Why illicit trade strategies fail (for Tax Stamp News)

Gaps in agency thinking – and opportunities to fill them (for Tax Stamp News, published by International Tax Stamp Association)

Telita Snyckers

CURRENT AGENCY APPROACHES HAVING A LIMITED IMPACT

The impact many agencies have on the illicit trade in cigarettes is generally quite limited: So, for instance an agency may note that it seized an impressive-sounding 1 billion illicit cigarettes over the course of a year. However, that translates into less than 1 percent of illicit cigarettes being removed from the market.  This is not an isolated example - it is a pattern that repeats itself the world over, with only 0.7% of all illicit cigarettes being seized globally. 

Agencies’ limited success does not just lie in their inability to detect and seize illicit cigarettes, but also in other indicators like the relatively limited progress with the implementation of instruments like the FCTC treaty. There has been no progress in the implementation of 7 out of 16 substantive treaty articles since 2014 (with the tobacco industry continuing to be the most important barrier in the implementation of the convention.) 

Many substantive proposals aimed at curbing the tobacco industry’s powers and abuses have been tabled as part of international treaties - and have consistently been diluted:  references to the industry abusing international trade and investment rules was deleted; all references to “tobacco industry interference” have been removed; proposals that the right to health takes precedence over any laws related to tobacco use, now simply acknowledge that the FCTC contributes to the achievement of health. The industry describes these as “tremendous outcomes.”

Technology-driven solutions, like tax stamps and traceability solutions, are the one consistent feature thatdoallow agencies to have a more positive impact.This makes it all the more important for tax stamp programs to become ever more effective tools in curbing the illicit trade in cigarettes – and gives tax stamp service providers a real stake in securing agency success.  

WHY TOBACCO CONTROL STRATEGIES FAIL

Why are some agencies more successful in targeting illicit trade and others less so? Experience highlights a number of possible causes:

·      The strategic importance of excise administration is under-valued. Excise duties are generally not a big money spinner for the average agency, as it does not affect the agency’s revenue bottom line significantly. However, illicit tobacco poses more than a public health and revenue risk – it has strong links to money laundering, counterfeiting, smuggling, organised crime and terrorism, offering a complementary source of income and a way through which to launder money. Agencies should make the illicit trade in tobacco a strategic priority not because of its revenue impact, but because it sits at the heart of criminality more broadly. 

·      The approach to managing risk is simplistic and unstructured. Few agencies have the required level of business intelligence and analytics capacities to identify the right consignments, issues and entities. Few agencies have a technically superior inspections and auditing capacity, or state-of-the-art scanning facilities capable of detecting co-mingled goods as they cross the border. And few agencies have the capabilities to look beyond just excise fraud, to more complex schemes around money laundering, thin capitalisation, transfer pricing and fictitious revenue schemes. The average agency generally has relatively little insight into how the industry operates, what tactics it deploys, and how sophisticated its evasion can potentially be. Policies are designed to regulate the legal market and known behaviours - and not the illicit market with its more opaque behaviours. For many, “risk management” is simply an audit control or post-clearance inspection. 

·      Agencies often view risk from a transactional, single-tax, siloed perspective. Audits and enforcement action tend to have a single-tax, single period view, looking for transgressions from a transactional perspective - instead of seeing companies for the complex and dynamic entities they are. The information submitted from a VAT, corporate income tax, payroll tax, customs and excise perspective should correlate, but often don’t. Exports declared should match imports declared to agencies in other countries, but often don’t. Agencies are often so focused on the minutiae of validating volumes declared that they fail to notice the billions being lost to more aggressive tax evasion schemes. 

·      The consequences of being caught are easily offset by the potential profits: A single untaxed smuggled container can make as much as $2 million profit(depending on the tax rates of the jurisdiction). Heroin trade yields a profit of around 1886% - untaxed illicit tobacco yields up to 4,200%.Illegally trafficked cigarettes now have a higher profit margin than cocaine, heroin, marijuana or guns. A penalty, or even a conviction, becomes a simple calculated cost of doing business that is easily discounted against the profits being made on other consignments. Despite its broad impact on health, crime, and taxes, lenient sentences are the norm; in some countries, cigarette smuggling is not even considered a crime. 

·      Even when agencies do find and seize consignments, they don’t follow the money trail behind it. Ultimately the illicit trade in cigarettes is about money. The profits have to be accounted for somewhere. The money has to be spent somewhere, or laundered somehow. While the detection and seizure of illicit consignments is critical, agencies need to follow the money. Who is this funding? Where is this profit being accounted for, or spent, or hidden? 

·      Agencies fall victim to industry rhetoric and industry agendas: They believe that the illicit trade in cigarettes is attributable largely to low-cost manufacturers, or cross-border smugglers based in neighbouring countries. They buy the false logic that tax rate increases drive illicit trade. They enter into partnerships with industry, giving it access to its law enforcement and policy making structures, because they believe that big tobacco is the innocent victim of illicit trade. 

·      Responsibilities for FCTC implementation are spread across a disparate range of government agencies: The FCTC Protocol was largely drafted by the medical community, for the medical community. Other key agencies who have a critical role to play in implementing some of the meatier provisions around traceability and criminality (like tax and customs departments) are often not fully engaged, do not appreciate the importance of the role they play, and view the protocol as a health-issue (if they are even aware of it). 

OPPORTUNITIES FOR TAX STAMP SERVICE PROVIDERS

In and amidst the challenges facing agencies in curbing the illicit trade in cigarettes, lies a number of opportunities for tax stamp providers in how they pitch their products, and in the support they offer to agencies, including e.g.: 

·      Helping agencies to develop a business case on the importance of excise administration, beyond a revenue-generating line item in the budget; 

·      Developing solutions that integrate insights across a range of taxes – beyond just excise duty calculations (because the marking of cigarettes won’t just curb excise duty evasion – it could reduce corporate income tax evasion too). This would allow tax stamp providers to showcase how their solutions have the potential to uncover far more complex evasion schemes (like inflated sales volumes), beyond just tracking local production volumes, and developing business intelligence modules that provide insights into entities, and not just transactions; 

·      Assisting agencies with the development of strategies that incorporate tax stamps as partof a broader solution, rather than touting tax stamps as an entire stand-alone solution;

·      Using their international experience to empower agencies to better understand industry tactics and how to counter them. 

Tax stamp service provider successes are very closely tied to agency successes.  If agencies fail, so do the service providers. 

CONCLUSION

What agencies are doing is having a limited impact - almost without exception. What successes they claim to have - usually an increase in the number of seizures - are having a negligible impact on the extent to which tobacco companies across the spectrum are paying the taxes and duties they should.

More is needed to change the paradigm, by better understanding the industry and its tactics, understanding how industry behaviours lead to tax and duty losses, the industry’s intimate involvement in organised crime, and exploring opportunities around improving compliance across the industry. It is a journey that tax stamp providers – with their global experience and insights – are potentially well placed to help agencies with. 

Governments need holistic solutions, not just tax stamps

Governments need holistic solutions, not just tax stamps

By Telita Snyckers and Michael Eads

As we discussed in our previous article[1]withat least 117 countries being unable to meet the requirements under either the FCTC Convention or the Protocol in the foreseeable future, what should be an undeniably enticing opportunity for potential solution providers may prove to be a challenging and complex environment to navigate. Of the 117 countries that potentially need your help, any number of them probably don’t even know it, and many likely can’t afford it. The long-standing history and prevalence of tax stamps make them an ideal platform for FCTC implementation, but with two possible distractions: they are often thought of as simple tax collection structures, belying their potential value as a platform around which broader excise modernisation strategies can be developed; and with cheaper, less-sophisticated, less effective stamps and marks potentially diluting the value proposition around marking.  

The same intractable challenges time and again

While the 117 countries certainly pose an opportunity, experience suggests that at least some level of scepticism is warranted. The tax stamp and secure printing industry appears to face the same intractable challenges time and again: solutions are pitched that never go to tender; tenders are issued but are never awarded; awarded tenders are challenged both in court and in the media; tenders are awarded for solutions that are never implemented; intentions to expand to other products never materialise; implementations are criticised as being ineffective; contracts are not renewed; and the tax stamp and secure printing industry ends up expending a considerable amount of resources on programs that never materialise. 

 Four key reasons for low implementation rates

There are arguably four key drivers that explain why tax stamp and secure marking programs meet with less success than they could (or should): absolute inertia at tax and customs agencies; agencies being at the mercy of industry-driven rhetoric around illicit trade and potential solutions; failing to leverage potential allies in the public health fraternity and academia; and a myopic focus that concentrates simply on pre-existing solution models that may not necessarily meet agencies’ overall needs.  

Agency inertia

 As we saw in our previous article[2], only 35 percent of agencies with obligations under the FCTC Protocol have or are considering implementing track and trace solutions[3]. Only 52 percent of them collect data on cross-border trade in tobacco products; and only 18 percent keep data related to the smuggling of tobacco products. 

Agency inertia – when it comes to managing the risks around excisable products like tobacco – is understandable: For many agencies, excise duties constitute a very small part of their revenue take (in some countries as low as 2 percent of total tax revenues), and with nothing to suggest otherwise, large manufacturers are assumed to be compliant and are treated as strategically important taxpayers. There tends to be a limited understanding at agency level of the different faces of illicit trade in excisable products, and little appreciation of how they are often intricately interwoven with organised crime more broadly. Little effort has likely gone into assessing the revenue losses from illicit trade or developing a comprehensive strategy to counter illicit trade. Even assuming agencies clear these hurdles, they tend to be fundamentally unschooled in terms of technology in general or the role a secure marking solution could play in curbing illicit trade in particular; have a limited understanding of the revenue optimisation potential; or succumb to the pressure of what are often undeniably some of their biggest employers and taxpayers (as a result of capture, corruption or simple political pressure).

 There is no burning platform jolting agencies out of their state of lethargy.  Or if there is, may well be driven by an industry agenda focused on eliminating smaller competitors, with information, rhetoric and agendas largely being driven by big tobacco or their proxies (see for instance the series of events now playing out in South Africa, with a controversial illicit trade survey funded by big tobacco being used to lobby for the targeting of smaller local manufacturers[4].)

The tax stamp industry tends to be in the business of selling what often boils down to “ink and paper,” and not holistic solutions, not crafting a strong-enough business case to jolt agencies out of their torporous state.

Industry controlling the rhetoric

By far the majority of the rhetoric and arguments around illicit trade and curbing it comes from the well-oiled machinery of the tobacco[5]industry and its proxies and intermediaries, with industry rhetoric drowning out the voices of more independent academics and NGO’s. 

This means that the public and policy makers most likely – but wrongly - believe that illicit trade is solely attributable to smaller local manufacturers and crime syndicates; that tax stamp programs are expensive and ineffective; that all tax stamps are easy to counterfeit; and that additional regulation simply increase levels of illicit trade as legitimate manufacturers struggle to compete; and that the increase in illicit trade will likely result in plant closures and job losses. 

 With little to balance this out in the media, this is the rhetoric that pervades, and the rhetoric that very often drives policy decisions. And as the tax stamp initiative traces its way through conceptualisation to the drafting of tender documents, the awarding of the tender, implementation and operationalisation, the attacks follow a fairly predictable course - one that could easily be countered with the right data points and factoids, but too often isn’t. 

Instead of pre-emptively empowering agencies with the relevant data and research and factoids that consolidate the best of academic research on what arguments to expect from industry, and how to respond when industry pushes back (either through capture, corruption political pressure or aggressive media campaigns), much of it is relegated to the chronicles of academia, and hardly ever dusted off and given the prominence it deserves. 

The tax stamp and secure printing industry has an opportunity to fundamentally shift the paradigm of considerations that shape public opinion and policy makers’ decisions. The result can only be more informed decision-making, with more tax stamp programs being implemented. 

Failing to leverage potential allies in public health and academia 

We remain astonished at the relative disregard the public health community has for the tax stamp industry. What should be an obvious partnership is instead characterised by distrust and almost no interaction. Where the tax stamp industry should have a seat at the table when it comes to developing and implementing secure marking solutions for cigarettes as part of something like the FCTC Protocol, it does not, and is instead pertinently excluded - even as observers during the 2017 MOP1 and COP8 meetings (made all the more egregious because the tobacco industry is known to have had a voice through proxies, as is evidenced by e.g. the Dirty Ashtray Awards handed out to some countries for parroting industry rhetoric.)

The tax stamp and secure printing industries are undoubtedly the single best and most uniquely positioned to deliver on some of the Protocol’s most fundamental objectives.  Instead there is poor if any communications and no formal structures for two parties who should be allies to come together.  The result may well be the tobacco industry’s solution paradigm (largely based on Codentify/Inexto) being implemented as a track and trace solution for governments. (There are already indications of this happening with the EC approving related entities as data service providers under the EC’s weak criteria for independence set out in the Commission’s Implementing Regulation (EU) 2018/574.[6])

If the collective aim is to eliminate the illicit trade in excisable products like tobacco (or even if only driven by a profit motive that seeks simply to increase the number of tax stamp programs implemented), the enmity and scepticism on the part of the global health fraternity needs to be far better managed. Arguably the best way to mitigate that risk would be by creating a network of allies working towards the same goal: reducing the illicit trade in cigarettes, through the use of proven technologies and strategies. In that sense, a partnership between organisations like ITSA and other trade associations, illicit trade experts, and something like the FCTC Secretariat seems like a natural fit. Unfortunately, the Protocol’s track and trace regime is largely developing without the inputs of subject-matter experts who have real-world experience in implementing tax stamp or secure marking programs, or more broadly in curbing illicit trade, simply playing into the hands of the very industry it was meant to control.  

Solutions that only partially solve the problem 

Tax stamps and secure marks are an inordinately important part of the ecosystem of solutions that help ensure better production control, traceability and overall compliance in respect of excisable products across the supply chain. But secure track and trace is only one element in an agency’s illicit trade strategy.  In order to be fully effective, and provide a comprehensive service offering it needs to be augmented by strong business intelligence, data analytics, enforcement capabilities and oftentimes additional cargo tracking and container security initiatives. 

This is not necessarily always immediately apparent to client agencies, who may well naively implement a secure marking and traceability solution believing it to be a panacea that does not require additional investment or capacity on the part of the agency.

This dilutes the effectiveness of tax stamps, secure marks and traceability programs across the board: how do you superimpose a generic solution if you don’t know what problem you are trying to solve? If your service offering only focuses on the secure track and trace component, but little else, how does that substantively translate into value-for-money for cash-strapped agencies? How does it actually improve not just production control for local manufacturers, but contribute to actually reducing the prevalence of illicit trade? And how does it help to mitigate rhetoric (very often planted by industry) that tax stamp programs are ineffective?

Focusing on broader outcomes

There is nothing wrong with being driven by a profit motive. There is nothing wrong with touting cost-effective solutions that maximise a company’s return on investment. But until the tax stamp/secure printing industry begins to develop holistic solutions that actually speak to illicit trade in very real terms it will continue to face the challenges it now does, and will continue to limit its potential success. 

Never forget why we have tax stamps, secure marks and traceability programs: to ensure that taxes are paid on excisable products, rooting out illicit traders that benefits from not paying taxes and duties. The challenge in 2019? Do more than just sell stamps – empower agencies to make informed decisions, and sell holistic solutions that have a quantifiable impact on illicit trade and transforms the way in which agencies administer their excise portfolios. 

Our next article explores just how that can be done by helping customer agencies better understand the problems they are facing, tailoring solutions to fit the problem taking agency capacity into consideration, help agencies position marking regimes within the context of a broader illicit trade strategy, and using tax stamp and fiscal marking programs as a platform to more broadly transform customs and excise administration.

[1]“117 countries may need your help. Some don’t know it. Many can’t afford it”, Tax Stamp News November 2018

[2]Ibid

[3]This number excludes countries who are not signatories to the Protocol. Moreover, only 78 percent of Parties submitted reports, which means that the actual extent of readiness is likely far lower than these numbers would suggest. http://www.who.int/fctc/mediacentre/news/2018/launch-global-progress-report-2018/en/

[4]For a brief summary, see e.g. http://www.tobaccotactics.org/index.php?title=South_Africa-_Country_Profile

[5]Although of course increasingly also alcohol, sugar and other manufacturers of excisable products.

[6]https://ec.europa.eu/health/sites/health/files/tobacco/docs/primaryrepositories_approvedproviders_en.pdf

Enabling legal frameworks for secure tax stamps and traceability

Enabling legal frameworks for secure tax stamps and traceability

Telita Snyckers, Michael Eads

INTRODUCTION

A tax stamp program has the potential to significantly disrupt illicit trade and excise-related non-compliance – but only insofar as it is supported by a responsive, empowering legislative framework that gives an agency the flexibility and powers it needs to do so.

Legislation can only deliver on these outcomes if a rigorous legislative design process precedes it, which is the focus of this article.  

Excise agencies are creatures of statute– they can act, regulate and enforce only insofar as they are empowered to do so in terms of legislation. If the legislation is weak, the solution is weak. Governments that are contemplating either establishing a new, or transforming a traditional tax stamp regime into a modern, secure tax stamp and traceability program, have a few key issues to consider from a legal perspective. The efficacy of any tax regime is highly dependent on the underlying legislative framework. No amount of clever solution design or technological wizardry can adequately make up for a poor legislative foundation.

DRIVERS SHAPING THE FUTURE OF TAX STAMP PROGRAMS

There are a number of drivers likely to shape the future of tax stamp programs, which put pressure on policy makers to revamp existing legislation in order to adapt and establish the flexibility required to underpin this evolving field. These include:

·       Governments’ expanding mandates -To balance revenue generation, trade facilitation, border protection and consumer health and safety across a broader range of activities, in an increasingly fluid environment and ever-tightening fiscal climate;

·      The profitability, growth and sophistication of illicit trade -Much of the growth in illicit trade is attributable to organized crime syndicates finding ways to introduce illicit products into legitimate supply chains, and to blur both the origin and chain of custody of goods;

·      Consumers are demanding safe, genuine products, and looking for solutions that let them validate the choices they make;

·      Technologythat allows government to utilise information related to revenue management in more innovative ways; 

·      Expanding regulatory and industry-drivenmandates  -The rise in the number of regulatory initiatives related to the pedigree, provenance and critical supply chain events for various types of goods, and including the World Health Organisation’s Framework Convention on Tobacco Control Protocol on Illicit Trade in Tobacco Products (“FCTC Protocol”) and the European Union’s Tobacco Products Directive (“TPD”); and

·      An increase in industry-driven supply chain integrity initiatives that run the risk of developing organically, eventually resulting in a series of disconnected systems that are more difficult to integrate over time, unless managed strategically by government. 

CONSIDERATIONS RELATED TO DRAFTING BESPOKE LEGISLATION

Drafting regulations to underpin a secure tax stamp and traceability program requires a significant amount of customization in order todeliver bespoke legislation thatis specifically tailored to the agency and its unique requirements. One cannot simply transplant law wholesale from another country or jurisdiction.

A full traceability regime requires the development of bespoke, tailored legislation – simply because legislation is not a copy and paste exercise: 

·      There is no global model tax stamp or supply chain security legislation;

·      There is a dearth of examples of legislation expressly aimed at securing full FCTC compliance, exacerbated by the lack of guidance from the FCTC Secretariat insofar as supply chain-related provisions in the Protocol are concerned;

·      Legislation has to be responsive to the agency’s objectives, mandates, demographics, compliance cultures, and external legislative frameworks. What works in one jurisdiction may not be appropriate or effective in another; and

·      Different agencies have different operational capabilities, and particularly smaller administrations may simply not have the capacity to implement or enforce provisions that a larger administration may find easy to do.

THE LEGISLATIVE DESIGN PROCESS

The purpose of promulgating new legislation is not to simply introduce a “thou shalt mark” obligation. It needs to:

·      Secure a system of regulation that has the necessary powers, obligations and discretions, and checks and balances to make it (near) impervious to fraud, manipulation, arbitrage and interpretive loopholes;  

·      Sufficiently empower the agency to deter, prevent, detect, assess, remedy and punish non-compliance and fraud; and

·      Be responsive to where real risk lies; flexible enough to allow the agency sufficient discretion to adjust its operations from time to time; give effect to agency and government objectives; and be relatively technology and product agnostic.

Legislation can only deliver on these outcomes if a rigorous legislative design process precedes it,which includesan assessment of the agency’s environment, developing explicit objectives, ensuring alignment with the solution design, assessing what legal powers the agency requires to give effect to its objectives, and only then crafting an appropriate legislative and regulatory framework.

DEVELOPING EXPLICIT OBJECTIVES THAT ARE RESPONSIVE TO THE AGENCY’S ENVIRONMENT 

Any legislative design has to start with an assessment of the agency’s environment,including an assessment of the prevalence and manifestations of excise fraud, reviewing the legal obligations imposed on the administration, considering the agency’s operational maturity, and understanding how the agency could benefit from international good practice. 

There is no solution that can stop all types of fraud or non-compliance, so it is important that the agency truly understands the problems they are trying to solve.  Typically, this involves conducting a thorough diagnostic or environmental scan, as well as assessing the agency’s overall strengths and weaknesses. Without a solid business case, there is little chance that a solution will be able to withstand resistance from well-entrenched status quo interests.  

Key questions an administration needs to ask in terms of understanding its environment include:

·      How prevalent are the different types of excise fraud, and at what cost to the fiscus?

·      Given existing operational capacity and maturity, what can practically be implemented? 

·      Does the agency have specific non-negotiable obligations (e.g. under the FCTC Protocol / TPD)?

·      What is allowed in terms of existing legislation?

Only once the agency has a deep understanding of its environment, can it begin to develop specific, explicit objectivesfor the program, which could include e.g. safeguarding revenue, combating illicit trade, and complying with FCTC or TPD obligations. Key questions an administration needs to ask in terms of setting objectives include:

·       What are the three or four single biggest objectives the agency hopes to achieve?

·       Which of these objectives are non-negotiable, imposed as a result of a legal obligation to secure compliance with specific rules?

·       Which of these objectives are aspirational and form part of a longer-term view, and which are important to the agency immediately?

·      How organisationally mature is the agency, and how sophisticated does the solution need to be?

·      To what extent does current legislation support the agency in achieving these objectives?

ASSESSING THE LEGAL POWERS THE AGENCY REQUIRES 

A traceability regime requires a number of building blocks from a legislative perspective. Some of the provisions are fairly generic (e.g. around licensing, debt and dispute management), while others require the introduction of new, tailored provisions. The precise legal powers an agency needs depends on its objectives, and grows in complexity as the agency’s objectives become more ambitious, but in general, tax stamp regulations require at least the conditions for release of goods, licensing, stamp specifications, liability for dealing in unmarked goods, and the like.  Insofar as the agency may have compliance with its FCTC or TPD obligations as an objective, it also needs to review the extent to which its legislation and practices meets the requirements of the Convention and Protocol. 

Alignment and engagement with non-traditional network partners (particularly where an agency is seeking compliance with its FCTC obligations)with whom the agency may not have an existing relationship, to manage overlapping mandates, interdependencies and pre-existing regulatory obligations including other government agencies (OGA’s) like the revenue agency, border protection agency, police, judicial system, consumer protection agencies, anti-money laundering authorities, the health department, etc. 

Equally important, though, is an understanding of the administration’s own legislationbeyond simply tax stamps, in particular in respect of officers’ powers, the limitations on the agency’s powers from a constitutional perspective, and other regulatory limitations or obligations that may be imposed on the administration (for example, data privacy rules and electronic evidence rules), and other legal instruments (e.g. customs union harmonization obligations; regulations around the placement of health warnings on tobacco etc.) 

Assessing the extent to which the agency is legally mandated to implement a traceability solution, empowered to enforce the obligations it seeks to impose; extent to which non-compliance is sufficiently criminalised; extent to which different rules would be required for different products; the impact that the specific solution would have on existing licensing requirements; system limitations the agency (and manufacturers) are likely to face; the impact on small, manual manufacturers who do not have automated manufacturing lines; and the impact of the solution design on existing import, export, transit and manufacturing processes; etc.

But perhaps equally importantly is to develop a legislative and regulatory framework that strategicallysets the agency up to counter typical legal challengesthat tend to emanate from industry and non-compliant players.

Key questions an administration needs to ask in terms of assessing its legislative gap:

·      In plain language, what are the key principles we want to introduce?

·      What legal powers do we require to give effect to this? 

·      What legal powers do we have currently? 

·      To what extent can we meet our objectives under existing legislation and discretionary powers, without requiring any changes in legislation?

·      Where amendments to legislation are required, what discretions and powers does the agency have to amend legislation itself, and what requires tabling in Parliament?

CRAFTING OF A LEGISLATIVE AND REGULATORY RESPONSE 

Only once the agency has established clear objectives, developed a high-level solution design and completed a legal gap analysis should is start crafting legislation. 

An agency may want to consider promulgating legislation in distinct phases, considering the limitations imposed under existing legislation, the time it would take to amend legislation, and the agency’s operational capacity. An agency could consider initially using existing legislation to institute basic controls; then retaining existing powers under primary legislation and changing only subsidiary regulations in-house to effect for instance production control measures; and then over time seeking to promulgate entirely new primary legislation to give effect to full traceability or to secure FCTC or TPD compliance. 

Key questions an administration needs to ask in terms of closing its legislative gap:

·      Does the new draft adequately give effect to the agency’s objectives, and protect it against fraud, arbitrage and subterfuge?  

·      Are there any other provisions in current legislation that are inconsistent with the proposed new legislation, and that would need to be repealed or amended? 

·      Could the agency benefit from phasing the promulgation of legislation? 

·      To what extent could timelines around the promulgation of legislation potentially impact on the planned delivery and implementation dates of the technology solution being considered?

What other (external) legislation potentially impacts on the solution design (e.g. the positioning of mandatory health warnings on cigarette packs, or legislation around the use of electronic evidence)

CONCLUSION

A tax stamp program has the potential to significantly disrupt illicit trade and non-compliance, to empower an agency to better meet its objectives, and to enable an agency to better target its resources – but only insofar as it is supported by a responsive, empowering legislative framework that gives the agency the flexibility and powers it needs. 

Implementing a full-traceability tax stamp program is a potentially audacious goal for any excise agency. It need not be, though, if agencies: 

·      View the program as an iterative journey, implemented in phases, and working towards a longer-term goal of full traceability over time;

·      Align the program with other good practices: entity-centric design, collaborative partnerships, whole-of-government solutions, standards-based solution design, and data-centric decision-making; and

·      Follow a structured process in developing empowering legislation, which is aligned with international good practice, but uniquely tailored to the agency’s specific environment. 

Supply chain security, and by definition, tax stamp programs, are an incontrovertible part of excise agencies’ futures. Without them, agencies will increasingly find it difficult todeliver on their ever-expanding mandates and respond to the ever-increasing threat from illicit trade.It is a journey that all agencies – regardless of size or level of sophistication – need to embark upon. But it is a journey that begins and ends with a robust, flexible legislative framework.

Developing track and trace solutions for the unique African environment

Developing track and trace solutions for the unique African environment

Telita Snyckers, Michael Eads

INTRODUCTION

A recent multi-part story by the Guardian highlighted the tobacco industry’s strategic focus on Africa as a growth market[1].  Indeed, recent months have seen increasingly more revelations about the extent to which big tobacco will go to capture markets in Africa. Facing increasingly stronger regulation elsewhere in the world, dramatically reduced rates of smoking in the West and increasingly hostile regulatory environments, Africa holds a number of strategic advantages for the tobacco industry[2].  Africa, with its growing wealth, booming youth market, generally low excise taxes (and cigarette prices), patchwork regulations, and relatively weak government structures, is ripe for the picking.  Tobacco is a business after all and business will always gravitate to these types of market conditions.  The downside for governments is that history has shown that as the industry executes its Africa-centric strategy, it brings with it a bevy of negative impacts. 

There are numerous reports of the industry turning to increasingly aggressive and some would argue “dirty” tactics; threatening and bullying governments, and filing lawsuits in order to delay or stop further regulation[3].

General estimates put the illicit trade in tobacco in Africa at around 43 billion sticks a year – with a trade share in some countries as high as 38% (Ethiopia,) and in several others hovering around an estimated 25% (e.g. Cameroon, Zambia, South Africa, Algeria, Nigeria etc.[4]), resulting in annual tax losses of around $10billion a year across sub-Saharan Africa alone[5].At the same time, African revenue agencies are under ever more pressure, with most facing daunting revenue challenges driven by the global economic downturn which bites especially hard when most countries’ economies are based on extractive industries (e.g., oil and gas, mining etc.).  Tax stamp and track and trace service providers should take notice as they are uniquely well placed to form strategic partnerships with agencies to develop solutions that will translate into tangible results.  Realising this unique opportunity will require some out of the box thinking and an appreciation for the unique challenges of Africa.  

 AFRICAN CONSTRAINTS & CHALLENGES 

With approximately 18% of surveyed countries in Africa having a tracking regime of any kind in place,[6]opportunities are rife for service providers. However, developing solutions for the African market is not like developing solutions for mature agencies in developed countries with advanced infrastructure and regulatory environments. Africa is unique – and solutions meant for it need to acknowledge that uniqueness. Experience across Africa highlights a number of aspects that solution providers may need to tailor their approach and service offerings:

INSTITUTIONAL CHALLENGES

Limited agency budgets, competing challenges and a negligible focus on customs and excise:Agencies the world over face budget constraints, but in Africa the challenges seem magnified. Most agencies in Africa are allocated miniscule budgets, with which they are required to improve compliance, replace legacy systems, professionalise staff, clamp down on corruption, and tighten long stretches of highly porous borders. Some government offices are still using old 286MB desktop computers, if any at all; most do not have professional data analysts, business intelligence capabilities or any concept or risk and compliance management; the majority do not have an explicit illicit trade strategy. For many, customs duty collections are a critical revenue driver (e.g. Lesotho, where 68% of tax revenue comes from customs); whilst for others, customs duties are virtually inconsequential from a tax revenue perspective (Mauritius at 2%, Algeria at 3%[7]).

 Tobacco industry revenues far exceed the gross national income of many African countries, making the playing field inordinately unequal:the average gross national income across Africa is $53 billion per annum–Imperial Tobacco makes $228 billion, JTI $235 billion, BAT $239 billion, and PMI $309 billion, per annum[8].

Service providers face two key challenges – a) securing financial support through external aid, technical assistance or donor funding, particularly for traceability projects (whose strategic importance may not be immediately apparent to agencies); and b) managing agency expectations in terms of the impact lower-cost solutions can be expected to have on illicit trade and compliance more generally. Best performing service providers may well be those who offer augmented strategy offerings beyond just traceability solutions, with a view to securing compliance beyond that which a tax stamp can secure, and offering governments the best possible value for money. This could include assistance with the development of broader illicit trade strategies, data matching and mining, targeted business intelligence offerings, and potentially outsourced field enforcement functions.

 Small budgets directly contribute to high levels of both corruption and capture: On the Corruption Perceptions Index published by Transparency International, countries with a score of less than 50 are regarded as having a serious corruption problem – in Africa, that accounts for 89% of countries[9]. While corruption is pervasive and potentially colours the entire continuum of a traceability project, service providers should not underestimate the extent to which many agencies have been captured by the industry – in everything from providing the intelligence on which an agency acts, assisting with the destruction of illicit goods on behalf of the agency, to developing illicit trade strategies for the agency, advising the agency where to target its enforcement activities[10]and prompting the agency on which solutions to choose – sometimes as part of overt partnerships that potentially flout FCTC rules[11], and sometimes more subtly. 

Regime change and lack of continuity: Throughout Africa we continue to see numerous examples of systemic instability that impede the functioning of government – we’ve seen unconstitutional changes in government in Algeria, DRC/Zambia, Ethiopia, Egypt, Nigeria, and more than a hundred coup d’états and counter-coups[12]. Unlikemany modern democracies, a change in government frequently results in a change in administration, often to the extent of replacing even lower level managers. The resulting lack of continuity, skills and loss of institutional memory and change in rhetoric is catastrophic for many projects – no matter how well conceived or justified, especially considering most track and trace programs require longer terms to yield positive returns for service providers. Consequently, contingency plans – in particular making sure that institutional knowledge and impetus are maintained in the event of a change in government – are perhaps more critical in Africa than in other more stable democracies.  Service providers should pay close attention to how they structure contracts to minimise risk and disruption as a result of potential regime changes.  They should be creative and look at ways to build in stability such as Public Private Partnerships (PPP) or other models that encourage a close working relationship with government. 

Exchange rate volatility:In Africa, some 14 countries use the CFA franc pegged to the euro, and three to the South African rand[13].  Forex volatility has escalated across most of the continent. In South Africa, political turbulence and international pressures have been reflected in the instability of its currency, and in its Volatility Index (a type of “fear gauge.”)[14],[15]. Angolahas had its currency almost double in the past four years to the US dollar. In Nigeria the naira has fallen from about N200 to $1 to almost N300.High volatility translates into risk for service providers and governments alike, potentially increasing the cost of solutions over time significantly. Finding local sources for key services and supplies is one way to ensure the solutions are not completely exposed to forex risk.  This is a win-win for both since governments generally want to encourage investment and capacity development and typically do not favour solutions that are wholly “imported”.

INFRASTRUCTURE

Limited internet and mobile phone connectivity: Africa has a relatively low internet penetration rate compared to the rest of the world (with the exception of concentrations in South Africa, Morocco, Egypt, Mauritius and Seychelles). A large percentage of internet traffic goes through expensive satellite links, making both internet and broadband access unaffordable to most[16].  Of the ten countries with the highest fixed-broadband costs in the world, seven are in Africa. Chad tops the list at $501 a month for a connection – in a continent where about 40% of people live on less than $1.90 a day.[17]Only around 43% of Africans can get a 3G data signal, and just 16% can access fast 4G mobile broadband.[18]The costs of downloading data are also higher in Africa than in most other parts of the world, in part because the data has to get there over thousands of miles of rough terrain. This means that it may not be possible to stream production data live to the agency; it may not be possible for officers to validate production data live during in-field inspections; and it may not be possible to capture enforcement findings directly to a central system. African markets likely need greater redundancies, offline solutions and backup systems.

Unstable electricity supply: The entire installed generation capacity of sub-Saharan Africa (excluding South Africa) is only 28 Gigawatts - equivalent to that of Argentina[19]. In many places less than a third of the country has electricity, and only around 26% of rural areas have electricity. Even being connected to the grid doesn’t ensure electricity supply – in South Africa up to 14% of electric connections never work, in Zimbabwe it is as high as 44%[20]. Ghana, Ethiopia, Nigeria, Zambia, South Africa and others have all been battling rolling power cuts[21],[22],[23]that have left the countries in darkness and businesses crippled. Solution design, in terms of marking solutions, data management and field enforcement solutions, need to be mindful of the impact of intermittent electricity supply and the impact of frequent power outages (and power surges) on equipment, battery life, and backup solutions. 

Rugged field conditions: Africa’s red dusty soil, corrugated roads, variable temperatures, torrential rains and intermittent flooding demand more from digital and technological solutions – especially those intended for field enforcement – to ensure that devices can hold up to a range of environmental stresses over the device’s operational lifetime. While devices might not need to comply with all 28 of the testing methods the U.S. Military requires (covering everything from temperature to fungal infestation and gunfire[24]), devices should at least be rugged enough to deal with both high and low temperatures, and be water resistant, humidity-proof, sand-proof, shock-proof, and oftentimes altitude-proof. Service providers could benefit from reviewing how best to reference standards like the US Army’s MIL-STD-810G standard, and Ingress Protection (IP) ratings[25], as a way of securing a strategic advantage for their in-field solutions.

BORDERS AND GEOGRAPHICAL CHALLENGES

 Porous borders:African governments find it difficult to police long, porous borders that are often the focus of conflict, separatism and smuggling[26].Nigeria has 84 official border crossings with its neighbours – and up to 3,000 fairly established unofficial ones, where most real trade is believed to take place[27], [28].South Africa’s long, porous borders comprises some 96 illegal points of entry [29]- 50 of them with Zimbabwe, and most known to be used by cigarette smugglers.[30](Police note that the borderline between South Africa and Zimbabwe is at a state of “complete collapse”.)[31]While some smuggling is effected corruptly at legal border crossings (for around $350-750 per container[32]), much of it is believed to be done at illegal crossings away from border posts – which is easily done with more than 61,000 kilometres of land borders stretching across the continent,[33]making managing the movement of people and goods an effort in near-futility. Effective solution design for client countries has to assume that national borders lack integrity, and include the development of complementary strategies that counter smuggling both at legal and illegal crossings.

 MARKET CONSIDERATIONS

Unique packaging configurations – conquering the continent stick by stick: In low-income countries it is common practice to sell consumer goods in the smallest possible volumes – you don’t need a dollar to buy a pack of cigarettes when you can buy a single stick for as little as 5 cents each (it’s twice as profitable to sell single sticks,[34]and is a way of securing a new generation of smokers). It is very commonplace – and generally not illegal - to find vendors in Africa breaking up cigarette packs and selling single cigarette sticks (often to children)[35]. Of course, the sale of single sticks severely limits the traceability of packs,[36]something that solution design needs to cater for.

Some of the drivers of illicit trade are relatively unique: A small component of the illicit trade in tobacco is arguably attributable to activities aimed at sanctions busting in countries like Zimbabwe: because of sanctions the country cannot freely export what is regarded as premium tobacco to Europe, so dealers re-brand Zimbawean cigarettes as South African[37].  Different drivers result in different behaviours and require a different response in terms of how solutions are structured. 

CONCLUSION

 Cigarette consumption in Africa continues to grow exponentially.  Western Europe saw a decline in consumption by 26% - over the same period Africa’s consumption grew by 57%.[38]And with 41% of its population under the age of 15, and the relative lack of regulation (compared to e.g. Western Europe) Africa is expected to continue to be a growth market for the tobacco industry.  With only around 18% of African countries having a traceability solution in place, it also constitutes a growth market for traceability service providers. Africa poses a unique opportunity to develop holistic solutions that cater for the unique attributes of African customers. Solution providers should think beyond traditional tax stamps and find ways to offer innovation and develop capacity. Across many industries, too often solutions offered to Africa are far too price focused and attempt to offer only basic functionality.  Instead, solutions should be aimed at generating more revenue for governments and paying for themselves over time.  A traditional, low cost tax stamp solution can only lead to a race to the bottom for the solution provider industry.   Instead service providers should define unique value-added solutionsthat partners them with agencies. This could include  assistance with the development of strategies targeting illicit trade more broadly, playing an advisory role in respect of FCTC implementation, assistance with data analytics, risk management and investigations.  It could even include the potential outsourcing of certain functions (e.g. market monitoring or even field enforcement) where government lacks capacity.  

There is an old saying that goes “Africa is not for sissies” and that is certainly true.  If you’re looking for a traditional, low risk market, Africa may not be for you.  But if you are willing to take the time to understand the client – from their perspective – and be creative about what you can offer, Africa may be worth your time.  Big tobacco has it sights set on Africa - so should traceability solution providers. 

[1]See for instance https://www.theguardian.com/world/2017/jul/12/big-tobacco-dirty-war-africa-marketand https://www.theguardian.com/world/2017/aug/18/british-american-tobacco-cigarettes-africa-middle-east

[2]http://articles.latimes.com/2012/dec/12/world/la-fg-south-africa-smoking-20121213

[3]https://www.theguardian.com/world/2017/jul/12/big-tobacco-dirty-war-africa-marketand https://www.theguardian.com/world/2017/aug/18/british-american-tobacco-cigarettes-africa-middle-east

[4]http://www.tobaccoecon.uct.ac.za/sites/default/files/image_tool/images/405/Training/Emerging_Researcher_Programme_2015/Illicit-Trade-Africa.pdf

[5]https://www.standardmedia.co.ke/business/article/2001235698/how-african-countries-lose-sh1tr-to-illicit-tobacco-trade

[6]As at the last FCTC implementation readiness survey, measuring “Tracking regime to further secure the distribution system developed”

[7]https://www.indexmundi.com/facts/indicators/GC.TAX.IMPT.ZS/rankings/africa

[8]Own analysis - industry revenues from http://www.statisticbrain.com/tobacco-cigarette-industry-sales-statistics/

and country GNI from https://data.worldbank.org/indicator/NY.GNP.ATLS.CD?year_high_desc=false

[9]Sub-Saharan Africa scores an average of 31 (Botswana the highest at 60, Somalia the lowest at 10.) https://www.transparency.org/news/feature/corruption_perceptions_index_2016; http://www.ey.com/Publication/vwLUAssets/EY-Transparency-International-Corruption-Perceptions-Index-2016/$FILE/EY-Transparency-International-Corruption-Perceptions-Index-2016.pdf

[10]See for instance BAT’s strong influence over South Africa’s illicit trade strategy over a period of years

[11]Something not just happening in Africa – see for instance recent coverage from Australia - http://mobile.abc.net.au/news/2017-08-26/big-tobacco-propping-up-law-enforcement-freedom-of-information/8841700?pfmredir=sm

[12]http://www.academia.edu/3034124/Unconstitutional_Regime_Change_in_Africa_TREND_PERSPECTIVES_AND_POLITICAL_REQUISITES_FOR_STRICTER_LAW_ENFORCEMENT

[13]https://www.fxstreet.com/analysis/african-currencies-nigerian-naira-and-the-new-us-dollar-volatility-201612071522

[14]https://www.jse.co.za/content/JSEBrochureItems/46%20-%20JSE%20New%20SAVI%20-%20April%202014.pdf

[15]https://vlab.stern.nyu.edu/analysis/VOL.SAVI:VIND-R.AGARCH; https://www.brookings.edu/blog/africa-in-focus/2016/10/14/figures-of-the-week-volatility-in-the-south-african-rand/

[16]https://en.wikipedia.org/wiki/Internet_in_Africa

[17]https://www.economist.com/news/middle-east-and-africa/21711511-mobile-phones-are-transforming-africa-where-they-can-get-signal-mobile-phones

[18]https://www.economist.com/news/middle-east-and-africa/21711511-mobile-phones-are-transforming-africa-where-they-can-get-signal-mobile-phones

[19]http://web.worldbank.org/WBSITE/EXTERNAL/COUNTRIES/AFRICAEXT/0,,contentMDK:21935594~pagePK:146736~piPK:146830~theSitePK:258644,00.html

[20]https://techcentral.co.za/inside-africas-electricity-crisis/64637/

[21]https://qz.com/422357/charted-how-electricity-problems-are-limiting-growth-in-many-african-countries/; https://www.euractiv.com/section/development-policy/news/energy-crisis-looms-near-for-africa/

[22]https://qz.com/411384/nigeria-is-shutting-down-for-business-thanks-to-its-worst-ever-fuel-shortages/

[23]http://www.theigc.org/blog/lights-out-zambias-electricity-crisis/

[24]MIL-STD-810G  is a standard issued by the United States Army's that is used to prove that equipment will survive in the field. They were designed specifically to test military equipment, but are now used to test a wide range of both military and civilian products, including mobile computers.

See e.g. https://gcn.com/articles/2013/05/08/8-tests-behind-mil-std-ratings.aspx

[25]See e.g. https://www.handheldgroup.com/why-rugged-handheld-computers/what-is-rugged/, and https://gcn.com/articles/2013/05/08/8-tests-behind-mil-std-ratings.aspx

[26]http://edition.cnn.com/2015/07/24/africa/kenya-back-door-porous-border-security-threat/index.html

[27]http://www.nation.co.ke/oped/Opinion/In-defence-of-smuggling-and-Africas-porous-borders/440808-2687084-857een/index.html

[28]http://studies.aljazeera.net/en/reports/2013/09/201398104245877469.html

[29]https://www.idsa-india.org/an-may-8.html

[30]https://audioboom.com/posts/2419944-50-illegal-crossing-points-from-zimbabwe-to-south-africa-pose-a-major-health-terrorism-threat-to-the-population

[31]Major General Meetsi, South African Police Service, https://www.saps.gov.za/resource_centre/publications/maj_gen_kr_meetsi_presentation.pdf

[32]See e.g. http://www.news24.com/Africa/Zimbabwe/Illegal-border-crossings-flourish-20100817

[33]https://www.sporcle.com/games/skSK/african_long_borders

[34]http://articles.latimes.com/2012/dec/12/world/la-fg-south-africa-smoking-20121213

[35]https://www.theguardian.com/world/2017/jul/12/big-tobacco-dirty-war-africa-market; https://www.pressreader.com/south-africa/pretoria-news-weekend/20161210/281659664671990

[36]Other commodities pose unique challenges too, like beer being sold in plastic bags.

[37]http://www.b-metro.co.zw/cigarette-smuggling-big-business/

[38]See for instance https://www.ncbi.nlm.nih.gov/pmc/articles/PMC4498629/