UK freeports plan raises illicit trade fears

Sergio Souza, Unsplash

The UK government has promised that a plan to create eight freeports with low-tax zones will boost the post-Brexit economy, but has also sparked fears that they could allow flows of illicit trade into the country.

The designated free-trade zones (FTZs) – due to be created at Felixstowe/Harwich, Liverpool, Hull, Southampton, London Gateway, Plymouth, Teesside and East Midlands airport – will attract investment and job creation in some hard-hit areas of the country, say backers of the proposal, headed by Chancellor Rishi Sunak.

Goods can be landed, stored, handled, manufactured or reconfigured and re-exported at freeports without being subjected to customs tariffs. In addition, companies operating inside the sites will be offered temporary tax breaks, mostly lasting five years.

In the other camp are those who point to the experience with FTZs in other parts of the world in facilitating the trade in things like counterfeit goods and drug trafficking.

In 2018, a report by the Organisation for Economic Co-Operation and Development (OECD) and the EU Intellectual Property Office found that FTZs were linked to a 5.9 per cent rise in the value of counterfeit goods exported from hosting countries.

“These results confirm the anecdotal evidence pointing to the misuse of FTZs to conduct illicit trade, and they should be a prompt for future actions,” it concluded.

Since then, the EU has started to pay more attention to the activities of the 82 FTZs within its borders post-Brexit, launching new rules to crack down on what the European Commission says is a “high incidence of corruption, tax evasion, [and] criminal activity.”

The UK government reckons it can move ahead with its freeport plan without the risk of stimulating illicit trade, based in part on the findings of a report published last year by independent research body the Royal United Services Institute for Defence and Security Studies (RUSI).

That study acknowledges the evidence of criminal activity taking place at freeports around the world, saying it most commonly takes the form of counterfeit goods, drug trafficking, smuggling of untaxed goods or trade-based money laundering.

Those dangers may be mitigated, it says, through careful risk assessment at each geographical location where freeports are established, making sure crime prevention measures are proportional to those risks, and close vetting of businesses wishing to operate in them.

The freeport operators should also be regularly placed under scrutiny to assess their effectiveness in “discharging their security-related responsibilities,” and recommendations laid out by the OECD should also be adhered to.

The latter includes making sure the authorities have access to goods and related documentation, ideally digital, in addition to screening of businesses operating in the FTZ.

In its notice for the tender for freeport operators published last November, the government says operators “must adhere to the OECD code of conduct…and the specific anti-illicit trade and security measures therein,” as well as the UK’s obligations on money laundering, terrorist funding and transparent transfer of funds.

RUSI’s research has shown that a lack of oversight in freeports provides opportunities “to manufacture, assemble, tranship, relabel and repackage illegal goods, including counterfeit medicines, electronics and fashion items.”

It also notes that ‘leakage’ is common, where goods are smuggled from a freeport into a host economy, thus avoiding relevant checks on health and safety standards, import taxes and VAT.

At least seven freeports operated in the UK between 1984 and 2012, when the government stopped renewing freeport licenses and switched its attention to “enterprise zones”, which also provide tax breaks in a bid to encourage industrial growth and community regeneration.

RUSI notes that the US does seem to be able to operate FTZs without increasing the risk of illicit trade, and says it is “reassuring that, for some parts of government at least, tackling economic crime remains top of the agenda.

Critics of the UK plan, including the opposition Labour Party, think there are other downsides as well.

One viewpoint is that rather than growing the economy, the freeports will simply move it around the country, benefitting deprived areas but providing no net gain overall.

Some also argue that the net result will be even worse – a reduction in tax contributions from industry to the treasury – with businesses elsewhere undercut by those operating within freeport. Others meanwhile are concerned that the rights of people working within the FTZs will be diluted.

“If the government thinks freeports are a magic bullet that will create hundreds of thousands of new jobs, bring billions of additional pounds to the Exchequer and radically transform an area it is mistaken,” according to Professor Catherine Barnard, deputy director of UK in a Changing Europe.

“That is not to say they should not be created but the thought they’re going to transform the wealth and prosperity of this country is simply untrue. It will help the regions that get a freeport – but possibly to the detriment of those that don’t.”

Source: Securing Industry, Phil Taylor, 10 March 2021

WCO – Free Zones and the Necessity for Enhanced Customs Involvement

Coega SEZ, South Africa

The expansion of Free Zones has been mainly driven by political decisions closely affiliated with national economic development strategies. In some countries Customs is the primary governmental authority that regulates and governs Free Zones, while in others Free Zones are governed by other authorities, with less involvement from Customs. Depending on the institutional set-up, the scope and degree of Customs control in Free Zones and the economic operations carried out there varies considerably from one Free Zone to another. 

Existing literature reveals that Free Zones attract not only legitimate business but also illicit trade or other illicit activities that take advantage of the regulatory exemptions of Free Zones. 

Numerous papers have outlined the risks associated with Free Zones, along with economic benefits. Most of them deal with the legality of Free Zones policies, particularly in relation to export subsidies as governed by the WTO Agreement. Several other papers have dealt with illicit activities that have been perpetrated by exploiting characteristics of Free Zones. Such illicit activities include money laundering, tax-evasion and trade in counterfeit goods or other illicit goods. 

The WCO research paper deals with Customs-related aspects of Free Zones, considering both the associated benefits and risks. The risks primarily concern illicit trade that exploits key aspects of Free Zones. 

Literature that focuses on risks associated with Free Zones, particularly illicit trade or other illicit activities, have several things in common. They tend to highlight the fact that supervision over cargoes/companies in Free Zones is somewhat relaxed in comparison with other parts of the national territory. The following factors have been pointed out or quoted, although details are rarely provided due to the technical nature of the topic. 

  • Relaxed controls inside Free Zones 
  • Insufficient Customs’ involvement in the operation of Free Zones 
  • Ease in setting up companies inside Free Zones 
  • Insufficient integration of Information Technology(IT) systems by governmental agencies inside Free Zones 

The WCO research paper’s key observations fall in line with those outlined above. It describes the low-level involvement of Customs in monitoring cargo movement and companies’ activities inside Free Zones. This includes Customs’ low-level involvement at the establishment phase of Free Zones, at the approving companies permitted to operate in Free Zones pahse, and during the day-to-day monitoring of cargoes in Free Zones. Limited Customs’ authority inside Free Zones is also mentioned. This paper touches upon relaxed Customs procedures/controls related to Free Zones and observes that they stem from Customs’ limited involvement and limited authority inside Free Zones. These limitations, combined with insufficient integration and utilization of IT, result in a lack of the requisite data concerning cargoes inside Free Zones, and render Customs’ risk-management-based controls – conducted for the purpose of preserving security and compliance without hindering legitimate cargo flows – virtually useless. 

The research paper considers the concept of ‘extraterritoriality’ concerning Free Zones, stemming from a misinterpretation of the definition of Free Zones contained in the WCO Revised Kyoto Convention (RKC), to be behind the aforementioned limited involvement by and limited authority of Customs. The definition within Annex D, Chapter 2 of the RKC does not state that Free Zones are geographically outside the Customs territory. The definition means that the Free Zone itself falls within the Customs territory. ‘Goods’ located in Free Zones are considered as being outside the Customs territory for duty/tax purposes only. 

WCO Research Paper No. 47 – ‘Extraterritoriality’ of Free Zones: The Necessity for Enhanced Customs Involvement

Source: WCO, Kenji Omi, September, 2019