Introduction
2.1
This chapter outlines the illicit tobacco market in Australia. It describes what falls within the definition of 'illicit tobacco', where illicit tobacco originates and its impacts. The chapter then discusses the causes and estimated size of the illicit tobacco market, and outlines the responsibilities of various government agencies to tackle the market.
2.2
Individual initiatives and improvements to the approach to reduce the size of the illicit tobacco market are discussed in chapter three.
What products?
2.3
There are two general types of illicit tobacco products available on the Australian market: loose leaf tobacco and pre-rolled cigarettes.
2.4
The first type, unbranded loose leaf tobacco, is colloquially known as 'chop-chop' and 'molasses tobacco'. This tobacco product is typically sold in boxes of 100 pre-filled tubes or in quantities of one kilogram or less. Loose leaf tobacco products are illegally grown in Australia or are grown abroad and smuggled into Australia. The Australian Taxation Office (ATO) informed the committee it has not issued a commercial production licence for tobacco growing since 2006, therefore any domestic tobacco growing is illicit.
2.5
The second stream of illicit tobacco products includes counterfeit tobacco, contraband tobacco, and what are known as 'illicit whites'. According to evidence provided by Philip Morris Limited (Philip Morris), these products are defined as follows:
Counterfeit tobacco products are cigarettes manufactured illegally and smuggled across borders and into Australia. These products are not sold by the trademark owner.
Contraband tobacco products are legitimately manufactured by the trademark owner but are illegally smuggled into Australia.
Illicit whites are similar to contraband products but have been smuggled across borders during their transit to the Australian market and subsequently have 'limited or no legal distribution and are sold without the payment of tax'.
Origins of illicit tobacco
Domestic illicit tobacco
2.6
Some illicit tobacco is grown domestically in Australia. The ATO is 'responsible for detecting, investigating and prosecuting illicit, domestically grown or manufactured tobacco products'. As noted above, any domestically grown tobacco is by definition illicit, because the ATO has not issued any commercial tobacco production licences since 2006.
2.7
The ATO submitted that 'based on the low levels of domestic illicit tobacco seizures since 2006 [it] considers that the overall domestic production of illicit tobacco products to be small'. The table below shows a comparison of ATO seizures of domestic illicit tobacco compared to the levels of foreign-source illicit tobacco seized by the Australian Border Force (ABF). These figures suggest that, while domestic illicit tobacco production was likely a significant contributor to the illicit tobacco market in Australia (at least based on ATO seizures in 2015–16 and 2016–17); in recent years it appears to have been a relatively and increasingly small contributor to that market.
Table 2.1: Tobacco Seizures from 2007–08 to 2018–19
|
|
|
|
|
2007–08
|
9.9
|
287
|
|
2008–09
|
0
|
180
|
|
2009–10
|
5.7
|
311
|
|
2010–11
|
31
|
258
|
|
2011–12
|
26
|
177
|
|
2012–13
|
0
|
183
|
|
2013–14
|
35
|
183
|
|
2014–15
|
16
|
182
|
|
2015–16
|
132
|
147
|
|
2016–17
|
147
|
358
|
|
2017–18
|
98
|
432
|
|
2018–19
|
41
|
633
|
Source: ATO, Submission 177, p. 5.
Foreign illicit tobacco
2.8
According to the Australian Criminal Intelligence Commission (ACIC), almost all illicit tobacco entering Australia comes from Asia and the Middle East. The major source countries are: China, Indonesia, the United Arab Emirates, Malaysia, Singapore, and the Philippines. The ACIC also reported that secondary source countries—transit countries—have changed in recent years and no discernible pattern has emerged.
2.9
Mr Rohan Pike, a consultant who was formerly an employee of the ABF, reported similar source countries, and stated that the people who organise the shipments of illicit tobacco into Australia utilise established smuggling routes into the country. Mr Pike noted tobacco products that are illicit in Australia are often grown or manufactured lawfully in countries such as Indonesia, China or the United Arab Emirates. For countries such as Indonesia, tobacco forms a large portion of the economy, and he submitted that these economic imperatives can be 'more important to a country of origin than the problems they may create at the destination'.
2.10
Mr Pike further highlighted that criminal organisations leverage customs brokers and freight forwarders to help navigate and ultimately circumvent the customs formalities of shipments of illicit tobacco.
2.11
The majority of illicit tobacco enters Australia via sea cargo routes, although in recent years there has been an increase in 'undeclared small consignments through the passenger, air cargo and international mail streams'. The ABF informed the committee:
The tobacco has been coming in, really, in every single stream imaginable. We've got tobacco coming in in large quantities in sea and air cargo but also coming in with passengers through the traveller stream as well as through the international mail…if you take it back three to four years, a trend has been strong growth in illicit tobacco coming in—as I said, in pretty much every stream—from countries in South-East Asia, and parts of the Middle East as well.
International mail
2.12
The international mail system is another entry point for illicit tobacco. At the 6 December 2019 public hearing, British American Tobacco Australia (British American Tobacco) told the committee that criminals are shipping large volumes of illicit tobacco products via individual small packages through the mail, 'and we need to be faster at dealing with those.'
2.13
At the same hearing, the ABF suggested to the committee that British American Tobacco's assessment was accurate up to a time, stating 'we had a lot coming in through international mail in packages. That was small quantities but very large quantities of small quantities, which added up to quite a lot.' However, the ABF went on to state there has been a 'significant drop' in such shipments after changes to the permit system on 1 July 2019 banning tobacco from coming through the international mail system as well as improvements to detection, including 'everything from your technological x-ray type approach through to dogs and humans as well.'
Distribution and sale
2.14
According to investigations conducted by the then Department of Immigration and Border Protection (DIBP) now the Department of Home Affairs, the illicit trade in tobacco products 'follow[s] similar distribution and sales patterns as duty-paid tobacco…and is available from a number of traditional tobacconists and tobacco retailers'. These products are 'usually concealed under the counter or in a paper bag, indicating that retailers make a conscious choice to purchase and then sell illicit tobacco and that illicit tobacco smokers make a similarly conscious choice to purchase illicit tobacco'.
2.15
The Australasian Association of Convenience Stores disputes this characterisation of the illicit trade in tobacco, and claims that illicit tobacco products are usually sold in 'pop-up gift stores' and from car parks and markets, and that common offenders are standalone stores not associated with a tobacco franchise.
2.16
The Alliance of Australian Retailers' (AAR) 2015 members' survey indicated that:
…virtually all of the illicit tobacco that is being sold, if it has actually been identified, are [sic] not from newsagents or corner stores; they are actually from other channels that do not even sell tobacco in the first place. The feedback we got was that there seems to be this great understanding out there that, because of the high profitability and the very easy way of getting away with it, other stores try and cash in on this opportunity.
2.17
The issue of illicit tobacco being sold by retailers and measures to address this issue is discussed further in chapter 3.
Estimating the size
2.18
Establishing a credible estimation of the size of the illicit tobacco market has been, until recently, a contentious issue. Over the course of this inquiry the committee has received a great deal of conflicting evidence. However, this issue has been largely resolved by the ATO Tobacco tax gap estimations, discussed later in this chapter.
2.19
Previous evidence to the inquiry indicated a significant difference in the two major estimates of the scale of the illicit tobacco market that have been undertaken: one of these estimates is provided by the Australian Institute of Health and Welfare (AIHW); the other is provided by the KPMG illicit tobacco estimates commissioned by the tobacco industry.
2.20
It is important to note that the AIHW surveys track the percentage of Australians who use tobacco products, and then estimates how many of that total number of smokers may use unbranded tobacco. The AIHW does not make further inference on other impacts, such as reduced Australian Government revenue. The KPMG study of the illicit tobacco market estimates the total weight of illicit tobacco, expresses that as percentage of tobacco consumption that is illicit tobacco, and then estimates the equivalent loss to Australian Government revenue through unpaid excise. The two estimates are therefore not expressed in the same terms and cannot be directly compared, particularly as they use different methodologies to gather data.
AIHW estimates
2.21
Every three years the AIHW conducts the National Drug Strategy Household Survey. The most recent available survey data is from the survey conducted in 2016 and is the twelfth under the auspices of the National Drug Strategy. This large population survey (with data collected from almost 24 000 individuals across Australia) 'asks people about their knowledge of and attitude towards drugs and their history of alcohol and other drugs consumption'.
2.22
The AIHW's submission outlined the survey's methodology for capturing illicit tobacco use. It stated that the survey separated illicit tobacco into unbranded illicit tobacco and branded illicit tobacco. The household survey's questions focus on the appearance of tobacco products because:
…[c]onsumers may not be aware of the legality of the tobacco products they purchase; they might not know what country they come from, how they were imported or if the appropriate taxes were paid by the retailer… Tobacco products without a brand name or which do not have plain packaging with the graphic health warnings visible to the consumer can be an indicator that the product falls outside the legal supply chain.
2.23
The AIHW's submission explained one of the aims of the survey is to determine the use of unbranded illicit tobacco in Australia over time. The survey shows that while the awareness and use of unbranded tobacco has significantly dropped from 2007 to 2016, the rate of decline has slowed. See figure 2.1 below.
Figure 2.
Use of unbranded tobacco by current smokers aged 14 years or older, 2007 to 2016
2.24
A critique of the household survey in the KPMG report noted the AIHW's acknowledgement that respondents tend to underestimate their alcohol and tobacco consumption levels. The KPMG 2015 Half Year Report referenced the Profiles of Health, Australia 2011–13 – Tobacco Smoking report from the Australian Bureau of Statistics that noted '[s]ome under-reporting of persons identifying as current smokers may have occurred due to social pressures'. The KPMG report concluded that '[i]llicit tobacco consumption is therefore likely to be under-reported to an even greater degree'.
2.25
Philip Morris added that the AIHW surveyed people aged 14 and over, which would likely result in a lower average smoking rate than KMPG's survey of people 18 and over.
2.26
In comparing the contrasting results from their survey with the KPMG estimates, AIHW reasoned that the different findings were due to the 'surveys targeting very different populations, and possibly the time period when they are collecting the data [was] different as well'. Further:
…one of the critical differences is that the National Drug Strategy Household Survey focuses on trying to get evidence at a population level—that is including non-smokers as well as smokers—and we are looking at the population through households, whereas in the survey that is done for the KPMG report they are focusing on smokers, so they are targeting qualified smokers who, I would assume, are invested in their habit and perhaps have more knowledge of the market than the general population.
2.27
Overall, the AIHW said that this is not a question of whether one survey is right and the other is wrong; they are in fact 'looking at different things'.
Tobacco industry estimates
2.28
KPMG has reported on illicit tobacco use in Australia since 2009, generally annually. The KPMG reports are jointly commissioned by British American Tobacco, Imperial Tobacco Australia (Imperial Tobacco) and Philip Morris. The reports' intent is to 'provide an overview of the nature and dynamics of the legal and illicit tobacco markets in Australia; and provide an independent estimate on the size of the illicit tobacco market in Australia'. The reports provide an estimate of illicit tobacco use as a percentage of total tobacco consumption.
2.29
The KPMG methodology separates the illicit tobacco market into unbranded tobacco and illicit manufactured cigarettes (counterfeit and contraband). It then combines these figures to generate a total for illicit tobacco consumption in Australia. For the unbranded tobacco component, 'a consumption model approach is used, based on results from a consumer survey'. The consumer survey is focused on tobacco consumption behaviour of regular adult smokers (aged 18 and over).
2.30
KPMG uses an Empty Pack Survey to determine the consumption of illicit manufactured cigarettes, based on the collection of discarded cigarette packs from across Australia. Validation analyses are also conducted that include a rolling paper analysis and data on the number of seizures intercepted at Australia's ports and airports.
2.31
Throughout the course of this inquiry, tobacco companies have maintained that the KPMG reports are the most accurate estimate of the scale of the illicit tobacco market and that those estimates show the market is significantly higher than all other estimates and is growing.
2.32
Imperial Tobacco submitted in 2016 that the 'KPMG Illicit Tobacco in Australia report confirms that the illicit tobacco market has grown dramatically in this country in recent years.' However, the 2016 KPMG report showed that the market share of illicit tobacco changed less than 2 per cent overall from 2010 to 2014 (see figure 2.2 below).
2.33
British American Tobacco argued in 2017 that '[t]he risk of the further growth of the illicit tobacco market in Australia will be heightened by the annual 12.5% ad hoc excise increases for the next four years that was announced in May 2016.' As shown by figure 2.2 above, the KPMG 2019 report shows a steady increase in the illicit tobacco market for the years to 2018, with a significant increase between 2018 and 2019. The 2019 KPMG study also shows that the fall in domestic tobacco sales was offset by the estimated increase in illicit tobacco consumption, resulting in a small increase in overall tobacco consumption from 2018 to 2019.
Figure 2.
Use of illicit tobacco and equivalent excise value
2.34
Imperial Tobacco also submitted that the illicit tobacco market 'has become so lucrative that it is, to a large extent, driven by well organised and orchestrated criminal gangs – and they sell to children, as documented in the significant parallel increase of underage smoking prevalence'.
2.35
The ATO raised concerns regarding the KPMG methodology, and informed the committee the research 'might capture tobacco products that are legally brought in, in small amounts, as people come into the country, and that it might extrapolate those into being illicit tobacco.'
2.36
Appearing before the committee, Mr Joshua Fett from British American Tobacco agreed with the proposition that the KPMG studies do not show any conclusive evidence that links taxation increases on licit tobacco products with increases in the illicit tobacco market. However, Mr Fett explained that British American Tobacco consider these issues are linked based on 'observations of what's happened in the market since the introduction of plain packaging and the excise increases.' Imperial Tobacco stated there is 'good, empirical fact based evidence out there for some of the statements we are making' [in relation to linking tax increases and illicit tobacco] and agreed to provide it for the committee. To date, the committee has not received this evidence.
2.37
The ATO concluded that the KPMG surveys on the one hand, and the AIHW surveys on the other, provide the 'upper and lower bounds' of illicit tobacco use:
All methodologies that seek to quantify the unknown have elements of estimation and assumption embedded in the modelling process. This means that there are bounds of confidence in respect of every estimate and that there is no single estimation process that will provide a determinative answer…Consequently, we believe that it is not a question of whether one process is more accurate than another but rather the range of estimates derived from varying methodologies set upper and lower bounds, where we can say with confidence that the actual answer lies somewhere in that range.
2.38
Dr John Coyne, then Head of the Border Security Program at the Australian Strategic Policy Institute, submitted that while quantitative research is often contradictory, continuing debate over the exact size was unnecessary as 'there are sufficient seizures at, and inside, Australia’s borders to reveal that the illicit tobacco market is alive and profitable.' Rohan Pike Consulting similarly submitted that the 'while the various parties argue over the size of the illicit market, the problem carries on in the marketplace with no discernible change as to the availability of the product'.
2.39
Mr Rohan Pike, who established the now disbanded Tobacco Strike Team within the ABF, was critical of both the KPMG and AIHW estimates. Mr Pike advised that, in his view, both were under-estimating the illicit tobacco problem, which would inhibit effective law 'enforcement policy from being developed and implemented'. As a result, in Mr Pike's analysis, Commonwealth policies to encourage smokers to quit by increasing excise rates are undermined; organised crime groups can profit in a risk-free environment; smokers are exposed to sub-standard tobacco products; and the Commonwealth's revenue is reduced.
2.40
Mr Pike argued that the lack of a government-produced estimate of the illicit tobacco market has meant there is a 'vacuum of information that has been filled by both smoking and anti-smoking lobby groups' (although, as explained below, the government has in fact since begun producing such estimates). For this reason, Mr Pike recommended:
classifying illicit tobacco as a serious financial crime;
including illicit tobacco in the National Organised Crime Response Plan; and
having the ACIC create a reference for illicit tobacco.
ATO Tax-gap studies
2.41
A significant amount of inquiry hearing time was dedicated towards comparing the value of the estimates provided by the KPMG and AIHW studies. Additionally, the ATO informed the committee in 2016 that it was working with the Australian National University to investigate a more accurate determination of illicit tobacco use.
2.42
The ATO regularly conducts 'tax gap' studies to estimate the difference between the amount the ATO collects and what should have collected if every taxpayer was fully compliant with tax law. The ATO has subsequently released an estimate for the tobacco 'tax gap' within the Australian economy covering three financial years from 2015–16 to 2017–18. For 2017–18, the ATO estimates the net tobacco tax gap to be 5 per cent, or $647 million, well short of the $2 billion claimed by the tobacco industry above.
2.43
The ATO engages an independent expert panel to provide advice on the suitability of its gap estimates and methodologies. The ATO informed the committee:
We have passed our methodology past independent experts who have been involved in all the ATO's tax gap processes, as well as an independent expert with particular speciality in tobacco. So we have a medium level of confidence in our estimates.
2.44
The ATO submitted that the tax gap 'has trended downward from 5.5% to 5.0% from 2015–16 to 2017–18 driven by better detection and disruption of illicit tobacco both at the border and domestic cultivation'.
2.45
It can be useful to compare the above figures to the licit tobacco market. The Final Budget Outcome official figures capture the size to the Australian legal tobacco market, including the revenue captured by customs and excise duties:
2013–14 $8,498 million
2014–15 $8,848 million
2015–16 $9,816 million
2016–17 $10,453 million
2017–18 $11,879 million
2018–19 $12,130 million
2.46
The ATO has submitted it considers domestic production of illicit tobacco products to be a smaller revenue risk than illegal importation, with the latter being the major source of illicit tobacco in Australia. The ATO informed the committee that for 2017–18, it estimated that domestic production accounted for less than one third of the tax gap. Before the changes of 1 July 2019 which shifted the taxing point to the border, warehouse leakage—where items are smuggled out of warehouses before duties are paid— was the third source of illicit tobacco entering the market.
2.47
Australian Government agencies have informed the committee they support the approach of the ATO, with the ABF stating 'we are confident in the advice on the tobacco tax gap that's provided to us through the ATO'.
2.48
The Department of Health submitted in November 2019 that it:
…accepts the estimates of the tobacco tax gap, as prepared by the ATO and Home Affairs as a reliable representation of the size of the illicit tobacco market in Australia.
Committee view
2.49
It is apparent to the committee that the broad range of estimates on the use of illicit tobacco cannot be directly compared due to their different underpinning methodologies. Another fundamental difference between the AIHW and KPMG studies is the reported outcome: the AIHW study presents findings on the number of smokers using illicit tobacco, whereas the KPMG study focusses on the quantity of illicit tobacco consumed. However, combined they provide insights into the scale of the illicit tobacco market.
2.50
The committee agrees with the ATO observation—made prior to developing its own tobacco tax gap analysis —that these surveys provide an upper and lower limit of illicit tobacco use and the answer lies somewhere in between.
2.51
The committee is greatly pleased that during the course of this inquiry the ATO has commenced its tax-gap analysis of the illicit tobacco market.
2.52
The ATO estimate is likely to now be the most independent and verifiable data to estimate the size of the illicit tobacco market. The committee firmly believes that this agreed understanding of the size of the illicit tobacco market will assist all stakeholders to develop appropriate responses to this problem.
2.53
The committee recommends that the Australian Taxation Office continues with its tobacco tax gap project on a permanent basis and, where appropriate, uses all available external information to assist in developing its understanding of the scale of the illicit tobacco market in Australia.
2.54
Currently, the ACIC's Illicit Drug Data Report references amphetamines, cannabis, heroin, cocaine, clandestine drug laboratories (clan labs) and precursors and other drugs. The committee agrees with Mr Pike's recommendation for this ACIC report to also reference illicit tobacco. As demonstrated in this inquiry, organised crime groups have a vested interest in illicit tobacco, and this interest both has parallels to and intersects with their involvement in the trafficking and distribution of illicit drugs. For this reason, law enforcement agencies need to improve data collection and analysis of the illicit tobacco market.
2.55
The committee recommends that the Australian Criminal Intelligence Commission consider the inclusion of data on and analysis of illicit tobacco in future iterations of the Illicit Drug Data Report.