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The
Scale of the Problem
Approximately one third of
internationally traded cigarettes (355 billion per year) are
eventually sold illegally with the avoidance of duty. This
reduces the price, increases demand, undermines national tobacco
tax policies and, as a result, harms health by increasing tobacco
use. By the late 1990s, cigarette smuggling in the UK
had reached epidemic proportions: according to tobacco industry
estimates, 25%-30% of the total market was made up of
illegally imported cigarettes although Customs & Excise
estimated the figure to be no more than 21%. Tobacco
smuggling was costing the Government more than £3 billion a year
in lost revenue. Action by HM Revenue & Customs (formerly
Customs & Excise) since 2000 has helped reduce the proportion
of smuggled cigarettes to approx 16% of the UK market.
Despite this success, 1 in 6 cigarettes and about half of
hand-rolling tobacco smoked in Britain are still illicit resulting
in a net loss to the Government of more than £2 billion a year.
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Who Benefits?
Organised crime and petty
criminals clearly benefit. The tobacco companies benefit because
average tobacco prices are reduced and hence demand increased and
cheap smuggled cigarettes may keep people smoking who otherwise
would quit. High levels of smuggling can also result in
governments reducing tobacco taxes in an effort to deal with the
problem. This keeps prices lower and demand higher in the legal market – again the tobacco companies benefit. The World Bank
has identified price as a key health and economic policy in
tobacco control, and smuggling undermines the effectiveness of
this policy.
The “White
van trade” Is Not The Main Problem
The trade in contraband
cigarettes is dominated by large-scale container fraud: as many as
10 million cigarettes can be hidden in containers which are
disguised to give the appearance of carrying legitimate products
such as food or furniture. This is very different from the
popular perception of cigarette smuggling, namely the “white van
trade” in which small scale operators exploit cross-Channel tax
differentials but pay duty in, say, Belgium or France.
Cigarettes obtained legally in lower-taxed countries and consumed
in the UK account for about 9% of the total cigarette market.
However, hand-rolling tobacco makes up a significant
proportion of tobacco imported illegally into the UK from mainland
Europe: in 2004-05 illicit market share was estimated to be
53% - 64% of the total market.
Case Study – Imperial Tobacco
Despite a steady decline in the
UK’s legal cigarette market of which Imperial Tobacco has a 45%
share, the company continues to report increases in profits,
due to a rise in its international operations. While some of
these sales will be legal, the company’s commercial success in
recent years has been partially dependent on growth in smuggling
and the export of UK-made cigarettes that will be smuggled back
into the UK black market. Imperial exports around 20 billion
cigarettes annually but many of these go to countries in which
there is little or no market for their products – except
smugglers, who smuggle them back into Britain. In the late
1990’s it was estimated that over half of Imperial’s
exports returned this way. In 2000, Imperial Tobacco’s
international business reported a record operating profit, up 23%
to £231m from £188m in 1999. Much of this international growth
was represented by products actually sold in the UK illegally.
According to a 1999 World
Customs Report, the top two brands being smuggled across Europe
were Regal and Superkings, both Imperial tobacco brands. In
2004-05 Superkings accounted for 22% of the genuine UK brands
seized by Customs officers. The report of an
investigation into tobacco smuggling by the House of Commons
Public Accounts Committee was highly critical of Imperial’s
involvement in the illicit trade and called on the company to
co-operate more fully with Customs and Excise’s strategy for
combating tobacco smuggling. Following this exposure,
Imperial took steps to reduce the amount of its product being
smuggled and now Gallaher brands make up the largest proportion of
genuine product that is being smuggled. In 2004-05, two
Gallaher brands – Sovereign and Dorchester accounted for 25% and
16% respectively of seized cigarettes.
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How Smuggling Works
Organised smuggling typically
begins when a bulk order for cigarettes is placed with a
manufacturer. After leaving the factory or bonded warehouse
with documents showing they are bound for a legitimate market,
they then go through a series of paper transactions that are
difficult to follow. Ultimately, the paper trail leads
investigators to non-existent or shell companies, with the
cigarettes having “disappeared” into the black market.
Sometimes the scheme involves forged transit documents and tax
stamps, in other cases, corrupt customs agents or other officials
are involved. All of the major multinational tobacco
companies are implicated in smuggling activities and have been the
subject of several legal cases to determine the extent of their
involvement. In the 1990s around 80% of smuggled tobacco entering
the UK consisted of UK-manufactured cigarettes or hand-rolling
tobacco that had been diverted onto the black market and smuggled
back into the UK, usually via large containers purporting to
contain other consumer goods.
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Smuggling and Taxes
It is frequently claimed by the
tobacco industry that high taxes cause smuggling. However, the
difference in duty levels between neighbouring states is only a
minor driver of smuggling. The economic driver of most smuggling
is the difference between the duty paid and duty not paid price,
since taxes account for a high proportion of the retail price of
tobacco products in all countries. Cutting tobacco tax
cannot solve the problem of smuggling. Even if all countries
levelled exactly the same level of taxes and had identical prices,
smuggling would still continue at a large scale. In Europe
until recently the highest levels of smuggling were found in
countries with some of the lowest taxes (Spain and Italy).
This pattern is reflected around the world. Large-scale
smuggling involves criminal organisations with a sophisticated
system of distributing tobacco at a local level. Criminals
are aided by the lack of control of the international movement of
tax-free cigarettes.
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Counterfeit Tobacco
In addition to the smuggling of
genuine UK manufactured cigarettes, which remains a serious
problem, there has been a significant rise in the smuggling of
counterfeit cigarettes in recent years. In 2001/02 15% of
large seizures of cigarettes made by Customs officers were
counterfeit. By 2003/04 this had risen more than three-fold
to 54%.
In 2005-06, 51% of illegal
cigarettes seized by Customs were counterfeit. Most counterfeit
cigarettes, which may be almost indistinguishable from the genuine
article, are manufactured in the Far East and Eastern Europe and
are smuggled into the UK in large quantities, predominantly as
maritime freight. As the supply chain is entirely illicit,
there are no legitimate manufacturers with whom the government can
work to restrict supply. However, as counterfeit products
undermine brand integrity and directly affect tobacco industry
profits, the manufacturers have an interest in trying to curb this
market.
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Tobacco Smuggling As a Commercial Activity.
Smuggling is based on
tax avoidance but it is driven by the commercial activities of
tobacco companies and organised crime and the extent to which law
enforcement creates costs and risks as a disincentive to
smuggling.
Tobacco companies have used
smuggling as a distribution channel to launch new brands, to enter
new markets and fight price wars with their competitors.
Once one company is involved, the others risk losing market share
if they do not effectively ‘compete’ to have their brands
represented in illegal markets. The major companies seek to
maximise their performance in the whole system – legal and
illegal and they exploit the lack of law enforcement to do so.
As the deputy chairman of BAT, Kenneth Clarke MP, said: “Where any government is unwilling to act or their efforts are
unsuccessful, we act, completely within the law, on the basis that
our brands will be available alongside those of our competitors in
the smuggled as well as the legitimate market.”
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What Can Be Done to Counter Smuggling?
In March 2000, the UK
Government announced a package of measures designed to curb
smuggling. These included the deployment of 1000 additional
Customs officers; additional specialist investigators and
intelligence staff; additional x-ray scanners; tougher sanctions
and penalties; and a public awareness campaign. In
addition, packs of cigarettes and hand-rolling tobacco sold for
consumption in the UK are now required to carry a duty-paid mark.
Through this campaign, Customs & Excise succeeded in breaking
up 43 smuggling gangs and reduced Cross-Channel smuggling by 75%
in 2000/2001. In 2003-04, the illicit market
in cigarettes fell to 16%. The current Government target is to reduce the
illicit share of the market in cigarettes to 13% by 2007-08.
In the 2006 Budget the
Chancellor announced new measures to further strengthen the
anti-smuggling strategy. These include working with tobacco
manufacturers to tighten controls along the supply chain.
Specifically, the companies have signed new Memoranda of
Understanding (MoU) with government which requires them to cease
supplying customers where they fail to demonstrate product
control; to put in place controls of raw materials and machinery
to prevent them becoming available to counterfeiters; and to share
information with Revenue and Customs. The tobacco companies will
be obliged to comply with these measures and will be penalised if
they do not comply.
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Despite the tighter measures of
the new MoUs, the UK companies are not legally bound by them. By
contrast, Philip Morris has signed a legal
agreement with the European Union to stop its products being
illegally imported into the European Union. This agreement arose
out of a lawsuit filed by the European Commission against Philip
Morris over the smuggling of cigarettes into the European Union.
Philip Morris International agreed to abide by the new agreement
in return for the EC dropping the legal action.
The
agreement requires the company to approve contractors and provide
customs with online information so that Customs can directly trace
back any PMI smuggled cigarettes to the purchaser who originally
bought them from PMI. In addition, Philip Morris will be required
to pay 100% of all taxes due on any genuine products that are
seized by customs.
Because smuggling is a global
problem, concerted action at the international level is also
required. This will be achieved through a protocol under the
Framework Convention on Tobacco Control. At the first Conference
of the Parties (i.e. the meeting of countries that have ratified
the global treaty) it was agreed that an expert group be set up to
tackle international tobacco smuggling. In its submission to
the FCTC negotiations, ASH recommended that the smuggling protocol
include: labelling every pack with its origin (manufacturer) and
destination (country); require health warnings on packs to be
printed in the language of the destination market; ban duty free
sales; require manufacturers to mark packs and to be able to
identify which wholesaler they sold a particular pack to on the
basis of the marking; require co-operation between law enforcement
bodies; and commit to meaningful penalties to introduce a
disincentive to smuggling.
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Smuggled & Counterfeit Tobacco