booklet illicit trade tobacco products

8/12/2019 Booklet Illicit Trade Tobacco Products

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Disclaimer and Statement of Purpose

The Illicit Trade in Tobacco Products and How to Tackle It is published by the International Tax and InvestmentCenter (ITIC), a non-profit research and education foundation. ITIC serves as a clearinghouse for information onbest practices in taxation and investment policy, and as a training center to transfer such know how to improvethe investment climates of transition and developing countries, thereby spurring formation and development ofbusiness and economic prosperity.

The purpose of this publication is to serve as a resource guide and best practices reference for tax, customs,and law enforcement officials to improve their efforts to combat the illicit trade in tobacco products.

ITIC received supplemental contributions from tobacco companies to help underwrite the cost of this publication.However, ITIC retained full editorial control and takes full responsibility for the content and any errors or omissions.

The publication is not intended to be a statement of ITIC policies, nor is it intended to endorse the views orpolicies of any of the contributing organizations or individuals (financially or otherwise), such as the WorldCustoms Organization (WCO), the European Anti-Fraud Office (OLAF) or the tobacco industry. Inputs to thispublication, including data and case studies, were provided by tax and customs officials, the World CustomsOrganization (WCO), industry representatives and various consultants.

About the Author

Elizabeth Allen, BA

Elizabeth Allen, a graduateof Bristol University, has over35 years of management,operational and policyexperience with Her MajestysRevenue and Customs (UK HMRC) and previously with

HM Customs and Excise. Her senior civil servicepositions included responsibility for the Alcohol andTobacco Fraud Review, Excise and Inland CustomsCompliance Strategy, implementation of the ExciseMovement and Control System and responsibility forthe administration of Environmental Taxes. Mrs. Allen

also worked on Customs Policy and Prosecutions. Shehas wide ranging experience in working with colleagues

from other governments and with private sectorstakeholders. Since retiring from HMRC in March

2009, Elizabeth selected the technical content of andchaired the ITIC Anti-Illicit Tobacco Trade conferencein Brussels in November 2009 and is also the authorof an ITIC publication entitled Guidebook to theSuccessful Introduction of a Specific Excise Tax onAlcoholic Beverages. She has also carried out 3 policydevelopment reviews for the UK Governments Officeof Government Commerce during 2009/10 and givenlectures on The Taxpayer as Customer as part of acontinuous professional development course for seniorcivil servants from developing countries. Mrs. Allen isnow embarking on an EU sponsored review of the illicittrade in Alcohol and Tobacco Products in the SouthernAfrican Development Community.


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The Illicit Trade in Tobacco Productsand How to Tackle It

Table of ContentsForeword 2

Executive Summary 3

1. What is the Illicit Trade in Tobacco Products? 5

2. Size and Measurement 6

3. Global Nature and Dynamics 9

4. The Impact of the Illicit Trade in Tobacco Products 13

5. Causes and Facilitators 16

6. How to Combat the Problem 22

7. Article 15 of the WHO Framework Convention on Tobacco Control 27

Glossary of Terms 29

Interesting Links 30

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ForewordWe live in an extremely fast moving world where global tradeis fundamental to the way we live and to our economicdevelopment and prosperity. Customs play a significantpart in ensuring that global trade conforms to internationalrequirements and that the taxes due are paid to governmentsto fund public services. Where goods are highly taxed andeasily portable criminals, terrorists and insurgents will takeadvantage of any weaknesses in customs and revenuecontrols to amass profits. They do not care whether laws are

flouted, consumers health is damaged, governments lose revenues or legitimatebusinesses lose trade. We have witnessed an unparalleled growth in illicit tradeof tobacco products over recent years, and we need to step up our efforts to tackle

the problem.New ideas, questioning, forward planning, learning from others and greatercollaboration across enforcement agencies, other national agencies and with thelegitimate trade will enable us to modernize and optimize the use of the expensive andscarce resources in tackling the illicit tobacco trade. We need to make governmentsand the public aware of the implications of illicit trade and gain their full support.An innovative approach, creating and building on partnerships will enable us totransform our efforts and achieve significant reductions both in illicit trade and thenumber of criminals who benefit from it.

This publication builds on the successful ITIC Anti-Illicit Trade in Tobacco Productsconference in November 2009 and brings together principles and good practicefrom across the world which I hope will lead to improved partnerships andworking practices.

Kunio MikuriyaSecretary General, World Customs Organization

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Executive SummaryThis publication aims to raise awarenessof the growing and evolving illicit trade

in tobacco products. It is a compilationof facts and views from a wide range ofsources including respected academics,private sector consultants, journalists,international enforcement organizations,government revenue authorities andindustry. It defines the different aspectsof illicit trade and provides informationon ways of measuring its size. It analyzesthe nature of the problem, its causes

and consequences, and offers authoritiesbest practice guidance on implementinganti-illicit trade strategies. Case studiesare used to provide evidence of goodpractice and global efforts to tackle thisserious problem. 1

What is the Illicit Trade inTobacco Products?Illicit trade manifests itself in three major

ways: smuggled, counterfeit and localtax evaded products. These categoriesare interrelated and show that the illicittrade in tobacco products is a globalphenomenon, covering all continentsand high and low income countries alike.Cigarettes, being highly taxed, easy totransport and possessing a lucrativerisk to reward ratio, are among the mostillegally trafficked goods in the world.

Size and MeasurementDespite the lack of robust global data theoverall consensus is that the global illicittrade in tobacco products is unacceptablylarge. Recent studies estimate thatapproximately 11% of the world cigarettemarket is illicit, representing over 600billion cigarettes a year and resulting in

annual government revenue losses ofover US$40 billion.2

Most governments do not attempt tomeasure the problem on a regularbasis and remain unaware of the manynegative effects the illicit tobaccotrade can have on their economy andsociety. Without a robust means ofmeasuring the extent of the problem, itis difficult for authorities to assess theeffectiveness of strategies to combat it.

Global Nature and DynamicsIn recent years the dynamics of illicittrade have evolved rapidly. There isan explosive growth of illicit whitecigarettes that are made specificallyfor smuggling. Another example is theincreased use of internet sites to selland ship cigarettes worldwide in smallquantities by the post to evade taxation.Furthermore, research demonstratesthat illicit trade has become amajor security challenge in differentenvironments around the world and isincreasingly used to fund terrorism. 3 There is also an expansion in distributionnetworks used by criminal organizationsfor the illicit trade in a wide range ofproducts including tobacco, narcotics,and human trafficking.

The Impact on SocietyIllicit trade has a huge impact on theeconomic and social fabric of society.In addition to vast amounts of lostrevenue which undermines the tax baseof economies, it obstructs economicdevelopment, undermines governmentpolicy objectives and the rule of law,supports corrupt practices, funds

1 The case studies in this publication have been provided by the industry, consultants, and academics.2 Framework Convention Alliance (2008).3 Dr. Louise Shelley, ITIC Conference Paper Illicit Trade: A Security Challenge A Case of Cigarette Smuggling (2009).

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organized crime and terrorism andencourages the expansion of criminalactivity. It undermines investment inmanufacturing, innovation, trade anddistribution by legitimate industry andnegatively impacts employment.

Causes and FacilitatorsThe primary drivers for this illicit tradeare twofold: Consumers to save money; and

Criminals to make money.Factors contributing to the probleminclude an unbalanced fiscal policy,disparities in tax driven prices between

jurisdictions, protectionist policymeasures, corruption, weak enforcement,lack of official controls in free zones,inadequate legislation and sanctions,growth in illegal distribution networksand public tolerance of the illicit tradein tobacco products.

How to Combat the ProblemIn developing comprehensive anti-illicittrade policies, governments need to payparticular attention to the involvementof all relevant government agencies (e.g.Customs, Ministries of Finance, Health,Justice and Trade) to ensure alignment

and commitment to achieving the samegoals. In addition, enforcement authoritiesneed to be given adequate resourcesand encouraged to work closely with theother domestic stakeholders to combatthe problem. Exchange of informationwith authorities in other countries andinternational enforcement organizationsmust be the norm, and legislation withdeterrent penalties and an efficientfunctioning judiciary are vital. Citizensmust be provided with information on the

implications of purchasing illicit productssuch as unwittingly supporting organizedcrime and terrorism.

Article 15 of the World HealthOrganization (WHO) FCTC 4

The critical importance of tackling theillicit tobacco trade on a global scaleis recognized in the WHO FCTC whosegoverning body is in the process of

negotiating an Illicit Trade Protocol.The Protocol aims to create moredetailed binding obligations for over170 governments aimed at curbingthe illicit trade in tobacco products.In particular, it sets out internationalguidance for national action on supplychain security, offences and enforcementand international cooperation.

4 Framework Convention on Tobacco Control (2003).

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1. What is the Illicit Trade in Tobacco Products?1.1 DefinitionsThe illicit trade in tobacco products is definedin Article 1 of the WHO FCTC asany practiceor conduct prohibited by law and which relates to production, shipment, receipt, possession, distribution,sale or purchase including any practice or conductintended to facilitate such activity.

The illicit trade in cigarettes and other tobaccoproducts exists in three broad forms:

Smuggled: the unlawful movement of tobaccoproducts (genuine or counterfeit) from one tax jurisdiction to another without the payment ofapplicable taxes or in breach of laws prohibitingits import or export.

Counterfeit: illegal manufacturing in which aproduct bears a trademark without the ownersconsent. Illegally manufactured products can be sold in the source country or smuggled intoanother country. Excise tax is rarely, if ever, paidon counterfeit products.

Local Tax Evasion: cigarettes manufactured forconsumption in the same jurisdiction, whichare not declared to the tax authorities. Thesecigarettes are sold without tax and may bemanufactured in approved factories or illegalcovert operations.

1.2 Other Common TerminologyContraband is another widely used term forsmuggled tobacco products.

In recent years a novel type of large scale smugglinghas emerged with cigarettes often termedillicitwhites or cheap whites . These cigarettes aremarketed on price and typically produced legally

but intended for smuggling into countries wherethere is no prior legal market for them. An exampleof this is Jin Ling, manufactured outside the EU

but the second most seized illegal brand within theEU in 2008.5

Unbranded tobacco is sold as loose leaf of tobaccoin half kilogram or one kilogram amounts. It carriesno labeling or health warnings and is consumedin roll your own (RYO) form or inserted into emptycigarettes tubes. Unbranded tobacco is also soldillegally in the form of loose cigarettes containedin clear plastic re-sealable bags (commonly knownas baggies).

Bootlegging involves individuals or small groupswho smuggle lesser quantities of cigarettes, takingadvantage of tax differentials, for resale. Examplesof this practice are labourers who cross theEuropean Union (EU)Eastern Europe border dailyfor work and bring in cartons (200 cigarettes) tomake some extra income; or couriers who fly backand forth between high and low tax jurisdictionsusing low cost airlines. These cigarettes are boughtand consolidated by organized crime groups whodistribute them in target destination markets.

Within a country there can also be leakages fromlegitimate tax exempt areas into the tax paid market.At the lowest level, smuggling is undertaken whenan individual imports cigarettes in excess of national

legal allowances6

for personal use.Cross border shopping is a legal practice ofavoiding higher domestic tax whereby theindividual purchases tax paid cigarettes withinthe legal allowance for consumption in another jurisdiction. The levels of these practices depend onthe tax and price differentials as well as the distanceand cost of travelling between jurisdictions.7

5 OLAF presentation, ITIC Conference (November 2009).6 A common duty free allowance is 200 sticks (one carton).7 For example, a correlation has been shown between the numbers of British tourists traveling abroad to lower tobacco tax

countries and the increase/decrease in domestic cigarette sales.

Counterfeit products, including cigarettes, are often sold at open-air markets.

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2. Size and Measurement

8 Understand, Measure and Combat Tobacco Smuggling, World Bank Economics of Tobacco Toolkit (2005).9 Framework Convention Alliance (2008); International Union Against Tuberculosis and Lung Disease (2009).

Estimated Incidence of Illicit Trade (smuggled, counterfeit, and local tax evasion) by Country

10% No reliable dataSource: Industry estimates * from 2010

2.1 SizeThere are, currently, no reliable global statistics on thesize of the worldwide illicit trade problem. The WorldBank Tobacco Toolkit8 published in 2005 estimatedthe scale at 6% to 9% of total tobacco consumption.A recent study estimates that approximately 11%of the global cigarette market is illicit, representingover 600 billion cigarettes a year.9 However, thesenumbers are not based on an independent singlemethodology or process but are simply compilationsof existing estimates from different sources, coveringvarious countries and points in time until 2008.

Studies estimating illicit consumption on a country bycountry basis are usually more accurate. For example,KPMG has estimated that in 2009 the counterfeit andcontraband share of cigarette consumption in the EUwas 8.9% based on an identical research methodologyapplied to each of the 27 Member States. The KPMGstudy is described in more detail under 2.3.

2.2 MeasurementWhilst there is general agreement that tobaccoproducts are one of the most illegally traffickedgoods in the world, measuring quantities preciselyis very difficult. However it is important thatindividual governments attempt to establish thescale of illicit tobacco use and tax avoidance toenable informed policy decisions and provide a baseline against which to assess the success ofanti-illicit trade strategies.

The objectives of an illicit trade measurement toolare to:

Measure the incidence and relative share ofillicit cigarettes including consumer usage,purchasing behavior and empty pack surveys.

Enable analysis of trends over the long termand evaluate their development.

* These estimates, due to methodology, may in some instances include cross border shopping.

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KPMG Methodology for Measuring Illicit Trade in Tobacco Products 10

KPMG have been contracted since 2005 by Philip Mor-ris International to make an independent assessmentof the size of the illicit tobacco products trade marketin the EU as par t of their cooperation agreement withthe European Commission and the Member States.The methodology was developed during a comprehen-sive pilot study conducted in 2005 in Germany, Polandand Finland after which the results were rigorouslychallenged and tested and a number of renementswere implemented. Subsequently, four full years ofresearch across all EU Member States have beenconducted using the methodology.There are three primary sources namely: empty packsurveys, legal domestic sales and consumer interviews.As its starting point, and because of the limitations ofdetermining consumption levels from consumer researchpreviously mentioned, the methodology uses legaldomestic sales plus an empty pack survey to determinethe overall consumption level based on the relativeproportions of legal domestic versus other packs.Because these surveys are conducted across the 27EU Member States, a further renement is then madeto account for out-ows of product from each market

(i.e. those cigarettes sold in one country but ultimatelyconsumed in a different country).This enables KPMG to determine the volume of overallconsumption split between legal domestic consumption(product legally sold and consumed in that country) andnon-domestic consumption (product originating from out-side that country). The next stage of the process is todetermine the split between non-domestic consumptionthat has been legitimately brought back to the countryby travellers and the proportion that is illicit. Legal owsare determined using primary research (over 159,000consumers were interviewed in 2009) to quantify howmany cigarettes travellers purchased while overseasduring the year. These volumes are then deductedfrom the total non-domestic consumption level withthe remainder being classied as illicit consumption.Before results are nalized, data is cross referencedwith all available alternative data sources together withanecdotal observations of trends and developments byCustoms and other experts involved in ghting the illicittrade. Moreover, seizure data and econometric data canalso provide good corroboration of results and trends.

10 Messrs. Robin Cartwright and Richard Stephens, ITIC Conference Presentation Measuring Illicit Trade: EffectiveMethodologies to Measure Total Consumption (2009).

Ensure consistency across time, country andpopulation, independently from smoking behavior or consumers acceptance of illicit trade.

There are a number of methodologies used byrevenue and customs authorities, regional andinternational organizations and the industry tomeasure the illicit trade size. Ideally, studies should be carried out on a large scale because the complexunderlying mechanisms of inflows from sourcemarkets and outflows to destination markets are best captured in a regional manner.

The application of a robust methodology is thefirst crucial step in the process as it needs to standup to independent scrutiny and be accepted by allparties concerned.

2.3 MethodologiesThere is no universally recognized methodologyto assess the size of the illicit tobacco trade anddifferent approaches might be required to meetpotential budget restrictions, particularly indeveloping countries. At the same time, multiplemethods can be used concurrently to establish amore accurate picture.

At its most basic, customs seizure data can bean indicator of a problem even though they aregenerally believed to represent only a small portionof the illicit trade volume. Moreover, seizure

statistics can be important in identifying trendsand changes in routes and types of illicit trade atan early stage.

Other methods include smoker surveys, empty packand cigarette butt collection analysis, comparisons between household survey estimates of tobaccoproducts consumption, government statistics oftax-paid tobacco products and trade monitoring.

In order to achieve robust results, it is criticalto acknowledge the inherent strengths andweaknesses of the chosen method. For example:

Primary data collection needs to be undertakenin a scientific, systematic and structured mannerthat ensures a representative sample andstands up to close scrutiny. For pack collectionthis must include physical checks to confirmtheir nature (counterfeit/genuine) and sourcecountry, if possible.

Consumer surveys there is extensive evidencethat smokers underreport their smoking levelsto a significant degree and so consumer reportingcannot be relied upon to determine accuratelythe overall consumption levels although it givesreliable smoking prevalence data.

International trade data is usually unreliableas import and export statistics are not readilyavailable in electronic format and can be subject

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3. Global Nature and Dynamics3.1 Nature and Composition of the ProblemThere are countries which are mainly a source of the illicit product (both for domestic consumption andfor export), others which play a part as transit routes and finally destination countries where consumptionoccurs. In many cases a country may be in more than one of these categories.

3.2 Source CountriesCutting off illicit trade at source is in theory themost effective means of tackling the problem.However, it is also the most difficult to achieve.

Identified common features present in manysource countries are:

Lack of political will to fight illicit trade(i.e. it is not seen as a priority);

Inadequate legal regimes (e.g. non-existentlaws including those which protect intellectualproperty, lack of prosecutions, weak penalties

for offenders);

Under-funded, poorly trained police forcesand customs officials;

Oversupply (i.e. cigarettes produced andreleased for consumption in the source marketin excess of domestic demand);

Lack of capacity;

Corruption; and

Availability of second hand cigarette makingmachinery or counterfeit machinery.

Regular comparison and analysis of seizurestatistics provides an indication of the global

Illicit Trade Source and Transit CountriesSource: Industry estimates from 2010

Source Transit

Transit and Source Not Applicable/No Data

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Case Study: Tackling Counterfeit Cigarettes in ChinaChina is the worlds largest tobacco market with anestimated consumption of approximately 2 trillioncigarettes (around one third of global cigaretteconsumption). The market share of internationalbrands is negligible in China.China is the leading source of counterfeit cigarettesin the world. It is estimated that up to 190 billioncounterfeit cigarettes are produced in China annually.Most of these counterfeits are of cigarette brands soldin China for the domestic market. About 1520% ofthe counterfeit cigarettes are exports, mainly to Europeand North America.Most counterfeit cigarettes in China are manufacturedin the southern provinces of Fujian and Guangdong.From there they are transported either to cities withinChina or, if they are destined for export, to the majorports of Xiamen, Shenzen, Guangzhou and Shanghai.The State Tobacco Monopoly Administration (STMA) hasprime responsibility for controlling the tobacco marketin China. This includes taking action against peoplewho contravene Chinas strict tobacco control laws bymanufacturing, transporting or distributing counterfeitcigarettes. Chinas penalties for dealing in counterfeitcigarettes are amongst the Worlds toughest withheavy nes and long jail terms for those convicted.The STMA has built up strong working relationshipswith the Ministry of Public Security (MPS) and theGeneral Administration of Customs China (GACC).

These relationships have meant that continuingpressure is placed on counterfeit cigarettes traders.Every year, thousands of arrests are made andbillions of cigarettes seized in raids involving policeand STMA ofcials.The manufacture, trading and export and smuggling ofcounterfeit cigarettes from China is controlled by highlyorganized criminal syndicates. These syndicates haveoperatives all around the world who attempt to organizethe smuggling of counterfeit cigarettes into the destina-tion or transit market.Given the international nature of the counterfeit cigarettetrade, global cooperation between the industry and lawenforcement authorities is essential. The GACC, throughits networks of global customs agencies is able to sup-port the work of Customs in Europe and North Americain stopping shipments of counterfeit cigarettes. Forexample, in August 2010, the European Union andthe GACC held a joint conference in Shanghai and oneof the key topics of discussion was cooperation onstopping the ow of counterfeit cigarettes from China.The STMA also cooperates closely with the majorinternational manufacturers, BAT, ITL, JTI and PMI.This cooperation extends back more than a decadeand is based on the sharing of information and intel-ligence to allow the STMA to take action in Chinaagainst identied counterfeiters and for the manufac-turers to take actions to protect their trademarks in

jurisdictions outside China.

12 The figures in the WCO report are based on the information provided by the Members Customs administration to the globaldatabase within the WCO Customs Enforcement Network (CEN) system.

13 Only seizures of more than 100,000 pieces are included in the WCO report.14 Singapore and Dubai, ranked #1 and #7 container port in the world, are primarily transit ports.

changes in illicit trade sourcing. The WorldCustoms Organization (WCO) publishes an annualCustoms and Tobacco Report which analyses seizuresreported by its member countries. The 200912 reportindicates that the highest amount of illicit productseized by Customs authorities originated fromAsia13 (21% of global seizures), followed by theUnited Arab Emirates (9%).

However, the UAE is known as both amanufacturing source and the transit ortranshipment location for consignments originatingin Asia. In Europe, the number of detections withUAE indicated as the source amounted to 249million cigarettes, out of more than 304 millioncigarettes indicated as departing from UAE in 2009.

China, North Korea, Philippines and Vietnamare known Asian sources of illicit cigarettes.Egypt features as a key source of contraband forthe Middle East. Zimbabwe is a main source ofcontraband detected in East and Southern Africaand Paraguay remains the source for the illicitconsignments destined mainly for Brazil.

In recent years, many illicit factories have beendetected and dismantled within the EU showingthat criminal gangs are bringing their productionsources within their final destination markets. Thesedevelopments undermine past beliefs that onlylower income, corrupt countries with weak legalstructures are the source of illicit manufacturing.

3.3 Transit PointsIllicit trade shipments are very often deliberatelytransited via several ports in order to make detectionmore difficult. During transit documentation ischanged and goods can be transhipped into othervessels. Transit points tend to be some of the largestand busiest ports in the world.14

In these days of fast moving global trade, portscompete for speed in processing cargo and theturnaround time of vessels. This means minimizingcontrols and often a low priority on the interceptionof potentially illicit consignments which are justtransiting through.

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Panama, Greece, the UAE and Russia are examples

of commonly used transit countries for illicittrade but this is a dynamically changing situation.As soon as one country improves controls, thecriminals switch to another route. New transitroutes are exploited as countries invest in betterroad and rail infrastructures and inland destinationmarkets (specific transit frauds are covered in 5.2.3).

Due to the difficulties of tackling illicit tradeat source, there is a lot of focus on interceptingconsignments in transit when they reach afriendly port where officials are willing toinvestigate containers and act on tip-offs.

3.4 Final Destination CountriesIllicit tobacco products are available throughout theworld in high income and low income countriesalike. Some common characteristics of finaldestination markets are:

A tobacco taxation policy that has resulted

in high retail prices relative to consumerincome (low affordability) or higher than thoseprevailing in neighboring countries;

Low law enforcement focus on the illicit tobaccotrade due to other priorities or a general lackof resources;

An inadequate legal regime (i.e. one in whicheither the legislation or judicial system do notproperly enforce intellectual property rights,and/or penalties for smuggling are too weakto be a deterrent and/or are simply not effectivein condemning smugglers); and

A culture of accepting illicit product or a lackof knowledge that the product is illicit.

Developments in recent years show that organizedcrime will supply any country in the world as longas there is a demand for illicit product and thepotential for profit exists.

Case Study: Paraguay Source Country for Counterfeit and Illicit Whites in South AmericaCounterfeit cigarettes and illicit whites produced inParaguay have been found across Latin-America. Theillicit trafc involves major criminal organizations andlocal tax evasion. The magnitude of the problem isillustrated by the estimation that 44% of licensed retailoutlets in Brazil stock illicit brands from Paraguay.Paraguay produces an estimated 47 billion cigarettesper year although domestic consumption is estimatedat only 4 billion sticks per annum or less than 10%of domestic production. There are approximately 30manufacturing sites, thereof 14 currently active, withan estimated capacity of 100 billion cigarettes. TheParaguayan north-eastern frontier is 650 km long andthere are more than 1,000 km of river banks and lakeshores in the Ciudad Del Este / Itaipu Tri Border area.

Organized Crime Groups have been identied as beinginvolved in the illicit trade in cigarettes. Illicit whitesand counterfeits are transited through Bolivia by roadinto Chile and Peru then transported by sea to othercountries in South America, Panama and the Caribbeanor along the Rio Parana and smuggled into Argentinaand Brazil.The Paraguayan Government has commenced a pro-cess to better regulate internal cigarette production

such as working towards a digital verication system,and recently, there has been some success in lawenforcement involving cooperation both with theindustry and across frontiers. For example, BrazilianAuthorities have initiated a Cease and DesistProgramme to stop the licensed retail outlets sellingillicit cigarettes from Paraguay.Under this regime the government inspectors have thepower to close retail shops stocking illicit tobaccoproducts. The program involved a two phase approachwhere traders were rst warned not to stock illicitbrands. If this warning was not complied with, a formalCease and Desist letter was served on the retail outletwhich was required to be displayed in a prominentposition inside the outlet or in the window so it could

be viewed from the street. If there was further non-compliance the outlet would be closed on the spot.The program has been very successful with seizuresup 41% when compared to the same period in 2009.In addition, the Bolivian Customs Authority has restruc-tured its resources to be more effective in interdictingthe ow of smuggled and counterfeit product fromParaguay transiting Bolivia to Chile and Peru.

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Case Study: Cross Border Tobacco Smuggling into South AfricaSouth Africa is a prime destination for smuggling oftobacco products from neighboring and other countries.A signicant source of illicit whites is Zimbabwe wherethere are 6 factories manufacturing more than 20brands of cigarettes. These factories are situated inan export zone with concessions given to improveforeign currency ows and a minimum of 80% ofnished goods must be exported. There are no controlsover the movement of the nished product or the inuxof foreign currency. The situation is compounded by alack of political commitment to effectively address theillicit trade issue in the country.It is estimated that, annually, more than 4 billion sticksare manufactured in Zimbabwe for export destined forZambia, South Africa, Mozambique, Malawi and the

Democratic Republic of Congo. The majority of thisproduct actually enters South Africa. A portion is legallyimported under warehousing for export or local sale ofwhich about 500,000 sticks are declared for domesticconsumption with duties paid. A similar amount isseized in the market along the border. Overall the illicitinux from Zimbabwe is estimated to be more than2 billion sticks.

Corruption at border is high where up to US$50,000per container is offered to ofcials to let concealedcargo through. Enforcement actions within Zimbabweare a rare occurrence.However, a good working relationship with regularinformation and intelligence sharing sessions hasbeen established between the tobacco industry andlaw enforcement agencies in South Africa. A numberof national interventions involving the industry workingin conjunction with Customs and the South AfricanPolice Force have brought successful results with theseizure of illicit product in the market and along bor-ders. These operations have also included corruptioncharges against illicit traders.There is also close cooperation between the TobaccoIndustry of Southern Africa (TISA) and the authoritieswith quarterly review meetings of the Revenue ServicesForum, presentations to the South African CustomsUnion, the Southern African Development CommunityTax Forum, the Africa Tax Forum and the NationalTreasury. Furthermore, cross border forumshave been established between countries neighboringZimbabwe (i.e. Mozambique, Swaziland, Botswana,Angola, Namibia and Zambia).

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15 Framework Convention Alliance How Eliminating the Illicit Cigarette Trade Would Increase Tax Revenue and Save Lives INB3 fact sheet.16

This figure is probably exaggerated as it uses a very high average excise rate and ignores double counting (i.e. when a tax-paid productin country A is then smuggled into country B, you need to deduct the tax paid in country A).17 European Commission/MEMO/10/448 (27 September 2010).18 Talking Retail (industry news) (10 December 2009).19 Royal Canadian Mounted Polices Contraband Tobacco Enforcement Strategy, p. 17 (2008).20 The Bureau of Alcohol, Tobacco, Firearms and Explosives Efforts to Prevent the Diversion of Tobacco (September 2009).21 Dr. Louise Shelley, ITIC Conference Paper Illicit Trade: A Security Challenge A Case Study of Cigarette Smuggling (2009).

4. The Impact of the Illicit Trade inTobacco Products4.1 The Impact on the Economy4.1.1 Lost Government Revenue

The illicit trade in tobacco products obstructseconomic development, undermines the rule of lawand weakens the tax base, costing governments vastamounts of lost revenue. Illicit trade means thereis less money available to governments for publicservices such as health care, education, defence,transport, and environmental concerns.

The Framework Convention Alliance15 has estimatedrecently that the global tax lost to governments at$40.5 billion.16 The European Commission estimatesthat the EU Member States lose up to 10 billionin tax revenue a year as a result of the illicit tradein tobacco products. In the EU, the average loss of

customs duty, excise duty and VAT on a smuggled40 foot container containing 10 million cigarettes isabout 1.5 million.17

As well as loss of indirect taxes governments willcollect less income tax, social contributions andcorporate taxes as the legitimate industry and tradelose legal volume and subsequently jobs.

4.1.2 Financial Loss to the LegitimateIndustry and Trade

Legitimate manufacturers and suppliers of tobaccoproducts are impacted as in addition to lostincome, illicit trade distorts competition in themarket, undermining investment in innovation,distribution, brand equity and employment.

Small tobacco retailers are among those worst hit by easily available illicit cigarettes. In the UK, theillicit tobacco products trade is reported as having adevastating effect on local retailers who have to com-pete with the black market economy. Shopkeepers,wholesalers and distributors are estimated to belosing 230 million to smugglers annually.18

Research19 in Canada by the Canadian ConvenienceStores Association and the Canadian TobaccoManufacturers Council found that the illicit traderesulted in a 30% revenue loss to convenience stores.

4.2 The Impact on Society4.2.1 National Security and Organized Crime

The infiltration of supply lines by criminal networksand terrorist groups hinders the fundamental building blocks of development, democracy, humanrights and the rule of law and supports corrupt

practices among Government officials and privatecitizens alike. These same networks are used totraffic humans, weapons and drugs.

In many countries, enforcement resources andharsh penalties are targeted at drugs and humantrafficking leaving the trade in illicit tobaccoproducts as a high profit but low risk activity. Asa result, the high profits available when measuredagainst the risks of being caught and the lowpenalties handed down should a prosecutionever take place, make cigarette smuggling a veryattractive option for organized crime gangs andterrorist networks.

Post 9/11 there has been a crack down on the banking systems making money launderingthrough the banks more difficult. So, criminalsand terrorist groups are now using illicit tradeto generate profits and move money across borders. The US Department of Justice Bureauof Alcohol, Fire-arms and Tobacco (ATF) claimsthat organized criminal groups, including thosewith ties to terrorist organizations, are engaged inillegal trafficking in alcohol and tobacco products,including counterfeit tobacco products.20

Academic research on terrorism, transnationalcrime and corruption has revealed that the peopleinvolved in the illicit trade in tobacco productsare also involved in other forms of illicit trade

(e.g. drugs, people, alcohol, diamonds, timber orantiquities). The illicit trade in tobacco productshas been growing, in part because of the absenceof coordinated control resources focused on illicittrade routes and distribution chains which areoften the same for many different products.

The extract of research on page 1521 by Dr. LouiseShelley Professor and Director of the Terrorism,Transnational Crime and Corruption Center atthe George Mason University, Arlington, Virginiaprovides an overview of the link between the illicittrade in cigarettes and the funding of terrorism.

4.2.2 Respect for the Rule of LawWhere the general public becomes aware that laws arenot being complied with and no consequences arise,there is a gradual erosion of respect for legislationand enforcement authorities. If people rarely hear ofarrests and successful prosecutions of those involvedin illicit trade, then the perception will spread boththat enforcement authorities are ineffective and thatthe law doesnt really matter. People who habitually

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22 Letter by the Dutch Minister of Finance to the Dutch Parliament (26 May 2010).23 The Center for Public Integrity Tobacco Underground by Marina Walker Guevara (19 October 2008).

Illicit cigarettes are often disguised and transported in unsanitary conditions.

break the law without suffering any consequencescan influence others thus lowering the standards ofacceptable law abiding behavior.

4.2.3 Public Health

The illegal trade in tobacco undermines publichealth initiatives to curb tobacco consumption by making cheaper cigarettes available in anunregulated environment where they may be soldto vulnerable groups such as minors.

Unlike legal tobacco products which aremanufactured and sold in compliance with strictregulatory requirements such as health warningsand maximum tar and nicotine levels, illicitlytraded products, especially counterfeit, are partlyor fully outside of this regulatory framework.

Research conducted by the Dutch NationalInstitute for Public Health and the Environment(RIVM) demonstrates that counterfeit cigarettescontain cadmium levels that are five times higherand lead levels that are six times higher than ingenuine cigarettes.22

The Center for Public Integritys investigationTobacco Underground23 says:many of the smokesare made from the lowest quality tobacco, full of stemand sawdust, and spiked with unusually high levels ofnicotine. Tests reveal that counterfeit cigarettes carry abevy of products that could further shorten even aheavy smokers life: metals such as cadmium, pesticides,arsenic, rat poison and human faeces.

The WCO has reported seizures of counterfeitcigarettes containing mites (pictured below) andidentified unprecedented methods of concealment,(e.g. in barrels of titanium sponge containing toxicchlorine gas) which posed serious health risks forthe law enforcement officers charged with inspectingand seizing the illicit cigarettes from inside thesecontainers and which therefore could have beenextremely hazardous if smoked by a consumer.

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Case Study: Illicit Trade: A Security Challenge (Shelley, 2009)For decades, the [illicit tobacco] trade has benetedcrime groups and corrupt ofcials, but terrorist organiza-tions have also exploited this illicit trade. The ItalianMaa has been involved in this trade since the early ormiddle of the twentieth century (Paoli 2003). However,the lure of prots from this commonly smuggledand trafcked commodity has attracted not only thetraditional organized crime groups. The U.S. governmentand international corporations have documented themanufacturing of counterfeit cigarettes in the Tri-borderregion of South America by terrorist organizations(Hudson 2003; Sverdlick 2005).Many other diverse terrorist groups have exploitedthe cigarette trade to generate nancial support fortheir activities such as Hezbollah, Hamas, Al Qaeda,

IRA, PKK, ETA (Basque Father-land and Liberty), andEgyptian and Palestinian Islamic Jihad, Farc have beenidentied as participants in this illicit trade (Coker2003; Billingslea 2004, Wilson 2008). Because of theinvolvement of so many different groups in this activity,the U.S. Government Accountability Ofce (GAO) (2003)ranks cigarette smuggling among the top fundrais-ing activities used by terrorists, along with illicit drug,weapon and diamond trade. Illustrating the lucrativenature of the trade, the combined total prot from

cigarette trafcking for the three primary factionsof the IRA (the Provisional IRA, Real IRA, and theContinuity IRA) reached approximately $100 millionbetween 1999 and 2004 (Billingslea 2004).The links between crime and terrorism continue to beidentied. Recently, the International Consortium ofInvestigative Journalists has shown that trafcking inillegal cigarettes is a major revenue source for terroristsin Pakistan (Center for Public Integrity, 2009; Wilson,2009). Russian researchers in Southern Russia in theconict ridden North Caucasus region are also ndingthat trade in counterfeit goods including cigarettes isa funding source for terrorism.Cigarette trade is a crime of choice among terror-ists because it commands limited attention from lawenforcement. Terrorists seek to secure funding in waysthat draw the least attention to themselves. Terroristssmuggle cigarettes because the risks of apprehensionare low and the prots sufciently high to fund terroristgroups and purchase arms and even dual use equip-ment with the proceeds of this criminal activity.Terrorists are increasingly turning to cigarette smugglingfor funding. Among the groups are the Taliban, for whomcigarettes are now second only to heroin as a fundingsource, and al Qaeda.

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5. Causes and Facilitators5.1 Economic Drivers of Illicit TradeThe illicit trade in tobacco products is a global phe-nomenon, covering high and low income countriesalike. The primary drivers for illicit trade are: A desire by consumers to save money by

willingly purchasing cheaper illicit products; and

The potential for criminals to make high profits.

Cigarettes, being highly taxed, widely consumed,easy to transport and possessing an attractiveweight-to-value ratio, are one of the most illegallytrafficked goods in the world.

Even in countries with a perceived low absolutetax rate, smuggling can be very profitable if thetax level is high relative to income. The tax evadedis shared between the consumer in the form ofcheaper cigarettes and the smuggler.

For example individuals in Eastern Europe arecontent to make a profit of just $100150 per week by smuggling small quantities since this far exceedsthe income from a regular job whilst, at the otherend of the spectrum, criminal gangs smuggling

container loads into the European Union can makemillions in profit per consignment.

5.2 Factors Facilitating Illicit TradeIn addition to the primary economic drivers,there are a number of other factors that have asignificant bearing on the incidence and scale ofillicit trade. Factors contributing to the problem arean unbalanced tobacco taxation policy, protectionistpolicy measures, inadequate enforcement,exploitation of free zones, inadequate legislationand sanctions and public tolerance.

5.2.1 Tobacco Taxation Policy

In most countries, tobacco is considered to be anideal candidate for taxation revenues: this is becauseit is widely consumed, demand is relatively inelasticand the negative externalities justify taxation.Indeed, tobacco has been subject to special taxessince the 17th century and today all countriesimpose at least one tobacco products tax, be it excise,import duty, VAT/sales tax or other related taxes.Notwithstanding a few legal exemptions (i.e. dutyfree traveller allowances), all these taxes are due to be paid in the country of consumption.

Case Study: Effect of Sharp Increases in Excise Duty on Cigarettes in IrelandExcise duty, price levels and tax revenue

Over the last decade, Ireland has experienced twoperiods of sharp increases in the excise duty paid oncigarettes, during 20012003 and 20062009. Thetotal increase in cigarette excise duty rates between20002009 was 76% in the most popular price cat-egory three times higher than the corresponding rateof ination (26.2%).From 20002005 cigarette prices increased by 31%and duty-paid volumes decreased by 16%. During thesecond period of steep duty excise increases (20062009), prices increased by 33%, reaching 8.45 apack almost 2 more than the EU country with thesecond highest prices.

In spite of these exceptional duty excise increases, theGovernment reported no scal benets, with revenuegained from cigarette taxation (excise duty and VAT),remaining virtually at between 2001 and 2009.

Cigarette consumption and smoking incidence

In 2005, illegal (non-duty paid) volume emerged in themarket, reaching approximately 8% of total consump-tion. However, the inow of contraband products esca-lated rapidly, reaching an estimated 25% of the marketin 2009, equivalent to 1.5 billion sticks.Since 2005, the legal (duty-paid) cigarette market hasdecreased further by 19% from 5.6 billion to 4.55billion sticks. By adding the number of legal and illegal

cigarettes together (4.55 billion plus 1.5 billion) it isclear that the actual consumption in Ireland for this

period remained at over 6 billion sticks and has notdecreased since 2003.This statistic is further substantiated by the evolutionof the smoking incidence level between 20002009which has remained virtually stable at around 30% ofthe adult Irish population.

Conclusions

The steep excise duty increases during 20002009have not resulted in a decline of total consumption andsmoking incidence which was the key health objec-tive driving the increases. The massive availability ofillicitly traded cigarettes, while fuelling organized crime,provided adult smokers and young people with cheap,uncontrolled product.The policy of sharp excise increases has also beencounter-productive from a revenue perspective as themassive rise in excise duty from 155 in 2001 to 261 per thousand cigarettes (an increase of 68%)did not result in any scal benets for the IrishGovernment as revenues remained virtually at.The limitations of this policy of sharp excise increaseswas recognized by the Irish Minister of Finance whostated, during the budget announcement on the 9thDecember, 2009, thatI have decided not to make any changes to excise ontobacco in this Budget because I believe the high priceis now giving rise to massive cigarette smuggling. My

responsibility as Minister of Finance is to protect thetax base.

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Tax Evasion Case Study: The Manufacturing of Tobacco Products in Certain FirstNations (Indigenous Peoples) ReservesThe location of First Nations territories along and

across the border between Canada and the UnitedStates creates a unique opportunity for illegal cross-border activity. Some First Nations strongly believe thatit is the sovereign right of their citizens to produce andsell tax-free tobacco products without the interferenceof federal or provincial governments. As law enforce-ment has been reticent to enforce tobacco laws andregulations on reserves, the illegal manufacturing andsale of tax-free tobacco products has proliferated overthe last 10 years.Licensed and unlicensed factories in these reservesproduce and sell non-duty paid tobacco products, whichare sold either directly to consumers at on-reserve out-lets, or sold in bulk to illicit distributors who sell to con-sumers off reserve. According to the Royal CanadianMounted Police (RCMP), approximately 100 organizedcrime groups are involved in illegal tobacco trafcking.Large and successive increases in tobacco taxes from2001 to 2005 created the incentive for smokers to buythese contraband tobacco products. Clear plastic bagscontaining 200 illegal cigarettes now sell for as little as$10 compared to an average price of more than $70for the equivalent amount of legal product.In 2008, illicit tobacco trade represented 32.7% of theCanadian consumption and, in the most populous prov-inces, Ontario and Quebec; contraband levels reachedrespectively 48.6%, and 40.1%. These contrabandtobacco products did not comply with any of Canadas

tobacco legislation or regulation (e.g. health warnings,

Lowered Ignition Propensity paper, testing and report-ing) and in 2008 represented a tax loss to governmentof approximately $2.4 billion. It is estimated that thelegal industry lost $900 million in revenue due to illicittrade in that same year. Retailers experienced a loss of$2.5 billion in tobacco sales in 2009 due to illicit trade.2,300 retail outlets closed due in large part to the lossof tobacco sales volume. Though seizures by law en-forcement in 2009 were 33 times the level in 2001, thisstill represented less than 2% of the total illicit volume.Within the past two years, some progress has beenmade in Canada. The prevalence of illegal tobacconationally has been reduced to 19%, reecting de-creases in the provinces of both Ontario and Quebec.Ontario continues to have the highest prevalence ofillegal tobacco at 32.4%. In Quebec, it represents17.9% of the total market.Starting in 2009 provincial governments introducednew enforcement measures, including a stronger policepresence, tighter management of raw tobacco leaf andstricter border monitoring and control.Actions to date have focused on increased enforce-ment. However the high excise levels will continue toprovide the incentive for the manufacture and saleof low priced illicit whites to consumers who demandthem. To successfully eliminate the trade, governmentswill need to pursue practical, long-lasting solutions thatinvolve the First Nations communities.

Excise is usually the main tax and it often accountsfor the majority of the final retail price. Besidesproviding governments with a secure, predictable

and easy to collect source of revenue, tobacco taxesare used by governments as a policy instrument todiscourage tobacco consumption.

The downside is that an unbalanced tobaccotaxation policy can trigger the emergence of illicittrade. It is therefore critical that governments balance their approach to the setting of excise rateswith the aim of optimizing tax revenues in a longterm and avoiding the development of an illicitmarket. In applying a principle of optimization,tax policy needs to reflect:

Consumer affordability tax levels on cigarettesshould be benchmarked against consumerspurchasing power.

Tax rates in neighboring countries or withina trade bloc to minimize incentives forcross-border shopping and smuggling.

Ease of administration and enforcement tominimize bureaucracy and tax compliance costs.

Sharp excise rates increases which lead to a sud-den decline in consumer affordability tend to beparticular drivers of the emergence of illicit trade

as demonstrated by the recent Irish experience onthe previous page. As illustrated below, Canadaprovides another example where particularcircumstances can result in a surge in illicit trade.

These examples show that tax policies can becounter-productive from both a revenue and healthperspective. In this regard, the World Bank hasstated that:

The potential for smuggling tobacco can limitincreases in tobacco tax rates. When setting tax rates,consider the risk of smuggling, the purchasing powerof local consumers, tax rates in neighboring markets,and the ability and effectiveness of the tax authoritiesto enforce compliance.24

5.2.2 Protectionist Policy Measures

Import restrictions, prohibitive import duties ratesor other protectionist measures aimed at imposingtechnical barriers to trade constitute an additionaleconomic impetus for illicit trade as consumer

24 World Bank Economics of Tobacco Toolkit, Ayda Yurekli Tool 4: Design and Administer Tobacco Taxes, What is the RightTax Rate? / Evaluate the Impact of Tobacco Excise Rates, page 22.

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demand for international brands exists. An exampleof this is China, where imports of foreign brandsare limited by strict quotas making them legally

inaccessible to the vast majority of consumers.5.2.3 Inadequate Enforcement

In many instances, laws are enacted that attemptto address illicit trade, however, once in place theyare not properly enforced for a number of reasons.

Official Controls

Policing millions of movements of goods across borders is resource intensive and requires theinvolvement of national and internationalenforcement agencies. The resources requiredinvolve skilled prevention, intelligence, detection

and investigation staff as well as the IT backupfor intelligence, risk assessment plus resourceallocation and intervention feedback as well asmutual assistance across borders. Mobile taskforces require transport equipment, mobilescanners and new technologies as they evolve.

For geographical reasons the borders of manycountries are difficult to police comprehensively.In most cases smuggling takes place throughknown entry and exit points (ports, bridges,interstate roads, airports and free zones).Inadequate controls at such points, often coupledwith varying levels of corruption, allow smugglers

to move products in large volumes undetected.The situation can be exacerbated due to politicalinstability in a country or region.

Goods in Transit and Transhipment

Goods in transit are those that have departed fromthe dispatch, loading or shipping point but havenot yet arrived at the receipt, offloading or deliverypoint. Transhipment is the shipment of goods to anintermediate destination and then from there to yetanother destination. Often this is due to a change

in the means of transport during the journey forexample from ship transport to road transport.Much international transhipment also takes place

in designated customs areas, thus avoiding theneed for customs checks or duties.

Both the OECD and WCO have raised concernsas to the lack of adequate legislation, controls andenforcement governing goods in transit. In its 2007report on crime the OECD statedvery often goodsin transit are specifically excluded from the prohibitionsrelated to counterfeit goods, which mean that theycannot be intercepted.

The table below lists the relevant categories.

An example of inadequate legislation for goodsin transit is given in the case study below:

Key Categories of Transit FraudNon-completion of transit procedures. This is thesimplest method of committing a transit fraud.The goods just disappear somewhere betweenthe ofce of departure and the ofce of destination.Fraudulent completion of the transit procedure. Criminals may create the impression that a transitoperation has been discharged through the use offorged or stolen ofcial stamps or the use of falsedocuments as return copies.Transit guarantee fraud. This may involve the illicituse of a genuine guarantee or may be the result ofa forged guarantee certicate.Misdescription of goods. This is a common customsfraud involving the misdeclaration of sensitive goodsor goods subject to high taxes to non-sensitive orlow taxed goods during transit.Concealment or substitution of goods duringtransportation. This is another common Customsfraud which sometimes includes tampering withofcial Customs seals on lorries.

Case Study: No Clear Legal Authority in Egypt for Customs to Seize Counterfeit Goods in TransitEgypt, with its strategic geographic position betweenAsia and Europe, is a hub for transhipment and transitof counterfeit cigarettes.There are signicant gaps in Egyptian IntellectualProperty Laws and regulations that hamper the Egyp-tian Customs ofcers in tackling the transhipmentand transit of counterfeit cigarettes. Egyptian Lawsdo not explicitly provide Customs with the authority toseize goods in transit that violate Intellectual PropertyRights (IPR). The Border Measures regulations (Importand Exports laws which are under the authority of theMinistry of Trade and Industry), leave room for interpreta-tion and confusion when enforced in conjunction with

the Customs Laws (under the authority of the Ministryof Finance). This can create uncertainty within customsand among judicial personnel responsible for IPR cases.As a result, Egyptian Customs may have no choice but

to let consignments pass through Egyptian Free TradeZones. Often, their only option is to coordinate withcounterparts in the goods destination countries.In 2009, two containers were in transit in Port Saidcarrying approximately 17 million counterfeit cigarettes.Thanks to Customs constant support over two months,the rights holder was able to initiate legal proceedings.However, the rights holder was unable to obtaina seizure order from the District Attorney. On Decem-ber 17, the two containers were cleared for shipmentto Mersin, Turkey. On December 25, Turkish Customsseized the containers on their arrival in the Mersin FreeTrade Zone despite the fact that the containers were

in transit to Famagusta in the Turkish Republic ofNorthern Cyprus. This case highlights the ineffective-ness of the current Egyptian Intellectual PropertyRights protection system.

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25 In 2002 there were approximately 3,000 Free Zones spanning 116 countries.26 OECD Report, The economic impact of counterfeiting and piracy 2007.27 WCO Guidelines on Controlling Free Zones in Relation to IPR Infringements Para 3 (January 12, 2005).28 Charles Kendall & Partners paper What is Effective Legislation, www.ITICnet.org (2009).

Case Study: United Arab Emirates (UAE) Jebel Ali Free ZoneIn the UAE there are multiple free zones within or

adjacent to sea ports containing 15 cigarette manu-facturing facilities. Nine of these are in the Jebel AliFree Zone (JAFZA), four in Fujairah Free Zone and oneeach in Sharjah and Ajman Free Zones. JAFZA is aknown source of considerable counterfeit cigaretteproduction which targets predominantly West Africanmarkets. Fake products from JAFZA have been found inGhana, India, Afghanistan, Iraq, Iran, various countriesin South East Asia, the Balkans, Eastern and WesternEurope and other States of the Middle East. JAFZA wascreated in 1985 and welcomes 100% foreign ownedcompanies which are free to employ whomever theychoose. There is no corporate tax and no import or ex-port duties. Since 2003, it is possible for international

businesses to establish offshore entities within JAFZA

benetting from unrestricted repatriation of capitaland prots. The free zone authority issues licencesfor trading, service and manufacturing activities withinthe connes of the free zone area.There are 54 companies in JAFZA listed under theTobacco and Cigarettes category. One of these,Concord Tobacco International FZE, has a long associa-tion with counterfeit cigarette production and is linkedto facilities in Afghanistan and Iraq. Concord Tobaccowas raided by Dubai State Security and Dubai Customsin May 2008 and two full containers of counterfeitcigarettes were seized in addition to large amountsof counterfeit packaging, loose sticks and othernon-tobacco materials.

Free Zones 25

Free zones are set up by governments in an effortto attract new business and foreign investment.They facilitate trade by eliminating tariffs, quotas,and minimizing bureaucratic requirements likecustoms procedures and disclosure requirements.

Criminal organizations use free zones to smuggleor divert illicit products to the domestic market

and even to set up production facilities forcounterfeit and contraband goods. Seizures ofcigarette containers in free zones reveal thatthey are often misdeclared as legitimate goods.Significant numbers of shipments seized in recentyears were intended to be transited/transhippedmore than once, and some underwent as many as

five transit/transhipment points before being seized.Reduced Customs controls are the key driver.

The OECD has identified the abuse of free zonesas a key facilitator for illicit trade.26 They aresometimes treated as outside the nations customsterritory with the result that goods enter or exitthese areas with minimal customs controls. TheWCO has recognized that Customs need to haveclear authority in law to monitor goods in transitand in free zones:In some cases it is not clear ifthe Government or the customs authorities do havethe jurisdiction to exercise controls in free zones.27

A recent examination of free zones controls28 suggests that, even where the necessary legislationexists, enforcement can be weak due to pressureon customs authorities to relax controls in orderto stimulate economic growth.

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Case Study: Russia Procedures Needed for Obligatory Destruction of Equipment orMachinery used for Counterfeiting

In Russia, despite the provision for destruction ofequipment (including machinery) in Chapter 4 of theRussian Civil Code, equipment or machinery used toproduce counterfeit cigarettes and seized in raids ofcounterfeit production factories is often not destroyed.This is because the Russian Criminal Procedure Codedoes not dene the destruction process clearly.In most cases, courts limit their decisions to the seizureof equipment and do not order its destruction. Similarly,when a criminal case is initiated and later suspended,there is no clear direction to judges as to what shouldbe done with material evidence, machinery and counter-feit products. Right holders, although not prohibited fromparticipating in the destruction process, are not formally

required to do so. Nor do right holders receive any of-cial notication of destruction. Russian law does notdetermine who, in cases where no natural or legal per-son is identied as the infringer, should bear the costsof destruction, which can be signicant in the case ofhigh-tech machinery used for the production of counter-feit products. As a result of the lack of clear proceduralprovisions regarding destructions, seized equipment ormachinery could easily re-enter circulation and be usedin future counterfeiting operations.

This problem could be remedied through the introductionof clear provisions in the Criminal Procedure Code that:(1) dictate that courts must order the destruction

of equipment and machinery shown to havebeen used or been intended for use to producecounterfeits;

(2) provide courts with the authority and obligationto order the destruction of material evidence insituations where a criminal case is suspendedand the material evidence is shown to be counter-feit or, in the case of equipment and machinery,it is shown to have been used to manufacturecounterfeit goods;

(3) provide for a procedure for the destruction ofequipment or machinery used for counterfeiting;(4) provide for the participation of right holders in

the destruction process;(5) provide for formal written notication to right

holders of destructions; and(6) dictate who should bear the costs associated

with destruction where there is no legal or naturalperson identied as the infringer.

The seizure and destruction of materials and equipment used to manufacture counterfeit cigarettes are critical componentsof legislation and an effective means to combat illicit trade.

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5.2.4 Inadequate Legislation and Sanctions

In many countries, enforcement agencies haveinsufficient legal powers to enable them to operateeffectively as illicit trade of tobacco products isconsidered a relatively minor offence. This attractscrime syndicates who see cigarette smugglingas a high profit, low risk activity which incurslighter penalties than criminal activities like drugtrafficking, human trafficking and arms smuggling.

The following statement by a (former) smuggler inthe 2008 Report Tobacco and Terror by the staffof the House Committee on Homeland Securityillustrates the limited deterrence effect of the law(still in place) in the US:Tobacco smugglers only fear is losing a load of cigarettes. We do not fear lawenforcement. They will pull us over, seize the load, andmaybe we get arrested, but most likely we do not. Theworst case scenario, we go to jail for a couple of monthsbefore returning to smuggling again. Think about it. Asmall fish like me can make $50,000 a month workingonly a few hours each week. The big fish make hundredsof thousands a week, most of which goes to the MiddleEast in cash or trade transactions.

Countries without strong deterrent penaltiespreferably including the power to confiscatethe proceeds of crime automatically put themselvesin a weak position to tackle the illicit trade intobacco products.

In addition, as the case study on the previouspage illustrates, the destruction of seized goodsand equipment used in the manufacturing of

illicit tobacco products should be mandatory.In some countries, goods and equipment areauctioned off with the result that they find theirway straight back onto the illicit market.

5.2.5 Public Tolerance

Consumer demand drives the illicit trade.Consumers are generally aware that they arepurchasing smuggled or counterfeit goods butstill decide to do so to save money. At the sametime, the general public is often unaware of theimplications of illicit tobacco trade and perceiveit as a victimless crime. In a study29 of smokersin socially deprived areas in the UK, Wiltshire etal. found that, far from being ashamed of such behavior, they saw it as a way of challenging aperceived injustice. They note that:Nearly allrespondents expressed dissatisfaction with the price oflegal tobacco products. It was thought to be unjust anddirected against people on low incomes.

A recent study by the NGO Action on Smoking andHealth (ASH) reports similar findings:Measuresthat are perceived by the public as unreasonable have potential to increase tolerance of illicit trade.30

29 Wiltshire et al. Theyre doing people a service qualitative study of smoking, smuggling and social deprivation,British Medical Journal (2001).

30 The Illicit Tobacco Trade: Monitoring and Mitigating Risk in New Zealand, ASH Action on Smoking and Health, p.3 (June 2010).

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6. How to Combat the ProblemA comprehensive government approach tocombating the illicit trade in tobacco productsrequires first and foremost a strong political will to

address the multi-faceted aspects of the problem.This should ensure adequate financial resources aremade available, targets are set and regular progressreports to evaluate success (or not) are presented.

In this chapter we list the main elements a com-prehensive approach needs to assess and, whererequired, amend or implement.

6.1 Understanding the Size andNature of the Illicit TradeAs a first step, governments and their lawenforcement agencies need to understand thesize and implications of the illicit trade in tobaccoproducts, identify those involved and the linkswith illicit trade in other goods. There are severalindicators of the presence and growth of illicit

trade in tobacco products. These include:

An unexplained drop in legal market sales usually noticed first by the industry and trade;

Disturbances in the flow of Government revenues;

An increase in seizures of illegal product either in frequency or quantities;

The emergence of brands which do not displaythe correct markings or which are not legallydistributed and sold in the country; and

Changes in the results of anti-illicit trade surveys.

The results of solid and robust methodologiesare usually instrumental in raising awarenessof the authorities and the general public aboutthe seriousness of the problem and can serve toinfluence the allocation of resources.

6.2 Evaluating the Main Facilitatorsof Illicit TradePlease refer to Chapter 5, in particular 5.2.

6.3 A Balanced Tax Policy andEffective Tax CollectionAs highlighted in 5.2.1, cigarette excise tax ratesshould primarily be set to optimize tax revenuesover the long term. When setting tax rates,Governments need to take into account the level

of economic development, the purchasing powerof the consumer and the tax rates in neighboringcountries. Experience shows that radical exciseshocks are more likely to lead to the emergenceor growth of illicit trade.

Countries use different methods to collectand control tobacco taxation revenues. Exciseadministrative systems are usually based onchecking factory output, bonded warehouse andimport volumes. This can be complemented bythe use of fiscal markers (e.g. paper tax stampsor digital coding) affixed to each individual salespackage. These markers can be used either as anadditional audit mechanism or as a means of taxpayment itself (i.e. they bear the actual tax paymentfor the product to which they are applied).

However even the most sophisticated paper taxstamp systems cannot protect fully a marketagainst the threat of illicit products and havefailed to protect excise revenue. Like cigarettes,paper tax stamps are subject to very high qualitycounterfeiting, often within weeks of appearing,to avoid easy detection. Paper stamps are alsovulnerable to theft and re-use by smugglers.

With todays technology a digital tax verification

solution offers a far more secure approach to taxcollection and auditing. It uses advanced unique

Summary of Key Features of aComprehensive Strategy to Fightthe Illicit Tobacco Trade

U dersta d a d o tor t e s ze a dnature of the problem. E a uat o of t e a fac tators, c ud

manufacturing and export controls, freezones and transit operations, etc.

A ba a ced tax po c a d effect e taxcollection.

A a ze ex st e s at o a d re u at o sto ensure they work, the penalties areadequate and act as a deterrent.

E sure t e jud c ar s a are of t eseriousness of the crime and the needto destroy illicit product and equipment

in a timely manner. De e op a e force e t stratecomprising all relevant national agenciesand ensure they possess adequatepowers to act efciently.

Pro de suf c e t a c a resources foradequate law enforcement capacity.

Tac e de a d b educat a d forthe public about the implications of theillicit tobacco trade.

Bu d a d stre t e part ers ps bet eenational and international agencies.

Cooperate t e t ate dustr p a ers

to make best use of combined intelligenceand resources.

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digital coding technology printed directly ontopacks effectively replacing either a tax stampor a fiscal marker. It is easily readable and can

also serve as an authentication tool since theduplication of a genuine encrypted code is virtuallyimpossible. Governments obtain real-time andsecure information about the volume of cigarettesproduced both in and for their country thusoffering full transparency on the amount of exciseduties to be collected by each manufacturer andimporter. Digital tax verification for tobaccoproducts is fully in line with e-government ande-customs initiatives.

Digital tax verification is the way forward and, asthe most cost effective system, it is accessible to both developed and emerging countries.31

6.4 Effective Legislation and RegulationsTo be effective, legislation needs to be clear, simpleto administer and should provide law enforcementwith sufficient authority to take action. Importantlegislative requirements include:

Clear offences and appropriate penalties;

The systematic destruction of all seized illicittobacco products, raw materials, manufacturingequipment and components. In some countrieslegislation on the disposition of seized goodsis non-existent, creating confusion and theinability to destroy them promptly;

Means to recover tax revenue losses and costsfor destruction of seized goods, for examplethrough asset confiscation;

Supply chain control (e.g. manufacturinglicences, security markings); and

Strong protection measures for brand ownersagainst IPR violations.

To be in the best position to combat illicit trade,customs powers may need to be strengthenedand clarified so that there is no ambiguityregarding jurisdiction.

It is very important that the destruction ofconfiscated goods occurs within a reasonabletimeframe to ensure it cannot be misappropriatedfor recycling into the illicit trade.

It is not recommended in any circumstancesthat legislation allows government agencies toauction or otherwise sell any seized items whichare directly related to the manufacture or saleof tobacco products including counterfeit andcontraband cigarettes, manufacturing equipment,tobacco and non-tobacco raw materials.

As a fundamental principle, all regulatory measuresaimed at reducing tobacco consumption should takeinto account their potential impact on illicit trade.

Authorities should ensure that any measures beingdeveloped to reduce the legal accessibility, visibilityand availability of tobacco products to consumersare considered carefully by enforcement authorities before implementation so that no unintendedimpetus is given to illicit trade by:

Impeding the ability of health and enforcementagencies to identify illicit products;

Making it more difficult for government agenciesto identify contraband or for consumers todistinguish between counterfeit and genuineproducts when making a purchase; and

Helping those retailers who choose to dealin illicit products to mix them with genuinetobacco products.

6.5 A Functioning JudiciaryA large part of the ultimate success of any anti-illicit trade strategy depends on the judiciary andits capability to quickly deal with cases submitted by the enforcement bodies.

The interventions of enforcement authorities needto be based on adequate laws passed by national

legislatures and supported by appropriate penaltieswhich have to be made available to and used bycourts to disrupt the activities of the criminals.

6.6 EnforcementAn effective targeted enforcement strategy is thecornerstone of any comprehensive anti-illicit tradestrategy. Without it, all the other elements will beof little use. It is often the first step in the processas it is seen as the quickest solution to the problem.However, to be effective it does require considerableinvestment in skilled resources and tools.

6.6.1 Invest in Appropriate and Effective ResourcesAt country level, the main enforcement bodiesare usually customs, border guards or specializedpolice units. Fully trained human resources arethe key tool in the fight against illicit trade. Theyneed to know the legal requirements for successfulprosecutions and be able to use IT tools andanalyze data sources. They should be kept up-to-date with intelligence and technical developments(e.g. counterfeit techniques, etc.). Leadership,management, appropriate remuneration and ethicstraining can help to counter a culture of corruption.

31 More information on digital tax verification can be found on www.ITICnet.org.

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Effective enforcement also requires investment intechnology solutions that address:

The analysis of production, import and exporttraffic and trends, together with real-time riskassessment of movements of goods, real-timeresponse operations and feedback/analysisof intervention results; and

Supply chain security in terms of tracking andtracing products through the supply chainand authentication of products seized andverification of tax declared in comparisonwith production.

Other tools that have proved effective are snifferdogs and scanning machines at transit points forinternational trade. Intelligence from all availablesources and analysis of seizures can help identifychanges of methods used by illicit traders.

6.6.2 Educate the Public

It is important that revenue and enforcementauthorities engage with the public to inform themof their new strategic direction. The media, bothnationally and locally, is an excellent tool to educatethe population at large about the implications ofthe illicit tobacco products trade so that successfulprosecutions receive maximum publicity. Examplesof public awareness advertisements in the UnitedKingdom are shown below.

Government agencies and the industry need toeducate consumers and the wider public about theimpact of illicit trade, the involvement of criminaland terrorist organizations and the consequencesof continued purchasing of illicit cigarettes.

32 http://www.hmrc.gov.uk/stats/measuring-tax-gaps-2010.htm.pdf.33 Lt. Gen. Jnos Nagy, ITIC Conference Presentation, How Hungary is Making Inroads into the Illicit Tobacco Problem:

Achievements of the Hungarian Customs & Finance Guard in the Field of Repressing Illicit Trade in Tobacco Productsbetween 20042009 (2009).

Case Study: Investing in Enforcementin UK and Hungary

In March 2000, the UK implemented a multi-facetedstrategy to combat the rapidly growing market ofcontraband tobacco products. It is under the controlof Her Majestys Revenue and Customs (HMRC)and included the allocation of signicant additionalhuman resources and investments in technology.Since inception the UK authorities have broken upover 370 criminal gangs involved in the large-scalesmuggling and supply of illicit cigarettes and haveseized over 16 billion cigarettes and over 1,250tonnes of hand rolling tobacco at UK seaports,airports and inland as well as en-route to the UK.The UK has successfully prosecuted over 2,000people and issued over 35 million worth ofconscation orders. This comprehensive strategy,combined with a revised excise policy approachof yearly increases in line with ination has led toa reduction over 8 years of the mid-point range ofillicit cigarette market from 21% to a mid point of11% (with a range from 5%17%), and the illicit ne-cut market from 73% to 49%. However HMRC stillestimates tax revenue loss up to 4 billion a year. 32 Faced with soaring illicit trade due to its require-ment to increase excise taxation rapidly on joiningthe EU, Hungary33 developed a comprehensiveanti-contraband tobacco products strategy in 2004.The focus was on increasing its Customs & FinanceGuard effectives to better control the border withUkraine in particular, which was the main source

of cheap cigarettes being smuggled into Hungary.Following the implementation of this extremelyeffective strategy the share of illicit marketdecreased from 25% in 2005 to 7% in 2008.

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6.6.3 Examples of ComprehensiveEnforcement Strategies

The catalyst for the adoption of a committedenforcement strategy is government awarenessof a growing illicit tobacco products trade andits undesirable effects. Several countries andinternational agencies have developed comprehensiveenforcement strategies to tackle it. In addition tothe United Kingdom and Hungary, examplesinclude the European Anti-fraud office (OLAF)and the Chinese tobacco monopoly (STMA).

A comprehensive enforcement strategy is crucialin tackling illicit trade, however, as a stand-aloneelement it cannot substitute required complementaryelements outlined in sections 6.1 to 6.8.

6.7 International CooperationBecause of its global nature and involvement ofhighly sophisticated international criminal networkswith substantial resources, active internationalcooperation is essential to tackle the illicit tradein tobacco products and bring about successfulinvestigation, arrest and prosecution of offenders.

Some international and regional organizations(e.g. WCO and OLAF) now have liaison resourcessited in strategic locations across the world. SomeCustoms authorities (e.g. UK and USA) havesimilar Liaison Officer Networks that work withthe local enforcement and revenue authorities andtobacco manufacturers to detect criminal activities.

The case study below provides an example ofsuccessful cooperation between customs andenforcement agencies in the EU and the USA.34

6.8 Cooperation with Legitimate IndustryThe successful combating of illicit trade in tobaccoproducts requires law enforcement authorities andthe legitimate industry to work together to addressthe problem constructively in a spirit of mutualtrust and cooperation.

6.8.1. Memoranda of Understanding (MOUs)

In many countries, the framework for cooperation between authorities and the legitimate industryhas been formalized in voluntary Memorandaof Understanding (MOUs) which supplementlegislation and regulations. As a rule, the keyelements that are covered in MOUs are informationsharing and assistance in:

Assessing and measuring levels and sourcesof the illicit trade in tobacco products andexchange of data;

A proactive approach to address the problem;

Monitoring of the movement of (suspected)illicit tobacco products and other materials inthe manufacture of tobacco products; and

Analysis and destruction of seized goods.

34 European Commission Press Release, OLAF/10/2, Brussels (8 February 2010).

Case Study: Jail Sentence for US Cigarette SmugglerIn the rst case of its kind, a third country nationalhas received a custodial sentence in the United Statesfor fraud (tobacco smuggling) against the nancialinterests of the European Union and has been orderedto re-pay $1.5 million in restitution.In the so-called Miami case, the Court in theSouthern District of Florida has sentenced a US

citizen to 2 years in jail and ordered him to re-paya massive $1.5 million to the EU authorities for hispart in smuggling millions of cigarettes onto the EUblack market. Roman Vidal was handed the sentenceafter pleading guilty at an earlier hearing to chargesrelating to his part in defrauding European taxpayersof several million Euros in customs duties and taxes.The defendant had conspired with individuals in theEU to smuggle cigarettes misdescribed as other goodsfrom the port of Miami into a number of EU countriesincluding Germany, Ireland and the United Kingdom.Following the sentencing, OLAFs Acting Director GeneralMr. Nicholas Ilett said This is another fantastic result

in this large-scale, complex international investigationwhich has been coordinated by OLAF. As well as theUSA, this investigation spanned nine EU MemberStates and several countries in Central and SouthAmerica. 43 million cigarettes were seized in theEU and 11 arrests were made. We are particularlygrateful for the excellent cooperation and supportwe have received from US Immigration and CustomsEnforcement (ICE) and the US Department of Justicein respect to the American aspects of this case. Notonly must Mr. Vidal spend the next 2 years in jail, hemust also pay back his share of the illegal prots.Mr. Ilett added that he would also like to congratu-late the Irish Revenue and Customs Service, GermanCustoms, the Guardia Civil in Spain and Her MajestysRevenue and Customs UK which have all played a sig-nicant role in ensuring the successful outcome in thisinvestigation and preventing further nancial losses.

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Case Study: Successful Cooperation Between Law Enforcement and the IndustryOn September 1st 2009, W, a criminal operating aninternational counterfeiting network from his base inGermany was sentenced to two years imprisonment(suspended for three years) and a ne of 200,000EUR to be paid to the public treasury and charitableinstitutions. The defendant also paid EUR 2.5 millionin damages to the trade mark owner, Philip MorrisInternational (PMI). The former car dealer and businessman headed an illegal operation responsible for coun-terfeiting millions of cigarettes. The criminal organiza-tion manufactured these cigarettes in China and NorthKorea and smuggled them into countries across Asia,Europe, the Middle East and Africa. Extensive coop-eration between law enforcement authorities and theprivate sector was the key to success.

Illegal activities were unearthed when one of Ws com-panies bought non-tobacco material similar to thoseused for Marlboro cigarettes. These goods were latertranshipped to North Korea via China. Investigationslater revealed that Ws ostensibly legitimate companieswere connected to a network operating in Dubai,United Arab Emirates.Ws company owned six cigarette trademarks regis-tered in over 80 countries. W had factories in China

and North Korea to produce not only his legitimatebrands but also millions of counterfeit Marlboro cigarettes as well. During this period, there werenumerous seizures in Europe and elsewhere ofcounterfeit cigarettes with the Marlboro trademarkwhich forensic analysi

booklet illicit trade tobacco products

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