13.7 Avoidance and evasion of taxes on tobacco products

The issue of tax evasion in the tobacco market was brought to the attention of the tobacco control community in the mid-1990s in two articles by Joossens and Raw. ^1,2 Frequently cited since that time and among the most well-known in the British Medical Journal's specialist journal, Tobacco Control, ³ the articles suggested that smuggling of cigarettes was occurring on a 'massive' scale across the globe and was costing government treasuries thousands of millions of dollars in lost revenue. On the basis of the 30% difference between total global imports and total global exports apparent at the time in the US Department of Agriculture reports on world markets and trade, the authors claimed that the international contraband market must be worth 30% of the value of world tobacco exports. ¹ The authors argued that it was this form of tax evasion rather than simple avoidance of taxes through cross-border shopping between European countries with widely varying tax rates that was the main cause of lost revenue for governments. It was further argued that the extent of illicit trade in a country had much more to do with the tolerance for corruption in that country than with its rate of taxes on tobacco products. ¹

The nature of the market for illicit tobacco products post-2010 appears to differ markedly from the picture painted in the Joossens and Raw articles from the 1990s. ⁴ The value of global tobacco exports internationally is now largely in step with the value of imports. ⁵ And a number of forms of evasion of taxes on tobacco products not described in the 1990s' papers appear to be apparent in many countries across the globe since the early-to-mid-2000s. ⁶

Quantifying the extent of use of illicit tobacco products is extremely difficult and all current estimates of the size of the illicit market should be regarded with caution. The major tobacco companies appear to be exploiting fears about the potential loss of revenue and alleged involvement of criminal organisations to discourage governments in many countries from adopting measures likely to significantly reduce consumption of tobacco products. Most industry-sponsored estimates of the extent of illicit trade appear to be highly exaggerated.

This section describes the various ways by which taxes on tobacco products can be avoided. It describes attempts to quantify the extent of illicit trade both internationally and in Australia. Industry estimates put the illicit market in Australia at about 13% of the legal market, but estimates based on data from the National Drug Strategy Household Survey would suggest that it is more like 2–3% of the total market.

This chapter also summarises policy measures proposed at the international and national level to minimise illicit trade, in particular the Protocol developed for the Conference of Parities for the WHO Framework Convention on Tobacco Control, and recent lowering of limits for import of tobacco products for travelers to Australia.

13.7.1 What constitutes avoidance and what constitutes evasion of taxes on tobacco products?

13.7.1.1 Legal avoidance versus illegal evasion

The distinction between legal avoidance and illegal evasion is not a completely clear one, with a considerable area of grey in the middle. Taxes on tobacco products can be circumvented in many different ways. Joossens, Chaloupka, Merriman and Y√ºrekli (2000) ⁸ and the International Agency for Research on Cancer in handbooks published in 2008 ⁹ and in 2011 ⁶ provide useful distinctions between: legal and illegal circumvention; products for personal use versus commercial resale; and products in small versus large quantities. ⁸

• Legal circumvention occurs frequently in Europe, North America and other parts of the world through:
  • legal cross-border shopping
  • legal tourist shopping
  • legal duty-free sales
  • 'distance selling' previously through mail order and in recent years predominantly through the Internet, where smokers in high-taxing jurisdictions might order cigarettes from vendors in low-taxing jurisdictions including other states, other countries or from tax-free jurisdictions such as Native American reservations where residents are not required to pay duties. ¹⁰

Efforts by tobacco companies to reformulate or rebrand products so that they are classified in a category or band that attracts a lower level of tax might also be thought of as a form of legal circumvention. ⁶

• Joosens et al use the term 'Quasi-legal circumvention' to describe behaviour that may not be in breach of any particular legislation as it currently stands, but are not condoned because they are not in line with its purpose and can be deemed as 'schemes' designed specifically to avoid taxes. They use the example in the US of:
  • grey-market sales involving export of cigarettes to wholesalers in one country who import them back to the country of origin, exploiting differences in taxes applicable to cigarettes destined for export and those destined for domestic consumption. ¹¹

Such activity may be clearly legal or illegal in other countries depending on the way that legislation is drafted.

• Illegal circumvention includes:
  • illicit growing and rudimentary manufacturing of roughly processed tobacco sold to consumers for use in roll-your-own cigarettes or pre-rolled into cigarettes. ¹² This form of illegal circumvention has been a notable problem in both Australia–commonly referred to as 'chop-chop' ^13,14 – as well as in New Zealand ¹⁵ and has also been detected in Canada ¹⁶
  • bootlegging by individuals or small-time operators or groups purchasing tobacco products in low-tax jurisdictions in amounts that exceed limits set by customs regulations, and then reselling them to others in high-tax jurisdictions
  • large-scale smuggling, involving the illegal transportation across borders of large consignments of products (including illegally grown tobacco, counterfeit cigarettes and genuine cigarettes diverted from the legal market) often reputed to involve highly organised criminal organisations
  • production of cigarettes that appear very similar to brands produced by licensed tobacco manufacturers but which are produced without the permission of the trademark holders. These are sold to suppliers who make them available either within their own countries or overseas at lower cost than the 'genuine' products, and are a concern to tobacco control in instances where distributors avoid payment of local duties and taxes. ⁶

13.7.1.2 Contraband 'versus' counterfeit cigarettes

The tobacco products distributed through the first three forms of illegal circumvention described above could be regarded as 'contraband', in that duties and taxes are not paid in the countries where the products are purchased. In the case of counterfeit cigarettes, duties and taxes may or may not be paid. ¹⁷

Counterfeit cigarettes are sometimes declared to Customs as genuine ones at the point of entry. In this way, counterfeit cigarettes are introduced into the licit market and, even though duties and taxes are paid, a substantial profit is still made by the criminals who no longer incur the additional costs associated with concealing the cigarettes.
World Customs Organization, 2012 ¹⁷

The overlapping definitions of 'contraband' and 'counterfeit' cigarettes have created considerable confusion among those writing and talking about illicit trade in cigarettes, with double counting apparent in estimates of use of such products in reports prepared for Australian companies–see Section 13.7.3 for further details.

13.7.1.3 Involvement of licensed tobacco manufacturers

Examination of industry documents released as part of settlements of legal action between US state attorneys general and major US tobacco companies revealed that several of the major international tobacco companies were involved in supply of cigarettes in the 1980s and 1990s to the 'duty not paid' market in the UK, ¹⁸ Canada, ^19,20 and in Africa ²¹ and Asia, where smuggling appeared to play an important component in companies entry strategies into markets which were previously closed to them due to restrictive trade policies. ⁶ After initiation and settlement of legal action against companies by several countries under provisions of the US Racketeering Influenced and Corrupt Organizations Act (commonly referred to as 'RICO') the European Union entered into agreements with several major companies to improve controls and reduce diversion of manufactured cigarettes to the illicit market–see Technical appendix 13.7.1 for further details ⁱ .

It is believed that an increasing percentage of the seizures made by authorities since the early 2000s in the European Union (EU) and elsewhere comprise counterfeit cigarettes, ²² with companies claiming that this form of smuggling had become a large and growing problem in Europe ^4,23 and beyond.

The country of origin of cigarettes seized by customs authorities suggest that large quantities of counterfeit cigarettes in recent years have been manufactured in China ^12,24 which is a major producer of tobacco with many small growers and manufacturing plants throughout the country. Reports based on interviews with tobacco industry respondents suggest that traders may source products from factories that produce legitimate products for manufacturers and use this activity as cover for 'overrun' production of counterfeits. ²² The World Customs Organization in its annual report for 2011 however notes a 'remarkable decrease of cases involving consignments departing from China.' ^{25 p5} A network of East European companies headquartered in Kalinigrad, a Russian territory between Poland and Lithuania and annexed by the Soviet Union after World War II, is also alleged to be involved in large-scale production of a brand of cigarettes called Jin Ling which resembles US brand Camel cigarettes and is made exclusively for the illicit market. ²⁶

It should be noted that customs authorities are mostly relying on intelligence and assessments by tobacco companies to determine whether goods are counterfeit. The licensed manufacturer may be able to detect whether cigarettes bearing the trademarks and other design features of their brands are counterfeit or not. However counterfeit products are often so close in appearance to the brands they are copying, that customs officials and consumers may not be able to distinguish 'counterfeit' from 'genuine' products. From the point of view of revenue collection authorities, the distinction matters not. Such agencies need only be concerned with whether or not revenue has been paid.

13.7.2 What factors drive or facilitate avoidance and evasion of tobacco taxes?

The review of tobacco tax policy by the International Agency for Research on Cancer (IARC) ⁶ provides a helpful discussion on the factors motivating the (legal) avoidance of taxes and the (illegal) supply and use of illicit tobacco products.

13.7.2.1 What drives (legal) tax avoidance?

It is evident that (legal) cross-border and tourist shopping are primarily motivated by the relative price differences between adjacent geographical areas that result from differing excise duties and differing rates of value added (or goods and services) tax. ²⁷ The extent to which consumers engage in these forms of tax avoidance depends on the amount of money they can save compared with the costs involved in making these forms of purchase (including transport, mailing costs and time) and the opportunity to engage in this kind of purchasing (for instance frequency of interstate or overseas travel for work or holidays). The IARC report reviews several studies (Vedder, 1997, Cnossen, 2005, Goel, 2008, De Cicca, 2010 and Merriman, 2010 ²⁸ ) that have demonstrated that differences in tax rates between proximate jurisdictions reduces the efficiency of tax policy, with evidence of responsiveness declining in line with proximity to borders with lower-taxing jurisdictions. Cross-border shopping in the UK increased substantially once the saving to be gained in buying cigarettes in France started to substantially outweigh the cost of the ferry trip between the two countries. ⁶

The IARC review also concluded that purchase of products via the Internet is also much more likely to occur among residents in high-taxing jurisdictions than among residents in low-taxing jurisdictions. People who purchase cigarettes through the Internet are primarily motivated by lower prices which are possible because on-line vendors rarely pay excise taxes. One survey of US smokers who had purchased on-line found that consumption by such smokers increased compared to purchasers paying full-price for cigarettes from bricks-and-mortar retail outlets. Remote purchasing of tobacco products has increased greatly over the 2000s with ever-increasing numbers of people regularly engaging in on-line shopping. The number of websites selling US cigarettes increased from 88 in 2000 to 772 in 2006. In 2003, 10% of vendors were based outside the US, out of the reach of US law enforcement agencies; by 2006 this had increased to 45%. ^6,29

(Legal) avoidance of taxes occurs in many countries regardless of levels of organised crime and corruption. ³⁰

13.7.2.2 What drives (illegal) tax evasion?

Relative costs of various products available to consumers are a key driver of tax avoidance, and must also be important in small-scale bootlegging. However the factors determining the extent of illegal circumvention of tobacco taxes in any country would appear to be much more complex. Many people prepared to engage in legal avoidance are simply not willing to engage in illegal evasion as a matter of principle. For potential suppliers who are willing to consider trading in illicit tobacco products and have the means to do so, the decision about whether or not to actually engage in such activity is still not an automatic one. Individuals are likely to consider not simply the price they could charge for products in the illicit market but rather the profit that they could expect to make once costs are deducted from income. The greater the expected rewards and the lower the costs, the more likely an individual prepared and able to be involved in illegal activity is to actually engage in such activity. ^6,22

The prices that suppliers can charge consumers for illicit products are determined partly by the prices of products in the legal market. But the prices suppliers can charge are also affected by the perceived consistency of quality and supply of the illicit goods and the costs to the consumer in terms of time and travel and any perceived risks associated with purchase (e.g. contact with those involved in crime, fear of detection by authorities and so on). ³¹

The costs for the supplier to be involved in the illicit tobacco market include

• direct costs such as money required to bribe officials or other operators in the illicit trade
• opportunity costs such as salary forgone from other possible employment and other potential use of capital (growing land, equipment, factory space, boats and the like)
• a judgement about the probability of detection in relation to the magnitude of penalties and social opprobrium of being prosecuted.

These three considerations are likely in turn to be affected by factors relating to the nature of international trade, transport and distribution channels, cultural norms relating to bribery and corruption, government diligence in record keeping, investment in law enforcement and the individual's attitude to the prospect of jail time. ⁶

Nature of international trade

Illicit trade can be more attractive in situations where

• restrictions on the supply of imported tobacco (through the imposition of quotas, tariffs and other non-tariff barriers) lead to significant price differentials
• cigarettes intended for export are significantly cheaper than those intended for local consumption.

Detection of illicit cigarettes is more difficult where there is a large volume of international trade with only a small percentage of cargo subject to checks.

It is believed that cigarette smugglers often take advantage of free trade zones. (IARC 2011 ⁶ citing World Customs Organization 2007 ³² ) The Financial Action Taskforce of the Organization for Economic Co-operation and Development (OECD) estimated that there were about 3000 free-trade zones in 135 countries in 2009. ³³ The International Consortium of Investigative Journalists documented cases of smuggling through free-trade zones on the island of Aruba, and in Colombia (Beelman 2000 cited in the IARC report ⁶ ) and the US Financial Action Task force indentified smuggling through China to the US through a free-trade zone in Hawaii. ³³

Logistical factors

Evasion can sometimes occur in situations where people suddenly find themselves under financial pressure and in possession of the immediate means to be involved in the illicit market. This occurred in Australia when tobacco companies reduced prices paid and then stopped buying from Australian growers some of whom then turned to growing chop-chop. ³⁴ It also occurred after China joined the World Trade Organization and the products of small regional factories in China were no longer competitive. ²⁴

Costs of production of cigarettes are quite small, and technological advances in printing make counterfeiting easier in recent times. However, obtaining raw materials (particularly the tobacco) and moving stock out of premises would be difficult to conceal in most locations.

Products that need to be cleared through major shipping ports are more likely to be scrutinised by customs officials than are products travelling by road or rail.

Distribution of illicit products is likely to be easier in countries with highly developed black markets for other illicit products and a well-developed network of street sellers and small market stall holders.

Poor record keeping

A loose export–import recording system and lax work practices and supervision reduce the likelihood of detection.

Law enforcement perceived as lax

Evidence reviewed in the IARC report ⁶ suggests that the relationship between perceived risk of prosecution and likelihood of engaging in the illicit tobacco trade is not a linear one. Rather there may be a threshold interception rate beyond which the rate of smuggling rapidly declines.

Poverty

As pointed out by Staake et al in their analysis of business strategies in the counterfeit market, ³¹ those involved in the supply of illicit cigarettes are generally very anxious to avoid detection by authorities and therefore must be extremely careful to hide their operations. This makes it difficult for large numbers of consumers to be aware of and purchase their products. While threat of seizures is unlikely to be a major concern, fine and jail times for individuals is likely to reduce the supply of people willing to be involved and increase the costs demanded by those who are involved, thus increasing the likely cost of the product. In some developing countries and among some impoverished groups in high income countries, some smugglers may be undeterred by very high levels of risk if the return from smuggling exceeded the likely lost earnings due to time in jail. However in wealthier countries the economics of tax evasion are much more precarious.

Political instability, corruption, war and organised crime

Criminal networks involved in smuggling operate more easily in countries where corruption is high or government controls are eroded by war or political instability, and such groups are well placed to become involved in the illicit tobacco trade. Black market cigarettes were an important source of income for people during periods of war in the Balkans. ³⁵ Using indicators of corruption based on an index created by international non-government organisation Transparency International, Merriman et al ³⁶ observed that contraband sales tend to increase not with tax levels or cigarette prices but rather with the degree of corruption in any country. ³⁷

13.7.3 How can the extent of avoidance and evasion be quantified?

Given the illicit nature of tax evasion, developing accurate measures of such activities is extremely challenging if not impossible.

13.7.3.1 Methodological approaches to quantifying avoidance and evasion

The International Agency for Research on Cancer's (IARC) Handbook on the evaluation of tobacco control strategies ⁹ outlines six possible approaches to quantifying the extent of avoidance and evasion. These are outlined below together with comments about the validity of estimates provided by each source.

1. Expert opinion:

   People who may be regarded as having expertise about the evasion of taxes on tobacco products would include:

   • investigators hired by tobacco companies to identify wholesalers and retailers selling illegally manufactured tobacco or counterfeit products
   • customs and other law enforcement officials
   • professionals employed in health and welfare agencies whose extremely disadvantaged clients may be more likely to be using such products

   Such experts can provide invaluable qualitative information about the sort of products being used and some of the characteristics of the individuals they have encountered who are involved in the illicit market. However none of these people has any particular ability or knowledge that allows them to judge the extent of use beyond what they have observed.

   Customs officials and customs records can provide valuable information about trends in interceptions of smuggled goods. Customs departments generally report on the number of interceptions and the quantities of good seized.

   Investigators and law enforcement officials are likely to have focused on high risk areas or groups or to have based their searches on tip-offs. Professionals working in welfare organisations are likely to be in contact only with the most disadvantaged members of the area their agency services. All three are likely to over-estimate use because they are prone to extrapolate through the prism of their day-to-day 'worst case' experience to the entire population. All three are likely to be affected by second- and third-hand stories from original sources who may themselves be biased or misinformed.

2. Comparison of import and export statistics:

   The basis of the claimed 30% size of the global market for large-scale smuggling of legally manufactured cigarettes has never been seriously examined. It is not known for instance, whether global exports during the 1990s were recorded and reported on in ways that systematically differed to the ways that imports were recorded and reported on. ⁱⁱ

3. Comparisons of tax-paid sales and individually reported consumption measures:

   The United Kingdom is one of the few countries in the world to produce regular yearly estimates of illicit trade, with a methodology based on the discrepancy between trends in legal sales and smoking habits as quantified in household surveys. ³⁸

   Tax paid sales generally reflect shipments at the factory or wholesale level rather than individual consumption. These can vary considerably from actual sales both because they occur at an earlier point in time than purchase and consumption, and because refunds of taxes can be obtained on stock supplied to shops but returned unused. It is therefore highly likely that reported consumption will differ from levels of manufactured tobacco, even if there were no illicit trade. Reported consumption in Australia is substantially lower than the extent of consumption suggested by tax receipts–see Chapter 2, Section 2.2. This would likely reflect under-reporting of consumption by smokers. It is unknown whether the extent of such under-reporting may be fluctuating over time.

4. Modelling of demand for tobacco products:

   Researchers in the US and European Union have undertaken several research projects which attempt to estimate the extent of evasion by developing models that include estimates of price elasticity and differences in prices between state (or Member states) and tax-free jurisdictions such as Native American reservations.

   This work is interesting and helpful in assessing the likely and observed increases in legal and quasi-legal circumvention following tax increases or in the presence of price differences. However, trends in legal circumvention may not be an accurate predictor of trends in illegal circumvention given that illegally manufactured and smuggled products are likely to be less readily and reliably available (and harder to find), and given concerns about illegality.

5. Survey of tobacco users' purchase behavior:

   Representative surveys of tobacco users that collect information on purchase location and prices paid can be helpful in determining the extent of various forms of avoidance of tax including cross-border shopping, direct purchase via the Internet and duty-free purchases. ⁶

   Surveys where respondents are confident about confidentiality can also generate estimates of use of tobacco products that are quite clearly illicit such as illegally manufactured tobacco (known in Australia as chop-chop). The accuracy of estimates will be crucially affected by the representativeness of such surveys. Market research companies running surveys for commercial clients typically suffer from very low response rates, with a likelihood that those who are most interested in such products (likely to be those who have used them) will be most likely to agree to participate. Large surveys conducted for government agencies or charities are likely to be more representative. Both sorts of surveys are likely to miss highly disadvantaged individuals such as those who are homeless or who suffer mental health problems who may be more likely to use these considerably cheaper products.

   Assessing the use of branded illicit cigarettes through surveys is another matter altogether. It is doubtful that respondents could accurately judge whether they have purchased counterfeit cigarettes. Reproductions of packaging can be highly convincing and small variations in the taste of tobacco products can occur for a variety of reasons–variations in tobacco leaf, variations or changes in manufacturing procedures ⁱⁱⁱ , freshness of the stock depending on age, deterioration of the product due to sun or heat damage, tooth decay, gum disease and fluctuations in the bacterial profile of the smokers' mouth and nose. Fluctuations in the taste of the product are therefore not a failsafe guide as to whether that product is likely to be counterfeit.

   The price of tobacco products is also not necessarily a guide to their legal status. Contraband (including counterfeit) tobacco products are not necessarily substantially cheaper than the cheapest products sold in the legal the market or the popular brands sold 'on special' at discount outlets.

   Consumers' likelihood of agreeing that cigarettes they purchased were counterfeit or contraband is also likely to increase substantially after major stories in the media reporting that such products are readily available.

6. Observational data collection:

   Relatively untested but potentially quite promising approaches to assessing several dimensions of tax avoidance and evasion is the direct observations of vendors selling illicit tobacco products, and the direct observation of packs provided by smokers observed directly by researchers. This has been helpful in several European countries where interviewers were trained to recognise the various health warnings, tax markings and tax stamps required in each country. ⁹

   Ayers, Ribisl and Brownstein reported in an article published in PLos One in 2011 on tracking Google keyword searches as a useful method of quantifying consumer interest in purchasing reduced-tax or tax free cigarettes following tax increases in the United States. ³⁹

   'Mystery shopper' studies could provide useful information in the future, but such studies pose quite a few practical difficulties–would retailers sell contraband stock while any person other than the purchaser was in the store? There are no reports in the literature of any such studies having been conducted to date.

   Littered cigarette packs have been used in Chicago in the US where most states require state-specific tax stamps to be affixed to cigarettes ²⁸ and New Zealand where cigarettes have carried pictorial health warnings larger than those in many other countries. ⁴⁰ The Chicago study provided a useful estimate of the extent of purchases of packs from the areas adjacent to the Chicago tax zone. The New Zealand study was less informative: packs purchased outside New Zealand (a tourist destination very popular for its spectacular natural scenery) may have been purchased by tourists or locals recently arrived back from overseas bringing in small quantities of tobacco for personal use.

   The adoption of ever-widening restrictions on smoking in outdoor places and strictly applied anti-littering laws would make it difficult to collect packs in many jurisdictions. As noted in the IARC review, ⁶ it is likely that the sort of people who litter–despite strong social norms against and laws fining people for littering–may well be significantly more likely than the rest of the population who smoke to purchase illicit tobacco products.

7. Composite models:

   In 2004 the European Anti-Fraud Office (OLAF) of the European Commission contracted professional services company Klynveld Peat Marwick Goerdeler (KPMG) to undertake a detailed assessment of likely market penetration of avoided and evaded cigarettes throughout the European Union. ⁴¹ The reported estimated that approximately 8–9% of cigarettes fell into that category, and that rates were substantially higher in Estonia, Hungary, Lithuania, Poland and Slovakia. Since 2005, Philip Morris International has funded KPMG ⁴² to continue this initiative known as Project Star. ⁴³ Project Star uses a combination of consumer surveys, discarded pack studies, analysis of sales data, import and export data, duty-free sales data, customs seizures and interviews with industry and customs officials to produce its estimates. Project Star is a highly elaborate model which provides a great deal of detail on the characteristics of the market in each country. The work has not been subject to peer review and relies on data provided by tobacco companies but not publicly available, so the extent to which it accurately quantifies both avoided and evaded taxes on tobacco products is difficult to assess.

13.7.3.2 A note on global compilations

Market research companies such as Euromonitor International ⁴⁴ and ERC Statistics ⁴⁵ provide estimates of the extent of illicit trade in country-by-country reports and several reports produced for health agencies ^46,47 have used such studies as a basis for global estimates. ⁴⁸ Reports provided by commercial market research agencies–no doubt because they rely on subscriptions for income and wish to discourage subscribers from going to primary sources–rarely provide a detailed account of how these estimates are derived. It should also be remembered these reports are not subject to the kind of peer review that occurs in academic papers, nor to the kind of auditing to which government departments are subjected, or to the kind of regulatory scrutiny that tobacco companies themselves receive from national securities and investment agencies concerned to ensure appropriate disclosure to potential investors.

As is clear from the discussion above and in Section 13.7.7.3 below, while representative surveys of consumers provide a reasonable estimate of the extent of legal tax avoidance and of clearly illicit products such as illegally manufactured tobacco, there would seem to be no good methods for quantifying use of contraband cigarettes other than those known to be designed specifically for the illicit market. It is likely that researchers are relying on anecdotal information from tobacco company executives and those involved in running anti-smoking education campaigns. The former has information on sales but cannot interpret whether declines in sales are due to reductions in consumption or a shift to illicit products. The latter sometimes have access to results of surveys in the process of publication, but these are unable to shed light on the extent of any use of contraband products for the reasons outlined above.

Estimates of counterfeit trade globally produced by organisations such as the OECD ²² are based on analysis of interceptions, trends in trade in goods likely to be counterfeited and overall volumes and trade trends. While they are helpful in providing an indication of the global scale of the problem, they are too blunt a measure to be useful in quantifying use in individual countries over time.

13.7.4 Extent of illicit trade internationally–a real concern, or scare-mongering?

There is little doubt that revenue authorities in many parts of the world are greatly concerned about the scale of (legal) avoidance of taxes. Regulations regarding duty-free and cross-border shopping appear to have been designed for a world prior to the Internet where international travel was infrequent. Long-standing trade agreements ^iv make it difficult to end or even scale-down the current concessions which were envisaged to apply only to a very small component of sales but now constitute quite a large component of sales in many jurisdictions. This is a real concern for governments relying on revenue from tobacco taxes to fund important government services and policy initiatives. ^49,50 It is also a concern because the availability of cheap products can reduce the effectiveness of tax policy in reducing consumption. ⁵¹

Similarly it is clear that (illegal) evasion of taxes on tobacco products also occurs in many countries. ^6,12 It could be that smuggling is a particular problem in countries experiencing war, extreme poverty and political instability. ^6,35,52–55 Evasion of tobacco taxes can be regarded as a law-and-order as well as a health issue. The large volume of counterfeit goods emanating from China has been an ongoing source of tension between China and the US and other trading partners, who feel that China has not done enough to protect the business interests of US-based companies. ²²

While (legal) avoidance of taxes is commonplace, the conditions that facilitate the (illegal) evasion of taxes on tobacco are, however, simply not applicable in many countries. Most developed countries quite tightly regulate the sale of tobacco products, and the vast majority of citizens have nothing to do with people involved in criminal activities. This, combined with the discussion in Section 13.7.3 about the difficulties of quantifying illicit trade, raises the question of whether tax evasion is a serious problem at all for some countries. ⁵⁶

British American Tobacco (BAT) has sponsored the production of reports that have produced alarmingly high estimates of the extent of illicit trade in Australia ^57–60 as well as in New Zealand ¹⁵ and the UK. ⁶¹ All of these have been a crucial component of campaigns opposing vigorous government action to discourage tobacco use through measures such as tax increases ^62–65 changes in tax arrangements for roll-your-own cigarettes ^66,67 and plain packaging of tobacco products. ^68–70 Tobacco companies and company-sponsored lobby groups frequently release news statements following documented customs seizures to raise alarm about the problem of illicit trade.

'Two big busts a sign of things to come', Alliance of Australian Retailers Media Release
1 August 2011

BAT in Europe has produced highly emotive video clips suggesting that well-meaning politicians wanting to increase tobacco taxes may be inadvertently promoting the influence of powerful criminals and increasing the likelihood of childhood prostitution. ^v

A number of academic papers, ⁷¹ reports produced by US government research agencies, ⁴⁹ political parties and research services ^72–75 and newspaper articles ^76–79 allege that powerful and dangerous criminal gangs and terrorist groups are involved in counterfeiting activities on a 'massive' scale. An advisory from the US Department of Treasury Financial Crimes Enforcement Network warned its overseas partner institutions in December 2005:

As published in the Federal Register on September 20, 2005, we found Banco Delta Asia SARL ('Banco Delta Asia'), which is headquartered in the Macau Special Administrative Region of China, to be a financial institution of 'primary money laundering concern'. As stated in this Federal Register notice, Banco Delta Asia has provided financial services for over 20 years to North Korean government agencies and associated front companies that are known to have engaged in illicit activities. North Korean entities are known to have engaged in currency counterfeiting, narcotics trafficking, the production and dissemination of counterfeit cigarettes, and the laundering of related proceeds, as well as weapons of mass destruction and missile proliferation. ⁸⁰

Such reports have been embraced enthusiastically by conservative parties and think tanks with a political agenda of opposing tax increases. ^73,75 When assessing the validity of these highly emotive, alarmist reports, it should always be remembered that it is in the interests of tobacco companies to 'talk up' the problem of illicit trade in general and counterfeit cigarettes in particular. Concerns about loss of revenue might discourage governments from adopting effective tobacco control policy. ⁸¹ As pointed out by Leverett et al, ⁸² cigarettes confiscated and destroyed by law enforcement authorities increase demand for replacement cigarettes and therefore sales by tobacco companies. Raising alarm about counterfeit cigarettes at worst for the companies may reduce the use of 'fakes' and may have the spin-off effect of discouraging consumers from shifting to competing overseas-made brands which (it could be surmised) might have some of the same problems with quality as counterfeit cigarettes. Involvement in cooperative arrangements with government agencies such as those established between the European Union and the major international tobacco companies effectively leverages the resources of government enforcement agencies to advance the tobacco industry's interests in protecting its intellectual property. Best of all for the tobacco industry, feigned concern about revenue and law-and-order allows tobacco companies to position themselves as legitimate and concerned corporate citizens ready and able to undertake research ⁸³ and work with governments in the pursuit of 'reasonable' regulation. ⁸⁴

Estimates of the extent of tax avoidance and evasion internationally based on a variety of sources have been included in a recent study by Joossens, Merriman, Ross and Raw, ⁴⁶ summarised in the report by the International Agency for Research on Cancer (IARC). ⁶ Estimates from this body of studies have also been included in the World Lung Foundation and American Cancer Society's 2012 Tobacco Atlas ⁴⁷ which uses estimates compiled by ERC, Euromonitor and industry funded studies, as well as those commissioned by government agencies or undertaken by academics. ^vi The estimates are drawn from a variety of sources including academic articles, official government publications, estimates from market research companies (commissioned in some instances by government agencies but in most instances by tobacco companies), tobacco trade journals articles, newspaper articles and estimates from customs officials. As the authors acknowledge, the methodological quality of sources varies greatly, and in the case of the reports by international market research groups, do not provide any methodological detail at all. Estimates for individual countries vary from 1% to as much as 50% of the market. ⁴⁶ Putting to one side reservations about methodological quality, Joossens et al estimate that illicit trade makes up about 17% of total global cigarette consumption among low-income countries, 12% in middle-income countries and 10% in high-income countries. ^6,46 They go on to extrapolate these figures to suggest that governments could gain an additional $31.3 billion in revenue and that 164 000 premature deaths could be avoided if illicit trade were to be eliminated. ⁶

How confident can we be in estimates such as these? The IARC report states '... a combination of methods, including informed expert judgement, is often necessary to cross-validate estimates.' It is possible however, that within any country, many of the estimates are based largely on previous estimates and are not in reality independent enough of each other to allow such validation.

Estimates of tax-free trade very commonly conflate estimates of legal and illegal circumvention–that is, they include not just illegal counterfeiting and large scale smuggling but also small-scale illegal bootlegging and entirely legal cross-border and duty-free shopping. Tobacco industry discussion of threats to tobacco tax revenue typically highlights illegal evasion:

'Monday, 20 October 2008 British American Tobacco today warned that governments worldwide, many increasingly indebted due to the global financial crisis, will this year lose around US$20 billion in unpaid tobacco taxes at the hands of smugglers and counterfeiters.'

'Taxpayers lose $1 billion while criminals make millions {Media release}. Sydney: 1 March 2011'.

Reports by government agencies and health groups that discuss or attempt to quantify avoidance and evasion of tobacco products similarly also often use the term 'illicit' to cover both forms of evasion. The US General Accountability Office in its report to Congressional Committees in 2011 for instance was titled 'Illicit Tobacco: various schemes are used to evade taxes and fees' when much of the focus of the report was actually about avoidance of taxes through (what is arguably legal) cross-border trade.

In many countries it is likely that legal circumvention makes up a large component of estimates of quantities of non-taxed tobacco or levels of revenue forgone.

While the topic of illicit trade appears to attract a great deal of hyperbole and moral panic, it is interesting to note that reported seizures across the globe are declining despite greatly increased surveillance activities throughout Europe and elsewhere. Reporting on analysis of 2 550 pieces of information on cigarette seizures with a minimum of 100 000 pieces carried out in 2010 and 2011 by 64 Members of the World Customs Organization, the WCO comments in its annual report released July 2012:

'The relevant figures recorded in the CEN database come to a total of 1 524 seizures in 201 and 1 026 in 2011 accounting for 3.2 billion pieces in 2010 and 1.9 billion pieces in 2011. The figures show a remarkable decrease in both the number of seizures and the amount of contraband seized in 2011.'
World Customs Organization, July 2012 ²⁵

The next three sections describe what is known about the extent of three forms of evasion of tobacco taxes that have been documented in Australia: bootlegging between Australian states and territories which was a major form of evasion in the 1980s and early 1990s; sale of untaxed, unprocessed tobacco (known as chop-chop), a form of evasion that emerged in the late 1990s when state fees were abolished and which remains a serious challenge for the Australian Taxation Office; and smuggling of cigarettes, a large problem in some regions of the world, and instances of which have been documented in Australia.

13.7.5 'Butt-legging' between Australian states and territories

Between 1972 and 1998, Australian states and territories charged tobacco wholesalers and/or retailers licence fees based on a percentage of the value of sales in the previous months. The percentage which applied varied widely over time and between states. The variability in licence fees–see Table 13.4 in Section 13.2.2– resulted in considerable differences between states in the retail cost of cigarettes, with fees in Queensland substantially lower than in other states until 1992–93. Differences in legislation in each jurisdiction resulted in differences in definitions and treatment of stock transferred within companies between states and licence holders. A variety of schemes emerged in the early 1990s that enabled tobacco sellers to minimise payment of fees, or to avoid paying them altogether.

An internal report produced by the National Crime Authority, ⁸⁵ indicated that various schemes for bootlegging (or ' butt-legging' as it was dubbed in newspaper headlines at the time) included:

• failing to renew licences, thereby avoiding fees on stock sold in the previous month
• forging of documents to obtain a proportion of stock free of licence fees
• transferring of stock within companies to interstate warehouses, thereby avoiding fees in either the origin or destination states
• transporting of tobacco across several borders, allowing lawful sale to unlicensed wholesalers or to retailers who would dispose of products in undeclared sales
• purchasing of stock from jurisdictions with lower licence fees
• false representation of interstate sales
• non-disclosure of transactions involving unlicensed merchants.

In 1994 the Victorian Revenue office estimated that it had lost approximately $39 million per year due to schemes such as the above, which amounted to 15.6% of revenue collected in 1990–91 and 9.2% in 1992­–93. The NSW Office of State Revenue estimated a revenue gap of approximately 3% in 1994 after state licence fees had increased in Queensland (personal communication State Revenue Office, Victoria).

The abolition of state business franchise fees brought these schemes to an abrupt end, however a new form of illicit trade very quickly emerged to fill the void.

13.7.6 The problem of chop-chop

With the end of the state business franchise fees after a High Court ruling that these were unconstitutional–refer Section 13.2.2–all excise duty in Australia was collected directly from manufacturers and so sources of cheap cigarettes evaporated. ⁸⁶ Faced with lower prices paid by manufacturers and the phasing out of purchases from Australian growers, ^87–89 several operators began to work with landholders with spare capacity to distribute illegally grown, unbranded, minimally processed tobacco known as ' chop-chop', suitable for use in roll-your-own cigarettes. ^34,90 Producers of chop-chop evade regulations on tobacco growing, processing and sales in order to avoid excise and GST. ⁹¹ In a report of prosecution of one such operator in August 1998, the Customs Minister claimed that authorities were aware of several factories cutting and packing illicit tobacco run by major crime syndicates. ⁹²

Anecdotal reports suggested that a large number of smokers experimented with chop-chop when it first emerged in Australia. ^13,93 A telephone survey of NSW smokers late in 2004 reported in the Australian and New Zealand Journal of Public Health ¹⁴ that about 3% of respondents always used chop-chop and that 2.6% used it occasionally. The study found that chop-chop smokers were more likely to be male, smoke more heavily and be less well educated. However, it seems that the majority of people who experimented did not persist in using this form of tobacco. The 2004 National Drug Strategy Household Survey found that 38% of all Australians aged 14 years and over were aware of chop-chop ^vii , and of the 8.8% of this group who had ever smoked it (about 3.3% of the total population), about 21.7% (0.4% of the total population) smoked it half the time or more.

Tobacco manufacturers and retailers were highly vocal in their concern about chop-chop, ^86,94 and argued vigorously that the problem resulted from increases in tobacco taxes. ⁹⁵

In a report prepared for British American Tobacco Australasia in 2005, consulting company PricewaterhouseCoopers estimated that 1 in every 17 cigarettes smoked in Australia in 2004 was illegal. This amounted to between $300m and $450m in lost tax revenue. ^58,94 A report published by the Australian National Audit Office in 2006 however put the estimated loss in excise revenue much lower, at about $98 million in 2004–05, but still a 56% increase in estimated losses since 2001–02. ⁹⁶ This estimate was much more consistent with the data from population surveys.

Since 2005, British American Tobacco (BAT) sponsored five further reports claiming to quantify the extent of illicit trade in Australia; two reports by PricewaterhouseCoopers ^59,60 and three by Deloitte. ^97–99 These put the estimates for use of unbranded tobacco in Australia at about 15.7% of the total legal market. Reports by Quit Victoria ^100,101 analysing the Deloitte reports suggest that surveys on which these estimates are based are unlikely to be representative. They also suggest that consultants have prepared estimates that would seem to be based on quantities purchased by frequent users rather than all users. The estimates fail to take account of the trends reported in Australian National Drug Strategy Household Surveys ^102,103 showing that the majority of people who have ever used unbranded tobacco no longer use it and that among those that do still use it the majority use it only occasionally.

The Australian Taxation Office (ATO) put considerable resources into pursuing growers and distributors of chop-chop and its annual reports suggest that it believed that these activities successfully prevented any major growth in diversions of tobacco to the illegal market in Australia– see Technical Appendix 13.7.2 for further details. The Australian Taxation Office's estimates of the quantities of tobacco grown and the quantities diverted to the illegal market are presented in Table 13.7.1. The table also includes records of the quantities seized by the ATO and other law enforcement agencies.

In its 2007 report on compliance activities, ³⁴ the ATO stated:

'The end of Australia's legal tobacco growing industry in 2006 has meant that the mischief involved in illicit tobacco has changed from the diversion of legally grown tobacco to illicit importation and growing. We are monitoring this issue and will undertake enforcement action with the Australian Customs Service as required.'

Reports on seizures of tobacco products by the Customs and Border Protection Service since 2006–07 are set out in Table 13.7.2.

Recent trends use of unbranded tobacco in Australia are provided in the 2010 National Drug Strategy Household Survey. ^viii While some 24% of recent smokers had tried unbranded tobacco at least once in their lifetime–only 4.9% of recent smokers were still using it on a continuing basis and only 1.5% of smokers used it half the time or more.

Comparison of data from the last three National Drug Strategy Household surveys indicates that fewer smokers over time are using unbranded tobacco, but that a slightly higher percentage of those users are using regularly.

13.7.7 Contraband cigarettes–a growing problem in Australia or a threat about which people are increasingly aware?

The extent of any diversion of cigarettes produced by licensed manufactures in Australia (either historical or recent) is unknown. In 2000–01, Australia exported more than 1 800 metric tonnes of tobacco products including 8.5 metric tonnes to Australian territories and 942 metric tonnes to various South Pacific islands. ¹⁰⁹ In some cases, the amounts exported to particular countries seem very high compared with the population of those countries. ^110,111 Stock exported to distributors in particular countries could be being sold to retailers beyond that country, so it is difficult to judge the significance of any apparent discrepancies.

Counterfeit cigarettes have been identified in seizures of contraband good destined for Australia on a number of occasions. But it is unclear how big the trade in counterfeit cigarettes really is.

13.7.7.1 Well-documented cases of evasion of taxes on cigarettes in Australia

In June 1996, prominent investigative journalist Brian Toohey reported in an article in the Australian Financial Review ¹¹² on the successful prosecution by the New South Wales Fraud Enforcement Agency and the Australian Customs Service of several Chinese-born people found to have been distributing counterfeit Winfield cigarettes in Australia. The article reported that an investigation by company Control Risk Pacific for its client Rothmans traced the cigarettes back to two factories in China, one in Changchun in northern China, and the other in Filin in central China. According to an assessment performed by the Australian Government's Australian Transaction Reports and Analysis Centre, these factories were owned by the Chinese Government Tobacco Monopoly. The packets were outstanding copies. The article also reported that private investigation firm Nationwide Security employed by Philip Morris uncovered imports of counterfeit Marlboro soft pack cigarettes. An editorial, which appeared to be a close paraphrase of the Toohey article, appeared in the August edition of the Australian Retail Tobacconist. ¹¹³

The government's Transaction Reports and Analysis Centre (AUSTRAC) included the following case studies in its annual reports documenting its assistance to customs authorities seeking to identify and prosecute those involved in the illicit tobacco trade:

Case study 11, 2007 reproduced as Case study 3, 2008

'Company directors generate false receipts to evade tax

Directors of a company were involved in purchasing large quantities of duty free cigarettes and alcohol to sell on the domestic market contrary to their export-duty free status, thus avoiding tax obligations. By not paying any tax on the goods the company was able to markedly increase profits. The syndicate also generated false receipts that purported to come from an export company detailing their alleged cigarette exports. Investigations into the company confirmed that no such exports had ever been made. Payment for the cigarettes was made to the delivery driver on a cash-on-delivery basis. A large number of the company's sales occurred over the internet from customers paying via credit card. Payments for these orders were made from one of two credit cards linked to Belize bank accounts. One of these cards was held in the company's name. The money in the Belize bank account was sent there by one of the directors using several false names from Australia, Belize, Hong Kong, and Vietnam. The director conducted structured wire transfers under false names and from company accounts. The funds were deposited at well known banks, with multiple transactions occurring on the same day at different bank locations, and all of the cash transfers were conducted in amounts of just under AUD10 000 to avoid the reporting threshold.'

Case study 15, 2009

In 2009, AUSTRAC helped identify a consignment of contraband cigarettes from the Middle East that were shipped to Australia via New Zealand. An unexpected invoice by the shipping container company after a delay in New Zealand ports resulted in identification of the Australian importer:

A law enforcement agency discovered a shipping container in New Zealand, destined for Australia, which allegedly contained illicit tobacco products. The container originated in the Middle East and, following its arrival in New Zealand, the shipping agents received instructions to forward the container on to Australia. 'Transhipment', in which international cargo passes through a third country on the way to its final destination, is one method used by criminal groups attempting to prevent illegally imported goods being detected. However, in this case, the container was held at the New Zealand shipping agent for some time and the intended recipient in Australia was required to pay storage fees before the shipping agent would release the container. AUSTRAC information identified an international funds transfer from Australia to pay the New Zealand shipping agent, enabling law enforcement officers to identify the intended recipient of the illicit tobacco products in Australia. Due to the low cost of illicit tobacco products in the Middle East the importers attempted to disguise payment for the tobacco within their normal business activities. The importers' legitimate business activity included regular international transactions, providing a veil of legitimacy under which to import products illegally. AUSTRAC ^{114 p31}

13.7.7.2 Extrapolating case studies to estimates of total use

As indicated in Table 13.7.2 above, relatively small quantities of cigarette sticks have been seized by the Customs and Border Protection authority in Australia–82 million sticks compared with the total 22 000 million sticks estimated to have been sold in Australia in 2009–10, or just over one-third of one per cent of total sales.
This information is of little help in determining the total extent of use in the Australian market. It is not known whether seizures represent a tiny per cent of the total amount of contraband stock coming into the country ¹¹⁵ or–at the other extreme–all or close to all of the stock that would have been imported had the stock not been seized.

Table 13.7.6 below provides an estimate published by Euromonitor International of the penetration of counterfeit and other contraband cigarettes in Australia.

No information is provided about the source of the data for this estimate so it is impossible to judge its accuracy. The industry-sponsored Deloitte reports put the size of the market for contraband and counterfeit cigarettes in Australia at 1.3% in 2010 ⁹⁷ and 4.4% in 2011. ⁹⁹

The National Drug Strategy Household survey in 2010 also asked about awareness of 'counterfeit' cigarettes and whether people had ever picked up differences in taste and packaging (questions 28, 29 and 30). ^ix This question would underestimate the extent of use of (assumed and actual) contraband products in that no questions are asked about intentional purchase of such products. It would overestimate use to the extent that question 28 might predispose respondents to answer in the affirmative on question 29.

13.7.7.3 How reliable are consumer estimates of use of contraband cigarettes?

It is likely that respondents inadvertently over-estimated the extent of their use in both the Roy Morgan survey used in the Deloitte report to estimate extent of population use, and in the National Drug Strategy Household Survey. Levels of perceived use in both surveys could be unrealistically high due to people making any of the following erroneous assumptions:

• People may have assumed that heavily discounted cigarettes are illicit whereas it could just be a case of retailers selling off stock that has become old or difficult to move.
• Cigarettes that tasted different to usual may have been assumed to have been counterfeit whereas they may have just been a batch that was slightly different because of small changes in the manufacturing process (e.g. a change from local to offshore processing, or after the implementation of measures to comply with legislation on reduced ignition propensity). ^x
• Cigarette cartons with Asian print on the packaging may be assumed to have been counterfeit when they were in fact merely manufactured in Asia. The Australian Retail Tobacconist for instance lists Malaysia and Singapore as places of manufacture for Dunhill cigarettes. Now that tobacco is no longer grown in Australia, companies are increasingly manufacturing overseas.

Given the subjective nature of judgements about taste, and the likelihood that consumers who have heard publicity about counterfeiting would be more attentive to brand names and packaging, it is likely that the percentage of people believing that they had bought such cigarettes increased over the past two years due simply to the very high levels of media discussion about cigarette smuggling elicited by the previous Deloitte reports ^97,98 and the extensive media coverage about this topic generated by media releases from BAT and other tobacco companies.

People answering questions in the Roy Morgan Survey on which the Deloitte report for 2011 was based may have assumed that very cheap cigarettes they had tried with Asian-sounding names were counterfeit or contraband, when in fact they were just very cheap cigarettes imported from Asia with the duty legitimately paid. In 2011, there were at least 12 brands that were being legitimately imported from Asia, all substantially cheaper than local better known brands. The table below lists the recommended retail prices of these brands from The Australian Retail Tobacconist, but it is likely that many are sold in Asian groceries and the like at discounted prices considerably lower than these. For comparison:

Brand	Local manufacturer	Country of origin		RRPMay/June 2011
Dunhill	British American Tobacco	Australia (in addition to Malaysia and Singapore)		$13.90 for 20s, $17.20 for 25s
Winfield	British American Tobacco	Australia		$13.45 for 20s, $16.55 for 25s

But note:

Brand	Local importer	Country of Origin	Overseas manufacturer	RRP as at May/June 2011
Carnival	Pt Korea Pty Ltd	Korea	KT&G South Korea	$9.90
Chunghwa	Patron Group (Australia) Ltd	China	Shanghai Cigarette Factory	$11.40
DJ Mix Special Feel	Trojan Trading Company	Hong Kong	Not stated	$12.64
Double Happiness	Patron Group (Australia) Ltd	China	Shanghai Cigarette Factory	$9.15
Esse Blue	Pt Korea Pty Ltd	Korea	Not stated	$10.70
Golden Deer	Patron Group (Australia) Ltd	China	Not stated
Panda	Patron Group (Australia) Ltd	China	Shanghai Cigarette Factory	$17.00
Peony	Patron Group (Australia) Ltd	China	Shanghai Cigarette Factory
Raison Blue	Pt Korea Pty Ltd	Korea	KT&G South Korea	$10.70
Shuangxi	Everbright Int'n Trading Co Pty Ltd	China	China Tobacco Guandong Industry Corp	$9.60
Yuxi	ATA International Pty Ltd	ATA International	Not stated	$10.55

Source: The Australian Retail Tobacconist trademarks and prices lists, May–July 2011 ¹¹⁹

Given the difference between the prices of these brands and top-selling brands such as Winfield 25s, it would be little wonder if many people thought that Asian brands were contraband.

It may also be possible that some respondents to surveys may confuse electronic cigarettes with counterfeit cigarettes, both sometimes being referred to as 'fake cigarettes'.

13.7.8 Estimates of total illicit market for tobacco products in Australia

What conclusions can be drawn about the size of the illicit tobacco market in Australia?

Tobacco companies have funded estimates of the size of the illicit tobacco market in Australia for the years 2007, 2010 and 2011 and half-yearly since 2012. Copies of these reports and detailed critiques of each of the last six reports can be found at  https://www.cancervic.org.au/plainfacts/browse.asp?ContainerID=illicittobacco   

13.7.8.1 Expert opinion

Tobacco industry investigators employed to assist companies in identifying sale and counterfeiting of cigarettes are likely to focus on complaints and retailers in areas identified as 'high risk' based on complaints and factors such as ethnicity believed to be associated with involvement in illicit trade. ¹¹² For this reason the estimates of such people relied upon in the PriceWaterHouseCoopers and Deloitte reports might be inclined to over-estimate likely use.

13.7.8.2 Analysis of reported use of tobacco products compared with receipts of product subject to excise duty

As discussed in S13.7.3.1 above, another method of estimating the extent of illicit trade is to quantify by how much reported consumption (estimated from population prevalence multiplied by reported by the average number of cigarettes smoked per person per day) exceeds consumption based on official tax receipts. In Australia however, reported consumption is substantially below that estimated through official tax receipts. (This is most likely due to smokers underestimating their consumption.) The extent to which reported excise and custom receipts exceed reported consumption was somewhat lower in 2000–01 and in 2009–10, both years in which there were significant increases in excise/customs duty. The explanation for this could lie in some increase in use of illicit tobacco, but equally it could be the result of variations in consumption across the year related to the timing of the survey in relation to the tax increase. Reported consumption assessed in May to October 2010 (when the NDSHS surveys were being conducted) straight after the increase in duty in April 2010 may have been lower than for the 2009–10 year as a whole.

Table 13.7.8
Consumption estimates based on self-report versus customs and excise receipts 1998 to 2010

	1998	2001	2004	2007	2010
Prevalence of daily, weekly, or monthly smoking	24.9%	23.4%	20.7%	19.4%	18.0%
Population 14+	15 038 764	15 693 890	16 389 918	17 226 200	18 396 129
Smokers 14+	3 979 600	3 645 700	3 395 100	3 345 000	3 328 959
Average cigs per day per smoker	14.4	15.6	14.1	13.9	14.7
Total annual consumption (based on estimated numbers of smokers and reported numbers of cigarettes smoked )	20 958 279 143	20 796 635 243	17 437 476 107	16 918 532 143	17 913 604 187
Total cig. equivalents dutied per annum	31 311 578 462	25 475 471 114	25 883 730 608	24 598 548 233	23 644 571 100
Dutied cig. equivalents smoked per smoker per day	21.6	19.1	20.9	20.1	19.5
% by which dutied consumption exceeds reported consumption	33%	18%	33%	31%	24%

Sources: M Scollo calculations using data from the Australian Institute of Health and Welfare reports on the National Drug Strategy Household Surveys ^102,103,108 and excise and customs data from Chapter 2, Section 2.2

13.7.8.3 Observational data

No studies have been published in Australia reporting on characteristics of discarded packs. Without tax stamps or other forms of overt markings, contraband or other contraband cigarette packs will be indistinguishable unless they fail to display Australian health warnings. Even discarded packs without Australian health warnings could be packs purchased overseas by tourists travelling in Australia.

No studies have been published on the results of test purchases by mystery shoppers.

13.7.8.4 Estimates based on surveys of consumers

Tobacco industry estimates based on consumer surveys, 2007, 2009, 2010 and 2011

The estimates prepared for Australian tobacco companies over the four years from 2007 would seem to suggest an increase and then tailing off of use of unbranded tobacco, and small but growing use of illicit cigarettes–refer Table 13.7.9 below. Tabulating the results of these studies in this manner several inconsistencies become apparent. First, the size of the legal market in 2007 is impossibly high if, as the report suggests, unbranded tobacco was 1 827 000 ks and made up 6.4% of the market. Second, the PriceWaterHouseCooopers report assumed a substantial overlap between 'counterfeit' and 'contraband' tobacco, however the Deloitte report appears to treat these as completely non-overlapping and adds them together.

Table 13.7.9
Tobacco industry estimates of size of illicit tobacco market in Australia based on consumer surveys, 2007, 2009, 2010 and 2011

	2007	2009	2010	Mid 2011 (not released)	2011
Unbranded, '000 kg	1 827	2 119	2 430	2 193	1 427
Contraband, '000 kg		133	116	212	407
Counterfeit, '000 kg		228	134	223	430
Total contraband & counterfeit, '000 kg		229	250	435	837
Overlap between contraband & counterfeit (calculated from reported figures attached)		99.6%	0%	0%	0%
Total illicit market, '000 kg	1 827	2 348	2 680	2 628	2 264
Total legal market, '000 kg	28 547	19 089	16 853	16 853	16 861
Total illicit & legal market, '000 kg	30 374	21 341	19 399	19 258	18 695
Unbranded share of legal market	6.4%	11.1%	14.4%	13.0%	8.5%
Contraband & counterfeit share of legal market	0.0%	0.7%	0.7%	1.3%	2.4%
Unbranded share of total market	6.0%	9.9%	12.5%	11.4%	7.6%
Contraband & counterfeit share of total market	0.0%	0.6%	0.6%	1.1%	2.2%
Total illicit share of legal market:	6.4%	12.3%	15.9%	15.6%	13.4%
Total illicit share of total market:	6.0%	11.0%	13.8%	13.6%	12.1%

Sources: PriceWaterHouseCooopers 2008 ⁵⁹ and 2010, ⁶⁰ Deloitte 2011a ⁹⁷, 2011b ⁹⁸ and 2012 ⁹⁹ using Roy Morgan surveys

The surveys of consumers on which the PriceWaterHouseCoopers and Deloitte reports are based consisted of very small numbers of smokers drawn from a panel whose willingness to complete a survey on this topic makes it unlikely that they were representative of the total population of smokers.

Estimates based on findings of National Drug Strategy Household Survey and customs seizures

Estimates of prevalence and frequency of use of unbranded tobacco using data from the National Drug Strategy Household Survey are described in Section 13.7.6 above. Using this data and estimating the numbers and weigh of tobacco products used, Quit Victoria has prepared estimates of the size of the market in Australia. ¹⁰⁰

Table 13.7.10
Number of detections and quantities of tobacco and numbers of cigarettes seized by Australian customs authorities, 2006–07 to 2010–11

	2006–07	2007–08	2008–09	2009–10		2010–11
Quantity of loose tobacco, '000 kgs	67	287	180	311	258
Quantity of sticks, '000 pieces	42 000	107 000	50 176	68 728	82 000
% that illicit cigarettes make up of total quantity of illicit tobacco products seized	39%	27%	22%	18%	24%

Source: Australian Customs and Border Protection annual reports ^104-107

As discussed in Section 13.7.7, estimates of use of counterfeit cigarettes drawn from the NDSHS are not considered accurate. However, a rough indication of the size of the market for illicit branded cigarettes in Australia might be gained by looking at the proportion of tobacco product seizures that are for branded cigarettes rather than unbranded tobacco.

Using these percentages, it is then possible to scale up the estimates of the size of the market for unbranded tobacco to generate an estimate of the total size of the market.

Table 13.7.11
Estimated market share of illicit trade in Australia based on National Drug Strategy Household Survey reports and assuming use of illicit cigarettes compared with unbranded tobacco is similar to the proportion that illicit cigarettes make up of total seizures

	Chop-chop smokers		All smokers
Number of current users	162 194
Average daily cigarette consumption	18 (chop-chop cigarettes)		14.7
Number of cigarettes smoked per year	347 816 599		17 913 604 187
Note: Population estimates based on NDSHS 2010 weightings.
Frequency of chop-chop use	N	%	N cigarettes smoked per year per chop-chop smoker	Total: N cigarettes smoked per year
Only use chop-chop	20 599	12.7%	6 570	135 333 052
Mainly use chop-chop	19 301	11.9%	5 256	101 446 508
Use chop-chop half the time or more	9 894	6.1%	3 285	32 501 245
Use chop-chop less than half the time	3 568	2.2%	1 971	7 033 056
Use chop-chop occasionally	108 832	67.1%	657	71 502 738
Total:	162 194			347 816 599
Estimated revenue forgone:	$125m
Using different assumptions regarding daily cigarette consumption of chop-chop: smokers	Estimated size of market for unbranded tobacco (chop chop) as share of total tobacco market		Estimated size of illicit tobacco market (including both unbranded tobacco and illicit branded cigarettes) as share of total tobacco market
15	1.6%		2.0%
16	1.7%		2.1%
18	1.9%		2.4%
20	2.2%		2.7%
22	2.4%		3.0%
24	2.6%		3.2%

Source: Quit Victoria, 2012 ¹⁰¹

13.7.9 To what extent does avoidance and evasion of taxes on tobacco products reduce public health, increase health disparities and reduce public safety?

Avoidance and evasion of tobacco products are a concern to tobacco control for several reasons. First and probably most importantly, fear about losing revenue can deter governments from adopting effective tobacco control policy ⁸ or even to reverse important policy decisions with severely adverse consequences for public health. ¹²¹ Second, cheaper products readily available to consumers reduce the effectiveness of tobacco taxes both as a source of government revenue and a means of reducing tobacco consumption, ^6,122 particularly among more disadvantaged groups.

13.7.9.1 Effects on availability of cheap tobacco products for consumption (and therefore public health)

Analysis of data from the International Tobacco Control Policy Evaluation Study (ITCPES) shows that smokers who have access to un-taxed cigarettes are less likely to say that they will make a quit attempt ¹²³ and to actually make such an attempt than those who only buy full-priced cigarettes. ¹²⁴ They also tend to less vigorously reduce consumption in response to a rise in prices. ¹²⁵ In some countries it seems that young people are able to access cigarettes from the tax-free market ^126,127 and that cigarettes available tax-free determines brand choices. ¹²⁸

Despite concerns about consumption effects, and even in countries where the level of smuggling would appear to be quite high (even allowing for industry exaggeration), such activity has by no means completely undermined tobacco control policy. In South Africa for instance where illicit trade was estimated to have occupied between 7% and 11% of the market in 2007, consumption in the total market, including both the illicit and legal market, has declined in size consistently. At the same time, tax revenue from higher excise taxes has offset the tax losses as a result of illicit trade. ¹²⁹ This is also the case for Australia where even the industry's (most likely exaggerated) estimates of the amount of the quantity of illicit tobacco consumed and the estimated revenue forgone by tax evasion are substantially lower than the additional revenue the government has received following increases in taxes, with substantial reductions in consumption evident (though not highlighted) in industry figures ¹⁰¹ –see technical appendix 4 for further details.

13.7.9.2 Health disparities

Whereas increases in taxes can help to prompt greater quitting among disadvantaged groups, it seems likely that access to cheap sources of tobacco disproportionately affects low income groups who are more price sensitive. ¹³⁰

Several studies have demonstrated that smokers who are poorly educated are more likely to (legally) avoid taxes. ^10,131 Cases of socially disadvantaged groups purchasing smuggled cigarettes have also been reported–among ethnic Chinese in New York ¹³² and in extremely deprived areas of Scotland where residents perceived smugglers as 'providing a valuable service to the community.' ¹³³

A study in Australia published in 2009 ¹³⁴ found that chop-chop users are more likely to have taken up smoking at a young age, with 'a 60% greater odds of' reporting below average social functioning and the sF-8 scale and nearly twice the odds of reporting a measurable disability.' They are also more likely to report significantly worse health. The authors imply that there may be some causal relationship between use of chop-chop and worse health outcomes. However, given that chop-chop only became available in Australia in about the turn of the 20th century, well after current users took up smoking, and given that those who took up smoking at an earlier age are much more likely to be heavier smokers more prone to ill health, it seems likely that the relationship works in the other direction. It is highly disadvantaged heavy smokers with significant health problems who have been more likely to use chop-chop. It cannot be determined how many additional people would have quit had chop-chop not been available in Australia.

13.7.9.3 Greater access for children?

A cross-sectional survey of 15- and 16- year olds in the (low-SES) North-West of England found that 28% of teenagers reported using 'fake' cigarettes. ¹³⁵ It is not clear how the teenagers would have known whether the cigarettes were fake. The percentage purchased from 'street sellers' was not disclosed. In April 2011, the industry-funded Alliance of Australian Retailers claimed that the government's National Drug Strategy Household Survey showed that Australian children as young as 14 years old were smoking illicit tobacco. The Australian Institute of Health and Welfare's analysis of the 2007 NDSHS ¹⁰² reported that 4.5% of teenagers aged 14 to 19 years reported having ever tried illicit tobacco products. It should be noted however that fewer than 1% (+/- 50%) indicated that they used it 'half the time or more'. The figures quoted in the report relate to 14–19 year olds as a group. Prevalence of use for teenagers of each age (14, 15, 16 and so on) cannot be determined from examination of the report. Detailed examination of the data file on which the report was based however shows that only 1.2% of 14-year-olds reported ever having tried unbranded loose tobacco. Most importantly, examination of that file reveals that no 14-year-olds at all reported currently smoking unbranded loose tobacco.

Figure 13.7.1
Advertisements placed in Melbourne Age and other Australian newspapers, 20 to 22 April 2011

13.7.9.4 Are illicit tobacco products more dangerous?

The Centre for Regulatory Effectiveness in the US ¹³⁶ has compiled a number of studies discussing the harmfulness of counterfeit cigarettes as part of its efforts to oppose regulatory control over menthol by the US Food and Drug Administration. The studies include

Pappas R, Polzin G, Waston C and Ashley D. Cadmium, lead and thallium in smoke particulate from counterfeit cigarettes compared with authentic US brands. Food and Chemical Toxicology 2007;45:202-9. Available from: http://www.ncbi.nlm.nih.gov/pubmed/17011104

which found substantially levels of cadmium 2.5 time higher, lead 1.4 to 4.9 times higher in counterfeit cigarettes supplied by a UK government agency compared to genuine counterparts. Levels of thallium were also higher than for most of the authentic brands. ¹³⁷

and 

Swamia K, Judda C and Orsinia J. Trace metals analysis of legal and counterfeit cigarette tobacco smaples using inductively coupled plasma mass spectrometry and cold vapour atomic spectometry. Spectroscopy Letters 2009;42(8):479-90. Available from: http://www.tandfonline.com/doi/abs/10.1080/00387010903267799

which found higher levels of metal Be, As, Mo, Cd, Sb, Tl, Pb, and Hg. ¹³⁸

Heavy metals are problematic for health because they accumulate over time. Other studies have shown that such heavy metals vary widely between brands of cigarettes in various countries. ^139–151 Cigarette smoke contains more than 7000 chemicals. ¹⁵² In any two samples of cigarettes, some chemicals will be significantly higher in one sample than another, some will be significantly lower and some will not differ significantly. While heavy metals are harmful to health, it is the carcinogens and poisonous gases rather than the heavy metals in cigarettes that cause the greatest morbidity and mortality.

The Centre also quotes highly alarming material from a translated copy of an article purportedly produced by the Shandong Provincial Tobacco Monopoly Bureau asserting that counterfeit cigarettes use inferior or even waste or contaminated waste products. They talk of a parasite found in tobacco plants the eggs of which can be inhaled and cause great harm to the nervous system including in severe cases necrosis of the brain. The article talks of industrial dyes that when combusted 'will produce severe damage to the reproductive system and visual system.' Tobacco used in cigarettes, it is claimed, may be produced from waste products including cigarette butts in bins. A UK government report states that counterfeit cigarettes have been found to contain 'rat droppings, camel dung, sawdust and tobacco beetles.'

These alarming reports ignore the fact that very few countries in the world require companies to test and report on contaminants or on residues from pesticides, herbicides or fungicides in tobacco used in 'genuine' cigarettes to kill mould, parasites and the like, or, indeed, on the effects (when combusted) of these or any substances added during production. Any health problems associated with counterfeit cigarettes (and with illicit tobacco) would be insignificant compared with the number and severity of major health problems caused by smoking itself.

13.7.9.5 Law and order issues?

US authorities believe that money gained from illicit tobacco trade has been used for other serious criminal enterprises. ⁴⁹ None of the reports alleging involvement of terrorist organisations have provided details of evidence on which these assessments were based, so it is difficult to judge how credible they are. Widespread use of illicit tobacco would be a legitimate concern in any country in that such activities could reduce barriers among citizens to the purchasing of other black market goods, and could also provide incentives to public officials to facilitate black market activities. ^8,72,153

13.7.10 How can legal and illegal circumvention of tobacco taxes be reduced?

In 2009, Canadians Sweeting, Johnson and Schwartz undertook an extensive review of the effectiveness of policy measures to reduce avoidance and evasion of taxes on tobacco products. ¹⁵⁴ Little is known about the effectiveness of policies to reduce avoidance, and it seems likely that activities will continue so long as they are deemed legal. ¹⁵⁵ As the authors point out, the nature of illicit trade changes over time, largely in response to government efforts.

13.7.10.1 Knowledge and experience on measures to discourage internet selling

Internet sales have the capacity to undermine the public health benefit of higher cigarette prices. ¹⁵⁶ Given the difficulty of collecting local taxes from suppliers based in overseas jurisdictions, many tobacco control advocates have called on governments to ban the advertising of such products to internet users. ^xi Other proposals to disrupt internet trade in cigarettes have included preventing the vendor from hosting a website (by seizing relevant domain names), ¹⁵⁷ preventing the vendor from receiving payment (by banning credit card payments for cigarette purchases over the Internet) and preventing shipments (by restricting local mail carriers and delivery services). ¹⁵⁸ In the United States, several credit card companies voluntarily refused to provide service to such vendors. ¹⁵⁹ Several states in the US are now successfully collecting taxes from residents purchasing from Internet sites after requiring vendors to supply purchase details under the terms of the so-called 'Jenkins Act' (15 USC 376a). ⁶

13.7.10.2 Measures to reduce or eliminate duty-free sales

Article 6 of the WHO Framework Convention on Tobacco Control states that Parties should

…adopt or maintain as appropriate measures which may include:
…b. prohibiting or restricting, as appropriate, sales to and/or importations by international travellers of tax- and duty-free tobacco products'. 

Several jurisdictions internationally have banned duty-free sales or reduced allowable limits for the purchase of duty-free cigarettes.

13.7.10.3 Knowledge and experience about effectiveness of measures to prevent illegal circumvention

Sweeting et al conclude that reducing smuggling and other forms of illegal circumvention requires a range of measures including amendments to taxation legislation, improved enforcement and public awareness campaigns. Policy measures that were effective at one point in time may be less effective in other locations at later times as those involved in the illicit tobacco trade change their practices to reduce the chance of detection. ¹⁵⁴ The Framework Convention Alliance (of international non-government organisations) has compiled much material ^160–162 drawn from experience in jurisdictions such as UK, the European Union and Canada, all of which appear to have made some progress over the 2000s in reducing illicit trade. This knowledge and experience have been brought to bear in the drafting of the WHO Framework Convention on Tobacco Control and associated guidelines and a Protocol specifically on illicit trade.

13.7.11 The WHO Framework Convention on Tobacco Control (draft) protocol to eliminate illicit trade in tobacco products

The reduction of illicit trade is an important element of the WHO Framework Convention on Tobacco Control (FCTC) which came into force on the 27 February 2005. ¹⁶³

13.7.11.1 The Convention

Article 15 of the FCTC obliges ratifying countries including Australia to:

2. ... adopt and implement effective legislative, executive, administrative or other measures to ensure that all unit packets and packages of tobacco products and any outside packaging of such products are marked to assist Parties in determining the origin of tobacco products, and in accordance with national law and relevant bilateral or multilateral agreements, assist Parties in determining the point of diversion and monitor, document and control the movement of tobacco products and their legal status. ¹⁶⁴

Article 15 goes on to state:

'In addition, each Party shall:

(a) require that unit packets and packages of tobacco products for retail and wholesale use that are sold on its domestic market carry the statement: ' Sales only allowed in (insert name of the country, subnational, regional or federal unit)' or carry any other effective marking indicating the final destination or which would assist authorities in determining whether the product is legally for sale on the domestic market; and

(b) consider as appropriate, developing a practical tracking and tracing regime that would further secure the distribution system and assist in the investigation of illicit trade.

3. Each Party shall require that the packaging information or marking specified in paragraph 2 of this Article shall be presented in legible form and/or appear in its principal language or languages.

4. With a view to eliminating illicit trade in tobacco products, each Party shall:

(a) monitor and collect data on cross-border trade in tobacco products, including illicit trade, and exchange information among customs, tax and other authorities, as appropriate, and in accordance with national law and relevant applicable bilateral or multilateral agreements;

(b) enact or strengthen legislation, with appropriate penalties and remedies, against illicit trade in tobacco products, including counterfeit and contraband cigarettes;

(c) take appropriate steps to ensure that all confiscated manufacturing equipment, counterfeit and contraband cigarettes and other tobacco products are destroyed, using environmentally-friendly methods where feasible, or disposed of in accordance with national law;

(d) adopt and implement measures to monitor, document and control the storage and distribution of tobacco products held or moving under suspension of taxes or duties within its jurisdiction; and

(e) adopt measures as appropriate to enable the confiscation of proceeds derived from the illicit trade in tobacco products'.

WHO Framework Convention on Tobacco Control ^{164 p14}

According to Article 33 of the Convention, the Conference of Parties (COP) may adopt protocols to the Convention. Only Parties to the Convention may be Parties to a protocol. Any protocol to the Convention shall be binding only on the Parties to the protocol in question.

At its second session in July 2007, ^xii the COP decided to establish an Intergovernmental Negotiating Body (INB), open to all Parties, to draft and negotiate a protocol on illicit trade in tobacco products. The protocol would build upon and complement the provisions of Article 15 of the WHO FCTC. The INB held its first session in Geneva in February 2008 ^xiii , followed by its second session in October 2008 ^xiv . The third session of the INB took place in June 2009 ^xv and the fourth in March 2010. ^xvi The COP reviewed the progress made at its fourth session in Uruguay in 2010. ^xvii The Conference decided that negotiations on a protocol should continue at a final session of the INB to be held in 2012, and that an informal working group, composed of representatives of regional groups of Parties, would work in 2011 to facilitate negotiations at the final session of the INB. This group met in Geneva in March–April 2012. ^xviii At the outcome of the negotiations, the INB decided to recommend to the COP that the draft protocol to eliminate illicit trade in tobacco products, on which consensus was obtained, be considered by the COP at its fifth session. (FCTC/COP/5/7, at paragraph 14 http://apps.who.int/gb/fctc/PDF/cop5/FCTC_COP5_7-en.pdf ). ⁷

13.7.11.2 The draft protocol on illicit trade

The draft protocol to eliminate illicit trade in tobacco products ⁷ outlines obligations under the following core areas:

• Part III: Supply Chain Control. Provisions to control thesupply chain of tobacco, tobacco products and manufacturing equipment
• Part IV: Offences. Requires Parties to make unlawful under domestic law certain conduct.
• Part V: International Cooperation. Provisions that provide for international co-operation, including sharing information regarding illicit trade, sharing enforcement information, cooperating with training and technical assistance matters, and law enforcement cooperation.
• Part VI: Reporting. Provisions that provide for reporting under the Protocol through the WHO FCTC reporting instrument.
• Part VII: Institutional Arrangements and Financial Resources.

Part III Supply chain control

Licensing

Article 6 of the draft protocol would require Parties to establish a licence or equivalent approval or control system. Parties would be required to:

1. prohibit without a licence the manufacture of tobacco products and manufacturing equipment and the import or export of tobacco products and manufacturing equipment
2. endeavor to license to the extent appropriate any person or legal entity involved in retailing, growing, transporting commercial quantities of tobacco products or manufacturing equipment, or wholesaling, brokering, warehousing or distribution of tobacco, tobacco products or manufacturing equipment (except for traditional small-scale growers, farmers and producers)
3. establish an effective licensing system by

    

   1. designating a competent authority to issue, renew, suspend, revoke and/or cancel licences
   2. requiring licence applicants to provide proof of identity, tax registration numbers, location, details of proposed activities, description of manufacturing equipment, documentation regarding criminal records, identification of all bank accounts and payment details and description of intended us and intended market
   3. monitoring and collecting licence fees
   4. preventing, detecting and investigating any irregular or fraudulent practices
   5. undertaking periodic review, renewal, inspection or audit of licences
   6. establishing a time frame for expiration and subsequent reapplication or updating
   7. obliging any licensee to inform the competent authority of changes in location
   8. obliging any licensee to inform the competent authority of any acquisition or disposal of manufacturing equipment and
   9. ensuring any destruction of equipment takes place under the supervision of the competent authority.
4. Ensure that no licence is assigned without receipt of required information and prior approval of the competent authority.
5. Five years following the entry into force of the Protocol, the Meeting of the Parties (the Protocol equivalent of the COP) shall ensure at its next session that evidence-based research is conducted to ascertain whether any key inputs exist that are essential to the manufacture of tobacco products, are identifyable and can be subject to an effective control mechanism.

Due diligence

• Article 7 would require that Parties require that all persons and entities engaged in the supply chain of tobacco, tobacco products and manufacturing equipment conductdue diligence before the commencement of and during the course of a business relationship. It outlines that due diligence includes obtaining and updating information relating to customer identification.

Tracking and tracing

• Article 8 would require that Parties establish within five years of entry into force of the Protocol, a tracking and tracing regime comprising a national and/or regional tracking and tracing system and a global information sharing focal point located at the Convention Secretariat of the WHO FCTC.
• This will require within five years for cigarettes (and within 10 years for other tobacco products) unique, secure and non-removable identifications markings such as code or stamps, affixed to, or to form part of, all unit packages. As part of this system, each Party will require that the following information be available to assist with monitoring the movement of products and with determining their legal status:

a. date and location of manufacture

b. manufacturing facility

c. machine used to manufacture

d. production shift or time

e. name, invoice, order no. and payment records of the first customer not affiliated with the manufacturer

f. intended market of retail sale

g. product description

h. warehousing and shipping

i. identity of any known subsequent purchaser

j. intended shipment route, shipment date, destination, point of departure and consignee.

Information in a, b, g and where available f will appear as part of the unique identification markings.

• Parties would also be required to cooperate with each other and with competent international organizations as mutually agreed to facilitate the sharing and development of best practices for tracking and tracing systems.
• Obligations under this provision shall not be performed by or delegated to the tobacco industry, and Parties must ensure that its competent authorities, in participating in the tracking and tracing regime, interact with the tobacco industry and those representing the interests of the tobacco industry only to the extent strictly necessary in the implementation Article 8.

Record-keeping

Article 9 would require, as appropriate, that each Party requires that persons and entities engaged in the supply chain of tobacco, tobacco products and manufacturing equipment maintain complete and accurate records of all relevant transactions, to provide information on request to competent authorities on market volume, trends and forecasts as well as products in stock or in tax and customs warehouses.

Security and preventive measures

Article 10 would require, as appropriate and consistent with national law and the WHO FCTC, that Parties require all licensees take necessary measures to prevent the diversion of tobacco products into illicit trade channels, including reporting to competent authorities the cross border transfer of cash in amounts stipulated in national law or of cross-border payments in kind, and all 'suspicious transactions', as well as reporting any supply of tobacco products or manufacturing equipment not commensurate with the demand for such products.

All payments would be required only in the same currency as appears on the invoice and only through legal modes of payment from financial institutions located on the territory of the intended market. Each party shall ensure that any contravention of the requirements of this Article is subject to 'appropriate criminal, civil or administrative procedures and effective, proportional and dissuasive sanctions.'

Internet sales

Article 11 would require each Party to require that persons and entities engaged in any transaction with regard to tobacco products through the Internet to comply with all relevant obligations covered by this Protocol, and to consider banning retail sales through the Internet and any other evolving technology-based modes of sale.

Free zones and international transit

Article 12 would require Parties within three years of the entry into force of this Protocol to implement effective controls on all manufacturing of, and transactions in, tobacco and tobacco products, in free zones, by use of all relevant measures as provided by the Protocol. In addition, the intermingling of tobacco products in a single container at the time of removal from the free zone shall be prohibited.

Each Party would also be required, in accordance with national law, to apply control and verification measures to international transit or transshipment within its territory.

Duty-free sales

Article 13 requires Parties to implement effective measures to subject any duty free sales to all relevant provisions of this Protocol, and establishes the requirement that no later than five years following the entry into force of the Protocol, the Meeting of the Parities shall ensure that research is conducted to ascertain the extent of illicit trade that can be related to duty-free sales, and to consider appropriate further action.

Part IV Offences

Article 14 requires Parties to make it unlawful to:

1. manufacture, wholesale, broker, sell, transport, distribute, store, ship, import or export tobacco, tobacco products or manufacturing equipment contrary to the provision of the Protocol
2. do any of the above without the payment of applicable duties, taxes and other levies or without bearing applicable fiscal stamps, unique identification markings, or any other required markings or labels or to engage in any other acts of smuggling
3. to manufacture or engage in trade in any tobacco, products , equipment or packaging bearing false stamps, unique identification markings or labels
4. to conceal tobacco products by mixing them with non-tobacco products during progression through the supply chain
5. to intermingle tobacco products with non-tobacco products in free zones or in international transit
6. to use the Internet, telecommunication, or any other evolving technology-based modes of sale of tobacco in contravention of the Protocol
7. to obtain products or equipment from anyone not licensed
8. to obstruct any public or authorized office in their duties
9. to make false, misleading or incomplete statements, to fail to provide required information or to mis-declare any items or fail to maintain records or;
10. to fail to create or maintain records required by the Protocol
11. to launder the proceeds of unlawful conduct.

Parties are also required, subject to domestic law, to determine which of the above offences shall be criminal and to inform the Secretariat of such determination. Parties are also encouraged to review national laws regarding money laundering, mutual legal assistance and extradition.

Enforcement

Remaining articles of Part IV of the Convention covers arrangements concerning liability of legal persons (Article 15), Prosecutions and sanctions (Article 16) and seizure payments (Article 17) disposal and destruction (Article 18), and Special investigative techniques.

Part V International Cooperation

Part V of the Protocol covers General information sharing (Article 20), enforcement information sharing (Article 21), confidentiality and protection of information (Article 22), assistance and cooperation related to training, technical assistance and cooperation in scientific, technical and technological matters (Article 23), assistance and cooperation in investigation and prosecution (Article 24), protection of sovereignty (Article 25), jurisdiction (Article 26), law enforcement cooperation (Article 27), mutual administrative assistance (Article 28), mutual legal assistance (Article 29), extradition (Article 30) and measures to ensure extradition (Article 31).

Part VI Reporting

Article 22 sets out arrangements for reporting and exchange of information.

Part VII Institutional arrangements

Article 33 describes arrangements for the meeting of the Parties. Article 34 establishes the Secretariat, and Article 35 sets the ground rules for relations between the Parties and intergovernmental organisations and Article 36 describes arrangements for financing. ⁷

13.7.11.3 Challenges posed by illicit tobacco for the integrity and effectiveness of tobacco control

Liberman et al have described several challenges inherent in efforts to address the problem of illicit tobacco. 'While illicit tobacco trade is a health problem,' they point out 'the expertise, experience and capacity needed to combat illicit trade are not traditionally found in health agencies' but rather lie within the mandates and expertise of customs, revenue, law enforcement and justice agencies. They point to the need to work with other agencies both domestic and international such as the UN Office on Drugs and Crime and the World Customs Organization to 'ensure both an effective response' and an efficient use of limited governmental resources'. Combating illicit trade does require the involvement of tobacco companies, but this could pose dangers if 'relationships and norms of cooperation spill over into other areas of FCTC implementation.'

In many parts of the world, tobacco companies work very closely with governments on measures to prevent illicit trade, ^xix providing training of customs and other government officials and contributing resources to assist governments with surveillance and law enforcement activities. ⁸⁴ This kind of activity sits uneasily with Article 5.3 of the WHO FCTC which states 'in setting implementing public health policies with respect to tobacco control, Parties shall act to protect these policies from the commercial and other vested interests of the tobacco industry in accordance with national law.' ¹⁶⁵ Guidelines for Article 5.3 contain suggestions for limiting interactions with the tobacco industry to only those strictly necessary for effective regulation, ensuring transparency with respect to interactions with the industry and rejecting partnerships. ¹⁶⁶

While tobacco companies are likely to continue to work closely with revenue and customs agencies, Liberman et al suggest the adoption of institutional arrangements to ensure that the World Health Organization, the Conference of the Parties to the WHO Framework Convention on Tobacco Control and the FCTC Secretariat are all quarantined from inappropriate interaction with tobacco industries so that the FCTC remains health focused and 'its culture remains one in which the 'fundamental and irreconcilable conflict between the tobacco industry's interests and public health policy interests...' is always recognised. ⁸⁴

13.7.12 What has been done in Australia to date to reduce avoidance and evasion of tobacco taxes?

13.7.12.1 Internet sales

Surveys of smokers in Australia to date reveal very few cases of people reporting purchasing of cigarettes via the Internet. ¹⁶⁷ However there are several Internet sites with Australian domain names that do sell cigarettes–see Chapter 11, Section 11.12 for further details. Amendments to the Tobacco Advertising Prohibition Act 1992 first introduced in 2010 ¹⁶⁸ and passed in early 2012 ¹⁶⁹ clarify that while it is illegal to advertise tobacco products on the Internet, sale of tobacco products through the Internet is allowed in Australia. The Act provides for the establishment of regulations that require:

'information about any fees, taxes and charges payable in relation to tobacco products' S4(b)ii

13.7.12.2 Duty-free

Economists Collins and Lapsley noted in a paper for the Economic Society of Australia in 1994 ¹⁷⁰ the inconsistency of duty-free concessions for alcohol and tobacco given the large social costs that they had recently documented associated with use of these drugs in Australia. ¹⁷¹ They also drew attention to several international trade agreements that they believed may have prevented Australia from ending such concessions.

No recent figures on quantities of duty-free sales appears to be publicly available, however an estimate prepared in 2002 found that had duty been paid on all the products which were sold duty-free in Australia in 2001, revenue would have totalled more than $130 million. ¹⁷² Without duty-free status, sales may have been considerably lower, so it is unclear how much extra revenue the government would gain if duty-free sales were to be abolished.

In 2003 the Government undertook a review of duty-free allowances and decided against removal of concessions. On 1 February 2005 it amended a by-law under the Customs Tariff Act 1995 ¹⁷³ to revise quantities allowed under the concessions from 250 grams of tobacco products (assumed to be equivalent to 250 cigarettes) to specifically include 250 cigarettes or 250 grams of cigars.

In its 2012–13 Budget handed down in May 2012, the Australian Government announced that it would reduce
the personal allowance for duty-free tobacco from 1 September 2012 from '250 cigarettes to 50 cigarettes or
50 grams of other tobacco products.' This measure is expected to increase receipts by $660 million over the forward estimates–by $127m in 2012–13, $165m in 2013–14, $176m in 2014–15 and $192m in 2015–16. ¹⁷⁴

There would be no legal impediment to the government banning sale in Australia of duty-free products for arriving passengers to import duty-free or for leaving passengers to export. However, Australia is a party to several agreements relevant to the import of duty-free products purchased elsewhere.

These include:

• the Convention Concerning Customs Facilities for Touring as amended 5 September 1966 the 'New York Convention' (New York, 4 June 1954) ^xx
• the International Convention of the Simplification and Harmonization of Customs Procedures of 18 May 1973 (as amended by the Protocol of Amendment to the International Convention on the Simplification and Harmonization of Customs Procedures of 18 May 1973, Brussels, 26 June 1999) 'the Kyoto Convention' ^xxi and
• the OECD Decision–Recommendation on International Tourism Policy 1985 ^xxii

The New York Convention defines 'tourist as a non-resident and therefore only applies to non-residents. The Kyoto Convention sets out a recommended level only, rather than a binding Standard. The OECD Decision–Recommendation states:

'In adopting this Decision–Recommendation, the Council:

1. NOTED the reservations and observations made by individual Member countries with relation to certain elements of Annexes 1 and ii to the Decision–Recommendation and expressed hope that it would be possible for these to be removed over the course of time.
2. AGREED that the adoption of the Decision–Recommendation did not prevent a Member country from taking action which it considered necessary for the maintenance of public order, or the protection of public health, morals or safety.'

The provisions of these agreements would need to be assessed before Australia could move to further restrict the import of duty-free cigarettes in Australia.

13.7.12.3 Smuggled tobacco products

Australia has contributed to an anti-tobacco smuggling alliance established in 2004 to exchange information and coordinate efforts to fight smuggling within the Asia Pacific region. ¹⁷⁵

In June 2012 the Australian Government introduced legislation to make smuggling of tobacco products an offence punishable by up to 10 years imprisonment or 100 penalty units. ¹⁷⁶ This legislation was passed in November 2012. ^xxiii

13.7.12.4 Protocol on illicit trade

Staff from Australian government agencies have had some involvement in the development of the protocol. Before Australia decides whether to become a Party, the Parliament would refer the Protocol for assessment of its Joint Standing Committee on Treaties. ^xxiv

Acknowledgement

Thank you to Jonathan Liberman and Nicholas Coxon for comments on an earlier draft of this paper. Remaining errors and imprecision are the authors' own.

Relevant news and research

For recent news items and research on this topic, click  here. ( Last updated March 2021)

 

i For details on the agreements between the European Commission's European Anti-Fraud Office and tobacco companies Philip Morris International (2004), Japan Tobacco (2007), British American Tobacco (2010) and Imperial Tobacco Limited (2010, see http://ec.europa.eu/anti_fraud/investigations/eu-revenue/cigarette_smuggling_en.htm

ii Cigarette imports in some countries, for instance, are dutied according to the quantity of cigarettes, and in other countries customs duty is charged on the basis on the weight or the value of the product. International research agencies for convenience often assume that one gram of any tobacco product is equivalent to a single cigarette. However in reality cigarettes weigh considerably less than one gram. In Australia, any measure of cigarettes imported based on a standard conversion of tobacco weight would be underestimating the number of cigarettes imported by 25 to 30%.

iii In Australia, manufacturers recently had to change production procedures required to comply with regulations aiming to reduce ignition propensity

iv These include

1. The Convention Concerning Customs Facilities for Touring as amended 5 September 1966 the 'New York Convention' (New York, 4 June 1954).

2. The International Convention of the Simplification and Harmonization of Customs Procedures of 18 May 1973 (as amended by the Protocol of Amendment to the International
Convention on the Simplification and Harmonization of Customs Procedures of 18 May 1973, Brussels, 26 June 1999) 'the Kyoto Convention' and

3. OECD Decision–Recommendation on International Tourism Policy 1985

v See YouTube clip at http://www.bat.com/group/sites/UK__3MNFEN.nsf/vwPagesWebLive/DO6TNKVW?opendocument&SKN=1&TMP=1

vi See Section 19 http://www.tobaccoatlas.org/uploads/Images/PDFs/TA4_pdf_sourcesandmethods.pdf

vii Up from 28.7% in 2001

viii The question asked about illicit tobacco in 2010 differed somewhat to the question asked in 2007–see Technical Appendix 2 for further details.

ix The 2010 survey asked in addition
D28. Have you ever seen or heard of counterfeit cigarettes?
D29. Have you ever purchased what you thought was your usual brand and then noticed a difference in the taste or packaging?
D30. How often has this occurred?
Once a month
Once every six months
Once a year.

x It should be noted that the Reduced Fire Risk cigarette regulations came into force in 2010 (over the period of the Roy Morgan surveys), ¹¹⁷ implementation having been brought forward as a result of concerns in the wake of the Black Saturday bushfires. ¹¹⁸

xi Or to enforce existing provisions of legislation prohibiting tobacco promotion–see Section11.x

xii For further information, see http://www.who.int/fctc/cop/sessions/second_session_cop/en/index.html

xiii For further information and documentation, see http://www.who.int/fctc/protocol/illicit_trade/first_session_inb/en/index.html

xiv See http://www.who.int/fctc/protocol/illicit_trade/second_session_inb/en/index.html

xv See http://www.who.int/fctc/protocol/illicit_trade/third_session_inb/en/index.html

xvi See http://www.who.int/fctc/protocol/illicit_trade/inb4/en/index.html

xvii See http://www.who.int/fctc/cop/sessions/fourth_session_cop/en/index.html

xviii See http://www.who.int/fctc/protocol/illicit_trade/inb5/en/index.html

xix

xx See http://www.austlii.edu.au/au/other/dfat/treaties/ATS/1967/1.html

xxi See http://www.austlii.edu.au/au/other/dfat/treaties/ATS/2006/22.html

xxii Not available on-line.

xxiii See http://www.comlaw.gov.au/Details/C2012A00146

xxiv See http://www.aph.gov.au/Parliamentary_Business/Committees/House_of_Representatives_Committees?url=jsct/index.htm

xxv In 2003 it was reported that the ATO had some 100 excise staff investigating the illegal chop-chop trade.

xxvi A seizure at Port Melbourne in November 2004 for instance netted nine tonnes of loose tobacco from the Philippines.