Duty free sales within Europe appear to have won a reprieve. But how hard will airlines be hit if duty free is eventually abolished?

To bureaucrats, the abolition of duty free must have looked a simple matter when it was mooted. The European Union (EU) decided in 1991 to scrap duty free sales for travellers within the region as part of taxation and excise measures to make the single market a reality. It was supposed to happen in tandem with the harmonisation of taxes in the EU - but that remains a distant prospect.

The abolition of duty free may have been proposed in 1991, but the industry has made little headway towards preparing for its departure. No viable alternative has been set up to replace duty free. "There is a realisation that if we abolish duty free, then we will leave an absolute shambles in its place. Across the EU people are crying 'stop doing this so hastily'," says Bob Parker-Eaton, deputy managing director of charter airline Britannia and vice chairman of the Duty Free Confederation.

The worldwide duty free industry has enjoyed phenomenal growth. By 1995 it had grown from a base of virtually zero 50 years ago to a global turnover of $21 billion. Europe accounts for half of the total and duty free is more important to the UK than to any other European state.

The departure of duty free would not only mean lost revenue. KLM uk has already announced that it is making one third of its cabin crew redundant ahead of duty free abolition. An estimated 140,000 people would forfeit their jobs and ticket prices would rise by on average of 30%, says the Duty Free Confederation.

The numbers are scary. If the duty free industry rolls over and dies, landing charges for EU flights could need to rise by some 30% to compensate, according to the Confederation. Aviation charges at regional airports would need to be increased by 25% on all flights, or 32% on intra-EU flights, to make up for the shortfall in revenue. In relative terms, duty and tax free revenues are even more important for regional airports because a higher proportion of their traffic is intra-EU.

But hopes are growing that duty free will get another lease of life. An eleventh hour effort to save duty free surfaced at the end of last year, following the summit of EU heads of government in Vienna on 11 and 12 December. Those in favour of maintaining duty free, or at least suspending its abolition, are now optimistic that member states will review their previous decision to abolish duty free sales within the EU from 1 July, 1999.

Industry hopes for saving duty free shopping soared as the UK joined France and Germany in calling for the abolition of duty free to be delayed for another five years. At the Vienna summit other EU heads of government agreed a "possible limited extension" to the life of duty free - although they stopped short of agreeing to a reprieve. Twelve of the 15 EU states want to stop the abolition of duty free next June. But Denmark, the Netherlands and Belgium remain opposed to any extension of duty free sales and argue that it distorts the single market.

A compromise deal was agreed at the December meeting, with the heads of government asking the EU and the European Council of Ministers to examine the likely impact on employment of the scrapping of duty free and suggest solutions to the problems raised.

The duty free debate was again raised at a European Council of Finance Ministers (Ecofin) meeting in January. The European Commission (EC) and the Ecofin were to review the economic and social impact of duty free abolition and report on this by 15 March.

By mid February Barry Godard, secretary general of the Duty Free Confederation was confident that the EU governments would vote to extend duty free. "We are extremely encouraged that the EU member states have reached a unanimous decision to review the abolition of duty and tax-free shopping. We will obviously work closely with the UK Government in looking at possible solutions and urge them to ensure that the necessary decision to postpone the abolition date is taken without delay," said Godard.

But those trying to extend the lifespan of duty free should beware of misplaced optimism. The review of the implications of duty free's demise may still result in a recommendation for eventual abolition.

The final declaration of the Vienna summit did not contain a U-turn on the future of duty free. It would take a majority vote in favour of duty free to overturn the unanimous 1991 decision on abolition. But it would only take the veto of tiny landlocked Luxembourg to block a reverse.

The EC seems reluctant to step down and save duty free, referring instead to the last minute attempt to rescue the perk as "some states panicking a bit". The industry has had since 1991 to adjust, it says.

Jacques Santer, the EC president, reaffirmed Brussels' opposition to the continuation of duty free at the end of last year and said that any extension would only be for a few months and not the five years many are demanding.

The reprieve appears to have come too late. Even the Board of UK Airline Representatives concedes that ":we should have been more active six months ago".

In its defence, the Duty Free Confederation maintains that "-the industry can't get its act together until we find out what will replace duty free. The EC hasn't come forward with a suitable alternative system or tax regime", the confederation says. "A five-year delay would give the industry sufficient time to develop and implement workable alternatives", it adds.

Franz Kotraba, president of both ACI Europe and Vienna Airport, also argues for a stay of execution while a proper successor regime is sorted out. Kotraba maintains that Europe needs more time to "-put in place the necessary successor regime and to adjust to the ultimate ending of intra-EU duty free".

The future of duty free may be teetering in the balance, but one certitude remains - the end of duty free will hit hard. Passengers face average increases in costs of package holidays of up to $92 for a family of four and fare increases of up to 20% on the new low-cost scheduled airlines, says the Duty Free Confederation .

The loss of in-flight sales and the resulting increases in airport charges, will push seat costs up by between 3.5% and 5%, depressing traffic by 3-4%, according to estimates by Airports Council International (ACI) Europe. The Charter Airline Economics study conducted by the European Travel Research Foundation (ETRF) says an increase in holiday costs of 5% could eliminate traffic growth and even lead to a reduction in total traffic as higher ticket prices depress passenger numbers to EU destinations. ETRF estimates that for a 1% increase in price, 3% of passengers will divert to another destination. This means EU traffic will be diverted to non-EU destinations, where operators still enjoy the benefit of duty free revenues. For Greece, this would, for example, represent a loss of 0.5 million charter passengers arriving. Other mature destinations may be similarly hit.

The loss of duty free would hit charter and low-cost airlines the hardest. For the low-cost scheduled market, an estimated fare increase of 5-20% means an equivalent fall in passenger volume, according to the Duty Free Confederation. British Midland chairman, Sir Michael Bishop, predicts that the end of duty free sales is set to bruise badly low-cost carriers such as Dublin-based Ryanair. "The likes of Ryanair have a strong margin on sales of duty free, but this is unlikely to continue after June 1999," he says.

Charter airlines will also bear the brunt of the abolition of duty free. With limited opportunities to replace these sales, EU charter airlines would suffer a total net loss of 320 million euros ($356 million) in revenue. The greatest loss of income would be in Germany, the UK and Scandinavia, which together account for nearly 90% of total sales. Consultants SH&E says the loss of allowances would be greatest in the Scandinavian market, where the average gross duty and tax free sales total per charter passenger is almost 60 euros.

The ETRF predicts that an estimated 1,000 direct jobs could be lost with EU charter airlines. These would mainly affect cabin attendants, but also other staff directly involved in duty and tax free operations. The charter industry needs duty free to prosper. While traffic volume in intra-EU charter markets grew at an average of 7.3% a year between 1991-5, reducing annual growth rates are an indication that some markets are maturing. Between 1995 and 2000, the average annual growth in intra-EU charter passengers may be some 4%, says the ETRF.

Bob Parker-Eaton, deputy managing director of Britannia, says: "Unless a sensible, workable replacement for duty free is agreed by all the EU member states to cover the loss of sales on board aircraft following an abolition, the result will be increased holiday prices and job losses."

Britannia is committed to the campaign to stop abolition. The airline has painted the slogan "Keep Duty Free" on to its 29 aircraft to try and raise public awareness of the debate.

Parker-Eaton says: "It is important that awareness is raised as, without public support, European tax and duty free trade will cease in 1999 with the result of increased holiday, air and travel costs with no justifiable benefits whatsoever."

In the event of the demise of duty free, airlines would not only need to cope without onboard sales, they would also face hefty increases in airport charges. The end of duty and tax-free sales will result in a loss of between 56% and 81% of gross profits from airport retail sales, jeopardising the future growth of airports, claims the Airports Council International (ACI) Europe. If the rise is only applied to intra-EU flights, in an extreme case an airport might have to double its charges, concludes ACI Europe. The vast majority of Europe's airports rely heavily on intra-EU duty free revenue. "Each year, Europe's airports invest $4-$5 billion in their capacity enhancement. One of the primary sources of these vital infrastructure investments is intra-EU duty free," says Philippe Hamon, director general of ACI Europe.

Hamon is critical of a working document, released by the EC in November, which outlines the economic instruments that are available to offset the negative impact of duty free. The document says that only airports in Greece, Spain, Portugal or Ireland "-may be eligible for support from cohesion funds in cases where the implementation of plans to extend/ improve infrastructure is endangered by the abolition of duty free sales". This leaves hundreds of EU airports in other member states with no hope of an alternative source of financing for their development programmes, claims Hamon. "Once abolished, there will be no replacement for it. No community structural funds will ever match the scope of duty free revenues which are earned by the industry itself through the voluntary spending of passengers. To talk about any state funding in this era of financial austerity is not only politically undesirable - it is just wishful thinking." The Commission's working document advises airports "-to recover the cost of airport operations by setting the level of charges accordingly. In cases where duty free revenues have been used to keep airport charges low, airports would be able to raise their charges", runs the text of the working paper. The EC says the EU's own programmes for poor regions and employment training run out at the end of 1999 and that member states can develop strategies in their 2000-2006 programmes to deal with the abolition of duty free. The execution of a small business scheme with an allocation of 1 billion euros is slower than planned and significant appropriations may be left unused at end of 1999, adds the EC.

The EC also says member states that find duty free abolition disrupts air transport services could grant state aid to ensure a public service is provided. Understandably, the EC's working document has provoked widespread indignation. David Zimmer, secretary general of the International Duty Free Confederation, says the document "-is an insult to member states and, most importantly, the ten of thousands of workers whose jobs are now being threatened. The document is totally disingenuous and it has fallen well short of all expectations. It offers nothing new and tells us nothing new."

As if the prospect of steeper airport charges is not bad enough, carriers would also have to grapple with an administrative nightmare. As abolition will apply only to journeys between EU countries, passengers will still be able to buy duty free on long-haul flights, outside the EU or in tax-free enclaves. This means that airlines will have to issue boarding passes showing whether the passenger is entitled to shop at duty free prices.

It may sound simple, but it is not. The most bewildering aspect will be in working out which country's duty and tax has to be paid. Regulations say that goods must be taxed at the rate imposed by the country where they are loaded on an aircraft. But if they are subsequently sold in another country's airspace, they are subject to that country's tax and the operator has to reclaim the amount paid at the point of loading.

The EU says that, when airlines sell goods inflight, they must add valued-added tax at the rate that is charged in the country from which the aircraft originally took off. But the rate of duty must be that in the airspace through which the aircraft is flying when the sale is made. Passengers on the same flight could therefore be charged different prices for the same goods.

The fact that, after seven years' warning, few operators, if any, have prepared for the abolition of duty free reflects the view that common sense will prevail. As Godard of the Duty Free Confederation says, "-it's nonsense. What Brussels has done is to say, 'let's abandon duty free and then sort out the mess'. But everyone knows you don't dig up the road without knowing where the gas main is."

Source: Airline Business