Richard North, 09/03/2017  

Breaking news yesterday was a report via Politico concerning the investigation of a major VAT/customs fraud, in which the "continuous negligence" of UK Customs (HMRC) is said to have deprived the EU of €1.987 billion in lost revenue – a sum which is now recommended for recovery from the UK Government.

The fraud centres on Chinese textiles and shoes imported by organised criminal gangs, a problem that has been growing ever since quotas were lifted in 2005, but now has the UK acting as a hub. 

The investigation was carried out jointly by the EU's anti-fraud office, Olaf, and Member State customs services, and goes back to 2013. Basic details of the latest stage were published last September by the French Customs and simultaneously by Olaf, detailing the operation code-named "Octopus".

That joint investigation found that most of the imports arrived for customs clearance in the UK, mainly the English ports of Felixstowe and Dover, which have established themselves as the main entry points for Chinese textiles and footwear coming into Europe.

Even goods delivered to other European ports – Hamburg is specifically named – have been moved to the UK under EU transit rules, before being cleared by UK customs. This is a route well known to UK authorities. In a report for the year 2014-15, it was observed that, in the ro-ro freight mode, a considerable increase had occurred in the number of detentions involving IPR-infringing goods originating from China.

A significant number of detections had involved clothing, footwear and electrical items such as earphones. These had occurred primarily at Dover but also at other locations such as Tilbury Docks, Immingham, Harwich and Hull.

Said the report, "It is highly likely these goods originated from China and arrived in the EU primarily via container ports in the near continent. Detections have been recorded at the ports of Hamburg and Rotterdam, destined for the UK. UK importations are often facilitated by Eastern European HGVs utilising cover loads of "foot wear", "toys", "groupage", "textiles" and "shoes", which often featured poor-quality paperwork with incorrect delivery details or gave addresses that appeared to be self-storage facilities". 

In this current scam, the goods were following the same route. On arrival at UK ports, they were declared at falsely low values - so-called undervaluation fraud. As an example, Olaf found that, in the period 2013-2016, women's trousers imported from China were declared to UK customs at an average price of €0.91 per kg, against the EU average of €26.09 per kg. Given that in the same period, the world market price for cotton was €1.44 per kg, says Olaf, it was clear that the declarations were false

However, that was only the first stage of the scam. Although the UK was the country of choice for customs clearance, the supplies were destined for the black market traffic of textiles and footwear in other Member States across the EU. Here, the investigation also found substantial VAT evasion. While under normal conditions, VAT should be paid alongside duty, the UK authorities were allowing the scammers to abuse the system for suspending payments (the so called customs procedure 42).

They were allowed to defer payments of VAT until they had supposedly reached the countries of final destination. In fact, VAT was never paid but, because the goods were destined for the markets of other Member States (such as France, Spain, Germany and Italy), the UK was unaffected.

These VAT losses are cumulatively in the range of €3.2 billion for the period 2013-2016. Losses of customs duties are calculated according to standard methodology and are estimated at almost €2 billion (€1.987 billion) for the same period. These losses are on-going as this fraud has not been stopped.

The VAT losses are borne collectively by the Member States and the EU institutions, and the loss of customs duties, 80 percent of which would have been remitted to the EU budget, have to be made up by direct contributions from Member States in proportion with their GNIs.

As to where the responsibility lies, Olaf is in no doubt. Well known as a problem by 2009, it had been 
flagged up as an "emerging issue" in 2011 by Europol. Despite that, for three full years since 2013, scammers have been able to evade customs duties by using fictitious and false invoices and making false declarations, without intervention from the UK customs.

In 2013, Reuters was observing how undervaluation was becoming a major problem, with Mafia connections heavily involved in the business. And as Italian customs moved in on one scam, rogue importers simply moved the base of their operations.

David Murphy, head of the trade customs fraud unit at Olaf, then told Reuters: "For a fraud investigation agency, it's very difficult to get to grips with it. When you do engage with it, it either melts away or moves somewhere else". But even then, Olaf was investigating six undervaluation cases, some already known to involve Chinese nationals. Most cases were tackled by national governments, so all customs needed to be on high alert.

And even then, VAT avoidance was a common by-product of valuation fraud. After paying falsely low customs duties at the port of entry – with Hamburg given as an example - VAT payment was deferred to a country of final destination within the EU.

In respect of the current UK (lack of) response, Olaf remarks that these large-scale frauds were the result of organised groups, "extremely reactive and having an excellent knowledge of the weaknesses of controls, logistic circuits, false invoice systems and clandestine financial flows".

Of further significance, Olaf claims that, despite repeated efforts by their own investigators, and in contrast to the actions taken by several other Member States to fight against these scammers, the fraud hub in the UK has continued to grow. Some 79.2 percent (€646.8 million) of the losses in customs duties in 2016 occurred upon importation through the UK alone. 

Olaf says it has kept the UK authorities permanently informed over the years about this fraud. In 2014, the UK participated to the joint customs operation Snake. Participating customs authorities detected more than 1,500 containers where the declared customs value had been heavily undervalued. The UK attended the six meetings organised by Olaf in 2015 and 2016, in the presence of other Member States.

In addition, bilateral meetings were also held by Olaf with the UK on four separate occasions where the magnitude of the fraud scheme and the related risks were drawn to the UK's attention. OLAF shared the relevant meeting reports with the UK authorities.

The UK also participated in Joint Customs Operation Octopus, conducted by the French customs authorities, with the assistance of Olaf and in cooperation with several other Member States. The debriefing results were presented on 19-20 September 2016.

As a result of what it thus considers to be the "continuous negligence" of HMRC, Olaf is recommending that the European Commission should seek the recovery from the UK of the €1.987 billion lost in customs duties.

In response, HMRC has been dismissive. It states that Olaf's estimate "is not one that is recognised by our experts who will be challenging their calculations". It adds that it has an "excellent record in tackling fraud and rule breaking of all kinds". The agency was "considering" Olaf's findings and recommendations, it said.

Inevitably, it is Olaf's recommendation that is getting most of the attention in the UK legacy media, with the Guardian, the BBC and the Telegraph all styling the proposed recovery as a "fine" – the latter's headline wrongly attributing it to the sale of counterfeit goods.

However, in a terse, and probably unprecedented rejoinder to HMRC, Olaf said that it had "repeatedly drawn the attention of HMRC over the last years to the scale of the phenomenon and to the on-going revenue losses". It states that it has "also alerted the UK authorities to the need to implement EU-wide risk profiles and to investigate the fraud networks active in the UK".

As far as it is aware, Olaf added, "the UK authorities have not introduced risk profiles and the measures that they have taken do not appear to have curbed this traffic. To date, they have not initiated any criminal investigations in relation to these frauds either".

The irony here is that the UK does indeed have an "excellent record" in tackling fraud, coming second in the fraud performance league according to the 2015 Olaf Report, with 3,334 irregularities detected, accounting for 6.30 percent of customs duties collected. Only Germany performed better, with 5,362 irregularities detected, accounting for 2.30 percent of duties collected.

Inevitably, this by no means tells the whole story. The Olaf observation that the "organised groups" perpetrating the frauds have "excellent knowledge of the weaknesses of controls, logistic circuits, false invoice systems and clandestine financial flows", suggest that the UK might have been specifically targeted by criminal gangs. Underlying flaws in UK systems at certain ports, and in particular the stress points of Felixstowe and Dover have created "chinks in the armour", leaving the entire system vulnerable.

An HMRC insider, with specialist knowledge of customs fraud, told this blog that there was a dearth of experience in dealing with valuation fraud, and little political will to resolve issues. On the other hand, there would have been a lot of pressure to keep the system moving. 

He believes that a lot of the problems stem from Gordon Brown's merger of revenue and customs. The smaller department, customs, has been subsumed and its functions weakened. In particular, dedicated Customs Investigation Teams have been weakened and, since 2000, are no longer responsible for serious fraud case work. A huge amount of organisational knowledge and expertise has withered. Poor leadership is also part of the problem.

If Olaf's findings are valid, the implications far more profound than the legacy media headlines would indicate. The inability to address problems even when they are detected – especially in terms of the alleged failures to introduce risk profiles as a fraud detection aid - do point to underlying weaknesses in the customs service.

Those weaknesses were already evident from the failure of the HMRC to secure a timely replacement for its CHIEF system. With Brexit on the horizon, it is clear that the customs function is going to need considerable strengthening to cope with a massively increased workload under unprecedented circumstances.

This episode is another indications that the HMRC is not up to the task. And, since the costs of any failure might run to tens if not hundreds of billions over term, the repayment of €2 billion to the EU might be a lesson which is cheap at the price. It is a pity those responsible do not have to pay it out of their own pockets.

There again, there are deeper issues at play, which could also have a significant influence on the Brexit talks. As the problem started in 2005 when the EU lifted quotas on Chinese goods, we are now seeing the Chinese dumping goods on the market, as they have been doing previously, in what amounts to a naked act of economic imperialism. The primary effect of this is to drive other producers into penury. Not even Bangladesh can complete, and the Africans have been severely disadvantaged.

The textile tariffs, in particular, are as much to protect other producers in less developed countries. We have very few volume producers in the textile sectors left. But, with the Chinese Government turning a blind eye, the trade has been taken over by the Chinese crime gangs. They do so with the complicity of established criminal organisations in Europe, such as the Mafia. On a huge scale, criminals are subverting the trading system.

Customs are in the front line here - not only engaged in revenue collection, but acting as guardians of government trade policy, helping to ensure that it works as intended. The trouble is that, in this case, the "government" is the EU. The UK Government, under pressure from retailers to let cheap goods in, and anxious to keep inflation low, has lacked commitment to the tariff policy. It has refused to put the resources needed into breaking up the criminal gangs.

Hence, EU players are seriously angry. They see themselves in the front line, holding the line against unfair competition from the Chinese and pushing back the gangs. In response, the criminals have moved to the UK where, in the view of the Europeans, they are being given a free ride by the HMRC as long as they kept their noses clean on our side of the Channel. Unsurprisingly, EU Member States are after blood, wanting to extract revenge for what they feel is a betrayal.

None of this will be openly admitted, and nor can incompetence be ruled out. But it runs alongside the incompetence of the HMRC, providing a toxic mix of incompetence and political indifference. And on that basis, we might be lucky if all we have to pay is €2 billion. The price extracted for any form of post-Brexit customs cooperation might be very much higher than that.

Pics courtesy of French Customs Service, taken during operation Octopus.

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