Trade off between keeping the flow going and revenue protection in ‘no deal’ scenario, says minister

The House of Lords External Affairs Sub- committee held the final two evidence sessions of its inquiry into Brexit and customs arrangements last week (July 19). In the first session evidence was given by Jon Thompson, Chief Executive, HMRC and Jim Harra, Deputy Chief Executive, HMRC. In the second session Financial Secretary Mel Stride and DExEU minister Robin Walker were the witnesses. The Chairman of the committee is Baroness Verma. Most of the questions related to the White Paper in which the Government outlined a facilitated customs arrangement (FCA).

In their evidence the government said –

  • The FCA can work even before a repayment mechanism is in place
  • In the event of a no-deal Brexit, HMRC would still seek to become members of the common transit convention
  • HMRC want to adopt the ‘single-window’ technology of Singapore which they consider ‘the best customs authority in the world’
  • The repayment mechanism would collect using a formula based on trade flows rather than counting up precisely amounts due on each good
  • 70 technical notes will be circulated over the summer covering issues that would arise if no deal is agreed, and a ‘trader communication plan’ will be rolled out
  • In a ‘no-deal’ scenario there may be a trade-off between ‘keeping the flow going’ and revenue protection

Session one - HMRC

Trusted traders

Lord Stirrup asked about the trusted trader scheme and the White Paper. Jon Thompson said one of the main benefits of being a trusted trader is that it lowers their risk. It also means that HMRC would notify them of a check, and indeed might visit their premises. Under the Union Customs Code (UCC) that would expand into a self‑assessment model rather than an individual transaction model. At the moment, 74 per cent of UK exports to the rest of the world, and 60 per cent of imports, are through a trusted trader scheme. HMRC want to adopt that sort of scheme for intra‑EU trade, so they would copy as much as possible of the existing scheme, which is being built under the UCC model for the end of 2020, and then HMRC will see whether they should go further than that. Harra said the FCA aims to put no new burdens on EU‑only traders. But importers in the UK who are importing goods from the rest of the world would have to operate either the UK tariff or the EU tariff, depending on where the goods are destined, so HMRC would seek to make them trusted traders so that at the outset they can identify which tariff is the correct tariff for them to account for.

Fraud

HMRC would like to negotiate with the EU a method of market surveillance that gives the EU confidence that the UK tariff, if it is lower than the EU’s, is being applied only to goods that are destined for the UK, and that the EU’s tariff is being applied to goods that are destined for the EU, said Harra.

FCA

Under the FCA, an agreement would be reached with the EU about the point at which those imports might acquire a UK origin and lose their foreign origin; for example, if they were substantially transformed through a manufacturing activity in the UK, but there would be no routine rules of origin or certification between the UK and the EU.

Lord Triesman said there is a huge amount of discussion among companies that are producing relatively high‑value manufactured goods about the capacity of people to introduce as components things that are substandard, liable to be faulty and liable to damage the reputation of the company whose label is on the outside of the goods. How will HMRC help to prevent substandard materials or counterfeited bits arriving inside completed goods, he asked. HMRC already has intellectual property checks and standard checks and there would be a common rulebook between the UK and the EU for the standards of manufactured goods and agri-foods, he was told.

Baroness Brown of Cambridge observed that, if Jaguar Land Rover is making a vehicle that might be exported to China or Germany, or might be sold in the UK, some of the gearbox components may have crossed the border between different parts of Europe several times. Will they have to take into account at each transition the potential different tariff levels because of the final destination of the vehicle, she asked. Thompson said HMRC are trying very specifically to avoid any intra‑EU customs checks. There is currently no process for parts for the gearbox that come and go from Germany to the UK multiple times and the White Paper maintains that situation. If you introduced customs declarations between the UK and the EU, HMRC’s current estimate is between £17 billion and £20 billion of administrative costs per year, he added.

Thompson told Lord Horam that FCA can work without the repayment mechanism being ready. “All of this is relevant only when there is divergence between the UK tariff and the EU tariff, and we do not know when that will happen”, he said.

‘No deal’ Brexit

In the event of a no-deal Brexit, Thompson said HMRC would still seek to become members of the common transit convention. “That could make some difference, and there are ongoing negotiations. It is not an EU mechanism.” Harra said: “Our assumption is that if no agreement is reached between the UK and the EU, in that no‑deal scenario, customs controls would operate both ways on goods moving between the UK and the EU, meaning customs declarations and the potential for checks on goods. Although the UK would wish to have facilitations in place to make that as easy as possible, such as trusted trader schemes, those would not be mutually recognised because there was no agreement. There would be unilateral facilitations that would help to some extent, but they would not be as good as mutual recognition of those facilitations, which is what you would seek to reach in an agreement.” Harra explained  the UK would have a plan in place to enable the introduction of customs controls between the UK and the EU from March 2019 if there is no deal. “There would be a functioning operating customs system between the UK and the EU, and we can put that in place. It would not be optimal from day one. We would need to make a number of improvements from March 2019 to try to reduce friction and costs in that system.”

Recruitment

Thompson explained that in leaving the EU, there will be the repatriation of various powers and policies. For example, the UK will have to make decisions about VAT policy, so HMRC will require an increase in the number of policy officials dealing with those sorts of areas. There are subsidiary issues in relation to technology and IT systems and so on, he said, that is how the tax authority ended up with the estimate of 4,000 to 5,000 additional staff needed. Currently there are 750 staff dealing with 55 million customs declarations. That will need to increase threefold, the committee was told.

Harra said there is no doubt that over time HMRC would need to rebalance the size of the workforce, but the rate of wastage, for example with retirements, means that it is not unusual for HMRC to recruit between 6,000 and 8,000 people in a year in any event. A significant amount of HMRC’s 67,000 employees are EU nationals.

Future

HMRC have a project that is looking at the best customs authority in the world, Singapore, and the adoption of the so‑called single-window technology, where everything is done electronically and you can remove the ‘wet stamp’. The long‑term aim would be to introduce something like that in the UK, he said. “Singapore has very much thought about the trader and integrated all of government around the trader.” The single-window technology would take around five years to implement in the UK.

Costs to business

HMRC’s estimate of £17 billion to £20 billion cost only arises if the UK has to introduce customs declarations for intra‑EU trade. Under the FCA, HMRC’s estimate is that the administrative burden on businesses is £700 million a year. The difference is because the FCA would affect only existing UK importers from the rest of the world who are already complying with customs arrangements and, in the case of 60 per cent of the value of that trade, are already trusted traders and have the financial securities in place. If you are doing only one or two declarations a month, it may be easier to outsource them to a customs agent and do it that way than to go down the route of the authorised economic operator scheme.

The full session can be viewed here.

Session two – ministers

FCA V ‘Max Fac’

In response to a question from the committee chairman, Financial Secretary Mel Stride said that there are two significant advantages of the FCA model over the max-fac model. “The first of those advantages are substantial cost savings in the operation of this model compared with that model. The second is that... the Northern Ireland-Ireland border issue falls away under this model.”  Robin Walker reiterated that it is the combination of the FCA and the common rulebook that allows for that. “We understand, of course, that customs arrangements in and of themselves would not resolve the issue and would not allow you to avoid barriers at the border. That is why the common rulebook is so important, covering agri-foods and industrial products, and ensuring that there are arrangements that allow for no friction.”

FCA timetable

Lord Horam queried the phrase “phased implementation” in the White Paper in relation to the FCA. Mel Stride explained that the FCA model “has various component parts, and some will be deliverable relatively quickly - for example, negotiations with the EU about how the payment mechanism works between us and the EU 27 in the operation of the model. The netting out of the various tariff collections that are occurring will by definition have to be bottomed out very early for there to be an agreement. However, other elements of the model, such as the repayment element, will take longer to deliver.”

Questioned further on how quickly the repayment mechanism could be set up, Mel Stride acknowledged that “what it looks like will depend on the negotiations. In the event that it might go beyond 1 January 2023, the end of the implementation period, we would clearly need to negotiate on it at the time. Clearly, our intention would be to have the model up and running by the end of 2022.”

The repayment mechanism

On day one after the implementation period UK tariffs would be the same as the EU’s, said Mel Stride. That may change, he said, but “to the extent that the tariffs are aligned, of course there is no need for repayment.”

Responding to a question from Baroness Brown of Cambridge about the distribution of money between the UK and the EU via the repayment mechanism. Stride said the government envisaged the actual mechanics “not so much counting up exactly what is happening at our border and what we are collecting on each good or set of goods coming through, but using a formula based on the trade flows that we know are occurring between ourselves and the EU 27 and the different tariffs that might apply to those different flows. That is how you would back into the kind of amounts that would then be transferred between us and the EU 27 or vice versa, rather than looking at the individual movements themselves.”

Additionally, using the repayment mechanism would be optional. “Clearly the business would not bother to engage with the system if the costs of administration outweighed the benefit of receiving the lower tariff,” said Stride. “In that sense, there would logically be no additional cost to the businesses that fell within the scope of that part of the arrangement.” Lord Stirrup followed that up, suggesting that if the cost of reclaiming is such that businesses do not do it, goods which importers wish to import into the UK under reduced tariffs as a result of a free trade agreement will not be cheaper in the UK, rendering the free trade agreement pointless. DExEU minister Robin Walker acknowledged this point but said that that was “exactly why we want to ensure that the repayment mechanism is designed in a way that fits the needs of business and actually engages with their key concerns.”

Point of reclaim

Robin Walker said that one of the ‘positive evolutions’ of the FCA from the earlier New Customs Partnership suggestion was that “it deals with substantial transformation of a good as well as the consumption. Instead of having to follow a good all the way through to a point of consumption, you could say that when the wheel was attached to a car it counted as the substantial transformation. If that process took place in the UK, a UK tariff would be eligible. When we have a free trade agreement with Elbonia that removes tariffs, Elbonia would be able to say that the destination of that good for substantial transformation was the UK.” Mel Stride added that this was an important point. “The point at which we would trigger the ability to reclaim a tariff difference, if there was one, would be at the earliest stage of the supply chain.”

Walker acknowledged that it would be important to reach agreement with the EU about what would constitute ‘major transformation’. That would mean having conversations about rules of origin as well. “We propose a detailed negotiation on how that arrangement will work and how it will recognise, on an agreed basis, substantial transformation, so that we can then have differential tariff collection.”

Trusted traders

Responding to Lord Stirrup, Mel Stride said that 60% of UK imports from the rest of the world, and more than 70% for exports, is covered by trusted traders, or authorised economic operators (AEOs) as they are known. “We have to end up with mutual recognition between ourselves and the EU 27 on AEOs, so it follows that the negotiation itself will determine exactly what we are putting together, which partly drives the answer to your question. We are looking closely at what the costs might entail. We are cognisant of the fact that we want to make this as simple as possible.”

Mel Stride acknowledged that there is a higher level of uptake in Germany for its equivalent to AEOs compared to the UK, but said the UK’s is a ‘very comprehensive’ scheme. “Ours may do more than others do, so what we mutually agree between us could be a simplified version of that, or it could be an expanded version. That, in turn, will determine how onerous or otherwise it is to get involved and what the costs would be.”

Stride said he did not know what proportion of the membership of trusted trader schemes is in the SME sector. “I would speculate that those companies would in the main be larger, for the obvious reason of the cost of entering into the arrangements. There are various things that you have to do to maintain your status as an AEO, including security measures at your locations in the UK for example, which would of course be a cost. These are certainly elements that we are closely looking at, among all the other things, as we look at the ideal form and shape of the AEO regime going forward.”

No-deal Brexit

Lord Dubs asked about preparations for a ‘no-deal Brexit’. Mel Stride said it was unlikely but the government were making plans and would make a statement shortly (see next article). Additionally, “[o]ver the summer, there will be some 70 technical notes covering a number of issues that would arise as a consequence of no deal. We will be rolling out a trader communication plan over the summer and beyond, to make sure for example that the 140,000 businesses that export only to the EU and do not export to the rest of the world and are therefore unfamiliar with customs arrangements are duly aware of what they will have to do in those particular circumstances. The priority will be to keep the flow moving. There is a trade-off between keeping the flow moving, raising revenues, and security. We will not compromise on security, but particularly in a place such as Dover, where you have to keep flow moving very quickly or you end up with all sorts of problems, there may be a trade-off between keeping the flow going and revenue protection.”

Stride added that there is an ‘end-state’ model with no deal, “which would be a very highly streamlined and very facilitated and efficient border. That end model could not be delivered by 29 March next year, and we recognise that. One component would be an inventory-based system at the port that allows you to match pre-declarations made en route to Calais, via vehicle number plate recognition technology, to the inventory system, which would tell you what is on the particular truck. That would help to control the whole process and keep it moving. We will not be able to deliver that by 29 March next year, but that is not the same thing as saying that we cannot deliver something that works.”

Irish backstop

Responding to Baroness Suttie Robin Walker confirmed that the government were still committed to negotiating a backstop.

Communicating with business

“We believe that there are 140,000 businesses trading only with the EU, as opposed to businesses that are also trading with the rest of the world, and that are above the VAT threshold, so are known to us,” said Mel Stride. “In the communication planning that I referred to earlier, it would be easy to interact with them, to write to them and get in touch with them. We estimate that there are a further 100,000 businesses below the £85,000 turnover threshold for VAT. It will be more difficult to get through to them and we will need a broader campaign. About 250,000 businesses are just trading with the EU 27 rather than elsewhere. As Robin says, one of the strengths of [the FCA] is that they will see no change at all; they will carry on as before.”

Forthcoming negotiations

“The October European Council meeting is looming large,” said Lord Stirrup. “Are both sides standing ready for almost nonstop negotiations between now and then?” Robin Walker confirmed that “we are prepared to move at pace on this and across a wide range of areas, and we really want to accelerate the tempo of negotiations. So far, that is what we have heard back from the Commission too.” “Action this day is the mantra of the moment,” said Stirrup. “Absolutely,” affirmed Walker.

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