Practical Considerations for Implementing Tax Stamp and Traceability Systems

Over the years, the business case for using tax stamps has increased considerably, in tandem with the emergence of new technologies and best practices for managing excise and other goods that require robust supply chain controls.

But, in order to take advantage of these best practices, a tax stamp programme should conform to several parameters that render it more effective and feature-rich and that ensure it complies with international obligations.

With these requirements in mind, this article looks at the steps involved in analysing, planning, designing, building, and implementing modern tax stamp and traceability programmes.

Phase 1: analyse and plan

The first phase of implementing a tax stamp and traceability programme involves analysing the existing environment to quantify the current situation and identify gaps and opportunities for improvement. This is called environmental scanning. A plan for delivery is also typically part of this critical foundational phase.

This is perhaps the most important phase of any project, as to first understand the nature of the environment and the reasons for commencing with the effort in the first place is essential. Indeed, many programmes (including tax stamp programmes) have failed because of poor planning and analysis.

The typical activities involved in environmental scanning are:

• Illicit trade study and data analysis – illicit trade can manifest in various forms, depending on factors such as the local production environment for both raw materials and finished goods, geography (eg. landlocked countries), price points, and taxation rates.

The various types of illicit trade include, inter alia: smuggling across borders; export, free-trade zone and transit trade; undeclared production; and counterfeit and low-cost, unbranded products destined for illicit markets.

A critical concept to understand during the planning and analysis phase is that each form of illicit trade has somewhat different implications for tax administration and enforcement, including different requirements for tax stamps and track and trace systems.

In its guidebook, ‘FCTC Protocol to Eliminate Illicit Trade in Tobacco Products – Guidebook on Implementing Article 8: Tracking & Tracing’, the Framework Convention Alliance advises that assessing the size and prevalence of illicit trade is a relatively specialised field, and countries may benefit from securing the services of independent institutions which have refined a range of methodologies, and whose work is peer reviewed. One such institution is the FCTC Knowledge Hub on illicit trade based at the University of Cape Town’s Economics of Tobacco Control Project. Private studies, particularly those funded by the industry itself should not be used as the sole basis for quantifying the illicit market.

• Revenue/excise capability assessment – this focuses on understanding the human resource aspects (‘People’), procedural aspects (‘Process’), and tools (‘Technology’) used by excise management authorities in carrying out their day-to-day duties (referred to as PPT analysis).

Coupled with data analysis, PPT analysis provides a solid basis for solution design and implementation. This is also typically supported by extensive time spent in the field to validate data points and capture additional insights.

• Supply chain analysis – product supply chains are usually very broad, commencing with growers and farmers and other raw material providers, and continuing to manufacturers, wholesalers and distributors, retailers and finally consumers. A tax stamp and traceability solution will need to consider product movements across this complex and ever-evolving supply chain into, within and in-between countries.

Understanding the end-to-end supply chain process, in terms of stakeholders, supply chain events, data generation, storage points, data carriers (eg. QR codes), data privacy, quality, accessibility and integrity, is critical to ensuring a practical and efficient track and trace solution.

This will include a volumetric analysis to identify the volume of tax stamps required and number of stamp variants needed (eg. alcohol banderols, direct marking, tobacco tax stamps).

Other considerations related to supply chain analysis include data collection requirements for reconciliation, waste and other track and trace monitoring; the security of the supply chain from stamp manufacture to application onto product; by whom, where and when stamps will be authenticated, and unique identifiers collected; data formats and data sharing.

• Financial analyses – the illicit trade study and data analysis will provide inputs for estimating the revenue lost as a result of poor compliance and fraud. This should also include an estimate of the existing tax gap (ie. the difference between projected taxes to be collected and actual taxes collected) to establish an assumption of what revenue can be collected.

• Legal analyses – a legislative gap analysis is required to quantify what powers and authorities a government has, compared to what it needs.

For example, if the authority would like to implement the WHO FCTC Protocol, some of the provisions can likely be implemented under existing legislation, whilst others may require legislative changes. In many countries, for instance, tobacco products are already subject to fiscal marking regimes (tax stamps), which are similar to some of the track and trace requirements set out in Article 8 of the Protocol. In this case, the revenue authority can simply phase in additional Protocol requirements.

• Stakeholder consultation – a critical aspect of any tax stamp and track and trace solution is the stakeholder landscape within which it is to be implemented. While some stakeholders have an interest in ensuring the solution succeeds, others (such as the taxpayers themselves) may prefer that it never gets implemented at all.

Governments have a multifaceted role and responsibility in ensuring that these interests are balanced and prioritised. The key to achieving this is to establish a stakeholder management strategy which will ensure effective engagement and interaction with stakeholders throughout the lifecycle of the solution.

The industry is a stakeholder in the sense that whatever system is ultimately chosen must be implemented by it in various points across its supply chains. Industry input is therefore essential, particularly with respect to ensuring that the industry’s supply chain practices and constraints are incorporated into the solution design in order to minimise supply chain disruptions.

On the other hand, international experience highlights the importance of government independence in developing policy positions, and of the very real risk of regulatory capture where governments adopt policy positions and systems that simply reflect preferred industry positions and do little in real terms to reduce the potential risk of products being diverted to illicit markets. For this reason, engagements with industry should be well-structured and limited to that which is necessary to design a solution that has minimal disruption on supply chains whilst maximising government regulatory control and oversight.

• Governance model – typically, a governance model develops structures, roles and relevant responsibilities based on a set of defined problems and requirements to address those problems. Since many programmes will focus on addressing illicit trade and poor compliance, a well-defined governance model is essential in terms of overall accountability, measurement and sustainability.

Typically, governance models contain three key components which, within a tax stamp programme context, would include:

1. Oversight – which establishes key roles, responsibilities, policies and auditing and reporting processes.

2. Control – which involves the use of technologies including security features and data capture and system integrity tools.

3. Validation – which ensures the overall verification of the system, and that integrity is maintained over time.

Practically, most regulatory authorities will not build the system themselves but will rely on outside vendors and suppliers. The governance model must therefore clearly assign key accountabilities and responsibilities to various stakeholders across the solution.

Phase 2: design

Once the environment is understood and a plan (including the governance model) is established the programme can proceed to design, which includes setting up a project delivery team, and developing a motivated and defensible business case and solution blueprint.

At this stage, the authority will typically identify the funding mechanisms and budget necessary to support the project at each phase and in terms of materials, systems, and operations. Solution costs can be absorbed in different ways and the authority may wish to utilise internal and external sources of funding.

The stakeholder consultation from Phase 1 will provide key inputs on technologies best suited to the authority’s business requirements and contribute to the solution blueprint for the overall construction of the tax stamp. Key considerations in this respect include the type of substrate (eg. paper), inks, adhesives, security features, as well as the overall stamp design and position on the product.

It is advised that authorities interested in implementing a tax stamp programme obtain and thoroughly review ISO 22382: 2018 – ‘Guidelines for the content, security, issuance and examination of excise tax stamps – which can be purchased through national standards bodies (see https://www.iso.org/standard/73859.html for more information).

Other key activities in this phase include the overall technical architecture (eg. data storage), as well as detailed business requirements that allow the authority to channel a tender document through its internal approval process.

Phase 3: build

This phase entails building the solution, which could involve procurement and selecting solution providers as well as upgrading enterprise systems to interface with the new solution.

In this phase, the authority has a very specific idea of what it wants and has expressed this in a formal Request for Proposal, which would include a detailed solution design.

For most authorities, procurement is the preferred choice as the operation of a tax stamp and track and trace system go well beyond its core competence, and the technologies (security features, high-speed printing, supply chain event monitoring) and business processes associated with track and trace will most likely not be familiar.

Most current systems in operation have been based on one of two models:

1. Straight procurement – where the authority undertakes a procurement process (tender) and contracts with a third-party service provider for a set duration of time and for an agreed price.

2. Public-private partnership – where the authority and a third party establish a business entity together to provide the tax stamp and track and trace functions.

Within a tender document the authority will specify the volume of stamps required, the products the stamps or marks are to be affixed to, the format of the stamps (singles, sheets and/or reels), the technical specification, track and trace requirements, the duration of the contract, delivery schedule, incoterms (set of rules which define the responsibilities of sellers and buyers for the delivery of goods under sales contracts), together with many other criteria.

Proposals from suppliers should be reviewed on an equal basis and take into consideration both the technical aspects of the solution as well as the overall cost and creditability of the supplier.

A competitive procurement process is very much an achievable endeavour given the sheer number of tax stamp suppliers. The additional systems associated with track and trace are somewhat generic in that the underlying techniques and technologies are utilised across many different industries that employ supply chain track and trace in various iterations.

It must be noted that the cheapest solution may not always be the best solution, so authorities are encouraged to develop specific evaluation criteria that are objective and measurable.

In the interest of attracting the best the market has to offer, authorities should be careful not to issue tenders that can only be fulfilled by a limited number of players and avoid proprietary inputs in their solution designs. This is particularly applicable to security features and credentials or qualification criteria.

The duration of tax stamp contracts can vary significantly, but typically last between 2-5 years with clauses for contract extensions.

ISO 22382 provides additional guidance on practices related to managing a procurement, which should be reviewed and where applicable incorporated into the overall process.

Phase 4: implement

This phase should include strong measurement mechanisms for the implemented solution, both in terms of supplier performance and performance of the system itself.

In terms of supplier measurement, considerable attention should be focused on ensuring that the supplier meets its contractual obligations as set out in the tender specifications and contracting documents.

The contract between the authority and the supplier should include service level agreements (SLA) with respect to the system’s performance, services rendered and also cater for services that will be rendered to supply chain actors on behalf of the authority.

For example, it would be a good practice to ensure that there is an SLA not only between the supplier and the authority but also between the supplier and the relevant supply chain actors. This will ensure that the system operates within pre-defined parameters and there are clear procedures in place to deal with any issues.

In terms of solution measurement, the authority must ensure that the solution is securely linked to enforcement strategies and related operations and resources. Authorities must be mindful that the solution will not automatically eliminate non-compliance and illicit trade.

Across the enforcement paradigm, there are a number of functional and organisational design considerations required to properly implement the solution, including: 

• Establishment of effective enforcement teams to conduct market surveillance with automated reporting devices.

• Monitoring sales channels for contraventions, and if found, tracing illicit products back to their origins.

• Obtaining detection equipment for use at customs and border posts.

• Utilising risk profiling and analysis tools, as well as data from the tax stamp solution.

• Establishing and enforcing significant financial penalties and penal provisions.

• Providing for secure destruction of seized products.

• Educating the public on the impact of illicit trade.

• Ensuring resources are available to audit and validate compliance with the various obligations under the law.

• Cooperating with other agencies to secure evidence and prosecutions where necessary.

All these activities should be measured in terms of output, ie. ‘how much’ the authority has done, as well as in terms of the overall outcome of these activities.

Examples of output measures could include an increase in the number of audits conducted at manufacturing premises, as well as an increase in the number of cases submitted for prosecution. And examples of outcome measures could include the number of convictions, an increase in the taxes and duties declared by supply chain actors, and, at a macro level, a reduction in the size and prevalence of illicit trade.

At a minimum, the solution should result in: better understanding of the manifestations of illicit trade; improved ability to authenticate legitimate products, thereby enabling easier identification of illegitimate products; increased number and success rate of enforcement activities; improved targeting of enforcement activities, through better intelligence, data-matching and data mining; improved measurement of compliance; and increased barrier of entry for operators in the illicit supply chain.

This article is extracted from Chapter 6 of the Reconnaissance publication ‘Tax Stamps & Traceability: A Market Analysis and Technical Update’. The chapter, entitled ‘Practical Considerations of Implementing a Tax Stamp and Traceability System’, was written by Michael Eads and Ziyaad Butler of Sovereign Border Solutions. Click here to purchase the report.