Brexit: Customs Arrangements

A customs union is a trade bloc where the partner countries agree to remove tariff barriers on each other's goods, to have a common external tariff against third countries and to remove the majority of customs formalities (thus facilitating free movement of goods).

This can be distinguished from a free trade agreement, where the partner countries agree to remove tariff barriers on each other's goods but there is no common policy vis-a-vis third countries and full customs formalities will normally continue to apply.

The UK is part of the EU Customs Union;  as such, not only are no tariffs payable on goods imported into the UK from the EU (and vice versa) but the majority of customs formalities have been removed. This means that at Channel ports, for example, HGVs can simply roll off ferries and continue their journey to their destination, without having to wait for customs clearance.

Free trade agreements tend to focus on reducing/removing barriers to trade such as import tariffs.  The key advantage of a customs union is that, as well as removing tariffs, it reduces border red tape so that goods can flow freely between the member states with minimal transaction costs.  Typical border red tape where there is NO customs union includes:

• Additional paperwork:  Goods must usually be accompanied by a customs declaration explaining what they are and where they are from, together with a VAT declaration indicating their value (which may need to be supported by an invoice).  Whilst not necessarily difficult to comply with, all this adds to administrative costs.  By way of example, large courier firms such as DHL typically charge about £15 per item shipped to cover the administrative costs they incur.  In some cases, paperwork may also be required to prove the origin of the goods (see Question 8 below).
• Conformity testing:  Some goods (e.g. many electrical products) may be refused entry, unless accompanied by paperwork demonstrating that they comply with relevant product standards.  Alternatively, the goods may have to be held at the point of entry until samples have been tested by a UK lab to demonstrate conformity, for which a fee will be charged and storage costs will have to be incurred until the test results are received.  
• Delays:  Where customs controls are in place, goods must await customs clearance before they can leave port and some may need to subject to full customs inspections.  This has the potential to introduce delays, which may in turn undermine the efficiency of just-in-time distribution systems or result in perishable goods being unfit for consumption by the time they reach their final destination.

Some idea of the economic impact of a customs union may be gained from a 2014 World Bank report, which suggested that replacing Turkey’s partial customs union with the EU with a free trade agreement (without a customs union) would result in costs increasing by about 2% and Turkey’s exports to the EU decreasing by 3-7%. 

The main disadvantage of being in a customs union is that it restricts the freedom of the parties to conduct independent trade policies.  In particular, all members of the customs union must agree to maintain the same external tariff vis-à-vis third countries.  However, membership of a customs union does not necessarily prevent a country concluding trade deals;  for example, Turkey is in a partial customs union with the EU but retains the ability to conclude free trade agreements with third countries.  However, its freedom to negotiate is heavily constrained by the fact that it has agreed to align the majority of its goods tariffs with those of the EU.

For reasons outlined at Question 2 above, customs controls are likely to impose extra administrative costs on business.  Importers are likely to find that the cost of goods imported from the EU will increase due to the additional transaction costs, whilst exporters may find that their goods become less competitive than those of EU rivals.

In the short term, there is also a risk of significant disruption to trade.  For example, according to the Port of Dover, each roll-on-roll-off ferry contains on average about 2 miles of traffic - and Dover handles about 100 miles of traffic each day.  It is not clear that the UK has the necessary resources or infrastructure in place to cope with the application of customs controls to such a high volume of traffic (nor is it clear that ports or customs administrations on the continent would be adequately prepared either).   According to the UK Chamber of Shipping, customs declarations to HMRC would be likely to increase from 85 million per year to over 300 million, which would have significant implications for IT systems and staffing.  In particular, HMRC's computer system, CHIEF, does not at present have the capacity to handle this level of customs declarations.  Port facilities would also need to be reconfigured to allow for inspections.  Widespread reliance on "just in time" distribution systems means that it is not inconceivable that shortages of goods could arise within a relatively short period, as occurred during the fuel protests of 2000.

These are not necessarily insurmountable problems (see Questions 9 and 10 below) but they highlight the need for careful planning;   they may also make it highly desirable for the UK to remain in some form of customs union with the EU for an interim period, to allow more time to prepare for the introduction of customs controls.

It may be possible for the UK to remain in the EU Customs Union for a transitional period - indeed, from a practical perspective, there may be a strong case for maintaining existing arrangements because both the UK and its EU partners (particularly France) will need time to adapt to the reintroduction of customs controls (see Question 4 above).

However, as regards the longer term, it is generally thought that a non-EU country cannot be in the EU Customs Union (the ' Customs Union'); even EEA-EFTA countries are not members. The only non-EU country that is linked to the EU in a customs union relationship is Turkey, which has a partial customs union with the EU covering industrial goods and certain processed agricultural products.

A fully comprehensive customs union between the UK and the EU would only make sense if the UK were planning to remain within the Common Agricultural Policy and Common Fisheries Policy (which does not appear to be the case).  However, there does not seem to be any reason in principle why the UK could not seek an arrangement with the EU similar to Turkey's (which is a partial customs union, covering only industrial goods and processed food, not agricultural products) – or even Single Market membership coupled with a partial customs union.

The main advantage would be avoiding increased costs due to red tape at borders between the UK and the EU (see Question 2).  The main disadvantage would be constraints on the UK's ability to conduct an independent trade policy (see Question 3). 

The balance of advantage here is hard to judge.  The cost to business of increased border red tape could be considerable, given the extent of EU-UK trade – and there is a real prospect of significant short term disruption when customs controls are first introduced (see Question 4).  On the other hand, the EU appears to be finding it increasingly difficult to conclude ambitious trade agreements – as demonstrated by the difficulties with ratifying the Canada-EU deal and the level of political opposition to the TTIP deal with the US.  In the longer term, there may be more to be gained from being able to act more swiftly and decisively on trade matters – in which case, the UK's interests may be best served by seeking the maximum possible freedom on trade policy (making any form of customs union with the EU undesirable). 

It has been suggested that for some sectors, such as car manufacturing, the UK could seek a special sectoral deal with the EU;  if this included a sectoral customs union, this could avoid some of the problems arising from the UK leaving the EU Customs Union, particularly in relation to rules of origin (discussed further at Questions 8 and 9 below).   However, such an arrangement would not meet the WTO requirement for free trade agreements relating to goods (including customs unions) to cover "substantially all trade" in goods (see Brexit: WTO Rules for more detail).  Whilst it is true that Turkey's customs union with the EU is not fully comprehensive, the only exception is for agricultural produce – so the EU and Turkey would not doubt argue that the vast majority of their goods trade is in fact covered by the arrangement.

That said, there may be scope for a sectoral deal as part of a wider EU-UK free trade agreement – see further Question 9 below.

Rules of origin are relevant where one country has a free trade trade agreement with another, as the UK envisages for its future relationship with the EU.  Such an agreement is likely to allow goods to be imported into the EU at lower tariffs than would apply under WTO rules (see Brexit: WTO Rules).  However, in order to benefit from this preferential treatment, UK businesses would have to demonstrate that a certain percentage of the product (e.g. at least 60%) originated in the UK.  This can become quite complex where the product has been assembled using parts imported from another country which does not benefit from the same preferential treatment.  Research suggests that where tariffs are already low, many businesses consider that the cost of proving origin outweighs the benefit of any preferential tariff – and therefore opt to pay the higher WTO tariff rather than comply with rules of origin.  In other cases, rules of origin can deter businesses from exporting to a particular territory altogether.  Particular concerns have been raised about the impact of rules of origin on complex supply chains, such as those in the automotive sector.

Rules of origin are explained in answer to Question 8 above.  In order to minimise their impact, the UK could seek agreement from the EU to the following:

• Self-certified origin documentation:   the EU-South Korea FTA provides for approved exporters to self-certify the origin of their goods by means of an "origin declaration", instead of having to obtain a certificate from customs authorities.  This should be easier to comply with than the standard approach to rules of origin, although approved exporters are expected to retain further documentary proof of the origin of the goods for at least 5 years and be prepared to produce it on request.  There are therefore some additional administrative costs to this option, compared with being in a customs union. 
• Cumulation of origin:  the EU-South Korea FTA also provides for "cumulation of origin".  This would be helpful to the UK because it would mean that a car assembled in the UK using parts from elsewhere in the EU would still be regarded as originating in the UK (even though a high percentage of the vehicle may in fact have been manufactured outside the UK).  Without cumulation, UK car manufacturers might have to restrict the percentage of parts coming into the UK from the EU or elsewhere – and UK components suppliers might find that EU car manufacturers would switch to competitors based in the EU.

A requirement for proof of origin could be dispensed with altogether (for goods traded between the UK and the EU) if the UK agreed to maintain tariffs on imports from non-EU countries which matched the EU's tariffs on such imports into its territory.  In that situation, there would be no concern that goods being exported from the UK were unfairly taking advantage of the UK's preferential tariff arrangements with the EU.  However, it is not clear that this would work as a long term solution, assuming that the UK intends to enter into free trade agreements with countries outside the EU. Such trade deals would be likely to mean that goods from those countries could be imported into the UK at tariffs below those which would apply for imports of the same goods into the EU.  This would probably cause the EU to insist on rules of origin checks, at least in relation to categories of goods which could benefit from the UK's trade arrangements with third countries. 

That said, the UK could agree with the EU that, whatever deals it strikes with third countries, it will maintain the same tariffs in certain sectors (e.g. all automotive products) where UK-EU supply chains are particularly highly integrated.  Such an arrangement would potentially allow for a form of sectoral deal, as suggested by some commentators.  Provided that it formed part of a wider EU-UK free trade agreement covering most types of products, it would not necessarily be incompatible with the WTO rule requiring such deals to cover "substantially all" trade in goods. 

The UK could seek agreement from the EU to the following measures:

• Authorised Economic Operator (AEO) system:    essentially, this system allows approved importers and exporters to make use of simplified, fast-track procedures, so that most goods can clear customs with only a documentary check (rather than a full customs inspection, which may involve delays while the container is opened up to verify the contents).  The EU has such arrangements in place with the US, Japan and a number of other major economies.  The Japanese government has strongly advocated continued participation by the UK in the AEO system post-Brexit.
• Mutual recognition of conformity testing:   certain products, such as electrical goods, need to be accompanied by proof that they meet relevant standards (without which they will be refused entry).  Such proof is normally provided by a testing certificate from an approved laboratory.  Mutual recognition involves each country recognising that testing facilities in its jurisdiction can issue valid certificates under the other country's regulatory regime.  As a result, rather than the goods having to be held in port while testing is carried out, the testing can be done in the country of export, with proof of compliance being demonstrated by a certificate to satisfy customs requirements.

The following could be used in the event of a hard Brexit with no EU-UK trade agreements in place:

• Electronic systems:  technology such as number plate recognition can play a role in speeding up customs procedures e.g. an HGV arriving at Dover could be cleared automatically if its number plate has been notified in advance and UK customs has already been sent adequate documentation explaining what is being carried etc (and can therefore take a decision in advance on whether to pull the HGV over for inspection or effectively wave it through on the basis of the documentary checks).  However, this is likely to require substantial investment in new IT systems and facilities.
• TIR Convention:  TIR stands for "Transports Internationaux des Routiers" and could be a solution for HGV traffic transiting the UK on the way to Ireland.  The TIR system essentially allows goods to be sealed by customs authorities at the point of departure, thus allowing the cargo to pass through other customs checkpoints subject only to a check of the TIR documentation (rather than a full inspection).   This could be helpful for EU HGV traffic heading to Ireland because the cargo could be sealed in the EU and thus potentially pass through the UK without having to pay customs duty, as its ultimate destination would be another EU country.  However, UK customs authorities would no doubt wish to check that HGVs arriving in Ireland matched up with their records of HGVs entering the UK (and that the system was not being abused for the purposes of smuggling goods into the UK without paying import duties).   TIR will also involve some additional costs for HGV operators.