BRAY, Mr Michael, Head of Litigation and Regulation, British American Tobacco Australia

GREGSON, Mr Andrew, Head of Corporate and Legal Affairs Australasia, Imperial Tobacco Australia

ELLIOTT, Ms Rachel, Government and Stakeholder Relations Manager, Imperial Tobacco Australia

DICKSON, Mr Gary, Legal and Regulatory Compliance Manager, Imperial Tobacco Australia

KEULEMANS, Mr James Gerrard, Head of Government Affairs, British American Tobacco Australia

POWELL, Mr Mark, Manager Public Policy, Philip Morris Limited

RUSH, Mr Steve, Director of Finance, Australasia, British American Tobacco Australia

Committee met at 09:02

CHAIR ( Mr Craig Kelly ): I declare open this hearing of the Parliamentary Joint Committee on Law Enforcement. I welcome everyone here today. This is a public hearing and a Hansard transcript of the proceedings is being made. The hearing is also being broadcast by the Australian Parliament House website.

Before the committee starts taking evidence I remind all witnesses that in giving evidence to the committee they are protected by parliamentary privilege. It is unlawful for anyone to threaten or disadvantage a witness on account of evidence given to a committee, and such action may be treated by the Senate as a contempt. It is also a contempt to give false or misleading evidence to the committee. The committee generally prefers evidence to be given in public but, under the Senate's resolutions, witnesses have the right to request to be heard in a private session. If a witness objects to answering a question, the witness should state the grounds upon which the objection is taken and the committee will determine whether it will insist on an answer having regard the grounds which are claimed. If the committee determines to insist on an answer, a witness may request that the answer be given in camera. Such a request may also be made at any other time.

Welcome. I invite you to make a brief opening statement. The committee will then ask questions. Who would like to start?

Mr Gregson : I will. Thank you for the opportunity to provide evidence today and, importantly, to answer any questions that you may have. Both of my colleagues and I have significant expertise in dealing with the illicit tobacco trade. The fact that this committee is inquiring into illicit tobacco in Australia is an enormous step forward in combating the issue. Imperial Tobacco is, frankly, perplexed that recognising the problem of illicit tobacco in Australia remains difficult for some.

Allow me to give you some perspective on the size of the problem that we collectively face. Before you today are the three largest operators in the tobacco industry in this county. The fourth largest provider of tobacco is illicit. You have been presented with evidence in submissions that the illicit trade represents some 14.3 per cent of total consumption in this country. That is close to the same market share that Imperial Tobacco had when we entered the Australian market in 1999. It is a phenomenally large number. It represents around one in every seven cigarettes consumed in this country. It represents about $1.42 billion in lost excise revenue to the federal government at a time when the federal government could probably do with some extra cash.

Those numbers come from KPMG's Illicit tobacco in Australia report. I have no doubt that you will be hearing a bit about that report today from various parties, so let me address immediately a few issues concerning the report. Yes, that report is funded by Imperial Tobacco and our competitors here today. Some high-profile anti-tobacco activists claim that our funding the report means that we determine its contents. Such a claim is not only spurious and a slight on such a well-credentialled entity as KPMG but a slap in the face to the federal government, which in the last financial year alone commissioned over $103 million of advice from the same organisation. There is no wholesale rejection of the advice provided by KPMG to the federal government; why it should be otherwise in respect of the Illicit tobacco in Australia report escapes us entirely.

Moreover, the Organisation for Economic Co-operation and Development says that the methodology that KPMG use is 'the most authoritative assessment of the level of counterfeit and contraband cigarettes'. I do note that this phrase is used in association with their European work. Yes, there are some challenges within the methodology of the report, as there are with any such project. To reject the report based on those challenges merely reveals, in our opinion, an inherent bias on behalf of the commentator. Even if the methodology of the report leaves you feeling uncomfortable with respect to the absolute volume of illicit trade in Australia, we encourage you to consider the trend evidenced by multiple reports over a sustained period. The report indicates an upward trend which in itself is cause for alarm.

Ignoring illicit tobacco, and encouraging others to do so, sits largely within the realm of anti-tobacco activists. We understand that some people oppose our industry and we accept their right to hold that position. We do not, however, accept their logic that illicit tobacco does not exist when clear evidence exists to show that it does. A head-in-the-sand approach to this problem merely serves to encourage the organised crime gangs that federal agencies acknowledge are the primary perpetrators.

In our submission we state that the most significant action that this inquiry can take is to report that illicit tobacco exists in Australia, that it is a growing problem and that further action needs to be taken by the federal government to combat this major scourge.

Again, thank you for your interest. We look forward to assisting you with the inquiry and to candidly answering any questions, howsoever detailed, that you might have.

Mr Powell : On behalf of Philip Morris, I would also like to thank the committee for your invitation to share our views with respect to the illicit tobacco trade in Australia, an important and underattended public policy issue. Philip Morris is the leading international company involved in the legal tobacco industry. We support comprehensive regulation and effective taxation.

Like the government and our retail partners, we have a direct, legitimate interest in opposing the illicit, illegal trade in tobacco products. As with other industries, the illicit trade exposes consumers to substandard products which do not comply with regulations, rob government and taxpayers of needed tax revenues, take business away from legitimate retailers and help fund criminal organisations, many of which use the illicit tobacco proceeds to support other criminal activities.

This is an illegal business run by criminals, but it operates in the communities which each of you represent. Over the last couple of years we have briefed members and senators at the federal and state levels about this issue, providing example after example of illicit trade in local communities. In one location we found eight stores selling illicit tobacco within 500 metres of the member's electorate office.

Taxation and regulation play an important role as part of the broader public health policy to reduce smoking rates. However, when taken to an extreme, regulation and taxation of the legal market makes the unregulated and untaxed market more attractive for criminals. The tax office, Border Force, the National Tobacco Strategy and even the Henry tax review have all recognised the incentives for illicit trade and the need to guard against it, with the Cancer Council Australia and the National Heart Foundation noting that further regulation should be implemented 'following adequate investment in the control of illicit tobacco trade…'

There is a saying that if you cannot measure something you cannot manage it. Accurately measuring the trends of illicit trade is the fundamental first step to being able to understand and combat the problem. The ATO has attempted to measure the illicit trade in the past—and at the time they found it to be substantial—but quantifying an illegal, dark market is not an easy thing to do. I understand that the tax office and the Border Force are each working very hard on this very issue. For our part, to fill this void, Philip Morris and our partners have commissioned the KPMG report to measure the illicit trade and identify the trends over time to inform both policy and enforcement priorities. I understand that KPMG will appear later, so I merely note that, like democracy, their report may not be perfect, but it is better than anything else that is out there. In fact, the methodology was originally developed by KPMG for the European Union working in partnership with the tobacco industry to address Europe's serious illicit trade problem.

The committee, the parliament and, ultimately, the government now have an opportunity to act in the national interest to address the illicit trade, including officially measuring and monitoring the size, nature and trends of the illicit trade; carefully considering future policy measures to ensure they not only reduce the harm of smoking but also that those policies are designed to minimise the illicit trade impact and drivers; ensuring active enforcement and close cooperation between federal agencies, their state colleagues and the tobacco industry; introducing tough deterrent penalties and addressing gaps and inconsistencies in the law that currently prevent effective enforcement; and enabling and adopting the latest technology, including tracking and tracing, product authentication and digital tax verification solutions, although I note that these are currently banned by the plain-packaging regulations.

We have recently seen some success, with major operations by multiple agencies, by the joint waterfront task forces as well as by the Australian Border Force. I would particularly like to express our gratitude to the Minister for Immigration and Border Protection, the Hon. Peter Dutton, and the commissioner for the Australian Border Force, Roman Quaedvlieg, for their recognition of illicit trade as a top government priority needing to be dealt with and, as a result, the creation of the Border Force's dedicated tobacco strike team, which has already had incredible success.

Fighting illicit trade remains a top priority for Philip Morris, and we continue to invest significant resources to ensure strong controls in our supply chain, raise awareness and support law enforcement, all to ensure that our products, consumers and the community are protected. Our significant experience, sincere commitment and global understanding are offered to the committee by way of the observations and recommendations made in our formal written submission. Thank you very much for the opportunity to appear today and to share our views.

Mr Rush : Good morning Mr Chairman and members of the committee, and thank you for allowing us to present to this inquiry today. The aim of our presentation will be to help you understand the size of the illicit problem in Australia and what has driven it to its record high levels and, more importantly, to present recommendations on what we think you can do to make significant inroads into this black market. As we have heard, according to the KPMG report, 14.3 per cent of tobacco consumed in this market is illegal. That represents approximately $1.4 billion that the government and the taxpayers lose in revenue each year, and that money goes to organised crime who smuggle product with an estimated street value of $2 billion across the border.

The Australian Crime Commission reports that the illicit trade in tobacco is embedded together with organised crime and that crime groups see the smuggling of tobacco and 'chop chop' as a low risk, high return activity, which they use to fund other forms of crime.

I am sure I speak on behalf of my colleagues, here, today when I say that we welcomed the formation of the Australian Border Force tobacco strike team last year. The formation of this team alone signifies that the government sees this as a serious problem. This was confirmed with the significant seizures that the task force has managed to achieve, early on, since it was set up. But this is a large and growing problem that must be dealt with and a lot more needs to be done.

I would like to make five recommendations to the committee on steps we believe the government could take that would make a significant difference in this area. The first is to change from the large ad hoc tax excise increases that we see to a more measured approach. We accept excise but large disproportionate increases are fuelling the black market. Secondly, we believe that the Australian Border Force tobacco strike team need more resources so that they can achieve more seizures. Thirdly, we would like to see enforcement of the Plain Packaging Act moved to the police or the Australian Border Force so that we can see real enforcement at retail level. Fourthly, we would like to see minimum sentences for those caught smuggling tobacco so that we actually have a real deterrent in this area. Finally, we would like the courts to have the option to impose both jail sentences and fines for those convicted under the Excise Act. I will briefly touch on each one of those.

We currently have disproportionately large excise increases and the fourth of those is due to happen this year. We would strongly recommend that the government does not continue with this high level of increase while we have such a large problem. Excise in Australia has increased by 100 per cent since 2010 and Australia is now the most expensive market in the world to buy cigarettes. A packet of cigarettes can be bought for 50c in source markets and smuggled into Australia and sold for around $12. That is around half the average pack price of legal products sold in this market. You can see the significant financial incentive that organised crime has to bring product into this country. By increasing excise disproportionately further than this, when we are already the most expensive market in the world for cigarettes, does not help address the problem but will only fuel it further. Secondly, greater funding for the Australian Border Force tobacco strike team ensures that we can build on the great work that they have already achieved and see greater seizures.

Our final three recommendations relate to amendments to the Commonwealth legislation. The first of those is around plain-pack enforcement. The easiest way to identify illegal product in this market is its noncompliance with the plain-packaging legislation. The enforcement of plain packaging resides solely with the Department of Health, which is, in essence, not an enforcement body. As a result we have seen no retail enforcement of plain packaging since the act was passed and implemented three years ago. The government needs to pass the enforcement of plain packaging to an enforcement body, such as the police or the Australian Border Force, so that we can effectively disrupt the black market supply chain at retail level. A large fine at retail level will discourage other retailers from doing the same behaviour.

Our fourth recommendation is for minimum sentencing for those charged with smuggling tobacco. We need a deterrent so this is not seen as a low-risk high-profit activity. We need to see minimum sentencing in both the Excise Act and the Customs Act. We would like to see clauses from the Customs Act replicated into the Excise Act to allow the courts to hand down both jail sentences and fines as opposed to the current situation. We currently have very few people charged and most of those charged will walk from the courts with only a fine.

This problem is very large and it is getting bigger. The bigger it gets the harder it is to stop. Many markets in Europe and Asia are seeing illicit trade at 20 per cent and, in some cases, 30 per cent of consumption. We certainly do not want to get to those levels here in Australia, so the time to act is now.

Thank you and we are happy to answer any questions that you have.

CHAIR: Thank you. If I could just start with the British American tobacco submission, there is a graph on, I think, page 17, figure 4, the global price of one packet of Marlboro cigarettes. Firstly, my understanding is that there is no more cigarette manufacturing in Australia.

Mr Rush : That is correct.

CHAIR: And the reason for that is not the fact that it is uncompetitive to manufacture here in Australia; it was more a legislative change.

Mr Rush : No, the decision was made to cease manufacturing by all manufacturers based on the decreasing size of the market and the efficiencies of production.

CHAIR: Singapore, Canada, France, Hong Kong and Germany—would each of those countries have their own cigarette manufacturing industry?

Mr Rush : A number of those countries do still manufacture and a number of them are solely import markets.

CHAIR: Do you need certain economies of scale to produce cigarettes efficiently?

Mr Rush : You do. You certainly benefit greatly from economies of scale in this industry.

CHAIR: With the illegal cigarettes that are being imported into Australia, what size of factory do you see them being made in? Are they being made by little backdoor operators or are they coming from a mainstream factory?

Mr Rush : I think they are being made in a variety of different sized factories. Most of the product is sourced from the Middle East, China and other parts of Asia and it is made in varying degrees. Most of it is purpose produced for import into Australia.

CHAIR: In a place like China, what would your market share be there?

Mr Rush : China is a controlled tobacco market, so all the international players are only given a small quota. I think the market is around 2½ trillion sticks and we are given about two billion. We do not have a large share of that market.

CHAIR: Do you have any idea of how many other factories would be manufacturing cigarettes in China?

Mr Rush : I can tell you that China had just under 200 factories and they went through a consolidation for economies of scale themselves and reduced that to about 80 factories. That actually created a lot of surplus manufacturing equipment, which we do know found its way to other markets and is used to produce illegal cigarettes.

CHAIR: Are you aware whether there is a black market for cigarettes in China itself?

Mr Rush : The Chinese government does not report having a black market for cigarettes and we do not have much information on that market.

CHAIR: With regard to the price differentials on that graph, are those price differentials between countries all excise duty and taxes? I imagine there would be a higher distribution cost and a higher retail cost here than in other countries.

Mr Rush : Each of those markets will have different levels of excise and have different distribution models that they follow, and some of them, as you said, manufacture and some do not. I think the comparison is that we have the largest levels of excise and that has driven our prices higher. It is that excise amount that provides the opportunity for organised crime, which is why much of it is driven into Australia from halfway around the world.

CHAIR: So the base cost in all of those markets of, say, a manufacturing price, or a landed price, or a wholesale price would be fairly equivalent; is that a fair assumption?

Mr Rush : It would be reasonably similar, yes.

Mr HAYES: I think ever since Mark first approached me, some 12 months ago, I was able to identify within about a kilometre of my office various outlets for chop-chop. It seemed to me that the tobacco companies had reasonable intelligence of where illicit cigarettes were being sold. I was very interested in what you were saying, Steve: that one of the options is to lay the prosecutions on the retailer.

Mr Rush : I do not think it is only at the retail level but I think the fact that there has been no enforcement at retail makes it very difficult to stop the distribution.

Mr HAYES: I am not aware of any effort being made by any of the cigarette companies with any of our law enforcement agencies to look at the retailing of illicit cigarettes. Is that right?

Mr Rush : We do provide a lot of information to our law enforcement agencies. We work very closely with them providing intelligence to try and address the problem. But most of those law enforcement agencies are not able to enforce at retail level.

Mr Powell : Can I also just say, on that point, that Philip Morris has reported hundreds of cases in Victoria, New South Wales and elsewhere to state enforcement bodies. That is usually the department of health, which is officially responsible for this, particularly at the state level, and it is the policy—

Mr HAYES: As was pointed out, they are not a law enforcement agency.

Mr Powell : They are provided with specific powers in almost every state—I cannot think of one that is not—to regulate the retail sale of tobacco products. Often we do not even receive a response to those and there is no indication that there is any investigation.

Mr Dickson : Imperial has been involved in doing investigations since about 2012 at a low retail level. We have worked very closely with local police forces. We regularly take briefs of evidence to the various police forces. In New South Wales in particular, we have worked very closely with the New South Wales property crime squad. They have adopted a model, given that there are resource constraints or impacts, whereby they rotate the problem, if you like, through various local area commands so that the manpower impact is not significant. As a result of that, we have done around 30 to 40 retail raids, and about half of those are still going through the court process at the moment.

Mr HAYES: Looking at the material that Mr Powell presented me with some time ago, I know that areas where there was suspected retailing of illicit cigarettes were very much in particular clusters. It was not widespread across New South Wales but very much cluster based, particularly in Western Sydney and areas like that. I do not know of any strike force of the New South Wales police operating in those areas at the moment.

Mr Dickson : There have been raids more recently. I think last year there were raids in Hurstville, Campsie and Liverpool, and, prior to that, in Fairfield and Bankstown. There have been a number of activities and they are coordinated by the New South Wales property crime squad working with the various local area commands.

Mr HAYES: Do you think one thing that we should be looking at across the board is making prosecutions more directed to retailers of cigarettes as being the end user before they are sold to the community?

Mr Powell : There is definitely a community impact of the illicit trade, in some cases completely negating public health policy in those areas. Also, from a Commonwealth perspective, the principle is that tobacco is an inelastic product and, therefore, tax can be applied because there are no substitutes. Looked at in a perhaps more realistic economic sense, tax-paid tobacco or legal tobacco does have an alternative and a substitute, and that is illicit tobacco. The challenge is that its very wide availability means that it is a very practical—in fact, sometimes easier—alternative for people to consume. So there is a local policing imperative from the community perspective, but I would also suggest that, from a Commonwealth revenue perspective, the fact that it is so readily available means that it undermines the tax and revenue policies that are put in place. The Commonwealth, which might traditionally go for the large organised crime groups alone, would also have a direct interest in curtailing that retail trade because of the tax impacts alone.

Mr HAYES: Absolutely; it is money that is not coming into the Commonwealth coffers—there is no question about that. One thing you raised when you spoke to me was the issue of the unregulated nature of chop-chop and the health effects that that could have on the community.

Mr Powell : Absolutely. Some time ago, the Department of Health did some work—it is referred to in our submission—where they identified a whole range of challenges that concern them over and above the known harms of tobacco.

Mr HAYES: If the retailer was retailing things under the counter other than just cigarettes and other illicit drugs, you would expect the retailer to be culpable and be prosecuted under criminal law. So wouldn't your consistent submission be now that a large focus of the inquiry should be on the retailers and making it more viable for the law enforcement agencies to prosecute them?

Mr Powell : I can only speak for Philip Morris, but I suspect it is true across all our organisations. When we enter into trading terms with tobacco retailers, they are required to sign up to terms essentially agreeing not to be involved in any law-breaking, sale to minors or other illicit trade, and, in our case, it is fairly rigorously enforced. If we can find out that someone has been involved, we will cease doing business with them completely, and we have done so repeatedly for people convicted or even where we are comfortable that there is a good case that they have been involved in illicit trade. So I do not think the exclusive focus should be on retail. Clearly, it is easiest to be stopped at the border, but, inevitably, as with any smuggled product, there is still plenty coming through to the community. It is not really one or the other; I would suggest that what we need to do is continue and increase the great work that is being done at a federal level, especially by the Border Force, and also add to that effective retail enforcement. There are significant powers already there; for example, the Department of Health is mentioned. They are just not used at present.

Mr Gregson : The key to tackling illicit tobacco is right through the supply chain. So, yes, you are exactly right: the retail end of the supply chain needs to be tackled. An opportunity in existing legislation exists to do that. The top end of the supply chain of import into the country needs to be further tackled, and Border Force are already doing a great job but could do with more resources. In the middle of that supply chain—remembering that not all illicit tobacco is imported in the form of manufactured cigarettes—loose tobacco, or chop-chop, constitutes somewhere around half the total volume of tobacco. Some of it is imported but some of it is grown locally. Disrupting the supply chain from end to end is the only way to effectively deal with the problem.

Mr HAYES: Yes, I can see that. In terms of importing illicit tobacco, as opposed to many other illicit substances that can be put into a duffel bag and stuffed somewhere in an obscure part of a container, you are talking about container loads. I think where Steve was coming from is that more support for Border Force is needed in terms of detecting that.

One of the things we are constantly being told by the Australian Crime Commissioner in terms of importation of other illicit substances is that the ratio for profitability is one successful importation of a drug out of 10 importations. You can lose the other nine. What would the ratio be for cigarettes in terms of the illicit value?

Mr Dickson : I believe the ratio is: if you send three containers and get one across, you have done your job.

Mr Rush : I think it is even more than that, depending on where you sourced it. Certainly, for a product coming from the Middle East, you only need to get through one in 20 to turn a profit.

Mr HAYES: Okay.

Mr Powell : About a year ago, we did have a discussion with the Australian Institute of Criminology, briefing them about this issue, and based on the sorts of numbers we were sharing with them—admittedly, this was an off-the-cuff comment; it was not the result of detailed work—they suggested the profitability equated to that of those who imported precursor chemicals and major importers of illicit drugs. The profit was the same.

Mr Keulemans : The point to make there is, as Steve mentioned, the risk-reward ratio. The reward is very high and the risk is very low because they know that, if they are caught, it is very unlikely they will serve jail time and they may get a fine. Again we come back to that point that there are some very practical legislative amendments the Commonwealth could make that would send a very strong deterrent signal.

Mr HAYES: I accept that and I understand the Commonwealth has a certain amount of buy-in on this because there is a lot of lost revenue. Similarly, for the legitimate tobacco companies, there is a lot of risk for them in terms of their market being cut. Would the tobacco companies be looking at also making significant contributions to Border Force for greater targeting of cigarette interdiction?

Mr Rush : We certainly do cooperate very heavily with all the enforcement agencies. If we look at the contribution from the members at this table, we pay close to $9 billion in excise, and I believe some of that should be used to improve the detection, collection and punishment of those following the illegal tobacco market.

Mr HAYES: Thank you.

Senator LEYONHJELM: Thank you, gentlemen. There are a couple of lines of questioning I want to pursue. One is that, in the Philip Morris submission, there is a reference to the WHO statement that 11 per cent of the world's tobacco market is illegal. Can you explain to the committee where that number comes from and what it is based on?

Mr Powell : I do not have the exact reference in front of me; it is referenced in the submission itself. The World Health Organisation has identified illicit tobacco as one of the major challenges as part of its work in relation to reducing the harms of tobacco use. It is a very significant problem globally. Last year, the World Health Organisation dedicated its World No Tobacco Day entirely to the issue of combating illicit trade. There was quite a significant amount of activity by public health authorities around the world in relation to addressing illicit tobacco.

Unfortunately we did not see much of that, at least here in Australia. However, it is a top priority. so much so that the WHO has encouraged the creation of what is called the Protocol to Eliminate Illicit Trade in Tobacco Products, or the illicit trade protocol, as it is commonly known. That is a public treaty that is yet to take effect. It is open for signature. It was finalised in, I think, 2012. The Australian Department of Health has been reviewing this prospective treaty after advocating for it ever since then—so for a number of years. I do not know what the status of the consideration of that issue is, but clearly this is a top priority for the World Health Organization and for countries globally, so much so that it is now the topic of a dedicated treaty to try to enshrine principles around dealing with the illicit tobacco trade.

Senator LEYONHJELM: If illegal tobacco globally is 11 per cent, you would expect that there would be countries with high illegal percentages of the market and countries with low percentages of the market. Have you looked at that and drawn any conclusions as to what the underlying factors might be? How do those with a low illicit market differ from those with a high illicit market?

Mr Powell : I think, like in any market, it is a case of supply and demand. The demand is always there for products at a price that a consumer wants to pay, and untaxed products—smuggled products—tend to be a lot cheaper and therefore more affordable for those consumers. That factor probably does not differ around the world. There is a set demand for tobacco based on levels of consumption, interest and so on. I think the supply factors are fairly significant, though, country to country. The level of taxation is clearly a very significant element. You will rarely find countries like Indonesia or even Japan, which have quite low tax rates, having a significant illicit trade problem. In fact, as far as I am aware there is almost no illicit trade in those countries, for example. Typically what you find is that there are also porous borders in developing countries, so they may have a relatively higher level of illicit trade. In Australia, as a country with fairly good law enforcement, low levels of corruption and being an island, we are very fortunate with respect to smuggling—it is quite will controlled. Against that there is a factor driving up the incredible profits to be made by criminals in smuggling to Australia because of excise tax rates. I think trading off across those factors is what causes our problem.

Senator LEYONHJELM: I think the BAT submission has some quite interesting information on the international experience in other countries. I am wondering, whether BAT or anybody else has looked at countries that have raised taxes, and then looked at the effect on illicit market. Or have there been any countries—probably unlikely—that have lowered taxes on cigarettes? And has there been any effect on the illicit market?

Mr Rush : Yes, I would agree with Mark's comment that, essentially, most of it is economics driven. So if you have a neighbouring country with lower—

Senator LEYONHJELM: That includes taxes, though.

Mr Rush : Yes, absolutely. Most countries with high levels of illicit—in the 30 per cent range—have that product come straight across a land border. Australia has had relatively low levels of illicit up until five or six years ago, because it was more difficult to bring product here and they could take product elsewhere. In terms of countries that have decreased, the only one I know was Brunei. Brunei massively increased their excise and their market went from about two per cent illicit to over 90 per cent illicit within about three months. They then reduced the excise by almost half, and the illicit market has remained. Once the distribution network has been established, it is very hard to reduce.

Senator LEYONHJELM: Also, in the Imperial Tobacco submission you have drawn a reference, without very much detail, to cigarettes and terrorism. I am just wondering what you can tell us about that: 'specific links between cigarette smuggling and international terrorist organisations such as the IRA, PKK, Hezbollah and al-Qaeda'. What is the source of that? Can you give us some more detail?

Mr Gregson : It is my understanding that a number of international organisations, including the World Health Organization, have drawn that link. If you would like specific data on where those links are drawn, we are happy to take that on notice.

Senator LEYONHJELM: Yes, please. I think I will have that one on notice, if you don't mind. There is another reference in the Imperial Tobacco submission relating to a 'NERA review'. I wonder if you could explain to the committee a bit more about what that involves and what you anticipate will come from it.

Mr Dickson : For some time we have been involved with KPMG, as you are aware. Effectively that report was about measuring the problem and the scope and size of the problem. We are looking to evolve our analysis of the illicit market. In doing that, we want to take more of an economic approach or an economic view. It is about taking the conversation to the next step and talking about how to go about addressing the problem. We are all involved in that. It is currently about to be started and will be available in around about May or June.

Senator LEYONHJELM: So it is not looking at the methodology—

Mr Dickson : It will obviously consider the scale and size but it will look at the problem more from an economic perspective than anything else. So it is not a measurement report, like the KPMG report. The idea is to define solutions to the problem. We will also be engaging with a reasonable number of stakeholders to do that.

Senator LEYONHJELM: All three of you have—how can I put this delicately?—taken a very prohibitionist approach, if you like, to solutions. There is mandatory sentencing, which is highly controversial in any arena, let alone this. There would be serious opposition to that. There is law enforcement generally and changes to the law. Some of you have made specific recommendations in relation to the law and beefing up law enforcement. The history of law enforcement in relation to illicit products on which there are high margins is not all that happy. We have any amount of illegal substances available that are totally prohibited and with law enforcement very well resourced and no equivocation such as you highlighted in your submissions. Why is it that all three of you have taken such a law enforcement based, prohibitionist approach in your recommendations?

Mr Rush : Our issue is the risk-return, as we said. If people are convicted of other crimes, particularly drug offences, there are significant penalties. That does not exist—

Senator LEYONHJELM: There are still a lot of drugs around, though.

Mr Rush : There are, but those penalties do not exist with tobacco. The Australian Crime Commission itself says that it is considered—

Senator LEYONHJELM: Einstein would suggest, if you keep doing the same thing expecting a different outcome, that is the definition of insanity.

Mr Rush : I agree, but if you have multiple options to choose from in terms of what you smuggle and traffic through the borders, and one has significantly lower penalties, in practice, that is the one that you will focus on most. That is the Australian Crime Commission's view as well.

Senator LEYONHJELM: I see. We should make tobacco less attractive so they go back to smuggling drugs, so to speak.

Mr Gregson : I think, if I may, that it is really a question of fairness of competition. As I said in our opening statement, illicit tobacco is the fourth major player in the Australian tobacco market.

Senator LEYONHJELM: I understand your priorities, yes.

Mr Gregson : Of course. I suppose I look at it this way. There is a choice to level the competitive playing field. Either we are allowed to compete on the same terms as illicit or they are forced to compete on the same terms as us. Practically speaking, it is highly unlikely that the plethora of regulation with which we comply is going to be dropped. As a result, enforcement against illicit tobacco is the answer that we are left with to ensure a competitive market.

Mr Keulemans : To add to that, I agree it is not that we want to come to this committee with solutions that are prohibitionist. It is the reality of the situation we find ourselves in.

In other words, because we have the highest tobacco prices in the world, the reality is: this is the only way that we can level the playing field.

Mr Powell : Can I just make one additional comment in relation to that. In the Philip Morris submission, we dedicate some time to talking about, essentially, prevention of the creation of drivers for illicit trade. I mentioned that in my statement earlier. That is not simply a case of never changing the excise tax rate or anything like that. At the moment, because there seems to be denial amongst some of the people responsible for dealing with tobacco as a policy, we are in a position where regulations are driven without any consideration for what their impact will be in the real world. We have a system of regulatory impact statements, for example, at the Commonwealth level in Australia. While they have their pluses and minuses, and sometimes they are done better than other times, you will almost never see any real consideration of an externality—which, in an economics sense, is what this illicit trade is—as to what will actually happen. It is usually just denied altogether. I have seen one regulatory impact statement which, after some small discussion of the KPMG report and illicit trade, quoted the former minister as saying it was not an issue, and then that was the end of the analysis as to what the impact would be.

While we are in a position where some of those who are driving regulation or taxation of tobacco do not take it into account, I think we will inevitably be in a position where illicit tobacco continues to be driven upwards because it is not taken into account in terms of responses, law enforcement or any other aspect at the time those regulations are created.

Senator LEYONHJELM: There are two other things I am going to pursue, because we are running over time a little. The first is: to what extent do you think there is a solution—and one of you referred to it in your submission—in the greater availability of e-cigarettes? Do you think that it could become part of an illicit trade? Or do you think that it is an alternative to, basically, diverting smokers to something that is regulated, taxed, controlled and away from illicit tobacco? I guess what I am asking is: what impact would e-cigarettes have on the illicit market?

Mr Rush : I think if we did have a regulated e-cigarette market then consumers would have another alternative—which we discussed before. But, in reality, e-cigarettes would not reduce the massive profitability that would still exist in the market. Just on an earlier point, if we do not look at jail time, which may sound very extreme, then to the point of only needing to get one in 10 or one in 20 through, if you merely impose a fine then that is just an accepted risk. I think we need to do things differently.

Senator LEYONHJELM: Yes, I understand.

Mr Keulemans : As an aside, it is absurd that in a market like Australia smokers cannot access harm-reduced alternatives. Irrespective of the fact it will not have any impact necessarily on illicit—it is a separate issue—there needs to be regulation around e-cigarettes for them to be made available.

Senator LEYONHJELM: I have a final point—just to try to get us back on time. We keep hearing from the Department of Health—and the Department of Health gets quoted by others, including in some of the submissions here. One of the law enforcement agencies has said the best estimates is three per cent. We will be asking them later on today why that is the best estimate. I do not want to get into methodology because we are going to ask them about their methodology—and will have an opportunity to look at KPMG, as well. What is the motivation, if you like, for insisting that the illicit market is three per cent when it is at least an arguable case that it is substantially greater than that? You are protected by privilege here, so say what you want!

Mr Powell : It is an excellent question. I have also looked at some of the other submissions that refer to the Australian Institute of Health and Welfare National Drug Strategy Household Survey done every three years. The figure quoted, I think, is 3.6 per cent. That is the percentage of smokers in that survey who acknowledge consuming chop-chop tobacco. Another question in that same survey asks people about the consumption of branded tobacco, which, for the last number of years, would essentially be almost always illegal in Australia. There is actually 18½ per cent of seam-branded tobacco. And, I think, around five per cent of smokers advise in that survey they consumed at least 15 packets or more in the last three months. That would suggest that these people are almost effectively daily consumers. For some reason, in that same survey, which presents a proxy figure if you like of an additional five per cent of people who seem to be illicit tobacco consumers, it is never mentioned, not even by the agencies who collect that data. I really cannot answer why you would ignore those numbers.

Senator LEYONHJELM: We seem to have, on the one hand, you folk and the KPMG study saying that the illicit market is 14 per cent of the total tobacco market in Australia and the revenue loss is $1.4 billion or something like that. On the other hand, we have the Department of Health and people associated with the department almost saying: 'Nothing to see here. It's really not that big, and we are not concerned about it. Yes, there is a bit there and, yes, Border Force should do something about it. But, really, it is seriously overstated.' I cannot for the life of me work out why it is in the interests of the Department of Health to pursue that argument when at least it is arguable that they are wrong. Can you think of any motivation for it?

Mr Gregson : Senator, if I may, it is conjecture—and thank you for the opportunity to leap to the defence of the Department of Health. We as an industry exist to sell a legal product in a commercial environment. As a result, when we make commentary on some of the externalities that face our industry, we are accused of bias, and in fact we are accused of bias in commissioning KPMG—and the report must be wrong because we paid for it. What I struggle to understand is that those on the other side of that argument, including the department and other anti-tobacco activists, who are in charge of keeping our industry down are not equally accused of bias. They have an inherent interest in promoting the fact that our arguments are wrong and, in so doing, produce evidence that, as I think you have just heard, is relatively spurious, yet for some reason they are not accused of an inherent bias, and that troubles me.

Senator LEYONHJELM: What is in it for them to persuade people to believe that the illicit market is a lot less than you say it is?

Mr Bray : If they are architects of certain policies which are creating a greater problem than they are trying to cure. Obviously they want to say the problem does not exist—but that is speculation.

Senator LEYONHJELM: You are arguing that they are creating a bigger problem than they are solving?

Mr Bray : Yes.

Mr Powell : I think it is also fair to say that the Federal Police and Border Force are trained organisations set up for the purpose of law enforcement. The Department of Health, I think as someone said before, is simply not competent to understand the illicit, illegal side and enforcement requirements. Otherwise, I cannot understand why, in the way that the plain packaging regulations were put together, for example, they banned one of the most effective law enforcement tools in terms of product security and tracking and tracing technologies. Nobody who understood what they were doing would have done that. So I think they are not competent to look at this issue because it is outside their expertise.

Senator LEYONHJELM: I should not let that point go. I might ask you to provide a bit more detail on the product tracking and tracing technology that you referred to. You did not give much detail in your submission. It may be something the committee can address in its report. Are you able to provide more about that on notice?

Mr Powell : Absolutely.

CHAIR: I would like to touch on one other point. How many tobacco retail outlets are there in the country if you take in the major supermarkets and the small tobacconist shops?

Mr Dickson : We believe about 30,000.

CHAIR: Of those, what market share do you three have of the product they would normally have on display? Is it 90 per cent? Do they source lawful products from outside of you three?

Mr Gregson : It is interesting that you say 'on display', because of course none of the products are on display.

CHAIR: Yes. Are there options for them to source their product from other than from you three?

Mr Rush : Essentially no. We would have 99 per cent of the product. There is another smaller company in the market which has about one per cent market share, which would be—

CHAIR: Effectively, if you do not supply them they do not have a business.

Mr Rush : No. I would also like to point out that we are not allowed to display the product; the product is behind closed doors.

CHAIR: It was a slip of the tongue there with the word 'display'. I understand. If I had a retail shop and I wanted to sell cigarettes, would I go to one of your distributors? Do you have a sales force? How does that actually work?

Mr Rush : We do direct distribution to most outlets.

CHAIR: Would you have a sales representative calling on those outlets?

Mr Rush : Yes, we do.

CHAIR: Let me just put something to you: at the moment the ACCC are looking at a case in the jewellery industry, where one of the major jewellery suppliers which has a large market share has banned a competitor from selling to the retail shops they distribute to. So the jewellery retailer is there and they have the product from that one company on display and are told, 'If you purchase from another company we will discontinue supply to you.' Could I put it to you that another potential solution to this is to decide to immediately cease supply to any retailer you find that is selling unbranded or counterfeit product.

Mr Powell : We certainly have done that unilaterally. The challenge is that if we were to get together to agree to do that the advice that we have internally is that it would be in breach of competition law.

CHAIR: That is the point I am getting to, yes.

Mr Powell : So obviously we do not do that.

CHAIR: So if you were to share information that a particular retailer was selling illicit product, and that therefore you would not supply them and you would encourage your other competitors not to supply to them—your understanding is that at the moment that would be in breach of our competition laws.

Mr Gregson : Potentially, yes.

CHAIR: So if that were clarified or in an exemption were given, that could be a potential way of closing down a substantial portion of the market.

Mr Gregson : Potentially, yes.

Mr Powell : Can I just say also that it is an excellent point, but there is also a large section of the illicit tobacco market that actually does not sell any legal product at all. These stores are devoted exclusively to selling illicit tobacco. They do not have retail licences and they do not buy products from legal tobacco companies. Some of them are part of vertically integrated from growing to retail illicit tobacco operations. There are many of them, and they would not be impacted at all by such a scenario. But your point is excellent.

Mr Rush : I would just add that the margins on illicit tobacco are actually higher than on legal tobacco, so unless we go back to having some enforcement and deterrent at the retail level that solution would actually not reduce the problem.

CHAIR: Thank you, gentlemen. That concludes this part of the hearing. The committee will suspend for a short period and resume its public hearing at 10.40 am. Thank you, gentlemen, for your time. We greatly appreciate it.

Proceedings suspended from 09 : 57 to 10 : 40