member States and the Chinese Government.
110 Member States are allowed to retain 20 per cent of customs duties collected as an administration fee. The remainder is transferred to the EU.
112 Explanatory Memorandum submitted by HM Treasury (10 October 2017).
113 Commission Impact Assessment SWD(2017) 428, p. 202.
114 European Court of Auditors, Special report No 19/2017.
116 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. The latter acts as a balancing mechanism, increasing if the TOR and VAT contributions shrink and vice versa.
117 The UK is the second-largest contributor with 17 per cent, after Germany.
118 See Commission document COM(2017) 383.
119 The Guardian, “UK faces €2bn fine over Chinese imports scam, say EU investigators“ (8 March 2017).
122 Explanatory Memorandum submitted by HM Treasury on 11 January 2018.
123 The European Commission disagrees with that line of reasoning, stating: “The Commission is of the view that Member States do have sufficient financial incentives to perform custom controls. Member States that apply the EU customs legislative framework diligently do not face financial liability for TOR that become irrecoverable for reasons beyond their control”.
124 For example, the Court has recommended that the Union Customs Code should make the indication of the consignor on the customs import declaration compulsory and the introduction of an EU-wide binding valuation decision.
125 See for more information the Committee’s Report of 22 November 2017 on VAT and e-commerce, which deals with the pending abolition of Low Value Consignment Relief for consumer goods bought online.
126 The other 12 per cent of import declarations are subject to normal customs procedures, and therefore documentary and physical checks. In the UK, almost all (99.77 per cent) were cleared from customs within one hour.
127 ECA Report 19/2017, para. 118. The Court of Auditors noted that, EU-wide, only 0.2 per cent of import declarations are subject to release controls. The Court of Auditors added that the lack of any release controls “is particularly serious in the case of the UK because the vast majority of import declarations are submitted using simplified procedures”. The EU average of simplified controls is 80 per cent of import declarations.
128 Rules of origin are applied to ensure differentiated tariff rates, as agreed through bilateral free trade agreements, are correctly applied and higher customs duties are not evaded by falsifying the origin of a good.
129 ConTraffic is the EU’s research prototype for a Container Traffic Monitoring System. It allows customs officials to obtain information on the actual and past movement of shipping containers as well as various results of route-based risk analysis done by the system.
130 ECA Report 19/2017, para. 30.
131 For risk management purposes the risk threshold value can be determined on the basis of fair prices. To overcome the risk of undervaluation, the Commission has developed a methodology to estimate “fair prices” in order to produce robust estimates for the prices of the imported goods. OLAF disseminates these estimates among Member States’ customs authorities.
In certain cases, importers submit supporting evidence (invoices, sales contracts, bank statements) which all match the declared (false) low values. Everything matches on the documents presented to customs and the undervaluation is difficult to detect. In such cases, there may be other payments either in cash or via third parties for the difference between the declared (undervalued) and real price.
132 HMRC converts TARIC 3 data into TARIC 1 manually before uploading it.
133 ECA report, p. 43. In sampled imports of textiles from Asia, the auditors found that such goods were frequently released for free circulation into the EU after importers declared a value for the goods that was below the price of the raw cotton.
134 Imports of Chinese textiles into the UK have risen by approximately 30 per cent, from under 600,000 tonnes in 2007 to over 900,000 tonnes in 2016; over that same period, the medium price per kilogramme of such imports decreased from €10 (£9) to less than €8 (£7). The only other Member State audited which saw an increase (of a far smaller 20,000 tonnes) was Poland.
135 See ECA Report 24/2015, p. 33.
137 As noted however, the UK apparently does not any conduct clearance controls at the UK border on goods subject to simplified customs controls (88 per cent of import declarations).
138 ECA Report, para. 97: “The UK does not apply the risk thresholds described in paragraph 92, nor does it request at release a guarantee for the release of goods declared with a potentially undervalued customs value in order to cover the potential duty loss”. Para. 92 reads: “For risk management purposes the risk threshold value can be determined on the basis of fair prices”.
140 The same issue will not arise in relation to VAT evasion on imports if the UK leaves the single VAT area, as the tax will have to be collected on all imports and CP42 will no longer be available for onward transport to an EU country.
141 The UK may remain in the EU Customs Union for the duration of the post-Brexit transitional arrangement.
142 Commission Impact Assessment SWD(2017) 428, p. 202.
29 January 2018