10. The due diligence condition – (Taken from Excise Notice 196)
10.1 General information
Due diligence is the appropriate reasonable care a company exercises when entering into business relations or contracts with other companies, and how it responds in a deliberate reflexive manner to trading risks identified.
Without effective safeguards in place, there are considerable risks to all businesses along alcohol supply chains of becoming implicated in illicit trading.
This condition requires that all excise registered businesses operating in the alcohol sector consider the risk of excise duty evasion as well as any commercial and other risks when they are trading. Doing so will help to drive illicit trading out of alcohol supply chains and reduce the risk to businesses of financial liabilities associated with goods on which duty has been evaded.
From 1 November 2014 it became a condition of your approval as an excise warehousekeeper, registered owner, duty representative or registered consignor that you must:
- objectively assess the risks of alcohol duty fraud within the supply chains in which you operate
- put in place reasonable and proportionate checks, in your day-to-day trading, to identify transactions that may lead to fraud or involve goods on which duty may have been evaded
- have procedures in place to take timely and effective mitigating action where a risk of fraud is identified
- document the checks you intend to carry out and have appropriate management governance in place to make sure that these are, and continue to be, carried out as intended
10.2 Assessing risks and carrying out checks
The fraud risks within a supply chain are unique to each business, and objective assessment of the likelihood of your trading activities contributing to fraud is an essential first step to developing effective due diligence procedures. You need to consider the full range of trading relationships you have established and the potential for fraud in each.
The main risks within the alcohol sector include:
- involvement in the supply of goods for fraud
- receiving goods that have been smuggled or diverted into the UK
- inadvertently facilitating fraud by providing import or warehousing services
A key feature of the smuggling or diversion of alcohol to the UK market is the ability to source product either where the excise duty has been suspended or it has been refunded under drawback provisions. To assess your exposure to this risk, you need to objectively assess if there is potential for duty evasion resulting from your trading activity. You need to know who you’re selling to and where the goods are destined for and understand the market for these products. Without this, there is a risk of supplying goods directly or through a third party into illicit supply chains.
Import and warehousing procedures are often exploited to provide cover for the illicit movement of goods. Fraudsters will seek to distribute duty evaded goods as well as counterfeit alcohol into legitimate retail supply chains. To assess your exposure to this risk, you need to objectively consider if the supply chain and trading activity is credible, which includes knowing who you source goods from and provide a service to.
High level indicators of risk include goods being received from unusually complex or apparently uneconomic supply routes, for example, regular supplies of UK produced goods that have been exported from the UK and then re-imported. If you’re sourcing duty paid goods, you need to consider the credibility of suppliers and the level of evidence you can get to demonstrate the provenance and duty status of goods.
For information about risk indicators read paragraph 10.5.
Once you have established the main risks of fraud you may be exposed to, your regular checks during trading should be of a type and level sufficient to establish the integrity of the excise transactions and supply chains you’re trading in. This level needs to be reasonable and proportionate to the risk.
Depending on the nature of your business and complexity of your transactions, checks will need to be individually tailored. In particular, they must be sufficiently sensitive, yet robust enough, to pick up potential fraud risks. These checks should provide protection from the threat of fraud or you becoming inadvertently involved in fraudulent activity.
As a general rule ‘FITTED’ checks should normally focus on:
- financial health of the company you intend trading with
- identity of the business you intend trading with
- terms of any contracts, payment and credit agreements
- transport details of the movement of the goods involved (if you’re directly involved in this)
- existence or provenance of goods — where goods are said to be duty paid you should normally seek sufficient detail to satisfy yourself of the status of the goods
- the deal, understanding the nature of the transaction itself, including:
- how the cost of the goods is built up, for example, if it includes appropriate taxes, transport and the likes
- why is it being offered
- if it’s too good to be true
- how the deal compares to the market generally
For more examples read paragraph 10.6.
10.3 Responses to identified risks
It’s expected that your due diligence procedures will provide effective control over the risks of fraud within your supply chains. Where your checks indicated real concerns, we would normally expect aspects of your supply chain to be changed to address this, for example, the supplier or the destination of the goods. However, if you should trade with another party remains a commercial decision for your business to take.
If your checks lead you to suspect duty fraud you should report this to HMRC.
10.4 Review of due diligence procedures
As part of our enforcement and general audit programmes, we will consider if the steps you have taken to embed anti-fraud due diligence into your trading activity are sufficient and timely to address fraud risks in your supply chains. We will aim to establish if you have objectively assessed the risks in your supply chain, and you must be able to demonstrate that you have put in place reasonable and proportionate checks and effective procedures to respond to fraud risks when they arise.
If your due diligence procedures are considered insufficient to address fraud risks, we will carefully consider the facts of the case before taking further action, but where appropriate we will seek to support you to strengthen your procedures.
In more serious cases such as a failure to consider the risks, undertake due diligence checks or respond to clear indications of fraud, we will apply appropriate and proportionate sanctions. For serious non-compliance, such as ignoring warnings or knowingly entering into high-risk transactions, we may revoke excise approvals and licences.
You’re also reminded that handling goods liable to excise duty held outside a duty suspension arrangement may cause you to become liable for any excise duty due on those goods and an excise wrongdoing penalty. Any of those goods you currently hold could also be liable to forfeiture.
For information about risk indicators and checks that you may carry out to identify high risk transactions, read paragraphs 10.5 and 10.6. These are not intended to be prescriptive or exhaustive.
Once you have established the most appropriate due diligence tests for your business, these should be used to test both new and existing transactions and supply chains linked to your business. Some checks may be more appropriate to your business than others.
10.5 Examples of due diligence risk indicators
You should be concerned about a prospective transaction where you identify one or more of the following indicators in both suppliers and customers, the presence of which may lead you to make further inquiries. This list is not exhaustive:
The following are examples and are not a full list.
Financial health of the company you intend trading with
There is no, or poor, credit rating but it’s still able to finance substantial deals.
There are high levels of debt.
They are:
- buying high value goods on extended credit
- a new company with little or no trading history
There are little or no fixed assets.
Identity of the business
There is a lack of detail about the business’ identity (for example, no address details or HMRC approval number).
They do not appear to be on Companies House records as originally described.
They are dealing in high value goods from short term lease accommodation or residential addresses.
There is no general visibility of the company you intend trading with (for example, they do not appear to advertise or have a website).
They have returned only partly completed application or trading forms.
If you’re a warehousekeeper, receiving duty suspension goods on behalf of a third party who is not WOWGR registered where they would otherwise be required to be registered.
Terms of contract, payment and credit agreements
An insistence on dealing in cash, especially where the deal is a high value one.
Cash payments made using money couriers.
Offers of credit appear to be outside normal business practice — payment terms are normally 21, 31 or 45 days but high-risk transactions may have short payment terms (for example, 48 hours).
You’re asked to make payment to an account or person which does not appear to be linked to the seller, or other unusual payment arrangements requested by the seller — the same applies to customers.
A valid pro-forma or purchase invoice is not or will not be provided.
The circumstances of the trading arrangement seem false or contrive (for example, a supplier provides you with the details of a customer for the goods they are selling to you, or offers you a contract with no financial loss to you).
Transport
The goods are to be received from an unusual source or supply route, for example, UK produced goods are sourced from another country and directly compete with those from a more direct supply route.
Existence or provenance of goods
The goods are claimed to be duty paid but your supplier (or person on whose behalf you’re storing the goods) cannot provide reasonable evidence of duty payment to support the status of the goods (find out more about what constitutes evidence of duty payment in Excise Notice 207: excise duty drawback).
Individuals in the company have little knowledge of your trade sector.
Where samples are provided or the goods have been received:
- for spirits there is no duty stamp in circumstances where there should be one or the duty stamp does not fluoresce
- the goods appear counterfeit, in that, the quality of labels and or packaging is poor when compared to the genuine article
- the supporting paperwork seems false
- the goods are older than supporting evidence (such as documents demonstrating duty payment) suggest, for example, the best before dates indicate an earlier production date whereas documentation gives the impression you were buying newer stock
The company has only been trading for a very short period of time but has managed to achieve a large income in that short period of time.
The deal
Customer demand for specific brands in other countries exceeds expected levels of consumption there.
The goods are to be moved in an unusual supply route that in itself would add significant logistic costs and bring into question the economics of that trade (unless duty was to be evaded).
Supplies are offered through unsolicited emails or flyers received out of the blue.
Goods are offered at incredibly low prices which seem too good to be true.
Free gifts of similar or other excise goods not fully documented and in themselves would place a question over the deal as a whole.
There are other incentives such as contingency discounts which overall make the deal sound too good to be true.
10.6 Examples of due diligence checks
Financial health
To conduct a financial health check, you must:
- get and undertake credit checks or other background checks on the business you intend on trading with
- where a poor credit rating is identified, establish how the transactions will be funded and what security is offered that you’ll be paid
- where credit is offered by the business and who is providing the credit facility
- what payment terms are offered and if they are commercially viable
Identity
Check company details provided to you against other sources (for example, website, letterheads and telephone directories).
Ask if your customer or supplier is a member of a relevant trade association.
Get copies of certificates of incorporation, VAT registration certificates and excise registration certificates (where appropriate) and where a trade class is quoted on these, check if it relates to the type of trade you’re engaging in.
Verify VAT and excise registration details with us (we recommend that these checks are undertaken regularly for new trading arrangements and proportionately longer for trusted ones, unless you suspect a problem).
If you’re a warehousekeeper receiving duty-suspended goods into your warehouse then you should be satisfied that the owner of the goods is registered under WOWGR where required.
Get signed letters of introduction on headed letter paper and references from other customers or suppliers.
Insist on personal contact with a senior official of the prospective supplier and where necessary, make an initial visit to their premises — you should use this opportunity to confirm the identity of the person you intend doing business with and keep a record of your meeting.
Establish what your customer’s or supplier’s history in the trade is.
Get the prospective customer’s or supplier’s bank details — in the case of an import or export, check if the supplier or recipient share the same country of residence as their bank.
Establish who you’ll be paying and if this is the same company as the one you’re directly dealing with.
Check if you’re providing a service and if so, who will pay for it.
Terms of any contracts, payments and credit agreements
Carefully consider the terms of any contracts and credit agreements before entering into these and challenge elements which appear unusual.
Check what recourse there is if the goods are not as described.
If payment is to be made to or from a third party check if:
- there’s a sound commercial reason for this
- it’s to or from an offshore account
Check if there are normal commercial arrangements in place for the financing of the goods.
Where payment is made from an overseas business, check how it should be made.
Check if your supplier:
- referred you to a customer who’s willing to buy goods of the same quantity and brand as being offered by the supplier
- offers deals that carry no commercial risk for you, for example, no requirement to pay for goods until the payment is received
Confirm the goods are adequately insured.
Check if there are high value deals offered with no formal contractual arrangements.
Confirm where you’re buying from a broker and:
- what value this link in the supply chain adds
- if it’s possible to source more directly
- how competitive the broker’s pricing is to those from a more direct route
- how the savings are made in a longer supply chain to make it viable
- check where transactions are being financed by a third party and if this person is a regulated financial body, such as a bank
Transport
Establish where the goods will be sourced from, including:
- the country of production
- why the goods are being routed in this way
Check who is responsible for the transport including:
- if the cost of the goods are inclusive of transport
- if the potential logistical costs make the unit price unrealistic
- retaining details of delivery vehicles and any expected variations to recorded transport arrangements
Existence or provenance
Check:
- how the trader contacted you
- if the goods exist
- if you can inspect the goods before purchasing them
- if the goods are in good condition and not damaged
- if the quantities on offer seem credible for the type of business you intend to trade with
- where goods are said to be duty paid and seek sufficient detail to satisfy yourself that they are — this will be easier the closer you’re in the supply chain to production and is especially important where you intend on holding goods on behalf of a third party
The deal
Check the nature of the transaction, including:
- the credibility of it
- the demand for the type of alcohol — if the demand is mainly from abroad, check the real market (consumption) for it in that country
- if, how and why the alcohol has come from abroad but is of UK origin
- if incentives are offered, when are these taken into consideration and if this makes the overall deal seem too good to be true
- the reason for the offer
- if normal commercial practices have been adopted in negotiating prices
- how the price competes with that offered by competitors
- the age of the goods — if the stock is old, you should seek an explanation as to its provenance
- if the price seems realistic — you should be aware of unit cost when duty and VAT values are removed
If you’re already established in a trading agreement, we’d recommend you continue to monitor correspondence and business paperwork, to identify changes in those arrangements and take any follow up action as necessary.
