The £4bn duty fraud scandal

The Government has announced new plans to crack down on duty fraud on beer. But it has also increased duty on cigarettes and alcohol - a move wholesalers fear will exacerbate the problem. So what can be done to stop the duty fraudsters, asks Peter Cripps


It appears to be an innocent transaction. A lorry drops off nearly 2,000 cases of lager at a retailer, and a month later £26,000 is paid into the account of a wholesaler. Everyone's happy - the retail outlet has lager it can sell at prices that compete with the multiples and the wholesaler has made a profit.

But there is more to this deal than meets the eye. The buyer may not have been aware, but the beer is not legitimate - excise duty of about £16,000 has not been paid. And the wholesaler's margin isn't 2%. It's more like 62%.

Welcome to the murky world of the duty fraudsters, a motley group of manufacturers, wholesalers and smugglers so unscrupulous they make expenses-abusing MPs look like naughty schoolkids. While the rest of us struggle to cope with the impact of the recession, the fraudsters continue to divert an estimated £4bn a year from HMRC's coffers - and swindle honest wholesalers out of hundreds of millions of pounds in lost revenue.

Beer, spirits, wine, tobacco, you name it, the fraudsters are swerving duty on it. Just this week, traders were warned against the rise of 'cheap whites', generic brands that are being sold at prices significantly below those of legitimate cigarettes because UK duty is not being paid (see news, page 8).

And the problem described by one wholesaler as "the biggest single threat to the wholesaler industry" is about to get a lot worse. In last month's Budget, the Chancellor may have acknowledged the threat by unveiling plans to crack down on duty fraud but, much to the frustration of legitimate traders and suppliers, he also announced an increase in duty on beer that offset November's 2.5 percentage point cut in VAT and committed to increasing duty on alcohol by 2% above inflation every year until 2012. Duty on tobacco, meanwhile, increased by 2%.

These rises will only act as an incentive to the fraudsters and encourage more retailers to switch to so-called duty-avoided tobacco and alcohol, warn senior industry figures. There are fears that even duty fraud on spirits, which since 2005 has been in decline, will start to rise again.

"The high duty on spirits presents an opportunity for dishonest people. The more you whack duty up the more opportunity there is for people to make money doing this," says Wine & Spirit Trade Association chief executive Jeremy Beadles.

"In troubled times, people will be tempted to do things to keep their businesses going. It's a very competitive marketplace and with sales dropping across the board, even some of the big guys are struggling to compete."

That was the case even before the Budget. Indeed, wholesalers report that duty fraud really started to escalate last summer when the full extent of the financial crisis began to become clear. The impact on beer sales was evident in the run-up to Christmas.

Last week, Makro admitted duty fraud had prompted a 15% drop in like-for-like beer sales in the final quarter of 2008 after 7% growth in the third quarter. Meanwhile, Parfetts and Bestway reported that sales of major brands were down as much as 90% and 60% respectively at points during the festive season.

With alcohol and tobacco accounting for two thirds of wholesalers' turnover, no wonder duty fraud is described as "potentially business-threatening" by Parfetts MD Steve Parfett. And it's not just threatening to businesses, it seems. One wholesaler reports hearing how a sales rep for a large wine manufacturer was dragged from a C&C and beaten "black and blue" when he questioned why his bottles were being sold for less than the factory gate price.

"These are not nice people," says another wholesaler. "They're the kind of people who are also involved in other crime, such as drugs and maybe even terrorism."

Retailers may think they're getting a good deal, but many would think twice if they realised who was behind that deal. Duty fraud is perpetrated by small network of organised gangs, according to Paul Riley, HMRC assistant director of excise policy.

One reason it's on the rise is they feel they can act with relative impunity. "It's all about risk versus reward," says John Murphy, FWD director general. "The penalties have not been as great as for smuggling cocaine and other drugs and there are vast quantities of money to be made."

Another issue is that many wholesalers simply do not know they are buying duty-avoided goods. Always on the hunt for the best deals, many buy from the grey market, which is legal - but open to abuse.

The legitimacy of goods bought on the grey market is also dependent on verification from HMRC, points out one wholesaler. "Of course I buy off the grey market - I have to, just to compete," he says. "I ask for assurances from the sellers and have even written to Customs to ask how I can be sure it is legitimate, but I never heard back. I hope I am not selling black market goods, but you can never be sure because they are so widespread."

Heavy promotional activity on alcohol by the multiples is exacerbating the problem, according to Murphy. "The mults shouldn't sell below cost and they patently do on alcohol. We don't think it's sensible to have £10 bottles of spirits over Christmas. We have always highlighted it as a simple win if everyone stops this."

Although the government has backed down on plans to charge a minimum price per unit of alcohol in England and Wales, it does intend to give local authorities the power to ban cheap deals on beer.

It isn't shying away from the duty fraud problem either, announcing in last month's Budget that it is putting more resources into stopping the perpetrators, and setting out two new measures. From 1 June it is banning wholesalers from storing alcohol in warehouses for export - effectively stopping traders claiming back duty unless the product is exported straight away. HMRC has also created regional teams and plans to make beer fraud as much of a priority as spirits and tobacco fraud.

Murphy thinks the new measures will make a real difference. "We are particularly delighted they have got rid of the warehousing for export. We think it's a big part of it and will have an immediate effect. The government has taken it on board and is determined to wipe it out."

Others, however, are less optimistic. "The new measures are a step in the right direction but won't automatically solve the problems," says Makro commercial director Allard Sjollema.

Some complain that HMRC still lacks the power and resources to cope with the fraudsters. "You hear stories about Customs officials stopping a lorry-load of duty-avoided beer and the driver just walking away and the Customs officials not being able to do anything about it," says Sam Wilcox, MD of AF Blakemore's wholesale division.

Fraudsters are so confident in their ability to beat the system they offer to replace any stock their customers have confiscated by Customs, claims another.

"The government needs to give resources to HMRC and make it relatively easy to take the case to court," adds Bestway MD Younus Sheikh. "It takes 12 to 24 months to prepare a case to go to court and it gets thrown out on technicalities ."

Riley says he would like to see further amendments to UK law. "We would be keen to restrict who can be an authorised warehouse keeper, but there are very strict EU rules on that and we can't go beyond those," he says.

Meanwhile, others are calling on the drinks industry to take the same sort of proactive role as the tobacco industry has. In agreement with the EU, JTI, for instance, has introduced measures to control the manufacture, sale, distribution and storage of cigarettes. "The agreement includes a 'know-your-customer' policy," says JTI head of communications Jeremy Blackburn. "We only sell products to customers who fully comply with all local laws and meet our own stringent standards."

Sjollema has written to five brewers for help. "I'm calling on the industry to work together - then the problem could become more manageable," he says. "Most people in the industry are honest and have no interest in supplying crooks."

Brewers should put batch codes on the accompanying paperwork to make goods easier to trace, adds Simon Hannah, a director at Scottish wholesaler JW Filshill.

For their part, brewers say they are doing what they can. "Our security teams alert HMRC when they see suspicious movements of beer and we help HMRC collect evidence when they make prosecutions," says a Molson Coors spokesman.

There would be no problem, of course, if everyone heeded Murphy's simple advice: "If it's too good to be true, don't buy it".

Unfortunately, with the economy in the state it's in and the rewards of duty fraud seen to outweigh the risks, the fraudsters aren't going to abandon their illicit activities any time soon.



The true price of duty
The latest increases are part of Alistair Darling's 'duty escalator', announced in the April 2008 Budget, in which he plans to increase duty by 2% above inflation every year until 2012. This means duty on a standard bottle of wine is currently £1.61, while for a can of beer it is 36p (see right). In the past year, duty on alcohol has increased by an average of 17%. This includes an increase last November to compensate for the reduction in VAT from 17.5% to 15%.

Many in the UK drinks industry claim that the higher the duty differential between the UK and overseas, the bigger incentive for fraudsters. "At a time when the government is offering other industries a helping hand, it is extraordinary it wishes to hurt the drinks industry with further tax increases," says Wine and Spirits Trade Association chief executive Jeremy Beadles.

"Thousands of jobs have already been lost in the industry and the decision to go ahead with a further tax increase puts thousands more at risk. It's a bitter irony that with falling sales, these tax hikes are unlikely to deliver the revenues forecast by the Treasury."

How big is the duty fraud problem?
Duty fraud is estimated to cost the state as much as £4bn a year in lost revenue. Tobacco fraud alone accounts for a 'tax gap' of between £1.6bn and £3.2bn.

The market share of illicit cigarettes is 13%, says Paul Riley, HMRC assistant director of excise policy responsible for alcohol and tobacco. However, this is down on 2002 when it accounted for 24% of the market.

Duty-avoided cigarettes cost the Treasury up to £2.3bn every year. Spirits fraud costs the state an estimated £500m a year. It is hoped the problem is declining following the introduction of duty stamps in 2005.

The true extent of beer and wine fraud is not known, but it is recognised as a growing problem that needs to be addressed. The FWD has been campaigning to bring the problem to the attention of the HMRC and estimates beer fraud is already worth hundreds of millions of pounds in lost revenue

HMRC calculates the amount it loses by comparing the revenue collected through taxes with a survey carried out by the Office of National Statistics that quizzes a representative proportion of the population on how much alcohol and tobacco they consume a year. The survey has been adjusted to compensate for the fact that most people underestimate how much they consume.
Source: Her Majesty's Revenue and Customs

How fraudsters get around the law
Sometimes the fraud can be as simple as smuggling the goods into the country and selling it on the black market. The recently formed UK Border Agency does not have the authority to stop vehicles at random unless it is acting on intelligence.

It is widely suspected that 'accompanying documents' - the legal paperwork that allows alcohol and cigarettes to be imported into the country - are reused until they are physically checked by Customs and the paperwork is registered as having been used. A new electronic system will have been brought in across Europe by April 2010 that should help stop this.

Much of the tobacco smuggled into the UK is also counterfeit and can contain illegal substances, Japan Tobacco International says.

In 2006, a system of duty stamps was introduced for spirits, which has helped to reduce the problem. But critics claim that even these can be faked. There is no equivalent system for beer and wine - so a law-abiding consumer or trader could unwittingly buy duty-avoided alcohol.

Alcohol manufactured in the UK has duty paid by the manufacturer, unless it is sold 'under bond', which effectively means that the duty does not need to be paid because the alcohol is due for export. However, some alcohol from 'bonded warehouses' is sold in the UK without the duty being paid.

As for alcohol that has been duty-paid, wholesalers can claim a refund of duty on alcohol that has been exported, known as 'duty drawback'. Fraudsters can more easily claim duty drawback on alcohol that they claim to be exporting by storing it in 'warehouses for export'.

HMRC acknowledges that the system is being widely abused. As a result, it has banned the warehousing for export scheme with effect from 1 June. Traders often create an elaborate paper trail and short-lived companies are frequently set up and closed down, all to throw HMRC off the scent.