HM Customs and Excise

Appropriatio Accouts 1999-2000 Volume 16: Class XVI Departmets of the Chacellor of the Exchequer: HM Customs ad Excise Report of the Comptroller ad Auditor Geeral HC 25-XVI 9 February 2001

Cotets Executive summary Part 1: Basis of the audit Itroductio Statutory basis for the audit Audit approach ad scope Work carried out for 1999-2000 Coclusios Part 2: Audit Fidigs Audit coverage Review of the operatio of Departmetal Iteral Audit Part 3: Developmets i Iteral cotrol Statemets of iteral fiacial cotrol Audit Committee Impact of the Year 2000 date chage o departmetal systems Part 4: Ladfill Tax Credit Scheme Backgroud The role of Etrust i regulatig the Ladfill Tax Credit Scheme Customs' moitorig of Etrust as regulator of the Scheme Departmet of Eviromet, Trasport ad the Regios' view of the Scheme Coclusios ad recommedatios Part 5: Losses to the reveue from excise duty diversio fraud Backgroud The extet of the reveue evaded How Customs have accouted for the reveue that caot be recovered Coclusios R1 R5 R5 R5 R5 R6 R6 R7 R7 R11 R13 R13 R13 R14 R15 R15 R17 R18 R19 R19 R21 R22 R22 R23 R23

AUDIT OF HM CUSTOMS AND EXCISE UNDER SECTION 2 OF THE EXCHEQUER AND AUDIT DEPARTMENTS ACT 1921 executive summary Audit of the HM Customs ad excise uder Sectio 2 of the Exchequer ad Audit Departmets Act 1921 1 Sectio 2 of the Exchequer ad Audit Departmets Act 1921 requires me to examie the accouts of Customs ad Excise to establish that adequate regulatios ad procedures have bee framed to secure a effective check o the assessmet, collectio ad proper allocatio of reveue ad to satisfy myself that ay such regulatios ad procedures are beig duly carried out. This report sets out the results of my examiatio i fulfilmet of these requiremets. 2 I April 2000, the Accoutig Officer, Richard Broadbet who was appoited i February of that year, itroduced a ew maagemet framework the aim of which was to clarify accoutabilities, streamlie decisio-makig ad support the more rapid implemetatio of decisios. O 17 Jauary 2001, the Departmet aouced their reorgaisatio ito two core activities: Busiess Services ad Law Eforcemet. Support fuctios will comprise logistics, fiace ad strategy, Huma Resources ad Legal ad the ew structure is to be i place by 1 April 2001. 3 Durig 1999-2000 I have performed examiatios icludig reviews of the impact of corporate goverace developmets ad the operatio of the Ladfill Tax Credit Scheme. I also aually review the operatio of key accoutig fuctios such as the VAT Cetral Uit ad Credibility Uit for makig VAT repaymets as well as reviewig the operatios of a selectio of local offices. Excise diversio fraud 4 O 1 Jue 2000, Richard Broadbet, the Chairma of HM Customs ad Excise, iformed the Paymaster Geeral, Daw Primarolo, that a series of excise diversio frauds betwee 1994/1998 appeared to have bee mishadled. He had commissioed a iteral review to ivestigate the matter. The weakesses i cotrols over the collectio of duty ad the failigs of Customs' maagemet had cotributed to the loss of substatial amouts of reveue estimated at aroud 668 millio from diversio oto UK markets. A further 216 millio was lost resultig from diversio oto overseas markets where duty would have bee due i the coutry of import had the goods ot bee frauduletly diverted. Figure 10 provides the breakdow of these amouts. 5 Although Customs became aware of the threat of outward excise diversio frauds as early as 1994 they did ot take effective actio to curtail these frauds util 1998. About half of the reveue could have bee protected if fraudulet cosigmets had bee itercepted rather tha lettig the ivestigatios cotiue i order to obtai sufficiet evidece to prosecute those ivolved or if effective actio had bee take earlier. 6 I the ormal course of evets my report would be published i the Appropriatio Accouts volume cotaiig details of Customs' admiistratio costs ad would also cover Customs' Trust Statemet, my audit of which fulfils the requiremet for me to be satisfied as to the correctess of reveues brought R1

to accout. The Trust Statemet for 1999-00 recordig reveue receipts ad paymets ad produced uder the directio of the Treasury has ow bee siged by the Accoutig Officer. Because of my cotiuig ivestigatio ito diversio frauds, I am as yet uable to coclude uder Sectio 2 of the Exchequer ad Audit Act 1921 either that: adequate regulatios ad procedures have bee framed to secure a effective check o the assessmet, collectio, ad proper allocatio of reveue ad to satisfy myself that ay such regulatios ad procedures are beig duly carried out; or the sums brought to accout i respect of such reveue are correct. 7 I propose to produce a further Report to Parliamet o the causes ad the lessos to be leared from the Departmet's hadlig of diversio frauds ad o the actio plaed by Customs. Key accoutig fuctios ad selected local offices 8 I foud that cotrols were operatig satisfactorily i these areas but there are sigificat issues which I brought to the attetio of maagemet. These icluded: weakesses i the way that departmetal stadards have bee applied to some traders ad which esure that they have systems ad procedures i place to record ad pay taxes at the right time; problems o re-paymets to traders of default iterest o uderdeclaratios of VAT; the eed to improve checks by Customs o cosigmets imported from outside the Europea Uio which esure that the correct amout of duties have bee paid by importers; the eed for improved procedures to esure that potetial liabilities ad provisios have bee properly cosidered, recorded ad reported i the accouts produced by the Departmet. Developmets i corporate goverace 9 I lie with other cetral govermet departmets, Customs produce a Statemet o Systems of Iteral Fiacial Cotrol for their two accouts which record their admiistrative expediture (the Appropriatio Accout records voted cash admiistrative expediture ad the Resource Accout shows resources utilised o a accruals basis). This statemet cofirms that the Accoutig Officer has satisfied his resposibility to esure that effective maagemet systems, icludig fiacial moitorig ad cotrol systems, have bee put i place. 10 I Jue 2000, Treasury issued guidace extedig this requiremet to all accouts that have to be laid before Parliamet for the 1999/2000 fiacial year. However, departmets were allowed to defer the applicatio of this guidace util the year edig 31 March 2001 if the required systems were ot i place for the year edig 31 March 2000. The Departmet have chose to exted the scope of their Statemet o Systems of Iteral Fiacial Cotrol to cover their Resource Accout. However, they do ot pla to wide the statemet to cover the systems i place for the assessmet, collectio ad allocatio of reveues util the 2000-01 fiacial year, because the timig of the Treasury's guidace meat that they were ot i a positio to retrospectively R2

seek evidece about the iteral fiacial cotrols relatig to reveue systems i operatio throughout 1999-2000. 11 Most major orgaisatios use a audit committee to ehace ad evaluate the iteral cotrol systems i operatio. The Treasury have issued guidace o the formulatio of such committees i the public sector ad have recommeded they be set up. Customs ad Excise are i the process of developig the role of their audit committee further. The Natioal Audit Office have recetly bee ivited to atted the Committee o a permaet basis. The operatio of the Ladfill Tax Credit Scheme 12 The operatio of the Ladfill Tax Credit Scheme ad the Ladfill Tax from which credits ca be deducted has bee the subject of cosiderable Parliametary ad media iterest, especially about the effectiveess of the scheme ad the projects paid for by cotributios ie the tax foregoe. The regulatios for the scheme as well as the workigs of the scheme itself are complex ad paymets for projects that fall withi the scheme's rules do ot cout as public expediture which makes exteral examiatio of the value-for-moey achieved by the scheme difficult for ayoe to assess. I have examied pricipally how Etrust regulate the scheme ad Customs' moitorig of Etrust's activities as regulator of the Scheme. Although I am satisfied that Etrust fulfils its duties satisfactorily, I have made recommedatios o the way Etrust ca improve their review of projects ad erolled evirometal bodies ad i the way Customs moitor Etrust. R3

R4 AUDIT OF HM CUSTOMS AND EXCISE UNDER SECTION 2 OF THE EXCHEQUER AND AUDIT DEPARTMENTS ACT 1921

AUDIT OF HM CUSTOMS AND EXCISE UNDER SECTION 2 OF THE EXCHEQUER AND AUDIT DEPARTMENTS ACT 1921 Part 1 Basis of the audit Itroductio 1.1 This part of my report describes the audit work udertake by the Natioal Audit Office to support my opiio o the systems established by HM Customs ad Excise ad discharges my resposibility to report to the House of Commos uder the Exchequer ad Audit Departmets Act 1921 as described i more detail below. Statutory basis for the audit 1.2 Sectio 2 (1) of the Exchequer ad Audit Departmets Act 1921 requires me to examie the accouts of Customs ad Excise o behalf of the House of Commos. This is to establish that adequate regulatios ad procedures have bee framed to secure a effective check o the assessmet, collectio ad proper allocatio of reveue ad to satisfy myself that ay such regulatios ad procedures are beig duly carried out. The legislatio also requires me to examie the correctess of the sums brought to accout ad to report the results to the House of Commos (Sectio 2(2)). 1.3 For 1999-2000 uder Sectio 5 of the Exchequer & Audit Departmets Act 1921, Customs ad Excise have prepared Resource Accouts givig details of their admiistrative expediture ad resources used ad I have provided a clear audit opiio o these. A Trust Statemet detailig reveues received ad repaymets made is also produced by the Departmet ad audited by agreemet with the Treasury. Audit approach ad scope 1.4 Each year, the work I perform to fulfil the statutory requiremet uder Sectio 2 (1) of the 1921 Act icludes: the examiatio of the Departmet's iteral cotrols; periodic i-depth reviews of existig systems coverig ay sigificat chages ad the evaluatio of ew systems; reviews of quality assurace work icludig the work of Iteral Audit ad other checks carried out by the Departmet; reviews of the Departmet's computer istallatios ad etworks ad specific iformatio techology applicatios; ad test examiatios of idividual trasactios ad balaces. 1.5 I also examie the ecoomy, efficiecy ad effectiveess with which Customs ad Excise have used their resources uder Sectio 6 of the Natioal Audit Act 1983. The results of these value-for-moey examiatios are published i separate reports to the House of Commos uder Sectio 9 of that Act. Sice my last report o the Departmet's systems ad procedures (HC11-XVI, 1999-2000), I have reported o VAT Assurace (HC15, 1999-00), o Bettig ad Gamig Duties (HC352, 1999-00) ad o the Regulatio of Freight Imports from Outside the Europea Commuity (HC 131, 2000-01). Other reports where there has bee coverage of Customs ad Excise iclude: Performace Measuremet (HC272, 1999-00) ad Risk Maagemet (HC864, 1999-00). 1.6 My review of ew Budget Assumptios ad the cyclical review of those used i the past ivolves coverage of the work of the Departmet ad has icluded assumptios about the forecast VAT yield, the expected reveues from tobacco ati-smugglig measures ad reveues from the Sped-to-Save programme (HC348 ad 959, 1999-2000). 1.7 At preset the Trust Statemet recordig tax reveues ad repaymets is draw up o a cash basis. I perform my audit by agreemet with the Treasury but, with the activatio of the relevat clauses of the Govermet Resources ad Accouts Act (expected to apply to accouts for 2000-01 ad beyod), my audit of these accouts will move oto a statutory basis. I aticipate that the itroductio of Whole of Govermet Accouts over the comig years ad, with a Cetral Govermet Accout due for 2002-03, the reveues reported uder R5

the Trust Statemet will be reported o a accruals basis. I am already workig with both the Departmet ad Treasury o the form of accout ad the accoutig policies to be applied as a result of this sigificat developmet. Work carried out for 1999-2000 1.8 My audit approach esures coverage of every reveue regime each year, ad details are provided i Figure 1 below: 1.9 Iformatio Techology is itegral to the admiistratio of idirect taxes. I perform specific IT reviews i support of the work outlied above ad further details are icluded at Parts 2 ad 3. Part 5: Losses to the reveue from excise duty diversio fraud. Coclusios 1.11 I the ormal course of evets my report would be published i the Appropriatio Accouts volume cotaiig details of Customs' admiistratio costs ad would also cover Customs' Trust Statemet, my audit of which fulfils the requiremet for me to be satisfied as to the correctess of reveues brought to accout. The Trust Statemet for 1999/2000 recordig reveue receipts ad paymets ad produced uder the directio of the Treasury has ow bee siged by the Accoutig Officer. Because of my cotiuig ivestigatio ito diversio frauds, I am as yet uable to coclude uder Sectio 2 of the Exchequer ad Audit Act 1921 either that: 1.10 The mai fidigs from our work are set out i the followig parts of my report ad iclude those areas where I have coducted more i-depth iquiries ad which therefore warrat separate metio: Part 2: The results of my audit work i detail icludig where I have relied o other auditors icludig Customs' ow iteral audit fuctio; adequate regulatios ad procedures have bee framed to secure a effective check o the assessmet, collectio, ad proper allocatio of reveue ad to satisfy myself that ay such regulatios ad procedures are beig duly carried out; or the sums brought to accout i respect of such reveue are correct. Part 3: Corporate Goverace developmets; Part 4: The operatio of the Ladfill Tax Credit Scheme; 1.12 I propose to produce a further Report to Parliamet o the causes ad the lessos to be leared from the Departmet's hadlig of diversio frauds ad o the actio plaed by Customs i respose. 1 Summary of coverage Tax/duty Fuctio VAT HCO Tobacco Spirits Wie, cider Beer Bettig & IPT APD LFT Customs Duty ad perry gamig Receipts 1999-2000 1 56.8b 22.5b 5.7b 1.8b 1.8b 2.8b 1.5b 1.4b 0.9b 0.4b 2.0b VAT Cetral Uit 4 Cetral Defermet Office 4 4 4 4 4 Cetral Collectio Uit 4 4 4 4 Greeock Accoutig 4 Cetre Drawback Processig 4 4 4 4 4 Cetre Errors ad adjustmets 4 Credibility uit 4 Isolvecy uit 4 Large Payers Uit 4 4 4 4 Natioal Import Duty 4 Adjustmet Cetre Regioal Offices 4 4 4 4 4 4 4 4 4 4 4 R6 Note: 1. Figures are provisioal.

AUDIT OF HM CUSTOMS AND EXCISE UNDER SECTION 2 OF THE EXCHEQUER AND AUDIT DEPARTMENTS ACT 1921 Part 2 Audit fidigs Audit coverage 2.1 The Departmet operates major systems to assess ad collect reveues from VAT, Excise ad Customs duties, imports ad separately for large payers. My review of the Departmet's key fuctios is show uder these headigs at Figure 2. 2.2 Sigificat issues which I have already brought to the attetio of maagemet iclude: weakesses i the way that departmetal stadards have bee applied to some traders ad which esure that they have systems ad procedures i place to record ad pay taxes at the right time (paragraphs 2.4-2.7); problems o re-paymets to traders of default iterest o uderdeclaratios of VAT (paragraphs 2.8-2.10); the eed to improve checks by Customs o cosigmets imported from outside the Europea Uio which esure that the correct amout of duties have bee paid by importers (paragraphs 2.11-2.23); the eed for improved procedures to esure that potetial liabilities ad provisios have bee properly cosidered, recorded ad reported i the accouts produced by the Departmet (paragraphs 2.24-2.29). 2.3 I have also take assurace from my review of the work of Iteral Audit ad the results of this are summarised i paragraphs 2.30-2.33. Weakesses i the applicatio of the departmetal stadards to checkig traders 2.4 The Departmet's approach to makig sure the correct amout of reveue is received is to check the systems ad accouts of those traders thought to be at greatest risk. They idetify these traders by reviewig factors such as the complexity of the busiess, the results of previous visits ad paymet history. Customs also take a radom sample of traders which is ot related to risk to moitor the geeral level of compliace. 2.5 From the iformatio held by Customs, staff cosider the most appropriate method of gaiig assurace, either through a visit to the trader or office based equiries. Followig their checks they may make recommedatios to traders for ay improvemets ad if ecessary raise assessmets if errors have bee idetified. To esure that Customs' procedures are efficiet ad effective, atioal rules gover the coduct of audits ad are cotaied i the Departmetal Audit Stadard. 2.6 I reviewig the Departmet's approach I foud that this Stadard was fully applied to large traders ad the Departmet is actively workig towards itroducig a adapted form for the assurace o the compliace of medium ad small traders. The amout of work carried out o these classes of traders depeded o the idividual judgemet of staff ad as a result there were wide variatios i the way that idividual traders were audited. Util the, there is a risk that i some cases the Departmet might ot be gaiig sufficiet assurace that the correct amout of reveue is beig paid. It also makes it difficult for both traders ad departmetal staff to kow whether the stadards they are workig to are sufficiet. 2.7 For those large traders audited, we foud areas of good practice although the documetatio produced by Customs' staff was ot i all cases up to the Departmetal Audit Stadard. I my view, this was likely to create most difficulties whe a trader's affairs moved betwee Customs' staff which could make it harder to cofirm that the trader had paid the correct amout of tax, ad could also give a poor impressio of the Departmet's performace to traders. I have recommeded that departmetal stadards for documetatio should be applied cosistetly to all large traders. R7

2 Customs ad Excise Fuctios Reviewed VAT EICS Imports Other VAT Cetral Uit: Cetral collectio uit: Natioal Import Duty Adjustig Cetre: Large Payers Uit: Recordig Processig receipts ad repaymets for Processig goods brought ito UK Esurig compliace Processig: ad Ladfill Tax uder the preferece system which i submittig returs Allocatio of VAT receipts/repaymets Isurace Premium Tax do ot have the appropriate ad repaymets Air Passeger Duty; ad certificatio (mostly VAT Credibility Uit: Wie, cider ad perry duty traders) Credibility checks o repaymets Cetral Defermet Office: Error ad Accoutig Adjustmets: Processig duties covered by duty Dealig with icomplete or derfermet system erroeous returs Drawback Processig Cetre: Isolvecy Uit: Duty drawback claims Esurig returs are received Cofirmig accuracy of debt Beer Duty Accoutig Cetre: Receipt of large divideds Cotrollig ad checkig the receipt of beer duty returs ad moies, icludig the assessmets ad pealties Greeock Accoutig Cetre: Collectio, processig ad allocatio of: Bigo duty Gamig duty Natioal lottery duty Geeral bettig duty; ad Amusemet machie licese duty 14 Regioal Offices (collectios) Debt Maagemet Uits Advice Cetres Local offices Local VAT Offices Registratios/ De-registratios Airports Seaports Source: HM Customs & Excise R8 Re-paymet of default iterest owed to taxpayers 2.8 Traders are liable for default iterest if they uderdeclare their VAT ad i 1999-2000 the Departmet recovered 48.5m i default iterest. Followig a VAT Tribual decisio i 1993, Customs' declared policy has bee to charge default iterest o et amouts due but i practice they have ot always doe so. As a result, the Departmet have charged iterest i some cases without makig allowace for overdeclared tax. 2.9 Overpaymets have bee made maily by the larger traders, ad could affect iterest charges back to 1990. The Departmet estimate that they may have overcharged up to 930 large traders ad are ow liable to repay both the primary sum ad compesatory iterest. The repaymet liability is estimated by the Departmet to be aroud 34m, icludig 7m i compesatio. Customs have repaid some 18.4m to date ad expect to repay the balace durig 2001-2002. 2.10 The Departmet are lookig at ways to improve the calculatio of default iterest ad are developig chages eeded to their computer systems. I the meatime, they are calculatig the amout of overcharges usig separate stadaloe systems ad procedures which may require sigificat maual itervetio. I have raised with the Departmet the adequacy of maagemet checks ad recommeded that they cosider implemetig more rigorous checks of the maual iput to reduce the risk of error. The Departmet assure me that appropriate maagemet checks are beig carried out to esure that the system is operatig correctly.

Checks by Customs o cosigmets imported from outside the Europea Uio; 2.11 Sice 1993 ad the commecemet of the sigle market, imports ("cosigmets") ito the UK are oly subject to checkig if they come from outside the EU. Importers make declaratios to Customs o "cosigmets" received for the duty ad VAT due. At the extremes a "cosigmet" could be a small parcel or the cargo of a large ship. 2.12 I have reported separately to Parliamet (HC 131, 2000-01), o the regulatio of freight imports from outside the Europea Commuity ito Great Britai. I my report, I have recommeded that the Departmet should improve their risk maagemet systems ad focus more closely o their objective for securig compliace with regulatios from importers. 2.13 Some 7.1 millio cosigmets of goods were imported from outside the Europea Uio i 1999-2000. Reveue collected o these imports totalled 20.6b. Airports such as Heathrow/Gatwick ad East Midlads are by far the busiest offices, hadlig 2.1millio ad 700,000 cosigmets respectively. Ports are likely to hadle smaller umbers of cosigmets, although these will o average be larger. 2.14 At the local office level, I visited 6 offices (out of a total of 47) which perform checks o cosigmets imported from outside the Europea Uio. While offices are ormally at the UK's ports ad airports, warehouse premises ca also be operated at some distace from the actual port of etry to facilitate the operatios of importers ad the busiesses they serve. 2.15 I oe regio (Belfast Docks) I foud the level of cotrol over the operatios of traders to be ieffective. While this office is relatively small, accoutig for less tha oe per cet of receipts totallig some 35m i 1999-2000, it is oly oe of two offices coverig Norther Irelad. The office also has resposibility for remotelysituated warehouses (called remote trasit sheds) ad temporary storage facilities o or close to the border with the Republic of Irelad. The mai weakesses I foud ad reported to maagemet are summarised i paragraphs 2.16-2.23 below. (a) risk assessmet 2.16 Local offices should have procedures to idetify the risks to the reveue from the importatio of cosigmets, for assessig those risks for the likelihood that duties will ot be paid, ad based o this to idetify which cosigmets should be selected for checkig. I Belfast this was ot beig doe adequately ad istead there was sigificat reliace o operators to pay the correct amout of duty. 2.17 Ulike the rest of the Uited Kigdom, the Belfast office was ot makig full use of a key facility o the Customs computer system, desiged to assist staff with selectig those cosigmets which preset risks to the reveue. Local Customs staff ca use markers called "profiles" (which ca also be set atioally) withi the computer system to idetify cosigmets for checkig. But, at the time of my visit, operatioal staff based i the Belfast local office rarely set markers for cosigmets to be checked, ad markers set by other staff were ot beig regularly reviewed. I have recommeded that local staff use the opportuities available to set up ad amed markers held o the computer system to make better use of their local kowledge ad that all markers should be regularly reviewed. (b) reviewig systems for trackig movemets of goods 2.18 Commercial port operators will ormally operate "ivetory-likig" systems to otify Customs of movemets of cosigmets. These key systems record all movemets of goods but we foud o evidece that staff i Belfast had reviewed them durig 1999-2000. Where warehousig facilities are based away from the port area, our experiece elsewhere i the UK is that the Departmet isist o the operatio of a ivetorylikig system as they allow goods, wherever they are physically located, to be traced for Customs' ispectio. However, operators of remote trasit sheds or temporary storage areas i the Belfast Docks regio do ot use these systems, ad i the absece of regular Customs ispectios the assurace that the Departmet have o cosigmets movig through these facilities must be limited. 2.19 Durig our visit we also observed that the "gate pass" system at Belfast Docks, which should esure that all cosigmets leavig port are properly authorised, was ot operatig effectively. I the past this weakess i the system has allowed goods to be removed from the port without authorisatio ad I have recommeded that the Departmet review the cotrol of removals from the port. (c) checks o traders usig Customs Freight Simplified Procedures 2.20 I 1997 Customs itroduced the Customs Freight Simplified Procedures which allows cosigmets to eter the Uited Kigdom without beig stopped by Customs for fiscal purposes. At a later date the importer submits supplemetary declaratios to Customs of all goods imported over the period, ad makes paymets for the amout of duty o those goods. Customs may subsequetly visit the importer to cofirm that they are complyig with the requiremets for usig the simplified procedures. We foud that, at the time of our audit, o visits had bee udertake or plaed to the oe operator usig these procedures i the Belfast Docks regio, for example to check the operatio of the ivetory likig systems i place at these operators. R9

R10 (d) Customs approvals provided to the operators of remotely-situated trasit sheds 2.21 The Departmet should agree locally with port operators ad owers of registered premises their resposibilities ad duties icludig for the operatio of remotely-situated trasit sheds. I the Belfast Docks regio, key cotract ad approvals documetatio could ot be foud or was out of date i a umber of sigificat areas, for example - the absece of documetatio would be importat i cases where checks were ot beig carried out properly ad where Customs would be seekig to eforce actio either to halt movemets or obtai reveue where there had bee losses. (e) checks of cosigmets to esure correct reveue paymets 2.22 Goods that are imported will arrive o a variety of types of ships ad ca be palletised or held i cotaiers. Customs will check the cargoes of ships either before uloadig (ofte physically difficult) or after idividual cosigmets have bee uloaded. I 1999-2000 there were 16237 import etries made at Belfast of which 5445 were subject to documetary checks. Three examiatios of ships' holds were also coducted ad 549 idividual cosigmets were physically examied. This is a similar proportio to those checked at other docks. 2.23 Importers provide lists of cosigmets expected to be brought ito the coutry ad these are checked to detailed maifests from carriers of goods that arrive. The local office i Belfast Docks could develop a procedure to esure that differeces betwee the two sets of iformatio are ivestigated. This may help to direct the work of the office to areas of potetial risk i areas where checkig is resource-itesive, ad where oly few physical examiatios take place. The eed for improved procedures to esure cosideratio ad the completeess of recordig ad reportig cotiget liabilities ad provisios. 2.24 The Resource Accoutig ad Budgetig iitiative requires Govermet departmets to report their icome ad expediture o a accruals basis for the first time. The aim is to help improve the way departmets both maage ad report o their resources ad the disclosure of iformatio o their actios ad performace. Whereas previously the accouts of may departmets (icludig Customs) were cash-based, Resource Accouts disclose icome ad expediture o a accruals basis as well as Notes coverig for example creditors, liabilities ad cotiget liabilities, i lie with geerally-accepted UK accoutig practice (UK GAAP). 2.25 I ay busiess the requiremet to disclose iformatio about provisios ad cotiget liabilities requires a cosiderable amout of cosultatio especially betwee operatios, fiace, legal ad ot least seior maagemet. Published accoutig stadards require that active cosideratio be give to the impact of possible future calls o the resources of the etity ad to evidece this. For Customs, closer commuicatio betwee policy braches ad the fiace fuctio is importat because, for example, costs ad iterest arisig from reveue-raisig actio may fall o the Resource Accout of the Departmet. 2.26 To illustrate this, icomplete otificatio of iformatio to the fiace ad accouts brach meat that a sigificat cotiget liability of 15 millio should more accurately have bee accouted for i the 1999-00 Accout opeig balaces as a provisio. The delay of some 4 moths before fiace staff were iformed of the impact of this award agaist the Departmet also meat that the full fiacial implicatios of the decisio came as a surprise. This sigificat ad uexpected charge o resources available for admiistratio had implicatios for maagemet ad could have had serious repercussios for the Departmet to remai withi their cash limit. The aticipated developmet of accruals accoutig ad reportig of reveues, as part of the iitiative to produce accouts which cosolidate the operatios of cetral govermet, may further icrease the umber of istaces where cotiget liabilities ad provisios will eed to be recogised. 2.27 For 1999-2000, the Departmet have successfully produced a Resource Accout which I have provided with a clear opiio. However, my review revealed that the iitial summary of cotiget liabilities was icomplete ad required revisio. Whilst the Departmet had itroduced procedures desiged to idetify, track ad classify such trasactios i accordace with Fiacial Reportig Stadards I foud that these had ot bee properly followed i all locatios ad that ot all cases had bee properly idetified ad evaluated. The moitorig ad maagemet procedures operated by the Departmet did ot idetify these issues ad gave o mechaism for maagemet to esure that iformatio was complete ad accurate. Because of these difficulties I had to carry out sigificat additioal uplaed audit activity to esure that the Resource Accouts preseted a true ad fair view ad the Departmet made a umber of amedmets to the accouts. 2.28 A further cosideratio is where maagemet judges that the disclosure of ay cotiget liabilities, as required by accoutig ad auditig stadards, could prejudice the outcome of legal actio. Maagemet's cosideratio of all potetial cotiget liabilities ad ay judgemet to withhold iformatio eeds to be fully documeted, appropriately reviewed ad available for the audit of the accouts.

2.29 The Departmet has agreed that the Audit Committee will review maagemet's processes i this area as part of their remit to look at the fiacial statemets as a whole. I support this approach ad recommed that early cosideratio is give by all those ivolved to the eed for reportig requiremets to be met whilst protectig Customs' legitimate cocers to fulfil their proper resposibilities. Review of the operatio of Departmetal Iteral Audit 2.30 As part of my audit I review the work ad idepedece of Iteral Audit. The Head of Iteral Audit reports directly to the Pricipal Fiace Officer of the Departmet ad also has access directly to the Chairma ad Board of the Departmet if ecessary. Iteral Audit provide a variety of reports to the Departmet, icludig a aual report o their ow performace, ad a certificate of assurace coverig the iteral cotrols. They are split ito seve braches i two locatios with a complimet of sixty-three staff of which there were sixty-oe i post at the time of my review. The majority of staff i the iteral audit fuctio are qualified or studyig for Istitute of Iteral Audit qualificatios at member ad professioal levels. 2.32 The Head of Iteral Audit has provided positive assurace to the Accoutig Officer that the overall cotrol framework cotiues to remai at a acceptable level. 95 per cet of Iteral Audit recommedatios o the outcome of systems audit work ad 96 per cet o maagemet audits were accepted, coverig for example the eed for maagemet iformatio to be accurate ad timely, ad that maagemet assurace programmes are ot always i place. 2.33 I have oted Iteral Audit's future plas ad the refocusig of work alog Moderisig Govermet themes icludig "Iformatio Age Govermet". I hope to be able to develop our co-operatio with Iteral Audit further i particular to take additioal assurace from Iteral Audit's work o iformatio techology aspects of the Departmet's orgaisatio ad operatios. 2.31 I have take assurace from the work of Iteral Audit i a umber of areas both for the audit of admiistrative expediture ad receipts ad for my review of systems supportig taxatio receipts ad repaymets. The rage of ivestigatios i 1999/2000 icluded: VAT Uregistered Traders, Excise ad Ilad Customs operatios, drawbacks, Authorisatio of Ilad Customs Traders, Debt Maagemet Iformatio systems, the Whisky Export Refud scheme, REDS ad Occasioal Importers, EC Ow Resources ad Natioal Ivestigatio Service maagemet review. I several areas, such as for staff expediture o travel ad subsistece ad o Regioal Office systems, Iteral Audit have performed testig o my behalf. R11

R12 AUDIT OF HM CUSTOMS AND EXCISE UNDER SECTION 2 OF THE EXCHEQUER AND AUDIT DEPARTMENTS ACT 1921

AUDIT OF HM CUSTOMS AND EXCISE UNDER SECTION 2 OF THE EXCHEQUER AND AUDIT DEPARTMENTS ACT 1921 Part 3 Developmets i iteral cotrol 3.1 I this part of my report I examie: Developmets i corporate goverace, lookig particularly at; q q Statemets of iteral fiacial cotrol; The role of the Audit Committee; Year 2000 results. Statemets of Iteral Fiacial Cotrol 3.2 I lie with other cetral govermet departmets, Customs ad Excise have to produce a Statemet o Systems of Iteral Fiacial Cotrol. This iitiative follows moves to improve the goverace of private sector compaies begu with the itroductio of the Code of Practice developed by the Cadbury Committee. The purpose of the statemet is to cofirm that the Accoutig Officer has satisfied his resposibility to esure that effective maagemet systems, icludig fiacial moitorig ad cotrol systems, have bee put i place. 3.3 For 1998-99, Customs ad Excise alog with other departmets had to make this statemet oly i coectio with their voted cash admiistrative expediture, recorded i the Appropriatio Accout. I Jue 2000, Treasury issued guidace extedig this requiremet to all accouts that have to be laid before Parliamet for the 1999/2000 fiacial year. However, departmets were allowed to defer the applicatio of these requiremets to "certai other accouts" util the year edig 31 March 2001 if the required systems were ot i place for the year edig 31 March 2000. 3.4 The Departmet have chose to exted the scope of their Statemet o Systems of Iteral Fiacial Cotrol to cover their Resource Accout. However, they do ot pla to wide the statemet to cover the systems i place for the assessmet, collectio ad allocatio of reveues util the 2000-01 fiacial year, because the timig of the Treasury's guidace meat that they were ot i a positio to retrospectively seek evidece about the iteral fiacial cotrols relatig to reveue systems i operatio throughout 1999-2000. 3.5 I September 1999, the Turbull Committee issued "Iteral Cotrol: Guidace for Directors o the Combied Code". Oe sigificat, ad ew, aspect of the Combied Code is to exted the directors' statemet o iteral fiacial cotrols to cover all iteral cotrols. Treasury have adopted this chage ad all departmets, icludig Customs ad Excise, will be required to make this broader statemet for the year 2001-2002. The Departmet have told me that they will be i a positio to give this assurace ad are already workig to establish systems to esure evidece to support such a statemet ca be provided by the Accoutig Officer. 3.6 The wideig of the statemet to iclude ot just iteral fiacial cotrols is a major developmet ad there is a cosiderable amout of work to be doe both to gather the evidece to support a statemet, ad to esure that it ca withstad scrutiy. Audit Committee 3.7 Customs' Audit Committee is formed by members of the Board of Commissioers ad oe of Customs' two oexecutive directors. I the past the Committee has bee led by the Chairma ad has ormally met twice-yearly, although oly oce i 1999-2000. 3.8 Matters discussed by the Committee have icluded: Iteral Audit plas, their aual assurace report to the Chairma, ad a review of the previous year's performace. Other items have icluded progress o curret audits, clearace of Iteral Audit recommedatios, feedback from audit cliets, followup o how Iteral Audit should respod to ew iitiatives such as Moderisig Govermet as well as liaiso with the Natioal Audit Office. R13

3.9 Most major orgaisatios use a audit committee to ehace ad evaluate the iteral cotrol systems i operatio. The Treasury has issued guidace o the formulatio of such committees i the public sector ad has recommeded they be set up. Customs ad Excise are i the process of developig the role of their audit committee further as suggested by best practice, for example: their terms of referece, membership ad chairmaship. The Natioal Audit Office have recetly bee ivited to atted the Committee o a permaet basis. Impact of the Year 2000 date chage o departmetal systems 3.10 Preparatios to couter the potetial Year 2000 threat for the Departmet's systems were successful ad o major difficulties were ecoutered. I have cotiued to moitor the effect of the date chage o the key systems of the Departmet ad am satisfied that o sigificat failures have occurred. 3.11 I February 2000, the Departmet carried out a iteral review of their Milleium project ad a further review was performed by cosultats. While both reviews cocurred o the success of the project, recommedatios were made which icluded: Retetio of the cross-departmetal ad exteral workig groups which were set up primarily for the Milleium project but which have a cotiuig role; Busiess recovery plas at both the site ad process level adopted for the milleium should ot be wasted but developed further as they were relevat to all risks of breakdow; Details of ivetories ad system owers should cotiue to be kept ad updated regularly. 3.12 The milleium project team has sice dispersed. As the recommedatios made i the above reviews are sigificat for the iteral cotrol of the Departmet, I recommed that the Audit Committee (through Iteral Audit) moitor implemetatio of the recommedatios made ad that reports i these areas be made at least aually to the Committee. R14

AUDIT OF HM CUSTOMS AND EXCISE UNDER SECTION 2 OF THE EXCHEQUER AND AUDIT DEPARTMENTS ACT 1921 Part 4 Ladfill tax credit scheme 4.1 This Part of my report examies the operatio of the Ladfill Tax Credit Scheme. Specifically it looks at: How Etrust regulate the scheme (paragraphs 4.9-4.21) Custom's moitorig of Etrust's activities as regulator of the scheme (paragraphs 4.22-4. 25) Moitorig of the impact of the scheme by the Departmet of Eviromet, Trasport ad the Regios (paragraph 4.26) Backgroud 4.2 The Ladfill Tax Regulatios 1996 established Ladfill Tax as the first UK tax with specific evirometal purposes. Waste material is liable to ladfill tax if the producer of the waste iteds to discard or throw it away ad the disposal is by way of ladfill or at a licesed ladfill site. 4.3 The 1996 Regulatios also itroduced the Ladfill tax credit scheme. Figure 3 sets out the admiistrative arragemets for the Ladfill Tax Credit Scheme. It shows that the operatio of the scheme ivolves complex ad ovel relatioships betwee the private ad public sector. 3 The admiistrative arragemets for Ladfill tax ad the Evirometal Bodies Tax Credits Scheme Ladfill Site Operator Calculates Ladfill tax ad credits with et amout paid to Customs Pays cotributios to bodies for projects Cotributios Third Parties Ladfill tax paymets ad credits Reimburse site operators for cotributios to evirometal bodies that caot be offset agaist ladfill tax liability HM Customs ad Excise Collects ladfill tax ad checks that paymets are correct Ivestigates mismatches betwee tax credits claimed ad cotributios made Iformatio Recovers tax credits where ot used i accordace with the scheme Moitors Etrust Etrust Cotributios Evirometal bodies Use cotributios from site operators o approved projects uder the scheme Provides Etrust with audited accouts ad otifies of cotributios Erols evirometal bodies Checks that evirometal bodies have complied with requiremets of the scheme Revokes erolmet of o-compliat Evirometal bodies Iforms Customs mothly of all cotributios to evirometal bodies Iformatio Fees Departmet of the Eviromet, Trasport ad the Regios Overseeig the policy o waste maagemet Source: Natioal Audit Office R15

Waste liable to ladfill tax Waste liable to ladfill tax is divided ito "iert" ad "active" waste. Iert waste icludes soil, brick ad stoe which does ot decay, pollute groudwater or cotamiate lad (as listed i the Ladfill Tax (Qualifyig Material) Order 1996). It is subject to ladfill tax at 2 per toe. Active waste icludes all taxable waste ot listed i the 1996 Order, such as household waste. The stadard rate of tax is 11 per toe which is due to icrease by 1 per aum to 15 per toe i 2004. The tax is payable by licece holders/operators of ladfill sites o each toe of taxable waste they receive. There are some 1500 licesed ladfill sites receivig taxable waste ad 838 operators registered for ladfill tax. I 1999-2000, Customs collected some 430 millio i ladfill tax. 4.4 The Scheme permits ladfill site operators to re-claim cotributios, made to evirometal bodies erolled with Etrust. The cotributio must be used for approved evirometal projects uder the Ladfill Tax Regulatios. Operators of ladfill sites ca claim credits of 90 per cet of the cotributios made, subject to a limit of 20 per cet of Ladfill site operators aual tax liability. The take-up has bee high with site operators claimig back i credits almost all of the ladfill tax they are etitled to uder the Scheme (some 93 millio (provisioal) i 1999-2000). Third parties, icludig local authorities ad govermet agecies, ca make cotributios to the site operator for the 10 per cet of cotributios that the operators are uable to claim i tax credits. A example of how the tax credits ad cotributios are calculated is set out i Figure 4. 4.5 To prevet possible abuse of the Scheme, for example projects gaiig fudig ufairly at the expese of other equally suitable oes, evirometal bodies are precluded uder the Regulatios (ameded i 1999) from applyig their fuds for the beefit of third party cotributors. Site operators are also required to disclose the ame ad addresses of the third party cotributors ad the amouts cotributed. Complex relatioships ca develop o the fudig of schemes (Figure 5). Etrust, the regulator of the Ladfill tax credit scheme recogise that these eed to be carefully moitored to esure that the requiremets of the scheme are complied with. 4 5 Example of the calculatio of the Ladfill tax ad tax credit Ladfill tax payable by Ladfill site operator 100 Ladfill site operator cotributes 20 ad claims tax credits o 90 per cet of the amout cotributed 18 Net ladfill tax paid to Customs by site operator 82 The et cost to the ladfill site operator of cotributig to the evirometal body The cotributio to the evirometal body 20 Less Ladfill tax credit 18 Net cost of cotributio to ladfill operator 2 Third party cotributio may be made to Ladfill tax operator represetig 10 per cet of the amout paid to the evirometal 2 body Net cost of cotributio to ladfill site operator 0 Source: Natioal Audit Office Case Study Normato Library ad Evirometal Cetre Ladfill tax credits of 300,000 are beig used to fud a evirometal cetre that will form a extesio to a buildig curretly i use as a commuity hall ad sports cetre i Normato, ear Wakefield i South Yorkshire. The project is beig implemeted by a evirometal body called Groudwork Wakefield Trust Limited, ad Wakefield Metropolita District Coucil (MDC) are fudig the refurbishmet of the existig buildigs which will become a library as part of the scheme. The cotributios which are fudig this project were origially made available by Yorkshire Water who passed the fuds to Yorkshire Evirometal Trust. The latter made the iitial commitmet to fiace the project i 1998. Whe Yorkshire Water was sold to Global Evirometal Limited i 1998 the fudig was trasferred to a Evirometal Body who committed themselves to the project. I tur, Global Evirometal Limited's sale of its ladfill operatios to Waste Recyclig Group has see the fudig trasferred to a third evirometal body, Waste Recyclig Evirometal. Wakefield MDC has ivited five cotractors, icludig Wakefield Public Services Departmet, to teder for the costructio work. The regulatios oly allow cotributig third parties such as Wakefield MDC to bid for costructio work providig the cotract is awarded by ope teder. If this was ot the case, the third parties could gai a ufair competitive advatage by providig partial fudig for evirometal projects. The regulator, Etrust, a compay limited by guaratee, ad appoited by Customs ad Excise erols Evirometal Bodies ad checks they are complyig with regulatios ad that projects are eligible for ladfill tax credits. They have decided that this scheme falls withi the rules that curretly operate. Source: Natioal Audit Office R16 4.6 Idividual site operators ad/or evirometal bodies decide o the type of projects that should receive fudig uder the scheme. Because the cotributios are made by private sector compaies to schemes operated by evirometal bodies the tax credits are ot classified by govermet as public expediture. Some 1,050 evirometal bodies (less tha oe half of all bodies) have received cotributios from site operators for aroud 3,700 projects. Bodies may receive o fudig if the projects they propose are upopular with site operators or are cosidered ulikely to provide worthwhile beefits. 4.7 It is up to site operators ad/or evirometal bodies to decide whether idividual projects represet value for moey icludig where appropriate by awardig cotracts for projects by ope teder ad for cotrollig admiistratio costs. Etrusts' data shows that the admiistratio costs of evirometal bodies average aroud ie per cet of total expediture. 4.8 From the start of the Scheme i 1996 to August 2000 evirometal bodies have received total cotributios from site operators of 285 millio of which 135 millio or 47 per cet has bee spet o projects. The mai reaso for the differece is that evirometal bodies have committed fuds to projects but have ot yet icurred the expediture. Where evirometal

bodies are holdig fuds Etrust, the regulator of the Scheme, expects them to commit these cotributios to projects withi two years after receipt, although this is ot specified uder the Ladfill Tax Regulatios. Ay bak iterest eared o the fuds also has to be spet o activities i accordace with the Credit Scheme. 6 The backgroud of Etrust s Board of Directors Waste maagemet idustry 3 Local authorities 2 Evirometal groups 3 The role of Etrust i regulatig the Ladfill Tax Credit Scheme 4.9 Etrust is the body resposible for regulatig the Ladfill Tax Credits Scheme. They erol evirometal bodies i the scheme ad moitor their expediture ad activities to esure that they act withi the rules of the scheme. To carry out its resposibilities Etrust has 26 staff operatig i four regios of the UK, Norther; Cetral; Wales ad West, ad Souther. I 1999-2000 their ruig costs were 1.3 millio, which was fuded by chargig evirometal bodies a erolmet fee of 100 ad two per cet of all cotributios they received. 4.10 As a private sector compay limited by guaratee, Etrust have a Board of Directors that has icreased from 9 to 13 members. Uder Customs' Terms of Approval with Etrust at least oe ad ot more tha three Board members should possess direct experiece ad kowledge of the waste maagemet idustry; local authorities; evirometal groups; fiace/accoutacy; academia, idustry geerally ad the legal professio. 4.11 While idividuals with a backgroud i the waste maagemet idustry form a large group o the Board they do ot have a majority (Figure 6). There is a risk, however, that the decisios of the Board o the regulatio of the scheme could be iflueced uduly i favour of site operators by such a large groupig, especially as the waste maagemet idustry provides the fuds to the scheme. This could lead to bias, eve uitetioal, agaist certai types of schemes or evirometal bodies. Customs cosider that they would otice if this risk occurred because seior officials atted the Board meetigs o a regular basis as observers. They also cosider that the recet appoitmet of four directors (reflected i Figure 6) with backgrouds i sectors other tha the waste maagemet idustry should help to reduce this risk. 4.12 Etrust's staff ad their cotractor Lodge Service make compliace visits to evirometal bodies which look at the structural, fiacial ad project compliace of the body. The evirometal bodies are selected for visits o the basis of a risk assessmet carried out by Etrust. I 1999-2000 Etrust ad Lodge Service visited some 420 evirometal bodies of which aroud oe third were foud to be fully compliat with the requiremets of the Regulatios (Figure 7). Academics 1 Lawyer 1 Accoutat 1 Idustry geerally 1 Note: Source: The Chairma of Etrust is ot icluded i the data above. Lord Crabrook who was appoited the Chairma i 1996 has experiece ad kowledge of both the waste maagemet idustry ad evirometal orgaisatios. Etrust 7 The result of Etrust's compliace visits to evirometal bodies 8 Number of Evirometal Bodies 140 120 100 80 60 40 20 Source: 0 137 100 98 96 90-99 Natioal Audit Office aalysis 80-89 70-79 Compliace score (%) 60-69 The iformatio evirometal bodies should provide to Etrust <60 Notificatio of cotributios received withi 7 days so that they ca be matched to tax credits. This iformatio is passed to Customs to eable them to carry out their checks o site operators claimig tax credits Audited aual accouts Certificate by auditor body complies with scheme Iformatio o fudig received ad fudig expeded Source: Etrust 4.13 The mai reaso why bodies failed to comply was because they did ot provide Etrust with iformatio required uder the Regulatios (see Figure 8). The iformatio allows Etrust to moitor regularly whether these bodies are complyig with the requiremets of the Scheme. 49 23 18 R17