Listening to the retailers association, the RCMP and Imperial Tobacco crying the blues over black-market tobacco is like listening to the cheating husband, his mistress and the wife lamenting over getting too much sex, not enough sex, and not wanting sex.

The first is crying wolf as they benefit from the problem, the second is crying about not getting enough when they aren’t doing anything to advance their cause, and the third is crying foul when they are possibly the source of the problem.

In every province except Quebec, there is an electronic program available to the government to not only monitor tobacco purchases on reserves, but to police off-reserve individuals and make sure they don’t get access to exemptions on tobacco that they are not legally entitled to.

You see, black-market tobacco is not the only problem.  There is also the issue of tax exempt tobacco, legally obtained for the purpose of resale on reserve, and then being sold illegally to off-reserve purchasers. This adds another $1.5 billion in fraud to the $2 billion already mentioned.

Every province employs a system for managing tobacco on reserves. Only one province even comes close to getting it right, but they do a pathetic job of it nonetheless.

In BC, it is done through a quota system in which every individual on reserves between the ages of 5 and 100 is eligible to receive 8 cartons of cigarettes per month, with the total number of available cartons delivered to the reserve, and then a claw-back instituted on anything not deemed a First Nations purchase.  Of course, there is absolutely no way to track this other than the 16 year old clerk making 10 bucks an hour who records a status card number, writes down what the individual bought, and has that individual sign off.  This is monitored by the same young clerks week in and week out as they diligently and religiously ensure that no individual exceeds their quota. Then they take all that personal information, with signatures, and submit it back to the BC government, who then decides whether they exceeded their quota, or not, and provides an exemption cheque, or not, to the retailer.

Really secure.

In Alberta, through the issuance of a “white-card”, each First Nations member is entitled to 8 cartons per month and no more than a couple of cartons a week within that monthly quota.  This is enforced by a star configuration server system, which is polled nightly and the next day updated to each retail site on reserve for quota limits, new recipients, and canceled cards.  Sounds good eh?

The process otherwise is the same as in BC at the retailer level, except instead of taking a status number, the individual presents their White Card to the clerk, who scans or swipes it at the point of sale, which then informs the clerk of whether this is a valid purchaser or not, and whether they are over limit or not.  Once this is ascertained, the clerk completes the transaction and has the First Nations member sign off on the receipt.

The only problem with this system is that it is a batch-based polling system, which means that there is a 48 hour to 72 hour gap in the updating process, which is why the White Card retails on the black-market for around $200.00.  A First Nations member in need of a quick cash fix sells the card, reports the card stolen, gets a new card immediately from the retailer, and the person who bought the card has a few days to use it for tax-free tobacco and fuel, and this doesn’t speak to friends off-reserve who the First Nations member might feel inclined to help out.

Believe it or not, this is the best system in the nation today on a province by province comparison.

In Saskatchewan, the system is almost identical to Alberta’s, except there they use the status card number.  In fact, the problem with the status card is often that the consumer just leaves his or her card at the gas-bar for convenience sake.  So now the retailer has a couple hundred cards sitting under the counter, and in walks an off-reserve purchaser.  What do you think the retailer does?  He sells at full cost and then uses one of the cards under the counter for the tax rebate.

In Manitoba, the system is a bulk purchase by the reserve, based on pre-defined limits based on population similar to BC’s model, but with even less control.

Ontario has no system for tobacco, except to prohibit sales of tax-out tobacco off reserve.  You drive onto the reserve, you buy, you drive off.  On a slow day there might be an OPP waiting just outside the reserve to bust you.  The charge is smuggling, by the way.  When you buy on reserve, unless it is a premium brand, you failed to pay the tax, and therefore are smuggling.

In Quebec, it’s pretty much the same as Ontario.  In the Maritimes, it works just like BC.

None of this would actually be a big problem, as most reserves are a bit of a pain for the average Joe or Jane to drive out to, but with the advent of urban reserves in major cities, it’s a serious issue.  Millions of dollars are being lost in tax revenue, and access to an urban reserve is easy for Joe and Jane, so they will make the effort.

Most of the illegal premium tobacco is coming from Puerto Rican manufactures, owned and operated by organizations such as Imperial Tobacco.  You got it, the ones screaming are obviously part of the problem.

They used to manufacture it in the States, but Phillips and Imperial got nicked doing that.

So what’s the cause of the issue? Well there are many probable points of failure in the existing programs. Here are just a few examples:

Primary subjects should be properly identified and controlled.  The following highlight some of the specific situations one must eliminate from the equation:

- Identification of qualifying individuals using effective and secure status cards
- Validation and enforcement to eliminate non-qualifying individuals for each product purchase
- Validation and auditing of retailers and wholesalers to avoid unlawful tax-free product distributions
- Create a minimum dependency on retailers and wholesalers through automation of the data collection and verification of eligible users of the program
- Minimum dependency on POS functions and POS companies.  Each device deployed at the retail level must ultimately be controlled by the government, and of robust enough design to facilitate upgrades and modifications virtually on demand.

Without the control measures, the abuse and misuse results in the previously mentioned chain of events:

- Non-qualifying individuals benefiting from tax -free items
- Individuals purchase and redistribute tax free items as a revenue source
- Retailers and wholesalers benefit from a larger volume of product distribution in addition to guaranteed tax rebates

Bluntly put, the elimination of the human element at the point of transaction is the only way to begin to control the situation.  To assume people will not abuse a system is to virtually ignore human nature as a whole.

One cannot eliminate all abuse.  No matter how well the mouse trap is designed, there will always be someone capable of beating it.  One might say it is a condition of human nature to find a way to overcome, and if the value is there for the effort, they will.

A government does, however, have the ability to make it so difficult that only a select few will find a value in attempting to end-run the system, and the control measures can be designed to be significant enough that those individuals are easily identified.

Essentially the pay-out becomes so insignificant compared to the cost of achieving it that only the most sophisticated will attempt to rip the system off.  That select few would have been a problem regardless. The government just makes it harder for them.

Non-qualified First Nations members may purchase tobacco or fuel while on reserve and obtain the exemption. The retailer is not in the business of tax policy enforcement (nor do they receive any benefit by doing so), and is the primary beneficiary of the sale. Thus, the retailer is subject to audit in questionable circumstances, such as invalid tax exemption activity.

Experience shows us that in the initial Nova Scotia deployment of its NSIFTE program (Nova Scotia Indian Fuel Tax Exemption Program), as well as in years of Alberta ITE implementation, manual card entry and transferring of the card number usage is frequently a target for abuse.

The typical retail business deals with up to 15% (or more) cashier associated abuse, theft and fraud.  This would result in illegal product distribution and tax loss.  Tobacco and fuel are typically the highest target products that might be subject to theft. The cashier is also the conventional manual purchase validation point, which must be deemed unreliable and ineffective.

At a minimum, the cashier will gain better job security and indirectly benefit from profiting retailers, and at a maximum, could be competent in committing electronic or other means of sophisticated fraud.

Because the retailer is the direct receiver and primary beneficiary of the tax rebate, minimum dependency and maximum allowable control should be put in place to effectively prevent possible abuse and fraud.  There is practically no money for an independent in fuel sales for example, and the temptation to commit fraud is strong as a result.

As previously mentioned, selling products is the primary business and interest of the retailer. In addition to conventional methods of carrying invalid tax exemption sales and/or misreporting of tax exemption sales and purchases, some retailers could also gain benefits from black market distribution.  These black market activities range from smaller scale “wholesaling” to high volume bulk “distribution”.

There are sophisticated fraud cases, which can range from something as simple as making bulk volume false claims, to situations as complex as electronic fraud. Any individual with minimal knowledge and some experience in the business can easily achieve both methods of fraud under the existing design of the SITE and AITE programs, and the other provinces manual programs have holes you can drive a truck through.

With defective designs, over time, these cases will continue to grow. Such cases are hard to catch, extremely costly, and impossible to prosecute.

There are reported occurrences of truckers stealing from either the retailer or wholesalers, or both. Lack of information collection makes it difficult to track this theft.

Fuel deliveries for example, are subject 5% tare lost.  However, new technologies are hitting the market which help reduce this number.  The dilemma is that they are horribly expensive, and out of reach for most retailers.  Typically, only major players in gas retailer environments can afford the cost, and understand it in relation to their bottom line.

Like the retailer, the wholesaler is not in the law enforcement business, and their primary interest is to sell products. They are typically off reserve and are closely controlled and audited by the government.  There may a temptation for smaller players who have at least tacit knowledge of occurrences on reserve (at least the known documented occurrences in relation to their business), to take advantage of the systems in place. Gaining control at the wholesaler level also indirectly controls the retailer by restricting some product availability.

Every police enforcement agency will tell you the number one crime in terms of complexity for prosecution purposes is fraud.

The reality is that our society has the means and technologies to prevent fraud and abuse of Tobacco.  We have the ability to seriously inhibit the distribution of illegal tobacco, and we are doing exactly squat to try and implement any significant change.

$3.5 billion to $4 billion in tax revenue is lost because of illegal sales of both illegal and legal tobacco per annum.  That’s a serious chunk of change, but it is still fitting into the individual provincial governments risk management numbers.  As long as they do not exceed those numbers, they figure everything is fine.

Of course, you and I as taxpayers get screwed in the deal, and because they (being governments) are not will to use modern day technologies to enforce the law, they essentially abdicate the responsibility they have to the public purse.

Governments believe that if you have information, you have control.  This is a false assumption, because you must have an enforcement mechanism as well.  So really it means that information, coupled with legislation, provides enforcement, which is control.

When you add in the division of responsibility between the provinces and the federal government, you end up with practically no information (most provinces couldn’t supply you with an accurate list of First Nations members if they tried), and zero accountability. Not my province’s problem, say the feds.  Not our problem, says your provincial government.

A simple, uniform swipe card with a biometric component, such as a fingerprint, would eliminate the $1.5 billion dollars per annum in fraud overnight, at a cost of perhaps $45 million in the first year.

The first part, the identity card, has been on the table and tested in various populations since 1998 starting with Treaty 7 in Alberta.  13 years later and less than 20% of First Nations members have it, and you would crap your pants at what the feds pay for a simple 2D barcoded swipecard that goes for $2.50 in the open marketplace.

Now go find your MLA, MPP, or whoever, and bitch about this, because if you think this is upsetting, you’ll cry in your beer when I tell you about the holes in the health care system and how they represent close to $30 Billion in lost taxpayers money every year simply because of the fundamental design flaws in the provincial systems, and that they could be fixed for less than $1 billion in upfront costs.

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Tags: black market tobacco, cigarettes, fraud

This entry was posted on Sunday, November 22nd, 2009 at 10:02 pm and is filed under Crime, Federal Election. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.