Upbeat assessment of Customs’ readiness for Brexit

27 Oct 2017

HMRC Chief Executive Jon Thompson and other officials appeared before the PAC to answer questions on Customs and Brexit. Ahead of the hearing he wrote to PAC chair Meg Hillier to update her and the Committee on the delivery of the Customs Declaration Service (CDS).

Letter from Jon Thompson (HMRC) to Meg Hillier (PAC)

In his letter Thompson states that HMRC has prioritised the CDS and is on track to deliver in January 2019.

HMRC plan to build the new CDS incrementally up to August 2018, and to complete transition from the existing CHIEF system to CDS in January 2019. HMRC procured two software packages (to manage customs declarations and carry out tariff calculations) and the remaining functionality comes from re-using and/or expanding existing HMRC IT systems, and a limited amount of new development.

In the letter, Thompson is keen to say HMRC have embedded ‘strong programme management disciplines’ throughout this work, maintaining regular contact with other government departments and agencies with an interest in the border and has’ robust’ independent assurance frameworks in place with Treasury, the Infrastructure and Projects Authority and the Government Digital Service.

He said HMRC have not identified any issues to suggest that CDS will not support the volumes required after leaving the EU. “We have taken decisive action to address resourcing needs through a combination of internal recruitment and engaging contractors with the skills that we need”, he said.

The tax authority is planning a period of dual running from August 2018 to coincide with the start of the transition period, in which they will be able to split declarations between the current CHIEF and new CDS systems. Since a related NAO review, HMRC have initiated contingency work to scale CHIEF so that it can handle an increased volume of transactions beyond March 2019. Contingency plans also include provision to vary the pace and timing of the transition period between August 2018 and January 2019 if CDS technology delivery is not ready for the planned date of August 2018, or if it does not perform as expected.

HMRC are on track to move businesses across to CDS starting from August 2018, with an increase in the number of meetings with businesses and delivery partners. The migration strategy will see them migrate a small number of carefully chosen customers to CDS first, before moving on to those customers who submit high volumes of declarations. HMRC is working with the main software developers update their reference materials and develop a training program for their users.

Post Brexit may see HMRC manage up to 250 million declarations within a 12 month period with CDS able to handle 100 declarations per second.

The letter can be read here.

PAC hearing on Brexit and the Future of Customs - Wednesday 25 October

Witnesses: Kevin Franklin, CDS Programme Director, HM Revenue & Customs; Nick Lodge, Director General Transformation and CDS Programme SRO, HMRC; Jon Thompson, Permanent Secretary, HMRC.

Brexit preparation funding

Jon Thompson told the committee that, of the £250 million announced last week by the Prime Minister that can be spent ahead of any policy decisions on Brexit, but in preparedness for Brexit, £78 million will be coming to HMRC.  This money will be spent in the current financial year, mostly on policy work in four areas: “Top of that list has been customs… [Then] there is, “What impact is there on indirect tax?”; “Where are we on the welfare state?”, because, clearly, we still have tax credits and child benefit… And then there is data sharing. So those are the four big things. We have been doing a huge amount of policy work in relation to those; they are mostly where the money is going. We have recruited more than 250 additional staff to work on all of those areas and you will see some of the products from that in relation to the White Paper, for example, in relation to the Customs Bill—preparing the Bill and all that kind of work.” He said the Customs Declaration Service was not being funded from this pot of money.  Thompson added that while £78 million was enough for the current financial year they would then be asking or significantly more. “It will be several hundred million pounds, if we are implementing the option of the United Kingdom leaving the European Union, with no ongoing special relationship, in April 2019. That is the most extreme version, I think, of leaving the European Union. In that scenario, you are looking at an estimate of between £300 million and £450 million.” His estimate was that, in this ‘no-deal scenario’, between 3,000 and 5,000 additional staff would need to be recruited.

This increase in staff would be to cope with an increase in the number of customs declarations annually from about 55 million to 250 million. Thompson explained: “We apply a risking model to every customs declaration that is made, and make a decision about where we will intervene. At the moment, although we intervene on approximately half of 1% of the number of declarations made, if the volume increases from 55 million to 250 million and you keep intervening at 0.5% of those declarations, you need to significantly increase the number of staff. There are approximately 750 people working in the national customs hub in Manchester. We would need to ramp the number of people up significantly to cope with this.” The vast majority of the extra staff would be in operational delivery, either in customer services like the national customs hub, or in customer compliance.

HMRC’s prioritisation challenge

Questioned by Sir Amyas Morse of the National Audit Office on whether HMRC needed to carry out a full prioritisation exercise of all their commitments Thompson agreed they did. “If you would like to think about HMRC from my perspective, there is this huge delivery organisation, which the Committee will get into in the annual report and accounts. You have, secondly, got one of the largest organisational transformation programmes in Europe. You have, thirdly, got leaving the European Union, and you have fourthly got Treasury Ministers who continue to have fiscal events that give us new policy, and changes. So there is actually a question for us about can the organisation actually continue to do all of that; or do we not need to do a full reprioritisation for the organisation. The answer to that is yes. We are planning to do that in quarter 4, between Christmas and the end of the financial year, and give that back to Ministers, because I do not believe that it is possible to take 250 existing programmes of change and simply add Brexit on. I think you reach the point of organisational capacity and capability and you simply can’t say “I can do 250; now I can do 320; now I can do 350.” I just do not think that is credible, so we have committed to Ministers to do exactly that.”

Asked later which of HMRC’s seven major projects would have the biggest impact if it did not happen in time Thompson answered: “Making Tax Digital would have the biggest impact on the Exchequer, because clearly there are significant additional revenues from that programme.”

Customs Declaration Service and contingency planning

The Committee spent the majority of the session questioning HMRC about the progress of the Customs Declaration Service (CDS), the new system that HMRC is planning to introduce as an update from its old CHIEF system. The Committee were interested in what obstacles might prevent the system from being implemented on time and what ‘plan b’ was if this did not happen. Thompson explained that HMRC “are having ongoing conversations with the Treasury about additional funding [for] a full contingency option, which would be the CHIEF system, enhanced so that it could take all the transactions. We have done some work on that since the Report was published, and we have an estimate of how much it would cost: up to £7.9 million additional.” This would enable CHIEF to handle 250 million transactions a year instead of the current capability o f 100 million. “We have signed some contracts. We know that there are eight phases of work to scale CHIEF from where it is now to handle the 250 million. We have started the first three of those phases, and we have committed a first tranche of £630,000. That will go into a test environment in January 2018, but I run out of money at £630,000, so we are in conversation with the Treasury about needing that additional money if they want an all-up, fully operating CHIEF in case CDS does not work. It is also worth remembering that one of the reasons for replacing CHIEF is not just the capacity question but also that CHIEF is not compliant with the EU Union Customs Code, which is required of all member states.” There was further discussion on the need to be Union Customs Code compliant despite Brexit.

Thompson was questioned by Labour MP Shabana Mahmood on when the committee would need to see him next year to get a definitive answer of either “We have done some testing, and we are 100% clear that we can do this by March 2019,” or alternatively, “It’s all going to pot. We’re going to miss this deadline and the whole of Government now need to give us a shedload more money to sort this out”? “Between April and July,” was Thompson’s answer. “April 2018 is the key milestone that we have set for this to integrate with our accounting system, which is fairly vital. July 2018 is when the risking model should be up and running.” Kevin Franklin said limited testing was already being carried out. “The next big milestone for the programme will be the first piece of real testing with software developers, which happens in December. Then we will start testing some of the functionality. We have five software houses lined up to help us do that testing, including two that currently have 60% of customs declarations go through their systems to the CHIEF system. We will then have six sessions of trade test drops, as we have called them, taking us from December through to June. We will be building up functionality as we go along, which will give us a clear view of whether or not CDS is working and on track. That is why we can say that July next year is a point when we could say “Go” or “No go” on whether we should invoke the contingency that has already been mentioned—the evolution of CHIEF.”

In response to questioning from Conservative MP Geoffrey Clifton-Brown, Franklin explained that dual running of CHIEF and CDS was already in place. “[T]here will be no loss of data on CHIEF until we are satisfied that we have fully migrated all of the data and all of the customers who use this system on to CDS. It will be a phased implementation. That phased implementation actually starts in August next year. You talk about us having a contingency of January through to March, but it is not quite so stark, because we will actually start doing that phased implementation from August next year.” Thompson confirmed that HMRC was now running two operations in parallel.

Trade remedy scheme and tariffs

As part of exiting the European Union, the UK will need to develop and design its own trade remedy scheme, which will be a new source of customs and duties to collect for imports. Asked when HMRC would need to know what the trade remedies are, to implement them by March 2019, the HMRC representatives said they would need to write to the Committee. Nick Lodge said that changes to arrangements within the tariff are not that difficult to make, “[b]ut if something wholly new or different came along, clearly we would have to have a look and assess how long it would take.” Franklin explained that, in the CDS, “we have already built a tariff component. It is actually a package that we have procured from an external organisation. Content into that tariff currently comes from the European Union. When we leave the European Union, that content will have to come from elsewhere. We have the capability to receive that feed from wherever that might come from, whether from another Government Department or the World Trade Organisation—wherever it comes from, we will have the capability in CDS to receive it and to make the change to the content.”

The Committee also asked about tariff rate quotas and Thompson confirmed that both the current CHIEF and proposed CDS handle such quotas.

Engagement with business and software houses

Thompson explained that there are 64 different software houses providing a range of software to the industry, including agents, exporters and importers. “[W]e know that there is a significant amount of work to be done with the software houses.” “There are currently 141,000 traders. That will rise to approximately 273,000 traders. There is a big piece of work to be done in 2018 on business involvement, business education, what are the rules, and how does it work and so on.” The timing of this work was important, he said. “The decision has been made that the ideal window is when we have more certainty about which of the options… is likely to be the outcome. So we know that we need to engage with importers and exporters and with the software agencies and so on… We have done limited work with importers and exporters because we think the window to do that will probably be between Easter and the summer. At the minute the advice to us from various industry organisations is not to do it yet because there is not enough certainty about what to do and what the timescale is to implement it.”

Mahmood suggested there was a need to talk to smaller traders early – “people who might not account for volume in transactions but who will be filling up our postbags in our constituencies. We will be very aware of the teething troubles of this system because we will hear about it, and I guarantee it will be from smaller, less-established traders who need more assistance to get used to a system they have never used before and to complete a transaction that they probably never expected to have to complete.”

Authorised economic operators

Thompson admitted that having only about 600 of 141,000 importers and exporters signed up as authorised economic operators was surprisingly low, though he said that, in terms of volume of trade, 60% of all imports and 72% of exports currently go through the authorised economic operator scheme. Conservative MP Nigel Mills suggested that, “One of the ways we will have resilience and make our new customs arrangements work is by having lots of authorised operators who we trust, whose trucks we do not need to check and who can pay monthly.” Thompson noted that, “in one of the scenarios—the highly streamlined customs arrangement—that was set out in the Government’s paper, “Future customs arrangements” there is extensive commentary on “mutual recognition of Authorised Economic Operators” status between us and the EU in terms of a future relationship.” Thompson said that at some point HMRC would promote the status and try to sign more people up to it, but he was waiting on whether the negotiation will bring some mutual recognition between us and the EU.

Irish border

Asked by Committee chair Meg Hillier whether HMRC had modelled how this system would work with the non-physical, virtual border that is currently the Government’s proposition for Ireland, Thompson said it had. He explained that to avoid any kind of infrastructure at all, “what that requires is at least a two-tier system: one where you have the trusted trader scheme and the second where you might seek some derogations for small traders, because the border is relatively fluid. What you do not want is a plumber or a milkman to be crossing the border, doing perfectly normal trade, and having to make customs declarations as they leave and enter the European Union. We are seeking some sort of derogation for those with a turnover lower than n to be negotiated, and to maximise out the authorised economic operators scheme and mutual recognition between us and the EU, at which point you are into the trusted trader scheme, self-assessment, and so on and so forth. That is a scenario where we, the UK, would not require any physical infrastructure at the border.”

Taxation of multinationals

At the start of the session, before addressing Customs issues, the chair questioned Thompson about “a very interesting story the Financial Times carried today about the increase in your estimate of what large corporations should pay in tax. According to an FOI request, you are now suggesting that multinationals avoided paying as much as £5.8 billion in tax, which is a 50% increase on your previous estimate. Why were your estimates so badly wrong before?” Thompson explained that there had been a misunderstanding. “It is correct that the tax under consideration—if you like, the amount we are questioning and querying with multinational businesses—has doubled. To put it in a relatively straightforward way, the amount we have opened inquiries on is the £5.8 billion quoted. That has increased because we have put significant additional resource into that particular area. I think it is unfortunate that the Financial Times went with “Tax lost doubles” but, hey, that is the way they have written it.” Thompson added that HMRC had put more people onto transfer pricing arrangements and other aspects of international business because they think there are more risks in that, and so have opened more inquiries.

The chair asked Thompson if he had “a guesstimate or an estimate for how much you expect to bring in as a result of opening those inquiries? Presumably you are not opening ones that you think are going to be hopeless.” Thompson responded that: “There might be some merit in opening ones that are hopeless, on the basis that it might change somebody’s behaviour. To be frank, we do some random inquiries on taxpayers. Although our primary methodology areas are risk-based, incisive inquiries, we also do some random ones, so having a random inquiry is not completely lost.”

Amazon Data Services

The second issue addressed before discussing Customs was HMRC’s relationship with Amazon Data Services. “You have changed contracts and you are now working with an Amazon company to hold HMRC data. Can you explain why HMRC did that, and whether that flies in the face of the Government’s proposals to contract with more small and medium-sized enterprises?” was the chair’s challenge. Thompson replied that it was “not that long ago that we just had one enormous deal, if you remember rightly, for more than £700 million a year. We decided to break that deal up, insource it all and then spin some of it back out into the market. That has provided a range of market opportunities, which we think has attracted somewhere in the order of 100 different SMEs that are now working with us that would not have before because we were working through that enormous deal.” However, “the market has moved on for very large businesses, and we are a very large business, into what’s called hyperscale cloud. So you’re not just dealing in a cloud environment; you’re dealing with enormous businesses holding significant data. We need resilience in data centres and we need someone who can hold all that data for us.” There are two such companies, “and the price reduction on this particular one [Amazon] was more than 50% for us, so there is a clear value-for-money case for us moving down this route of scaling up the way in which data is held. We then come out of the data centre business, so we do not have physical buildings ourselves. We get much more resilience, because data can be held in multiple sites, so that if one of them goes down we do not lose the data and we do not lose services to customers.”

Given that Amazon is an American company, Thompson was asked, “where is the data held and is any of it under US jurisdiction?” He replied that: “It is held in the UK and the answer to your second question is none”.

The full Hansard report of the hearing can be read here.