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# 31997Y1118(01)

**Annual report concerning the financial year 1996, together with the institutions' replies Volume I Report on activities financed from the general budget and on the activities of the sixth and seventh European Development Funds** 
  
*Official Journal C 348 , 18/11/1997 P. 0001 - 0417*

  

ANNUAL REPORT concerning the financial year 1996 (96/C 348/01)

The report, together with the institutions' replies to the Court's observations, was transmitted to the authorities responsible for giving discharge and to the other institutions.

Bernhard FRIEDMANN (President)

John WIGGINS

Giorgio CLEMENTE

Barry DESMOND

Patrick EVERARD

Armindo de Jesus de SOUSA RIBEIRO

Antoni CASTELLS

Jan O. KARLSSON

Hubert WEBER

Aunus SALMI

Jørgen MOHR

Kalliopi NIKOLAOU

François COLLING

Maarten B. ENGWIRDA

Jean-François BERNICOT

VOLUME I REPORT ON ACTIVITIES FINANCED FROM THE GENERAL BUDGET AND ON THE ACTIVITIES OF THE SIXTH AND SEVENTH EUROPEAN DEVELOPMENT FUNDS

TABLE OF CONTENTS

Page

General introduction 6

Part I Own resources

Chapter 1 Own resources 12

Part II Common agricultural policy

Introduction 46

Chapter 2 Budgetary management 49

Chapter 3 Market organizations - Plant products 64

Chapter 4 Common organization of the market - Animal products - Beef and veal premium schemes and selected BSE related measures 99

Chapter 5 Certain procedural aspects of export refunds on beef and veal 125

Part III Structural measures

Introduction 138

Chapter 6 European Regional Development Fund 143

Chapter 7 European Social Fund 175

Chapter 8 European Agricultural Guidance and Guarantee Fund, Guidance Section (EAGGF-Guidance) 198

Chapter 9 Common policy on fisheries and the sea 220

Page

Part IV Internal policies

Introduction 238

Chapter 10 Research 239

Chapter 11 Industrial policies - MEDIA 255

Part V External measures

Introduction 269

Chapter 12 European Development Fund 271

Chapter 13 Cooperation with developing and third countries (except Central and Eastern Europe) 293

Chapter 14 Measures to benefit the countries of Central and Eastern Europe and the newly independent States (the former Soviet Union) and Mongolia 317

Part VI Administrative expenditure

Introduction 345

Chapter 15 The Commission 349

15.1 General subsidies 351

15.2 Office for Official Publications of the European Communities 353

15.3 Decentralized Community bodies 360

15.4 Joint Sickness Insurance Scheme 361

Chapter 16 Court of Auditors 383

Chapter 17 The Economic and Social Committee and the Committee of the Regions 385

Part VII Financial instruments and banking activities

Chapter 18 Financial instruments and banking activities 391

Annex I Reports and opinions adopted by the Court of Auditors during the last five years 409

NB: The diagrams are all in Annex II at the end of this report (Volume II).

THE INSTITUTIONS' REPLIES

Page

Part I Own resources

Chapter 1 Own resources 37

Part II Common agricultural policy

Introduction 48

Chapter 2 Budgetary management 59

Chapter 3 Market organizations - Plant products 91

Chapter 4 Common organization of the market - Animal products - Beef and veal premium schemes and selected BSE related measures 118

Chapter 5 Certain procedural aspects of export refunds on beef and veal 135

Part III Structural measures

Introduction 142

Chapter 6 European Regional Development Fund 164

Chapter 7 European Social Fund 189

Chapter 8 European Agricultural Guidance and Guarantee Fund, Guidance Section (EAGGF-Guidance) 214

Chapter 9 Common policy on fisheries and the sea 233

Part IV Internal policies

Chapter 10 Research 249

Chapter 11 Industrial policies - MEDIA 263

Part V External measures

Chapter 12 European Development Fund 287

Chapter 13 Cooperation with developing and third countries (except Central and Eastern Europe) 312

Chapter 14 Measures to benefit the countries of Central and Eastern Europe and the newly independent States (the former Soviet Union) and Mongolia 337

Page

Part VI Administrative expenditure

Chapter 15 The Commission 373

15.1 General subsidies 373

15.2 Office for Official Publications of the European Communities 374

15.3 Decentralized Community bodies 376

15.4 Joint Sickness Insurance Scheme 378

Chapter 16

Chapter 17 The Economic and Social Committee and the Committee of the Regions 388

Part VII Financial instruments and banking activities

Chapter 18 Financial instruments and banking activities 406

GENERAL INTRODUCTION

0.0. CONTENTS Paragraph reference

Structure of the Report 0.1

Budgetary management 0.2 - 0.6

Administration and control 0.7 - 0.27

Justification of expenditure 0.7

Principal observations 0.8 - 0.27

Community income 0.9 - 0.10

EAGGF-Guarantee 0.11 - 0.13

Structural measures 0.14 - 0.18

Programmes managed by the Commission 0.19 - 0.24

Other expenditure 0.25 - 0.27

Coordination 0.28

Evaluation 0.29

Statements of assurance (Volume II) 0.30 - 0.33

Remedial action by the Commission 0.34 - 0.36

The Financial Regulation 0.37

The significance of audit 0.38

STRUCTURE OF THE REPORT

0.1. This 1996 Annual Report has a different structure from that of previous years; its first volume reflects the structure of the financial perspectives and a second volume incorporates the statements of assurance and related chapters for both the general budget and the European Development Fund.

BUDGETARY MANAGEMENT

0.2. A generous allocation of budgetary appropriations may create pressure for expenditure or, at the very least, discourage rigorous financial management. Chapters 2, 3 and 4 draw attention to the way in which regulations that fail to take account of world market prices result in unnecessary expenditure on support for agriculture. Checks during clearance of advances to Member States detect and correct errors and irregularities, but do not prevent the creation or maintenance of excessive levels of aid which cannot be regarded as sound use of public funds. The amounts involved are considerable: Chapter 3 draws attention to 3 000 Mio ECU of overcompensation for cereals, Chapter 4 to more than 800 Mio ECU for beef and veal producers. Special Report No 4/97 showed that EAGGF compensation payments and export refunds relating to German unification measures also involved substantial overcompensation and unnecessary expenditure.

0.3. Advances to Member States for structural expenditure are treated as definitive expenditure at Community level, without adequate accounting and control arrangements and without an adequate clearance system. This system facilitates maximization of fund transfers to Member States without ensuring the timely and rigorous use of funds in ways which meet Community objectives. Chapter 6 draws attention to the considerable delays in completing investment programmes from the 1989 to 1993 financing period. Chapters 6, 7 and 8 illustrate the poor definition of programme objectives and content, lack of co-financing, and a continuing lack of information as to the progress of actions. Substantial funds remain for long periods in the hands of intermediary authorities instead of being transferred to final beneficiaries. Numerous errors and problems of legality and regularity have been discovered in programmes which have been officially closed.

0.4. For PHARE and TACIS also, appropriations exceeded the level of financing that could really be used. Chapter 14 analyses the continuing increase in outstanding commitments from 1990 to 1996 and the Commission's difficulties in implementing and arranging contracts for adopted programmes for which it has made budgetary commitments. Special Report No 3/97 on the PHARE decentralized implementation system indicated that the Commission's concentration on full commitment of annual budgets, combined with the low absorption capacities of the beneficiary countries and the excessively wide range of programmes, resulted in 497 Mio ECU (38%) of advance payments during the period 1990-95 remaining in beneficiary national administrations' bank accounts at the end of 1995. Special Report No 6/97 on TACIS subsidies to Ukraine also drew attention to slow use of appropriations and the unnecessary mobilization of funds.

0.5. In general, in a Community financial system making extensive use of advances, with central accounts which treat them as budgetary expenditure, the rate of use of funds at final beneficiary level is unclear. Such a system cannot be regarded as meeting the requirement of sound financial management and makes it difficult to determine the appropriateness of Community resources' transfers.

0.6. A lack of commitment appropriations also creates problems. For instance, Chapter 13 shows how, as a result of the ceiling in the relevant part of the financial perspectives, the Commission had to postpone the commitment of amounts required for projects for which financing decisions had already been taken (including projects under MEDA programmes and a large project in India). Postponing commitment in this way infringes a basic concept concerning multiannual actions. The Court's recent opinion on the Financial Regulation (see paragraph 0.37) refers to this issue.

ADMINISTRATION AND CONTROL

Justification of expenditure

0.7. Under the present systems of subsidy the normal burden of proof, by which the beneficiary has to fully justify use of public funds, is very often reversed. The Commission's difficulties in checking legality, regularity and sound financial management aspects of the Union's finances are such that it is unable to properly assume its central role in managing the budget. The problems are particularly evident in the Structural Funds and significant for the common agricultural policy. The Commission advances Community funds and can only recover or reallocate them if it can prove that they have been wrongly used. This would be perfectly acceptable if beneficiaries and all intermediary organizations had accounting and control systems which could fully justify expenditure with sufficient and relevant proof and were obliged to present or make available the evidence to the Commission for an adequate level of checking by its services. The decentralization of management of Community funds has, unfortunately, not been accompanied by the creation of appropriate management information and accounting systems to permit the Community authorities to exercise, in the general interest, their overall supervisory function. The identification of errors and irregularities is thereby severely handicapped and the proper use of Community funding is uncertain. The criticisms and recommendations that the Court makes naturally reflect this fundamental structural weakness in the management of Community finances.

Principal observations

0.8. Almost all chapters of this Report (and five special reports to be taken into consideration for the 1996 discharge) include observations on administration and control weaknesses which demonstrate how far the development of appropriate systems of accounting and financial management, in particular in the Member States, has failed to keep pace with the expansion of Community activities and with their diversified nature.

Community income

0.9. Chapter 1 draws attention to the risks for own resources in the operation of customs-free zones and inward processing arrangements. It also mentions the frequent use of false certificates of origin to obtain preferential tariffs and the way in which, because of the length of investigations, legal time limits lead to loss to the Community. To avoid delays in making available own resources and to ensure their correct and harmonized collection, the Commission should establish a precise framework for resolving cases where it reserves its position with regard to the calculation of VAT and GNP resources.

0.10. Special Report No 5/97 on the management of cereals trade found that continuing difficulties were being experienced in recovering refunds paid, although exporters had accepted buyers' claims for shortfalls in quantities delivered.

EAGGF-Guarantee

0.11. The EAGGF-Guarantee chapters describe prob-lems with the implementation of the 1992 reform of the common agricultural policy with regard to cereals and beef. The integrated administrative and control systems, which are essential for adequate financial management, have still not been fully implemented. For cereals, the stabilizer system is hampered by imprecise regulations and Member State documentation fails to provide the necessary audit trail. Some Member States failed to comply with regulatory requirements concerning risk analysis, area and crop inspections and reporting. For beef, delays in adapting national mechanisms occurred and further improvements are needed to the cattle register, the administrative document and databases.

0.12. A specific aid programme for imports of beef into the Canary Islands was insufficiently controlled and necessary national legislation had not been enacted. Customs and veterinary checks on reimportation of beef exports rejected by Egyptian veterinary authorities were also inadequate.

0.13. In the wine market, the recent introduction of penalties for the provision of incorrect and incomplete information by beneficiaries for the Community's management information system has yet to be proved effective and vineyard registers are still not properly established. It is also regrettable, given the complexity of the aid system for tobacco, that the Member State control agencies foreseen in the 1993 reform have not been established.

Structural measures

0.14. The chapters concerning structural measures all contain, as in previous years, severe criticism of Member State statements of expenditure, which are often unreliable or inaccurate. Accounting and information systems must be improved so that there is an adequate audit trail from the Commission's payments to final beneficiaries' expenditure via the multiple levels of collection and certification of data.

0.15. Chapter 6 reports numerous problems of legality and regularity in actions from that part of the 1989-93 programmes which had been officially completed and closed. The Commission and Member States need systems to ensure that the Community budget does not finance ineligible expenditure.

0.16. Chapter 7 points out that Member States need a risk-based audit of final beneficiaries and the Commission should give greater attention to examination of final declarations, in order to ensure that the conditions for granting ESF funding, including the presence of national co-financing, are met.

0.17. Chapter 8 refers to cases where expenditure declared cannot be traced in accounting records or where individual amounts paid differ from those declared. National authorities have approved aid to firms processing agricultural products without reasonable market prospects or viability; incorrect expenditure declarations were also accepted.

0.18. The decentralized management of the Financial Instrument for Fisheries Guidance (Chapter 9) requires more thorough scrutiny by the Commission, particularly on-the-spot checks of the legality, regularity and reality of the expenditure declared. Follow-up of the Court's Special Report No 3/93 on restructuring of the Community's fishing fleet confirms that management information systems envisaged for effective monitoring and control are still not adequate for the efficient allocation of aid.

Programmes managed by the Commission

0.19. The Commission's handling of expenditure which it manages directly is also revealed to be unsatisfactory in many areas.

0.20. With regard to the participation of small and medium-sized enterprises in research, technological development and demonstration programmes, Chapter 10 concludes that weaknesses in SMEs' accounting systems and the complexity of the rules result in incorrect cost statements; more audits by the Commission are needed to establish the basis for recovery of overpayments and to deter irregular claims for aid. In general, the Community has to improve and simplify its procedures and develop specific measures to cope with the needs of SMEs.

0.21. The MEDIA I programme of assistance for industrial aspects of Community audiovisual policy (Chapter 11) was adversely affected by unclear contract arrangements for support agencies, inadequate audit of the agencies, and lack of instructions for the administration of venture capital and the recovery of outstanding loans.

0.22. Tendering during the period 1988-93 for EDF-financed works contracts (Chapter 12) shows many weaknesses in regulations and their application, affecting both the preparation and approval of calls for tender and the procedures for determination of compliance and for tender clarification.

0.23. Chapter 13 comments on the management, by a regional public financial institution, of a revolving fund for loans to export-oriented firms in Central America. The fund was set up in 1991, at a moment when the Court had just informed the Commission of important failures by the same regional financial institution in the management of another large project. Although the Commission included tighter conditions in the financing agreement for the revolving fund project, the financial institution failed to observe many of them and the Commission did not take effective action to ensure compliance.

0.24. For support to agricultural reform in the PHARE and TACIS countries, Chapter 14 refers to the Commission's failure, when considering programme proposals, to take sufficient account of the administrative organization of beneficiary countries or their institutional and legislative framework.

Other expenditure

0.25. Chapter 15 reveals the need to improve the definition of the use of grants to organizations advancing the idea of Europe and to delimit the type of expenditure and activity eligible for Community financing. It also draws attention to problems of budgetary presentation, accounting systems and internal control of the decentralized Community bodies. They should, while preserving their autonomy, cooperate with the Commission to improve their financial management.

0.26. Chapter 17 describes inadequacies in the system of reimbursement of travel expenses and allowances to members and alternates of the Economic and Social Committee and, to a much lesser extent, of the Committee of the Regions.

0.27. Chapter 18 - 'Financial instruments and banking activities` - concludes that any future operations similar to the loans with interest subsidies granted to Italy after the 1980 earthquake should be monitored by the Commission so as to ensure that the managing organization takes corrective action when borrowers do not respect their commitments.

COORDINATION

0.28. Administration and control is often adversely affected by lack of coordination. Chapters 6, 7, 10, 11 and 14 refer to noteworthy cases, as does the special report on humanitarian aid (No 2/97). Chapters 3 and 4 reveal that the development of the integrated administration and control system for agriculture has been handicapped by delays in the development of appropriate computer systems. Within the Commission's own services, five years after deciding to allocate substantial resources to the development of a management information system for development cooperation, the audit revealed that this major project had been badly handled.

EVALUATION

0.29. Evaluation is a key factor in ensuring proper use of public money. Weaknesses in the evaluation of the results of Community financing are described in Chapters 6 (particularly aid for SMEs) and 14, and in the special reports on humanitarian aid, on PHARE and on TACIS. In the absence of clear objectives and performance indicators, evaluation of the efficiency and effectiveness of structural expenditure is very severely hindered. The Court's assessment of the impact of aid for agricultural reform in Central and Eastern Europe (Chapter 14) was that its effects were at best limited. Special Report No 2/97 concluded that humanitarian aid seemed to have reached the intended beneficiaries, although sometimes with some delay. Every legislative proposal or financing decision that involves major expenditure needs to incorporate appropriate arrangements for determining success or failure in terms of precise objectives and in relation to firm baseline data. Only thus can the taxpayer's interest be protected against wastage. Finally, as Special Report No 2/97 recalls, the independence of the evaluation function from the operational departments of the Commission is necessary both for the effective use of resources and to encourage objectivity.

STATEMENTS OF ASSURANCE (VOLUME II)

0.30. Chapters 19, 20 and 21 concern the statement of assurance relating to the general budget and supporting information. For the general budget, the Court concludes that overall, with the exceptions mentioned in its statement, the 1996 accounts reliably reflect the Union's revenue and expenditure for the year and financial situation at the end of the year.

0.31. Because of the extent of the problems revealed by its audit of transactions underlying payments from the general budget, the Court declines to provide positive global assurance as to the legality and regularity of these transactions for the year 1996.

0.32. For EAGGF-Guarantee expenditure, improvements in a posteriori audit must be accompanied by completion of the installation of effective management controls in agricultural markets. For the Structural Funds, the high levels of substantive and formal errors again confirm the need for considerable improvement in accounting and control arrangements.

0.33. Chapter 22, which concerns the statement of assurance for the EDF, concludes that overall, with the exceptions mentioned in its statement, the accounts reflect reliably the revenue and expenditure for the year and financial situation at the end of the year and that the underlying transactions are legal and regular.

REMEDIAL ACTION BY THE COMMISSION

0.34. The Commission, in its replies to the Court's reports, has reacted positively to many of the Court's findings, often recognizing the need for action and, in some cases, indicating quite precisely its intentions with regard to remedial measures. It is, moreover, seeking to resolve many of the problems and weaknesses on which the Court reports by the implementation of its SEM 2000 financial management improvement initiative, both within its own services and in collaboration with the national authorities which handle and account for Community funds.

0.35. Success in strengthening the administrative and information systems which are the key to better financial management will be reflected in a fall in the rate of errors and irregularities detected by auditors. This Annual Report and special reports provide only very limited evidence of progress. A high rate of error and irregularity was still evident in 1996, particularly with regard to operations managed in the Member States other than agricultural guarantees. For agricultural guarantees there are, however, indications that the new financial clearance of accounts arrangements are having some beneficial impact.

0.36. There have been some other encouraging developments. Definition of eligibility criteria for Structural Fund assistance has been considerably clarified (although Chapter 7 draws attention to some remaining difficulties of interpretation with regard to Social Fund actions). Clearer definitions should reduce future errors and irregularities, but need to be accompanied by significant improvements in accounting and management information and in audits of operations (see Chapter 7). The decentralized financial management and the extent to which any programme can be modified by replacing an original component by a new one during programme implementation mean that there are no effective sanctions for incorrect declarations of expenditure by national administrations. As already discussed in other institutions, some real sanction, in the form of a net financial correction by the Commission, would be appropriate in serious cases of incorrect declaration.

THE FINANCIAL REGULATION

0.37. Opinion No 4/97 of the Court on a proposal to amend the Financial Regulation applicable to the general budget of the Communities concludes that it is time for the Commission to embark on a general overhaul of the Communities' financial regulations, first clearly redefining the fundamental principles on which they must be based. Numerous vague expressions and legal 'grey areas` need to be clarified and terminology scrupulously standardized. Many discretionary arrangements which run counter to a disciplined approach and hugely complicate accounting and financial management are not indispensable; some are irregular. The opinion lists principles and provisions that a new Financial Regulation should contain in respect of the budget, of the drawing-up of financial statements, and of the exercise of the internal control function in the institution. The Annex to the Court's opinion sets out in greater detail its general recommandations for a reformed set of financial regulations. The Court welcomes recent indications that the Commission intends to propose a general revision of the Financial Regulation and that the Court's opinion will be taken into account.

THE SIGNIFICANCE OF AUDIT

0.38. In the present state of accounting and financial management arrangements, the financial significance of audit is very high in terms of identification of expenditure which should not have been incurred, of amounts potentially recoverable and of possible future savings. This Report mentions considerable expenditure which was unnecessary, though not irregular (mainly overcompensation of agricultural producers), and numerous examples of potential savings which cannot be readily quantified. There is, in addition, the unquanti-fiable but significant deterrent effect of audit activity. The audit of Community finances whether by the Commission, by Member State auditors or by the Court is more than ever necessary to protect the interests of the European citizen.

PART I Own resources

CHAPTER 1(1\*) Own resources

1.0. CONTENTS Paragraph reference

General introduction 1.1

Implementation of the budget 1.2

Traditional own resources 1.3 - 1.119

Financial management 1.3 - 1.17

Follow-up by the Commission in response to the Court's observations 1.3 - 1.8

Financial management in the Member States 1.9 - 1.17

Free zones 1.18 - 1.43

Introduction 1.18 - 1.20

Designation and enclosure of free zones 1.21 - 1.24

Control of flow of goods and approval for free zone activities 1.25 - 1.33

Placing goods in free zones 1.34 - 1.35

Use of information note 1.36 - 1.37

Customs duties on goods unaccounted for in free zones 1.38 - 1.40

Customs checks 1.41 - 1.42

Conclusion 1.43

Inward processing regime 1.44 - 1.64

Introduction 1.44 - 1.46

Economic conditions on the grant of an authorization 1.47 - 1.53

Presentation of returns, establishment and making available 1.54 - 1.58

Rates of yield 1.59 - 1.61

Equivalent compensation and prior exportation 1.62 - 1.63

Conclusion 1.64

Establishment and ex post facto recovery of traditional own resources 1.65 - 1.119

Introduction 1.65 - 1.67

General observations concerning the regulatory framework, the procedures and the systems 1.68 - 1.88

Observations concerning the implementation of provisions in force 1.89 - 1.116

Conclusion 1.117 - 1.119

Own resources deriving from value added tax (VAT) and the gross national product (GNP) 1.120 - 1.156

Introduction 1.120 - 1.121

Adjustments to the VAT and GNP assessment bases 1.122 - 1.152

Control by the Commission and the entry of reservations 1.122 - 1.126

Situation as regards reservations and their financial impact 1.127 - 1.129

The entry of reservations in the accounts and their accounting follow-up 1.130 - 1.136

The monitoring of debts relating to reservations for the purpose of their recovery 1.137 - 1.149

The failure to charge arrears interest when own resources have been made available late 1.150 - 1.152

Conclusion 1.153 - 1.156

GENERAL INTRODUCTION

1.1. In the field of traditional own resources the Court's examination concentrated on the financial management by the Commission and the Member States as regards the establishment and recovery of Community entitlements, on the implementation of Community customs regulations in the field of free zones, on the financial management of the inward processing customs procedure (suspension system) and on the ex post facto establishment and recovery of traditional own resources in cases of fraud or irregularity. The Court also examined the monitoring of reservations entered by the Commission concerning the management of resources deriving from the application of a uniform VAT assessment base and a rate fixed in the framework of the budgetary procedure to the sum of the GNPs of all the Member States.

IMPLEMENTATION OF THE BUDGET

1.2. Table 1.1 summarizes Community revenue for 1996 and Diagram 1.1 shows that:

(a) actual revenue in 1996 was 81 275,1 Mio ECU, or 99% of the revenue provided for in the final budget, an increase of 8,3% on the 1995 figure (75 077,1 Mio ECU);

(b) net traditional own resources, less collection costs (1 509,3 Mio ECU), amounted to 13 583,6 Mio ECU, which is 16,7% of total actual revenue; these resources, which were 6% less than in 1995, comprised:

- customs duties of 13 069,1 Mio ECU gross, or 86,6% of gross traditional own resources (15 092,9 Mio ECU)(2);

- agricultural duties of 810,2 Mio ECU gross, or 5,4% of gross traditional own resources;

- sugar and isoglucose levies of 1 213,7 Mio ECU gross, or 8% of gross traditional own resources;

(c) the own resource based on value added tax (VAT) (taking account of balances and adjustments: 858,2 Mio ECU) amounted to 36 535 Mio ECU(3), or 45% of actual revenue; actual revenue was (39 127,34 Mio ECU) was 6,6% less than in 1995;

(d) the GNP resource (allowing for balances and adjustments: P27 Mio ECU) amounted to 21 058 Mio ECU(4) (including reserves of 237,9 Mio ECU), i.e. 26% of actual revenue; this resource was 48,6% higher than during the previous financial year (14 172,6 Mio ECU);

(e) the surplus from the previous financial year (9 215,19 Mio ECU) and miscellaneous revenue (915,93 Mio ECU) represent 12,5% of actual revenue, an increase of 40,4% on 1995.

TRADITIONAL OWN RESOURCES

Financial management

Follow-up by the Commission in response to the Court's observations

1.3. In its annual report concerning the financial year 1991(5), the Court of Auditors identified, on the one hand, traditional own resources which had not been made available to the Commission amounting to 2 Mio ECU and, on the other, entitlements made available late and amounting to over 2 000 Mio ECU on which the late payment interest due was estimated by the Court to be 25,72 Mio ECU. After audits in the Member States the Commission established that 6,5 Mio ECU of duties were still to be recovered, along with 25,0 Mio ECU of arrears interest. On 1 May 1997 only the sum of 0,1 Mio ECU of interest was still outstanding.

1.4. The Commission has recovered the 37 253 ECU relating to the specific cases mentioned in the Court's annual reports concerning the financial years 1992(6) and 1993(7). The Court's observations concerning the financial years 1994(8) and 1995(9) made it possible to recover 3,1 Mio ECU and issue recovery orders for an additional 2,5 Mio ECU.

1.5. As a result of these audits by the Court of Auditors followed up by the Commission, 169 recovery procedures were initiated. On 1 March 1997, 143 of these were still open; in 117 cases the actual amount of the debt had not yet been assessed. In the case of 21 recovery orders issued by the Commission, for a total of 25 Mio ECU, the final date for payment had passed by 1 March 1997. In 12 of these cases the final date for payment entered on the recovery order had passed more than a year previously.

1.6. In July 1995 the Court of Auditors established that the German authorities had neglected to make available to the Commission traditional own resources for the months of December 1993 and December 1994 amounting to 19,4 Mio ECU. The Commission was informed of this in August 1995. On its own initiative, the Member State concerned made the principal amount available to the Commission but did not pay interest in respect of late payment. On 29 November 1996, almost 15 months later, the authorizing officer issued a recovery order for the interest due.

1.7. In May 1995 Denmark informed the Commission that anti-dumping duties totalling 0,8 Mio ECU would be made available with a significant delay. Part of this amount (0,5 Mio ECU) had been established before 1991. In October 1995 the Commission asked for Article 11 of Council Regulation (EEC, Euratom) No 1552/89 of 29 May 1989 concerning interest on late payments to be applied to the whole period of arrears. A month later Denmark cited Article 7(2) of Council Regulation (EEC, Euratom) No 1552/89 of 29 May 1989, in anticipation of its amendment by Council Regulation (Euratom, EC) No 1355/96 of 8 July 1996, which was in the course of being adopted at the time, for the amounts concerning financial years prior to 1991. The invoked amendment introduced a time-bar of three years in respect of claims by the Commission on Member States where the latter had not previously been informed of the said claims. As of 31 January 1997 the recovery of the amount owed by Denmark was still pending.

Conclusion

1.8. The Commission encounters difficulties in timely recovering of amounts found to be owing following Community audits, notably interest on late payments. Furthermore, the amendment to Regulation (EEC, Euratom) No 1552/89 means that numerous recovery operations to be carried out in response to observations made by the Court risk falling victim to the three-year time-bar if they are not communicated to the Member States within the prescribed periods.

Financial management in the Member States

1.9. The Court has, during missions focusing on audit work related to the Statement of Assurance and on the audit of the topics reported hereafter, examined the establishment of Community entitlements, the accounting procedures and specific aspects of the collection procedures in all Member States.

Late establishment of own resources

1.10. In all Member States, the Court examined the extent to which national procedures ensure that, in accordance with Community legislation(10), customs debts are entered in the accounts at the appropriate time. The Court found that for:

(a) customs duties asseassed on operators after post-clearance examination (11) in other cases of irregularity where there are criminal proceedings: in the United Kingdom, customs debts are not established as soon as the conditions of Article 2 of Council Regulation (EEC, EURATOM) No 1552/89 are fulfilled. In many cases, such debts are established prior to initiation of criminal proceedings. Nevertheless, completion of the criminal proceedings and successful prosecution takes precedence over arrears collection;

(b) customs duties assessed on operators after post-clearance examination in cases of irregularities: in Spain the procedures applied created delays in establishment, bringing to account and making available of own resources, and to this extent did not comply with the Community legislation. Further, in Germany and Italy, the customs duties assessed from post-clearance examination were established up to 24 months late. In Belgium and to some extent in Germany lateness was systematic; and

(c) customs duties payable on incomplete declarations: in seven Member States(12) customs duties assessed on more than 10% of incomplete declarations were not properly entered into the accounts at the end of the period provided for in Community legislation(13) to allow operators to submit the particulars missing from their declarations. The customs duties outstanding or established late on a sample of incomplete declarations in Belgium, Spain and Ireland amounted to some 0,5 Mio ECU.

1.11. In the United Kingdom, the accounting system for managing cash deposits taken to secure potential tax debts does not allow separate identification of the deposits relating to Community own resources. In 1992, the British authorities acknowledged this to be a problem (14). In 1996 they stated that their accounting system was still not able to identify deposits either by revenue type or by reason for deposit and that further investigation would be needed to ascertain if there was a cost-effective solution to this problem(15).

1.12. In Germany, customs duties arising from period entry declarations(16) were in numerous cases brought to account three to four months late.

Separate accounts or B-accounts

1.13. Customs debts must be entered by the Member States in Community accounts. However, customs debts which have been communicated to the debtor but which remain uncollected and unsecured or, although secured have been challenged, should be entered in a separate Community account(17). In Italy, such amounts, in various offices, are not brought to account until the moment of recovery while Community legislation requires them to be accounted for at the moment of communication to the debtor. This procedure does not comply with Community legislation.

Write-off of established entitlements

1.14. In Germany, 0,2 Mio ECU were not made available to the Commission in application of Article 17(2) of Regulation (EEC, Euratom) No 1552/89 which allows Member States to be released from the obligation of making available own resources if in specific cases it appears that the recovery is impossible but the reason cannot be attributed to the Member State(18). However, in this case the non-collection was due to an error by the national authorities and the amount due should have been made available in June 1993.

Tariff classification

1.15. In the United Kingdom an error in the tariff had persisted for 17 years. The British authorities established and made available (in March 1995) the underpaid duties (3,36 Mio ECU) for a period up to three years prior to the date of discovery of the error (December 1991). Duties forgone during the period of enquiry necessary to establish and correct the error were not made available (0,3 Mio ECU). Late payment interest should apply to the underpayment made available more than three years late.

Duties payable on passengers' baggage

1.16. In some Member States, customs duties, excise and VAT are assessed on passengers' baggage at a flat rate. The receipts from passengers are subsequently, under national procedures, apportioned between the duty and tax categories. In the United Kingdom an incorrect percentage was used for three years in the apportionment of own resource revenue from passengers' baggage. This led to an underpayment of 3,9 Mio ECU of traditional own resources for the years 1993 to 1995. In March 1996, this amount was made available to the Commission. In Belgium, there is no periodic review of the national procedures for the apportionment percentage applied. This percentage, which has remained unchanged for 17 years, needs to be modified to take account of tariff or traffic changes.

Conclusion

1.17. Member States have the responsibility for the proper establishment of traditional own resources, for entering them to account, and for making them available to the Commission. They should ensure that Community legislation is properly applied. Moreover, they are entitled to retain 10% from the own resources made available to cover their collection costs. The Commission should monitor the way the Member States discharge this responsibility when carrying out controls and on-the-spot verifications. From a sample of approximately 3 000 declarations examined by the Court, at least 3 Mio ECU of own resources need to be recovered.

Free zones

Introduction

1.18. Free zones and free warehouses are defined in Community legislation(19) as parts of the customs territory of the Community but separated from the rest of it in which:

(a) non-Community goods are considered, for the purpose of import duties and commercial policy measures, as not being on Community customs territory, provided they are not released for free circulation or placed under another customs procedure or used or consumed under conditions other than those provided for in customs regulations;

(b) Community goods for which such provision is made under Community legislation governing specific fields qualify, by virtue of being placed in a free zone or free warehouse, for measures normally attaching to the export of goods.

1.19. Community regulations(20) currently list, as designated and operational, 33 free zones in 10 Member States. In Germany, Greece and Italy free zones are located in major national ports. Although reliable statistics are not available for the volume of goods passing through Community ports with free zones, it is estimated that such volumes do not exceed 10% of total goods movements for all Community ports. The Court's enquiry was conducted in six Member States(21) and included visits to 16 designated free zones.

1.20. The main principle underpinning the free zone concept is that the integrity of the customs territory be preserved by a combination of secure perimeters, entry and exit points, such as to facilitate supervision by the customs authorities outside the free zone and prevent any goods being irregularly removed. Rigorous recording in approved stock records is required for all goods brought into the free zone by authorized operators.

Designation and enclosure of free zones

1.21. Security arrangements for free zones in the Member States visited vary from nearly non-existent in the case of Ireland to very strong in Germany.

1.22. Ireland has two designated free zones, Shannon and Ringaskiddy. In one of these (Ringaskiddy), formally designated as a free zone in 1989, no free zone activity has taken place. While the two free zones are clearly defined, neither has secure perimeters or entry or exit points that facilitate customs supervision. The perimeters have not been designed to prevent goods from being irregularly removed from the zones. The Irish authorities place almost total reliance for the control of goods in free zones on documentary controls related to customs entry documents, on stock records maintained by free zone operators and on standard control procedures exercised over traders.

1.23. Tilbury Freeport free zone (United Kingdom) occupies the whole of the Port of Tilbury and, while adequately defined, fenced and secured, is simultaneously used as a free zone and as a normal port. The port is under customs supervision, but the free zone is a more abstract concept. Goods are 'placed` in the free zone as if it were a customs regime - up to 45 days after unloading in the case of goods arriving by sea - but are not segregated from other goods in the port under customs control or in free circulation. The 'virtual` free zone concept presents risks to Community own resources as free zone goods have been removed for free circulation from the zone, without payment of the appropriate customs duties. When discovered, the free zone goods have been replaced by similar goods from outside the free zone system. The regulations do not provide for the replacement of goods removed for free circulation by equivalent goods. Therefore, customs duties should have been collected on the goods removed pursuant to Article 201 of the Code.

1.24. In Italy, a listed free zone (Venice) has not functioned as a free zone since April 1993. A newly designated location, which does not have any authorized operators, has not been listed in the Official Journal of the European Communities as required by Community legislation(22).

Control of flow of goods and approval for free zone activities

1.25. Before an operator can carry out an activity in a free zone, he must first get the approval of the customs authorities for the stock records(23), in which he must enter all particulars of the goods brought by him into the free zone such as will enable the customs authorities to check the proper application of customs legislation.

1.26. The customs authorities responsible for supervision of free zones may, either at random or where they have reasonable doubts concerning compliance with the applicable legislation, check goods entering, leaving or remaining in a free zone(24).

1.27. Eight of the operational free zones visited by the Court have direct access to the sea(25). All of these, with the exception of Cadiz, comprise the major goods-handling facilities in each port. Consequently, the bulk of goods (including goods in containers) which are unloaded in these zones are for onward transportation inside the Community customs territory.

1.28. In the free zones of Germany and Italy, these goods, since they are not destined for the free zones concerned, are neither recorded in free zone stock records nor in temporary storage records as provided for by the Code(26). This is the case even though these goods sometimes remain within the free zone area for many weeks, circumventing customs supervision provisions.

1.29. The regulations make no distinction between goods being placed in free zones and goods entering free zones for onward transportation to other Community destinations. This fact, and the provision of the Code(27) that short-term storage in conjunction with transshipment shall be considered to be part of transshipment, mean that goods for onward transportation to other Community destinations can be described as transshipment goods and benefit from the free zone system without being subject to its rules.

1.30. In Germany (Bremen and Bremerhaven), the port authority which provides goods-handling and storage facilities is neither formally authorized as a free zone operator nor does it keep details of goods entering, leaving or remaining in the free zone in customs-approved stock records.

1.31. In Greece, when goods are conveyed in containers, the customs-approved stock records of the free zones' operators (the respective port authorities)only record container identification marks and brief descriptions of the goods. The requirement in the regulations that the stock records should enable the customs authorities to identify the goods and their movements(28) is not observed.

1.32. In the free zones of Trieste (Italy), the customs authorities do not generally enforce the requirement that operators maintain stock records nor do they, contrary to Community regulations(29), ensure that operators who engage in warehousing activities only seek their authority to conduct business within the zones by the presentation of applications for approval of stock records.

1.33. In the free zone of Barcelona, all the operators carrying out warehousing activities maintain their stock records on a system provided by the free-zone authority, a consortium of public bodies. None of the enterprises has sought the consent of the customs authorities to carry out activities in the free zone by making application for approval of stock records as required. In such circumstances, the consortium is the only entity against which the customs authorities can pursue customs debts arising under Article 205 of the Code.

Placing goods in free zones

1.34. The regulations(30) permit the placing of goods in a free zone without the need to present them to or lodge a customs declaration with the customs authorities. However, only operators carrying out activities in free zones with direct sea access can avail themselves of this right. In the other Community free zones, non-Community goods must first pass through another part of the customs territory, and therefore need to be covered by an appropriate transit arrangement. Transit arrangements invariably terminate on presentation of the goods and/or documents to customs.

1.35. In Ireland, non-Community goods are 'placed` in the Shannon free zone by means of a customs entry to the free zone as a 'customs regime` on their arrival on national territory. These entries are carried out without cover of a guarantee, which would normally be required for transit movements through the customs territory. A transit procedure is not used.

Use of information note

1.36. Community regulations make provision for an 'information note` which may be used by captains to facilitate the identification of vessels likely to be carrying Community goods(31). The same regulation, however, makes conflicting provisions(32) for the compulsory use of the information note where vessels are carrying non-Community goods to other Community ports and, in place of external Community transit procedures, where non-Community goods are carried by sea to free zones in Community ports. The information note, which records the vessel's name, its port and date of departure, port of destination and probable ports of call, does not record details of goods transported, nor does it distinguish between its compulsory and optional uses. It is only issued in a single copy, is neither numbered nor registered and, unlike full transit procedures, need not be discharged on arrival at the stated destination. The lack of coherence and clarity in its use has resulted in four of the Member States visited (Spain, Germany, Italy and Greece) requiring proof-of-status documents for goods arriving from any Community port of loading.

1.37. Consequently, when an information note is used in place of the Community transit procedures for the 'transport (of non-Community goods) to a free zone situated in a port`, there is a risk that it could be presented at another Community port or the non-free zone part of a named port and be accepted as proof of Community status for the (non-Community) goods being conveyed, on the basis that it had been authenticated to indicate that the vessel had set off with its initial load from a Community port.

Customs duties on goods unaccounted for in free zones

1.38. Article 205 of the Community Customs Code provides that a customs debt shall be incurred through the consumption or use in a free zone of goods liable to import duties under conditions other than those laid down in the legislation in force. Where goods disappear from a free zone and their disappearance cannot be explained satisfactorily to the customs authorities, the authorities may regard the goods as having been consumed or used in the free zone.

1.39. In the German free zones visited, customs debts on goods missing from the premises of free zone operators due to theft are waived. In Italy (Trieste), goods liable to customs duties which cannot be accounted for to the customs authorities are considered to have been re-exported from the customs territory and no customs debts are deemed to have been incurred.

1.40. In Greece (Piraeus) the sole free zone operator (the port authority) had contested customs debts which had arisen through the disappearance of goods liable to import duties from within the free zone area.

Customs checks

1.41. Generally, the optional customs checks provided for in the regulations(33) are carried out by the customs authorities of the Member States visited. In some instances, however, the management and effectiveness of these checks or audits were found to be unsatisfactory.

1.42. In Ireland (Shannon) no reports were produced of audits carried out nor was there evidence of the results or of follow-up action being taken in response to these audits. In Italy (Trieste), the customs authorities indicated that the checks carried out by them had been carried out without reference to stock records or other documentation. Checks on the stock records of operators in the Hamburg free zone were carried out by German customs without attempting to verify the completeness of the records by reference to the transport documents into and out of the zone. Major discrepancies came to light in the stock records of one free zone operator in the Bremen free zone, but were only detected by the national authorities after a change of ownership in the company.

Conclusion

1.43. The Court's findings suggest that each free zone operates in an almost unique fashion. The Commission should ensure that:

(a) information on the status and definition of free zones is up to date, accurate and clear and is disseminated to the customs authorities responsible for controlling the movement of goods between Community ports (see paragraphs 1.22 to 1.24);

(b) the regulations include a mandatory requirement that regular and systematic risk-based checks are carried out on free-zone goods and on the stock records and documents supporting their movement within free zones (see paragraphs 1.41 and 1.42);

(c) the risks posed for Community own resources by the non-application in the free zones of important aspects of the Community rules are eliminated; (see paragraphs 1.32 and 1.42);

(d) clear rules, which protect the financial interests of the Community, are prescribed for all non-Community goods which enter free zones (see paragraphs 1.28 to 1.30 and 1.35);

(e) appropriate duties are collected where dutiable goods disappear from within or are misused in free zones (see paragraphs 1.39 and 1.40);

(f) the regulations governing the customs treatment of goods transported by sea, and in particular non-Community goods transported from normal Community ports to ports with free zones(34) are amended to protect the financial interests of the Community but remain broadly compatible with the single market (see paragraphs 1.36 and 1.37).

Inward processing regime

Introduction

1.44. Inward processing is a customs procedure which allows the importation of non-Community goods, hereafter referred to as import goods, without payment of duty for the purpose of processing and export of the finished goods (compensating products) from the Community market. It can occur under two forms:

(a) the suspension system: in this case the duties due on the import goods, which are intended to be re-exported in the form of compensating products, are suspended at importation. However, if some finished products or import goods are placed on the Community market the duties become payable;

(b) the drawback system: the duties applicable to the import goods are paid at importation and are refunded if the finished products or import goods are later re-exported from the Community market.

To operate under inward processing a trader must first obtain an authorization issued by the appropriate national authorities.

1.45. In 1995 the Court audited a specific aspect of the scheme, focusing on compensatory interest to be paid on goods released for free circulation after having been placed under the suspension system(35). In 1996, the Court examined the implementation of the inward processing suspension system in eight Member States(36). The audit considered the potential impact on own resources of the way in which the suspension system is operated.

1.46. In the eight Member States visited authorizations delivered to operators in 1994 accounted for approximately 26 296,9 Mio ECU of goods imported(37). In the same year authorizations issued in the 12 Member States amounted in value terms to 36 997,8 Mio ECU. Some 1 200 authorizations were operational during the period 1995-96 in the 24 offices visited, of which a sample of 207 has been audited. Anomalies were found in 94 of those 207 authorizations. The Court established losses of own resources estimated at 0,5 Mio ECU from 25 of the 207 authorizations.

Economic conditions on the grant of an authorization

1.47. Prior to the issue of an authorization to participate in inward processing, an operator must satisfy the administration concerned that he complies with the economic conditions laid down in the Community legislation(38). The objective of these conditions is to protect the interests of Community producers who might be adversely affected by the importation of the import goods.

1.48. The economic conditions are regarded as fulfilled if the value of each type of goods imported by operator per calendar year is within a certain defined threshold(39). Where the value of the goods exceeds this threshold and where the nature of the operation is other than a simple handling operation the applicant must supply proof that he satisfies the economic conditions.

1.49. Where the economic condition claimed is that the use of Community goods is unsuitable because of their price, their quality, etc., then the particulars of the authorization concerned must be advised by the Member States to the Commission on a monthly basis so that it can inform the other Member States. In the case of milk and milk products and live animals the Commission must be informed in all cases(40).

1.50. In the Member States visited no instance was noted where an application had been refused on the basis of failure to fulfil the economic condition. If an economic condition claimed was not applicable then another economic condition was substituted. Furthermore, no instance was noted where an economic condition had been refused retrospectively as a result of a complaint by another Member State following notification through the Commission.

1.51. In Ireland, when an operator lodges an application for inward processing and claims an economic condition other than the value threshold (see paragraph 1.48), the Irish authorities apply the threshold if the value of the goods satisfies it. However, in such cases the authorization does not show that the threshold economic condition was granted. Thus, the relevant customs supervision office is not able to monitor its implementation.

1.52. In Portugal, the local customs office examines the economic condition under which it is claimed that the use of Community goods would be unprofitable. In the case of serious doubts the matter is referred to central level for decision. The examination should always be made at central level where adequate knowledge of overall market conditions and prices is available.

1.53. When the period of validity of an authorization exceeds two years the economic conditions must be reviewed at intervals not exceeding 24 months(41). In Germany national instructions do not comply with Community legislation as they require that this review should occur only every three years.

Presentation of returns, establishment and making available

1.54. When an operator is authorized to use inward processing, he is given a period within which the finished product (compensating product) must be re-exported(42). Within 30 days of the re-exportation period, the operator must supply the customs with a return (bill of discharge) showing the goods imported and discharge of the liability by export of the finished products, or assignment to a customs-approved treatment or use(43). If goods are placed on the Community market then the duties applicable to the import goods must be paid(44) together with compensatory interest.

1.55. The audit of 207 authorizations in the eight Member States visited leads to the conclusion that in some 20 cases about 14 Mio ECU were made available to the Commission up to seven months late, except in Spain where late payments may run from one year up to seven years late and in Germany from three months up to 27 months.

1.56. A pattern of late presentation of returns was found in the case of four operators in three Member States (Germany, Ireland, Italy), and in one large customs district in the Netherlands late presentation of returns was systematic. The Dutch customs authorities allowed the operators a period of 90 days for presentation of the bill of discharge and payment of duty, i.e. 60 days later than provided for by Community legislation. In Germany, an aggregation period of six months was granted to one operator instead of the monthly or quarterly aggregation period(45) provided for in Community legislation. The use of a six-month aggregation period has resulted in a delay of three months in the establishment and making available of own resources.

1.57. In Germany, for one large operator secondary compensating products and waste were not included in the bills of discharge and duty was not paid on their diversion to the Community market. The same exports were used to discharge several returns. In the case of another large operator a formal control was not carried out for a period in excess of three years.

1.58. In Belgium and Germany re-exportation periods were regularly and repeatedly extended without the operator justifying the need for extension. In some instances, the extended re-exportation period was not respected. Duties were not collected on import goods not re-exported within the period authorized for re-exportation.

Rates of yield

1.59. The rate of yield, which is defined as the quantity or percentage of compensating products obtained from the processing of a given quantity of import goods, should be subject to retrospective verification by the customs authorities(46).

1.60. In Belgium, France and Portugal the rates were not retrospectively verified by the customs authorities.

1.61. In Germany, one large operator presented bills of discharge which were completed on the basis of outdated rates of yield without a posteriori updating with the true rates. The differences between the outdated rates and the actual rates ranged from 10 to 150%. Re-export of import goods incorporated in compensating products had been overstated in 1995 resulting in a loss of own resources still to be estimated by the national authorities.

Equivalent compensation and prior exportation

1.62. An operator may be approved to use goods obtained on the Community market, instead of import goods, to produce compensating products (known as equivalent compensation). He may also be approved to export from the Community compensating products obtained from equivalent goods before importation of the substitute import goods. This is known as prior exportation. The authorization must allow for the use of equivalent compensation and prior exportation(47) and in the case of prior exportation, should specify the period allowed for importation of the substitute import goods(48).

1.63. In Spain, equivalent compensation had in one case been accepted in the bill of discharge without prior authorization. In the Netherlands, equivalent compensation was not applied in the manner provided for in Community legislation(49). In Germany and Spain, unauthorized prior exportation had occurred. In all of these cases own resources should have been collected.

Conclusion

1.64. The Commission should:

(a) assess the effectiveness of the implementation of economic conditions, take measures to limit the number of economic conditions applicable to those which are necessary to protect the interests of Community producers and ensure that these are effectively monitored; (see paragraphs 1.50 to 1.54);

(b) ensure that Community legislation is correctly applied by introducing a system for actively monitoring the implementation of the inward processing suspension system in particular as regards the control of the timely presentation of bills of discharge and making available own resources (see paragraphs 1.55 to 1.58), the retrospective checking of rates of yield (see paragraphs 1.60 and 1.61), the granting of equivalent compensation and prior exportation only on the basis of authorization (see paragraph 1.63);

(c) apply Article 11 of Council Regulation (EEC, Euratom) No 1552/89 on the payment of interest in the case of delays in making own resources available, where the customs debt arises as a result of inadequate monitoring by national administrations (see paragraphs 1.55 to 1.58).

Establishment and ex post facto recovery of traditional own resources

Introduction

1.65. In 1996 the Court examined, in eight Member States(50), the establishment and ex post facto recovery procedures for traditional own resources, concentrating on cases of fraud or irregularity dealt with by the Member States, in cooperation with the Commission, in the framework of mutual assistance (MA)(51). Most of the investigations carried out within this framework were intended to verify the regularity of certificates of origin issued in third countries which benefit from preferential tariff arrangements. The financial advantage arising from preferential arrangements granted to non-Member States is substantial. More than half of all Community imports benefit from preferential arrangements and much more than half of all cases of fraud and irregularity are committed under preferential arrangements. The Court's audit in the Member States was intended to complement the results of the audit conducted earlier on the same subject at the Commission(52).

1.66. From the point of view of protecting the Community's own resources, the rules on time-barring are the weak point in the procedures for the ex post facto establishment and crediting of traditional ownresources. This is because customs investigations are often complex and may extend over several years, particularly where they are intended to establish the regularity of certificates of origin. In such cases, except cases of fraud where national statutes of limitations apply, the time-bar comes into operation after only three years(53).

1.67. The Court has set out below the most common fundamental factors which regularly cause traditional own resources to be lost as a result of the time-bar. In the 23 cases in the sample examined by the Court, losses of this kind may be estimated to amount to 80 Mio ECU. In January 1996, the total number of cases appraised since 1988 and still being looked at in connection with fraud or customs irregularities was about 700 and the amount of duty evaded in those cases was estimated by the Court to be equal to 1 000 Mio ECU.

General observations concerning the regulatory framework, the procedures and the systems

Provisions concerning the protection of the financial interests of the European Union

Absence of legal basis for the provisional notification of entitlements and for the ex post facto requirement of a guarantee

1.68. In its annual report concerning the financial year 1994(54), the Court recommended in particular the incorporation into the Community Customs Code of provisions authorizing the taking of a security after goods have been discharged, as well as provisions permitting the period of time-barring to be interrupted from the moment an investigation commences, and permitting an estimate of the duties to be entered in the accounts. The cases established by the Court, in which own resources were already affected by the time-bar at the time the investigations were definitively terminated, confirmed that these recommendations were well-founded (see paragraph 1.67).

1.69. As regards the possibility of suspending the period of time-barring by a provisional communication, the Commission shared the view of the Court and submitted to the Council a proposal(55) intended to complement Article 220 of the Community Customs Code with a view to permitting an estimate of the amount of duty to be communicated. Allowing the customs authorities the option of requiring ex post facto security was also the subject of discussions at the Customs Code Committee, following which the idea was abandoned(56).

1.70. In May 1996 the Council requested the Commission to submit a proposal, the substance of which was to allow duties not to be recovered when, within the framework of preferential systems, the irregularities established originate in acts by the authorities of non-member States which the Community operators may not reasonably be expected to uncover(57).

Limited possibility of suspending the application of agreements in the case of insufficient cooperation on the part of the non-member States to which preferences have been granted

1.71. The successful outcome of investigations into the irregular or fraudulent application of preferential systems presupposes the cooperation of the authorities in the non-member States which issued the certificates of origin. It has only recently become possible for the Commission to institute proceedings to withdraw the preferences granted in cases involving fraud where no administrative cooperation is forthcoming, and in only one of the systems, the generalized system of preferences (GSP)(58).

1.72. In the case of orange juice from Israel, which was subject to conventional preferential arrangements, the Commission had to cope with the refusal of the local authorities to cooperate in getting to the bottom of the affair(59). The Israeli authorities agreed to check the authenticity of the stamps and the signatures which appeared on the certificates of origin but, faithful to their national legislation, refused to extend their checks to the actual origin of the juice, despite the fact that the Commission had observed as long ago as 1993 that the quantities of Israeli orange juice imported into the European Union were equal to approximately three times Irael's orange production capacity.

1.73. The unnecessary protraction of procedures and delays in replying may also be regarded as one of the administrative impediments to the recovery of evaded duties.

1.74. For example, a Community mission carried out at the end of 1991 to the Ivory Coast concluded that the tuna exported by the country in question to the Community since 1988 was of a non-original nature. The duties payable in this case amounted to about 17 Mio ECU. The Ivory Coast authorities, whilst not questioning the mission's conclusion, insisted that the Member States which had imported the tuna should submit, in accordance with the provisions of the Lomé Convention, individual requests for ex post facto checks on the relevant certificates of origin before they would institute recovery measures.

1.75. The Member States concerned then requested the authorities of the Ivory Coast, in the course of 1992, formally to declare void the certificates that had been inspected during the mission. Replies were provided to the Member States only in September 1995(60), and then they contradicted the findings of the Community mission. In France, the main Member State which had imported the tuna, the case had still not been settled in June 1996, although the customs authorities had, since 1991, taken down statements concerning duties totalling 8,7 Mio ECU (see paragraphs 1.107 et seq.). The opinion given in the framework of an administrative action brought by the importers concerned concluded that only about a third of the certificates covered by the official reports were irregular.

1.76. Finally, in certain cases the information forwarded by third countries is scarcely sufficient to remove doubts as to the regularity of the certificates of origin.

1.77. Textile products certified as originating in Jamaica were thus imported into France with exemption from duties (approximately 1,5 Mio ECU) from February 1989 to October 1991 under cover of 241 certificates of origin which were presumed to be false. A check on the stamps carried out by the French customs authorities showed that all the stamps on the certificates were different to the specimen stamps provided officially by the Jamaican authorities(61); one stamp even contained a misspelling of the name of the capital of Jamaica. The Jamaican authorities nevertheless confirmed to the French customs authorities in November 1994 that all the stamps in question were valid.

Inappropriate provisions which facilitate the circumventing of anti-dumping duties

1.78. Certain Community regulations instituting anti-dumping duties impose a variable duty based on a free-at-frontier minimum price; the difference between this minimum price and the price invoiced, if the latter is the lower, is collected in the form of an anti-dumping duty. Nevertheless, Community regulations(62) provide, in the case of successive sales of a product within the customs territory of the Community before it has been placed in free circulation, for the price at last sale to be accepted for customs valuation purposes. These provisions allow operators to circumvent the application of anti-dumping duties by presenting for customs valuation purposes invoices containing prices which are scarcely higher than the floor price.

1.79. The Court examined the case of Community imports from China of cheap shoes known in French as espadrilles, which were subject to anti-dumping duties instituted in December 1990(63).

1.80. In October 1993, the customs authorities drew up an official report relating to the sum of 0,2 Mio ECU payable by a Community importer who had cleared his goods on the basis of invoices drawn up by a Community intermediary established in another Member State(64). These invoices quoted a price that was almost three times that invoiced by the Chinese exporter. The free-at-frontier price which was declared was in the end only 0,0065 ECU higher per pair of shoes than the minimum price required for the non-imposition of provisional anti-dumping duties as instituted between the date of the order and the date they were placed in free circulation.

1.81. The customs investigations demonstrated that the Community intermediary had issued to the importer credit notes for a total amount which came to approximately 90% of the difference between his own invoice and the invoice of the Chinese exporter. As the customs investigations had been unable to establish any link between these credit notes and the sale of the shoes, the duties established were declared void in September 1994.

Non-uniform application of guarantee measures

1.82. When the customs authorities consider, during customs clearance, that the checks they have conducted could result in an amount of duty being payable which is greater than results from the information contained in the declaration, they require a sufficient guarantee to be provided to ensure that the duty to which the goods may ultimately prove to be subject can be recovered(65). This principle has been systematically transposed to the various agreements instituting preferential tariff measures and to the generalized system of preferences. If a measure of this kind is not to produce an unjustified change in trade flows, it must be applied uniformly in all the importing Member States.

1.83. The Court has established that even where there are serious doubts as to the validity of the certificates of origin submitted, and in spite of requests by the Commission, certain Member States do not insist on a guarantee for the imports at the time of customs clearance.

1.84. In August 1995 the Commission asked the Member States concerned to require guarantees in respect of the duties and levies payable on imports of concentrated orange juice covered by Israeli certificates of origin (see paragraph 1.73) and systematically to send the said certificates to Israel for ex post facto checks(66). The measures requested were applied immediately in Belgium, Greece and Italy and only from January 1996 in Germany and Spain. At the time of the enquiry the Danish, French and British authorities had no plans to institute guarantee arrangements because they felt that the evidence was insufficient to justify such a step. The Community rules do not allow the Commission to decide on the measures needed to ensure that guarantee arrangements are applied in a uniform manner.

1.85. According to Community statistics(67), the total value of orange juice imports from Israel into the Community increased by 52% between February and June 1996. During the same period, imports into the five Member States which had instituted guarantee arrangements remained stable, which suggests that imports shifted to other Member States.

Problem arising from the confidential nature of evidence gathered

1.86. The provisions of Article 15 of the Community Customs Code stipulate that 'all information which is by nature confidential or which is provided on a confidential basis shall be covered by the obligation of professional secrecy. It shall not be disclosed by the customs authorities without the express permission of the person or authority providing it; the communication of information shall be permitted where the customs authorities may be obliged or authorized to do so pursuant to the provisions in force, particularly (...) in connection with legal proceedings`.

1.87. Article 19 of Regulation (EEC) No 1468/81 concerning mutual assistance(68) also stipulates that information exchanged should be confidential. Paragraph 2 of this Article also stipulates that information obtained in the course of legal actions or legal proceedings subseqently instituted on account of failure to respect customs or agricultural regulations may be used. The strict application of the provisions concerning the confidential nature of certain information may cause attempts at ex post facto recovery to fail.

1.88. In Germany, the customs authorities notified an importer of video cassettes from Macao (see paragraph 1.91) that customs duties amounting to 0,1 Mio ECU, and anti-dumping duties amounting to 0,6 Mio ECU were payable. When an action was brought by the operator the German authorities submitted to the Court all the evidence available. However, national legal procedures stipulate that a court may only take into account those items of evidence which are available to both parties to the action. The court therefore requested authorization from the Commission to make the evidence available to the other party. The Commission said no, referring to Article 15 of the Community Customs Code concerning the confidentiality of information (see paragraph 1.86). The court then returned the items of evidence to the customs authorities and informed them that under those circumstances the recovery order for the anti-dumping duties could not be upheld.

Observations concerning the implementation of provisions in force

Delays in the legal evaluation of certain cases by the Commission

1.89. The Commission sometimes has to give an opinion on the legal aspects of a case before recovery measures may be instituted. If the examination takes a very long time it may result in a loss of own resources.

1.90. Delays of this nature occurred in dealing with the case of video cassettes from Macao. In order to circumvent anti-dumping duties(69), the principal producer of the video cassettes affected by the investigation had transferred his operations a number of times, first from Hong Kong to the People's Republic of China and then to Macao.

1.91. The Customs Code Committee (Origins Section) was asked on 31 July 1992 to decide whether, in accordance with Article 25 of the Code, which is applicable in the event of the rules concerning the origin of goods being circumvented, the video cassettes of the producer in question, which had been imported prior to April 1991 and declared as originating in China, and those imported after the said date and declared as originating in Macao, were subject to anti-dumping duties. When, in February 1994, the Committee completed its examination of the problem of anti-dumping duties by concluding that the imports from Macao were subject to the said duties, it was no longer important whether or not those from China were subject to them because of the time-bar.

1.92. If the Customs Code Committee had, within the appropriate time limits, adopted a decision to the effect that the video cassettes declared as originating in China were subject to anti-dumping duties, own resources estimated by the Court as amounting to more than 4 Mio ECU could have been preserved.

1.93. A second decision taken by the Committee in May 1994 also stipulated that the cassettes declared as originating in Macao could not benefit from the GSP.

Delays in making available to the Member States the results of joint investigations

1.94. Information from non-member States involved in investigations is usually communicated to the Member States via the Commission, which in some instances was late in forwarding to the Member States documents which were indispensable for starting recovery measures.

1.95. For example, with regard to the import into the Community of fish from Norway, the Commission did not forward to the Member States certain lists of non-valid certificates of origin communicated by the Norwegian authorities until more than two months after receipt.

Shortcomings in the implementation of results of investigations by the Member States

Non-uniform application of ex post facto establishment measures

1.96. In the investigation into car radios from Indonesia, the Community on-the-spot mission found that car radios imported into the Community under cover of certificates of origin did not meet the GSP criteria and, moreover, that the car radios from certain manufacturers should be deemed to have originated in South Korea and therefore be subject to anti-dumping duties. In March 1994 the Indonesian authorities confirmed the invalidity of the certificates they had issued.

1.97. For the most part the Member States visited by the Court have decided to establish the customs debt ex post facto and to notify importers of both customs duties and anti-dumping duties. However, some Member States considered that the evidence collected by the Commission was insufficient from a legal point of view to allow the recovery of the anti-dumping duties.

1.98. In the United Kingdom anti-dumping duties amounting to 1,5 Mio ECU were communicated to the principal importer in June 1994. In June 1996 the British authorities were informed that these duties had not been recovered in all Member States. In August 1996 they declared void the duties communicated to the principal British importer and in May 1997 they informed the Court that they planned to repay the anti-dumping duties already paid by three other importers.

1.99. In Germany, only customs duties were communicated; no ex post facto recovery measures had been instituted in respect of the anti-dumping duties because the evidence available was not judged sufficient by the German authorities. The amount of own resources involved was estimated by the Court to be 2,5 Mio ECU.

1.100. In Spain the competent authorities stated that they had not been aware until March 1996 of the confirmation from Indonesia of March 1994. Between April 1993 and March 1996 they had not instituted any ex post facto recovery measures, because they considered that the mission report and the lists of invalid certificates were insufficient for this purpose. In March 1996, however, all the import declarations pertaining to the 36 certificates referred to in the list of November 1993 became time-barred. The customs duties and the anti-dumping duties thus barred are estimated by the Court to be over 0,6 Mio ECU.

Other examples of delays and shortcomings in the implementation by the Member States of decisions taken at Community level

1.101. In some cases recovery measures were not taken or were subject to delays which resulted in a loss of own resources.

1.102. Table 1.2 shows for three Member States the estimated amount of duties time-barred in the case concerning video cassettes declared as originating in Macao. In the case concerning fish from Norway the amount of duties which lapsed because time-barred is estimated by the Court to be 0,6 Mio ECU in respect of three Member States, and in the case of car radios from Indonesia to be 1,1 Mio ECU in respect of four Member States(70).

1.103. The Court carried out thorough substantive tests in one Member State on the basis of a sample of 285 import declarations relating to video cassettes declared as originating in Macao and accompanied by certificates of origin issued by the Macao authorities. In the case of 15 of these declarations, the competent local offices had not carried out any ex post facto notification, and in 11 other cases notification took place after the cases had become time-barred. In six other cases the investigation instituted in good time by a regional office was not taken up at central customs level.

Inadequacy of accounting follow-up of establishments and recoveries

1.104. In Germany and in Greece the central authorities do not carry out out any systematic checks on the application at local level of the recovery orders they issue. In Germany, customs clearance operations continue to be insufficiently automated and still do not provide any guarantee that all import declarations which may be the subject of an ex post facto establishment will be identified. In Italy the central administration said that it was currently monitoring the progress of the enquiries but was unable, during the Court's on-the-spot visit, to supply any summary of the establishments and recoveries carried out by the local offices.

Suspension of payment not in accordance with the Customs Code

1.105. In application of the Community Customs Code, the amount of the customs debt must be communicated to the debtor as soon as it has been entered in the accounts (Article 221), and all amounts communicated must be paid within the time limit set, which is normally 10 days (Article 222).

1.106. Where the amount of duty has not been paid within the prescribed period, the customs authorities may avail themselves of all options open to them under the legislation in force, including enforcement (Article 232). The lodging of an appeal does not cause implementation of the disputed decision to be suspended; except in exceptional circumstances, suspension of payment may be granted only if a security is lodged (Article 244).

1.107. In Belgium and in France the taking of a statement is deemed equivalent to the communication of the amount of the customs debt and extends the period before time-barring takes effect.

1.108. In France, the official statements taken down by the customs authorities indicate the debtor and the amount of the debt. So long as the customs debt has not been recognized by the debtor or upheld by the courts no recovery measures are undertaken.

1.109. The result is that the French customs authorities in effect suspend implementation of the recovery procedure without the conditions for such suspension, as laid down in Article 244 of the Code, being met. At the time of the investigation an amount of approximately 21 Mio ECU, in respect of a sample of 26 official reports examined by the Court, was subject to such suspension. The French authorities told the Court that instructions would be given to the departments concerned to ensure that the request to pay the debt within 10 days was entered in the minutes.

1.110. In Belgium too there is sometimes a considerable delay between when the official reports are drawn up and the requests for payment are issued. The sample of 15 official reports selected by the Court related to a total amount of about 1 Mio ECU; the parties to whom these official reports were addressed had benefited from deferments of up to four years and some were still benefiting from them at the time of the Court's visit.

1.111. In the United Kingdom recovery orders refer systematically to a time limit for payment of 10 days. Nonetheless, the Court has established that the British authorities usually suspend implementation of enforcement measures without requiring the lodging of security for such time as the case is pending with the customs authorities(71).

Disputes between Member States regarding the application of the provisions governing failure to discharge an external Community transit document

1.112. The Court audited the progress made in the mutual assistance investigation into discharges at Irun in Spain, using false stamps, of 229 T1 transit documents issued between June 1991 and October 1992 by the customs office in Antwerp for consignments of milk powder originating in Eastern Europe and destined for Spain. The total amount of agricultural duties evaded is estimated to be over 9 Mio ECU.

1.113. Under the provisions of Article 215(1) of the Community Customs Code and Articles 378 and 379 of the implementing provisions, recovery action must be instituted by the competent customs authorities of the place where the customs debt is incurred. Where a transit document is not discharged the debt is deemed to have been incurred at the place where the goods were withdrawn from customs supervision; if this place is not known, the goods are deemed to have been so withdrawn in the Member State of departure.

1.114. The Belgian authorities, who informed the guarantor in March 1993 and drew up an official report in January 1994 against the three principals concerned, nevertheless failed to issue a single request for payment. They base their case on the conclusions of investigations conducted since 1993 in Belgium and in France, which state that the goods were withdrawn from customs supervision on Spanish territory.

1.115. At the time of the Court's examination the Spanish authorities had not instituted recovery procedures against those presumed to have committed the fraud in Spain either, because under national law administrative recovery procedures may only be instituted after a court judgment has established that the parties in question are guilty. The Spanish authorities also consider that they have no power to institute recovery measures against the Belgian principals either, because they believe there is insufficient evidence to show that the goods were withdrawn from customs supervision in Spain.

1.116. The Commission shares the conclusions of the Belgian and French authorities(72). At the time of the Court's examination, however, it had taken no steps to put an end to the dispute between the Member States or to ensure that the administrative recovery procedures provided for by the Community customs regulations follow their normal course, without prejudice to the pursuance of criminal proceedings at Member State level.

Conclusion

1.117. With regard to non-member States which benefit from preferential trade agreements, the protection of the financial interests of the Community requires that measures be taken to suspend the benefits granted in all cases where the Community budget has suffered from the failure by the other party to the agreement to respect obligations. The possibility of suspending such benefits should be extended to all preferential agreements (see paragraphs 1.71 to 1.77).

1.118. Within the customs union, the Commission and the Member States should work to ensure that the aims of the Community regulations on traditional own resources are respected (see paragraphs 1.86 to 1.88 and 1.111) and are applied rapidly and uniformly (see paragraphs 1.89 to 1.95). The Commission should:

(a) persuade the Member States, if necessary by proposing that its own prerogatives be reinforced, to adopt identical practices as regards preventive guarantees (see paragraphs 1.82 to 1.85), establishment (see paragraphs 1.96 to 1.103) and recovery (see paragraphs 1.105 to 1.111);

(b) ensure that regulations instituting special protection measures, notably anti-dumping duties, cannot easily be circumvented by operators, to the detriment of the Community budget (see paragraphs 1.78 to 1.81);

(c) institute rapid and efficient conciliation procedures, in order to resolve cases where the competences of Member States conflict and so prevent the recovery of own resources (see paragraphs 1.112 to 1.116);

(d) propose appropriate measures with a view to harmonizing the time-barring periods for recoveries (see paragraphs 1.68 to 1.70) provided for in the Community Customs Code with the longer periods concerning Community administrative sanctions as laid down in Article 3(1) of Council Regulation (EC, Euratom) No 2988/95 of 18 December 1995 on the protection of the European Communities' financial interests(73);

(e) propose a suitable regulatory framework so as to guarantee the uniform application of the security system in all Member States (see 1.82 to 1.85).

1.119. The Commission must make the best possible use of the accounting follow-up of investigations into cases of fraud and irregularities (see paragraph 1.104). Where necessary, it is incumbent on the Commission to institute infringement proceedings where there is found to have been negligence in ex post facto establishments and recoveries for which the Member States are responsible.

OWN RESOURCES DERIVING FROM VALUE ADDED TAX (VAT) AND THE GROSS NATIONAL PRODUCT (GNP)

Introduction

1.120. The method for calculating assessment bases for VAT and GNP own resources, which globally represent approximately 80% of own resources, are laid down in specific Community regulations(74). Statistical data play a decisive role. Moreover, with regard to the VAT resource, the many exceptions that arise within the joint VAT system in the Member States mean that subsequent corrections and compensation are required so that the theoretical assessment base that would result from harmonized application by the Member States of VAT-related legislation may be reconstructed.

1.121. The Community regulations concerning the making available to the European Union of own resources(75) prescribe that arrears interest should be paid by the Member State concerned where entries in the accounts are made late. The same applies when the Commission decides to call for additional funds from Member States(76).

Adjustments to the VAT and GNP assessment bases

Control by the Commission and the entry of reservations

1.122. For a given financial year, the Member States forward to the Commission the data concerning the assessment bases for the VAT and GNP own resources in the second half of the year following the financial year of reference. These data are checked by the Commission, which is responsible for ensuring that the Member States comply in a uniform manner with the applicable provisions regarding the calculation of tax bases.

1.123. Whenever the Commission believes that one of the factors used to calculate the assessment base is incorrect, it enters a reservation, which initiates the right, where appropriate, to make the necessary adjustments for the financial year under way, as well as for preceding financial years. Moreover, the Member States are also entitled to enter a reservation.

1.124. In general, reservations originate with problems relating to the statistical data used to calculate the assessment bases, or even with instances of violation of the regulations, particularly as regards application of the Sixth Directive concerning the joint VAT system(77). Amongst the matters currently outstanding for all Member States is that of the exhaustiveness of the GNP, i.e. the problem of taking the black economy into account.

1.125. The Court of Auditors has already had to deal with the handling of reservations in the past(78), and the European Parliament has expressed its opinion on this matter in the context of several discharge procedures(79). This year the Court decided to examine more particularly entry in the accounts, the monitoring of debts connected with reservations, and the charging of arrears interest when own resources are made available late.

1.126. What is at stake as far as these procedures are concerned is, on the one hand, the Commission's right fully to exercise its prerogatives as regards determining and making available the principal own resources of the Union and, on the other, the fact that Member States are required to respect their obligations in this field.

Situation as regards reservations and their financial impact

1.127. On 31 December 1996 115 reservations had been entered in connection with the VAT resource (including nine involving ongoing violation proceedings) and 115 concerning GNP. Half of these reservations, entered primarily by the Commission, had been notified between 1985 and 1992.

1.128. There is no information available as to the sums at stake in the cases currently pending. According to the Commission, any valid indication in this area actually depends on the Member States, so that the precise financial impact of any reservation can only be known with certainty when it is cleared.

1.129. The effect, both positive and negative, of the clearance of reservations on the VAT resource base resulted overall in additional payments of about 14 Mio ECU in 1996. The largest amounts related to three reservations in respect of which adjustments amounted, respectively, to 16,4 Mio ECU, 3,1 Mio ECU and 1,7 Mio ECU. It should, moreover, be noted that the raising of a GNP reservation on the VAT base (capped at 55% of the GNP) resulted, for one Member State, in the payment of 39 Mio ECU more by way of VAT resources.

The entry of reservations in the accounts and their accounting follow-up

1.130. For the purpose of ensuring exhaustive and efficient follow-up, the Financial Regulation stipulates that a debt estimate must be entered in the accounts, after the Financial Controller's approval has been given, for any measure or situation likely to give rise to or modify a debt, and thus any reservation. This constitutes a preliminary stage where the debt is not yet 'established, liquid and due` and it is therefore necessary to take effective measures with a view to determining the factors that will enable recovery, where appropriate.

1.131. The Court's audits have revealed that the reservations entered and the entry in the accounts of debt estimates do not always correspond. Hence, some reservations might not be entered in the accounts, and the primary objective of avoiding any oversights by making entries in the accounts is thus defeated.

1.132. The financial statements do not give a true picture of outstanding reservations, because the accounts do not systematically include token entries showing the impact which reservations may have on the current financial year. Moreover, in several cases the entry in the accounts did not take full account of all the previous financial years concerned either.

1.133. In breach of the detailed rules concerning the implementation of the Financial Regulation, the accounts do not mention in any detail what has been done to effect recovery. It is possible to establish the true circumstances surrounding each reservation only by systematically consulting the files of the unit of the Commission responsible for the audits.

1.134. The accounts system is designed in such a way that when reservations are entered and the Member State concerned remits the own resources, the recovery order is drawn up in a global manner and thus includes any other corrections. This being the case, in order to establish the amount remitted by the Member State in respect of each of the cancelled reservations, considerable research has to be carried out, which hinders the Community's monitoring and control procedures.

1.135. In these circumstances, entering reservations in the accounts constitutes little more than a formal application of the Regulation. As a result of its lack of reliability, the current system cannot guarantee at any one time the accuracy of the accounting entries relating to reservations nor that all of the European Union's entitlements and obligations in this field are accounted for.

1.136. Each department concerned, including the Financial Controller, has therefore set up its own monitoring system. These systems, which are not coordinated and in part serve different purposes, cannot take the place of a centralized accounts system organized in such a way as to ensure that all details are entered. In order to draw up a full account of existing reservations it is in fact necessary manually to cross-check the lists from the various Commission departments against the base files.

The monitoring of debts relating to reservations for the purpose of their recovery

1.137. The regulation applicable to the VAT resource(80) provides that where a Member State disagrees with a correction that is to be made to the assessment base, the Commission may take the measures it deems necessary for the regulation to be applied correctly. The Commission has similar powers with regard to GNP(81).

1.138. When a problem is detected in a Member State's calculation of the assessment base and a reservation is entered, the Commission enters into discussions with the national administration in order to find a solution to the case in question. The current procedure does not stipulate that time limits should be fixed. Nevertheless, in the few cases of violation of the Sixth Directive brought before the Court of Justice that are likely to affect own resources, the Commission set a time limit by which the Member State was to pay over the sums in question.

1.139. In 1991 the Commission set a maximum time limit for the cancellation of reservations of two years following the audits. At the same time the Commission undertook to resolve rapidly those relating to audits carried out in 1989 or preceding years(82). These objectives have not yet been achieved.

1.140. The following cases illustrate the concrete application of the monitoring system set up by the Commission.

VAT on motorway tolls

1.141. The Commission believes that exemption of tolls collected by toll-collecting companies in return for the use of road infrastructure contravenes the Sixth Directive and is likely to be detrimental to the VAT own resource. It entered reservations with regard to one Member State in 1985 and with regard to four others in 1987. It was only in July 1996, more than 10 years later, that the Commission decided to bring proceedings before the Court of Justice for infringement of the Sixth Directive.

Subsidies and the taxable amount

1.142. According to the Commission, pursuant to the Sixth VAT Directive, the taxable amount must include subsidies directly connected with the cost of the taxable transactions. As it believed that such subsidies were not being included and that the VAT own resource was affected by this, the Commission in 1993 entered a reservation concerning all the Member States and examined the situation together with them. Even though the facts have been established for some time, no decision has yet been taken with a view to clearing this reservation.

Vehicle-purchase compensation

1.143. Following an audit in one Member State, the Commission, in 1991, entered a reservation concerning the calculation of compensation in respect of the private use of company vehicles and asked for up-to-date information on this form of compensation. An agreement in principle appears to have been reached at the end of 1996 to correct the 1988 to 1995 bases.

1.144. With regard to another Member State the Commission entered a reservation in 1989 concerning the calculation of this kind of compensation. When an audit was conducted in 1995 the Commission considered that the national authorities should re-examine their statistics in this regard. An agreement in principle seems to have been reached at the beginning of 1997.

Method for calculating compensation payable to small enterprises

1.145. The traditional calculation method, based on enterprises' turnover, profits and input-related transactions, was questioned by the national authorities during the audit visit made by the Commission in 1988. Subsequent audit visits did not produce a solution. During the audit carried out in 1994, the Commission auditors wanted to obtain additional information. The information was forwarded at the beginning of 1997 and the Commission was able to withdraw the reservation after a check.

Gold-related transactions

1.146. Following an audit carried out in 1991 in one Member State, the Commission entered a reservation concerning the calculation of compensation relating to purchases of coins and medallions, which are not normally used as a means of payment. During the audit visits that took place in 1993 and 1995, the Commission expressed doubt as to the satisfactory nature of the data used for the years prior to 1992 and 1993. The Member State then corrected the compensation for the financial year 1991, but this remains to be done for the years 1989 and 1990. An agreement in principle was reached in February 1997.

1.147. These few examples are a good illustration of the fact that a specific procedure, governed by time limits agreed jointly by the Commission and the Member State on the basis of the difficulty of the problems to be overcome, needs to be laid down to ensure that pending files are dealt with in a uniform manner. Several years pass (generally between three and five years) before an acceptable solution is found and before the own resources concerned are paid.

1.148. The Member States and the Commission are jointly responsible for the complete and harmonized determination in good time of the tax bases for the VAT and GNP own resources. It is therefore their responsibility, once a reservation is entered, to take any expedient measure to enable a solution to be found and, in particular, to carry out any additional work that might prove necessary without delay.

1.149. After receiving a favourable opinion from the GNP Committee in March 1996 the Commission planned to ask the Member States to carry out the additional work that would bring about a resolution of the reservations relating to GNP. The time limit for certain Member States was to be September 1997; for others it was to be September 1998. By March 1997 the Commission had still not taken a decision on the matter.

The failure to charge arrears interest when own resources have been made available late

1.150. The time it takes to resolve reservations are attributable at least in part to the Commission's refusal to lay down a precise framework and systematically to apply Community provisions concerning arrears interest. This is, in fact, more of a pragmatic position than the result of limitations on the Commission's powers, which, if such were actually the case, have not induced the Commission to propose that the legal texts in force be amended.

1.151. The regulations concerning VAT and GNP own resources(83) allow the Commission every discretionary power in the event of persistent disagreement concerning a correction that is to be made. The Financial Regulation specifically provides that any additional payment from the Member States is due within 30 days of the date on which funds are called for, failing which arrears interest is payable.

1.152. During the financial year 1996, the authorizing officer charged a Member State arrears interest amounting to 5 Mio ECU on account of a technical error in entering a monthly amount of own resources, which the Commission itself considered had had no financial impact. The Court considers that this contradicts the practice applied in the case of reservations, where the financial consequences may be considerable and where the need to pay arrears interest could have a clearly dissuasive effect.

Conclusion

1.153. Entries in the accounts that give a true picture, for the purposes of transparency, of the reality of the European Union's entitlements and obligations are an essential condition if the authorizing officer, Financial Controller and accounting officer are to be able to carry out their monitoring and control responsibilities and the external control function is to be discharged.

1.154. The Commission's current procedure for monitoring reservations may, on account of the delays observed, lead Member States to fail to fulfil all of their obligations as regards safeguarding the European Union's financial interests. In this context, the Commission should ensure that it fully exercises its prerogatives as regards establishing the European Union's main resources within the requisite time limits.

1.155. The recovery of debts relating to reservations entered regarding the calculation of tax bases should therefore persuade the Commission to set up a uniform framework. Depending on the difficulties to be resolved, each reservation would, within this framework, be subject to a schedule laying down the means of settlement, the time limit by which the own resources at stake were to be made available and any arrears interest payable. The Commission would also be able to make legislative proposals if it felt that its existing powers did not enable it to establish own resources in a uniform and comprehensive manner within the prescribed time limit.

1.156. Reservations often arise as a result of the incorrect application of the VAT system, inappropriate statistical methods or even an insufficiently exhaustive assessment base, as is the case with GNP, where the black economy is not taken into account. As a result, a more rapid resolution of cases pending concerning VAT and GNP goes well beyond making own resources available more rapidly. It also guarantees the equal treatment of Member States as regards budget financing and, in short, greater harmonization of the national systems concerned.

REPLIES OF THE COMMISSION

TRADITIONAL OWN RESOURCES

Financial management

Follow-up by the Commission in response to the Court's observations

1.5. The Court's comments highlight the difficulties the Commission encounters in recovering amounts due from the Member States. It is often obliged to send repeated reminders when the amounts are not paid within the time limits set. Furthermore, long and difficult disputes arise in many cases because of their legal complexity. In some cases, the Commission even has to initiate infringement procedures. It would point out that default interest is charged whenever there is any delay in making the principal available.

1.6. The Commission regrets the delay noted by the Court. It has now taken appropriate measures to strengthen its internal procedures for following up the Court's comments.

1.7. The Commission sees no justification for the Danish authorities' position. The three-year time limit introduced by Regulation (Euratom, EC) No 1355/96(84) applies only from 14 July 1996 and cannot be applied retrospectively. The Commission is considering an infringement procedure if the Danish authorities still refuse to pay default interest.

Conclusion

1.8. The Commission would point out that the slowness in recovering entitlements identified during its controls is often due to the cumbersome national procedures for providing the Commission with the accounting information it needs. It expects the situation to improve as a result of measures taken under Phase III of the SEM 2000 initiative (sound and efficient management) which seeks to improve cooperation between the Commission and the Member States. The Commission is aware of the three-year time bar, which is why it ensures that the Member States are informed of its reservations concerning financial discrepancies as soon as possible.

Financial management in the Member States

Late establishment of own resources

1.10. The Commission shares the Court's concern about all these cases and the Member States in question are being contacted so that the situation can be remedied. Default interest is charged in cases where there are delays in making available own resources.

1.11. The Commission also considers that the amount of import duty should be indicated in the guarantee. It will ask the UK authorities to examine this situation in order to decide what measures are necessary to ensure a satisfactory degree of transparency in the accounts.

1.12. The Commission will examine the cases mentioned and will contact the German authorities in order to remedy the situation, with default interest being charged where appropriate.

Separate accounts or B accounts

1.13. The Commission feels that the procedure applied in Italy does not comply with Community legislation. It has already contacted the Italian authorities as part of its controls and asked them to improve the way they keep the B account.

Write-off of established entitlements

1.14. The Commission has contacted the Member State concerned. The German authorities subsequently informed the Commission in April 1997 that they would comply with the procedure for writing off amounts described in Article 17(2) of Regulation (EEC, Euratom) No 1552/89.(85) Germany will therefore report all cases since 1 January 1989 where the amount exceeds the threshold of ECU 10 000 provided for in the rules. The Commission will examine these cases and inform the Member State concerned where it considers that the amount should not have been written off.

Tariff classification

1.15. The Commission will ask the Member State concerned to pay the principal of ECU 0.3 million together with the default interest due since December 1991.

Duties payable on passengers' baggage

1.16. The Commission has informed the UK that default interest is due. In the case of Belgium, the Commission will contact the Member State so that the percentage can be changed.

Conclusion

1.17. Community legislation does actually provide for a clear breakdown of responsibilities between the Member States and the Commission. The Commission feels that the current situation could be substantially improved by a regular review of the rules and by strengthening its partnership with the Member States. The Commission is following both courses.

Free zones

Designation and enclosure of free zones

1.21 1.24. The Commission is planning to propose new legislation to improve the supervision of a number of free zones by means of control mechanisms modelled on the customs warehousing procedure. It also plans to publish an updated list of free zones every year. More specifically, it is examining how the UK authorities apply the rules governing the free zone at Tilbury and is studying the legal base for the free zones in Trieste and Venice.

Control of flow of goods and approval for free zone activities

1.25 1.42. The Commission will remind the Member States that, as a rule, the Community customs legislation, including the rules on customs debt, also applies within the free zones. The Commission will contact the Member States concerned in order to examine the cases mentioned by the Court. If necessary, it will ask these Member States to bring their practice into line with Community rules.

1.29. The Commission is aware of the problems raised by the failure to distinguish between the two types of goods which may enter the free zones. The proposal referred to in the reply to paragraphs 1.21 to 1.24 would strengthen the control provisions applicable to free zones using the customs warehousing procedure.

Placing goods in free zones

1.35. Community rules do not indeed allow the guarantee to be waived for transfers to the free zone under simplified procedures. The Commission will contact the Irish authorities to have this procedure changed as soon as possible and will ensure that the European Union's financial interests are not jeopardized.

Use of information note

1.36 1.37. It is planned to resolve the problem raised by the Court by means of an amendment of Community rules which is now being considered in order to guarantee the security of movements of goods by stepping up controls of their customs status.

Customs duties on goods unaccounted for in free zones

1.38 1.40. Like the Court, the Commission considers that any unexplained disappearance of goods stored in a free zone generates a customs debt. It will ask the Member States to remedy the situation.

Customs checks

1.42. The Commission will contact the authorities concerned so that they carry out customs checks in the free zones in accordance with Community rules.

Conclusion

1.43. The Commission shares the Court's concern about the operation of the free zones visited.

(a) The Commission is currently reviewing the status and definition of the free zones and will inform the competent authorities of the Member States of its conclusions.

(b) and (d) Proposals are now being drafted for legislation to improve the control of certain free zones by means of control mechanisms modelled on the customs warehousing procedure.

(c) The Member States concerned will be reminded of their responsibilities as regards control measures within the free zones, including checks of operators' stock records. The Commission will ask the Member States to make systematic use of risk analysis methods in this connection.

(e) The cases mentioned by the Court will be duly followed up by the Commission, especially when there have been unexplained disappearances.

(f) The Commission is drawing up proposals to guarantee the security of movements of goods by stepping up controls on their customs status.

Inward processing regime

Economic conditions on the grant of an authorization

1.50. The Commission is drawing up proposals to reform the inward processing arrangements, including the economic conditions.

1.51. In response to the Court's comments, the Irish authorities have stated that they will change their procedure so that the value threshold for the economic conditions can be checked.

1.52. The Commission shares the Court's view. It will remind the Portuguese authorities that the control of economic conditions on a Community scale should be undertaken at central level.

1.53. The Commission will contact the German authorities so that the situation can be remedied.

Presentation of returns, establishment and making available

1.54 1.58. During its controls the Commission too has noted delays in the re-export of compensating products. However, in most cases, these delays did not have any financial consequences since the time limit for re-export could have been extended if an appropriate request had been made. Default interest of ECU 22 883 was collected in the few cases detected by the Commission which actually had financial consequences. At all events, the Commission will examine the cases to which the Court has drawn attention.

Rates of yield

1.59 1.61. After its controls the Commission has already commented on the procedure used to determine the rate of yield. The Member States will be asked to be more vigilant in this respect. The Commission will take appropriate measures if major unexplained discrepancies between the rates of yield lead to the loss of own resources.

Equivalent compensation and prior exportation

1.63. During its controls the Commission has already discovered a number of discrepancies involving prior exportation. It will examine the cases noted by the Court in cooperation with the Member States concerned. It will then demand default interest where appropriate.

Conclusion

1.64 (a) The Commission is currently considering the possibility of revamping the inward processing arrangements to make them simpler and more practical so that their economic objectives are achieved without, however, jeopardising the European Union's financial interests. In 1996 the Commission published a green paper on the operation and future of the inward processing arrangements. The reform will also cover the economic conditions.

(b) The Commission has already conducted targeted controls of the operation of the inward processing arrangements, leading to observations similar to those of the Court, which the Commission will not fail to follow up.

(c) The Commission would point out that any delay in establishment resulting in traditional own resources being made available late leads to the imposition of default interest in accordance with Article 11 of Regulation (EEC, Euratom) No 1552/89.

Establishment and ex post facto recovery of traditional own resources

Introduction

1.66 1.67. The Commission is aware that the three-year time bar may lead to the loss of own resources. However, as a matter of principle, it feels that a time limit of three years represents a good compromise between the importers' legitimate interest in a reasonable level of certainty and the protection of the Community's financial interests.

The Commission is also considering whether to propose an amendment to Article 221 of the Community Customs Code to suspend the time bar for a further year if there are serious grounds for suspecting an irregularity. This proposal would replace the 1995 proposal relating to Article 220 of the Community Customs Code which the Court refers to in paragraph 1.69 and which the Council did not adopt.

General observations concerning the regulatory framework, the procedures and the systems

Provisions concerning the protection of the financial interests of the European Union

Absence of legal basis for the provisional notification of entitlements and for the ex post facto requirement of a guarantee

1.68 1.69. The extension of the time bar referred to in the reply to paragraphs 1.66 1.67 may, to a certain extent, be considered an 'interruption`.

The Customs Code Committee did in fact consider the possibility of a compulsory security for debts entered in the accounts after customs clearance, but this measure was considered impractical.

1.70. The Commission is drawing up a communication to the Council and Parliament on the application of preferential tariff arrangements. This communication also covers the questions raised by the Court.

Limited possibility of suspending the application of agreements in the case of insufficient cooperation on the part of the non-member States to which preferences have been granted

1.71. The Commission will give an account of the measures it plans to take, including those in connection with conventional agreements, in the communication referred to in its reply to paragraph 1.70.

1.72. The case mentioned by the Court relates to imports under the old EC-Israel cooperation agreement, which was in force until the end of 1995. The Commission is insisting that the Israeli authorities reply to all the requests sent to them for ex post controls.

1.73 1.75. The Commission will examine the recovery situation with the Member States concerned.

1.76 1.77. The situation described by the Court reveals some of the shortcomings of the preferential arrangements. Appropriate remedies will be listed in the communication referred to in the reply to paragraph 1.70.

Inappropriate provisions which facilitate the circumventing of anti-dumping duties

1.78 1.81. The Commission is aware of the questions raised by the Court in connection with the application of anti-dumping measures. However, it would stress that these questions arise only in some of the cases involving variable duties, which in turn are imposed in about 25% of anti-dumping procedures. In addition, the question of successive sales is currently being considered in order to determine whether any measures need to be taken.

Non-uniform application of guarantee measures

1.82 1.85. At present, Community legislation allows the national authorities to judge whether a guarantee should be required when goods are cleared under preferential arrangements. However, the Commission is aware that the different practices may divert trade flows. The question of establishing a guarantee under the preferential tariff arrangements will be tackled in the communication referred to in paragraph 1.70.

Problem arising from the confidential nature of evidence gathered

1.87 1.88. The question raised by the Court relates to the balance between access to information by judicial authorities and the protection of confidentiality. In the case referred to, the Commission was forced to reject the German court's request since it considered that not only the court but other parties too could gain access to these documents which contained information of a confidential nature.

Should similar cases occur in future, the Commission is seeking a solution which will satisfy the demands of the judicial authorities while protecting the confidential nature of its reply.

Observations concerning the implementation of provisions in force

Delays in the legal evaluation of certain cases by the Commission

1.89. The fact that the Commission gives its opinion on cases of recovery by no means relieves the Member States of their obligation to collect Community revenue. Member States are required to establish and recover own resources as soon as the conditions are met.

1.90 1.93. The Court has drawn attention to a real problem. Some cases are so complicated that it may take some time to examine them before the question of origin can be resolved; in extreme cases, this may lead to the situation described by the Court.

In the case at hand, the origins section of the Customs Code Committee did not give its opinion on the origin of video cassettes from Macao until February 1994 after a thorough examination which even required a detailed technical analysis of the production process.

Delays in making available to the Member States the results of joint investigations

1.94 1.95. The Commission regrets the delay noted by the Court and would point out that this is exceptional. It will ensure that any information of use to the Member States is sent to them as soon as possible.

Shortcomings in the implementation of investigations by the Member States

Non-uniform application of ex post facto establishment measures

1.98 1.100. The Commission would point out that recovery is now under way in the cases mentioned by the Court. The situation in the United Kingdom, Germany and Spain will be carefully examined.

Other examples of delays and shortcomings in the implementation by the Member States of decisions taken at Community level

1.103. Italy states that it has initiated legal proceedings for smuggling in nine of the cases concerned. The other cases are still being examined.

Inadequacy of accounting follow-up of establishments and recoveries

1.104. The Commission will contact the Member States concerned to remind them of their obligations in this connection.

Suspension of payment not in accordance with the Customs Code

1.107 1.110. The Commission observed the same anomalies during its controls in France and Belgium. It shares the Court's concern and has contacted the Member States concerned so that the problem can be resolved.

1.111. The Commission will contact the Member State concerned so that the procedure described by the Court can be brought into line with Community legislation.

Disputes between Member States regarding the application of the provisions governing failure to discharge an external Community transit document

1.112 1.116. The Commission regards the case brought up by the Court as a typical example of the shortcomings observed in the transit sector. It combines the problems of insufficient guarantee, the lack of cooperation between customs authorities, loopholes in customs legislation as regards proof of discharge and difficulties in identifying the taxable persons. The Commission has monitored this case from the outset and can confirm that recovery is difficult for the reasons set out above. It is continuing to insist that Spain, France and Belgium take the necessary steps to make an ex post entry in the accounts in respect of the amounts evaded.

As regards the need to improve the procedures mentioned by the Court, the 'transit action plan` contains a reference to the rationalization of debt recovery procedures.

Conclusion

1.117. In the communication on preferential tariff arrangements the Commission proposes that the range of agreements and arrangements in force be adjusted along the lines requested by the Court.

1.118 (a) (c) The Commission will be sure to apply the solutions proposed in its replies to the points raised by the Court.

(d) As stated in its reply to paragraphs 1.66 and 1.67, the Commission is considering whether to propose an extension to the time bar.

1.119. With the entry into force of Regulation (Euratom, EC) No 1355/96, the Member States must update previous fraud reports when they send the Commission the latest quarterly list. The cases referred to by the Court are followed up by means of a sample based on a number of objective criteria and the results are sent to the budgetary authority. At all events, the Commission monitors the recovery situation and the role played by the Member States in this field and does not hesitate to take whatever measures it deems necessary, including the initiation of infringement proceedings.

OWN RESOURCES DERIVING FROM VALUE ADDED TAX (VAT) AND THE GROSS NATIONAL PRODUCT (GNP)

Adjustments to the VAT and GNP assessment bases

Situation as regards reservations and their financial impact

1.127. The reservations concerning GNP were entered in 1992 (106) and 1994 (9). Of the reservations which are still being upheld in connection with VAT resources, 45 were entered before 1992 and the others since.

1.128. As only the Member States have the necessary information for determining the bases, only they can make a proper adjustment to the elements of the base subject to reservation. For its part, the Commission, using the same powers as for its control of the bases, checks that the adjustments made by the Member States are justified; the reservations cannot therefore be lifted without the Commission's consent.

The exact financial impact of a reservation cannot therefore be determined before it is withdrawn: the reservations are thus recorded as a memorandum item.

The entry of reservations in the accounts and their accounting follow-up

1.130 1.136. The system of administering reservations by means of debt estimates which the Commission decided to introduce in response to the Court's comments and other factors entails a workload which is made even heavier by the fact that it has no immediate financial significance.

In itself, a reservation merely indicates that there is a problem which, when resolved, might lead to a positive or negative adjustment of the national VAT or GNP bases. The debt estimates relating to reservations are thus drawn up as memorandum items and they are not converted into recovery orders until the reservation is lifted, giving rise to a debt which is certain, liquid and due.

As the reservations and the financial consequences of lifting them are expressly set out in the Commission's control documents, a possible delay in drawing up the debt estimates will not lead to any delay in the treatment of the reservations or in the entry in the accounts of the actual entitlements which result when they are lifted. Having said this, the Commission, mindful of its priorities, will still try to avoid any delays in drawing up the debt estimates.

To make it easier to administer the reservations, the Commission is also proposing to include budget headings for the entry of the current year's VAT and GNP reservations in the preliminary draft budgets for 1998 and subsequent years: by setting up Items 3198 and 3298, it will be able to record debt estimates extending to 1998.

As regards monitoring and interdepartmental cooperation, the current computer printouts are regularly controlled in tandem by the departments concerned. However, the Commission is on the point of setting up a new multi-user database which will record all cases of dispute and make administrative monitoring easier for the departments concerned.

The monitoring of debts relating to reservations for the purpose of their recovery

1.137 1.138. To resolve any problem involving the determination of a Member State's base, the Commission may, under the rules in force (Article 9 of Regulation No 1553/89), either enter into discussions with the national authorities to reach a solution by mutual agreement or, if the legal conditions are met, initiate infringement proceedings which could lead to a ruling from the Court of Justice.

If it is a legal issue relating to the proper application of the VAT directives or own resources regulations, the Commission initiates infringement proceedings. The first stage is to send the Member State a letter calling in the funds and indicating the time limit after which default interest is due. If the problem is technical, no time limit may be fixed unilaterally if discussions are continuing.

As already stated(86), the Commission does not plan to refer to the Court of Justice every technical disagreement on the determination of specific elements of the base. This would generate an enormous caseload, with the Court being called on to express its views on questions relating to, say, the methods of calculation or the use of some data in preference to others, which do not have any obvious legal aspect. Giving the disagreement more formal status might also delay the solution of issues subject to a technical reservation.

1.139. Experience has shown that the Commission's 1991 forecasts about the rapid lifting of reservations were unrealistic.

Subsidies and the taxable amount

1.142. Examination of national legislation has revealed that the problem of the VAT treatment of subsidies does not arise from the failure to transpose or the incorrect transposition of the relevant provisions of the sixth VAT Directive into national law. On the contrary, it may arise from the way these provisions are applied in specific cases. The general reservations which the Commission has already entered will therefore be withdrawn.

Vehicle-purchase compensation

1.143. The problems mentioned by the Court are on the point of being resolved as the Commission and the Member State have agreed on the method of calculation.

1.144. The reservation mentioned by the Court covers one aspect of a far greater problem relating to the calculation of compensation for the purchase and leasing of cars used for business purposes.

As the national rules for these operations were changed in 1992 and again in 1995, the whole problem was reviewed during the latest control visit in November 1996 and this question is now on the point of being resolved.

Gold-related transactions

1.146. The agreement in principle mentioned by the Court is being fleshed out for the calculation of the VAT base.

1.147. The examples brought up by the Court show that the Commission's pragmatic approach generally leads to satisfactory solutions which are reached by mutual agreement even though this sometimes requires long technical discussions. However, it is doubtful whether these discussions could be shortened by setting time limits to be agreed to by the Member States, as the Court suggests. If time limits were to be set, the Member States concerned would only accept the period technically necessary to resolve the problems.

1.148. The Commission always does all it can to have the reservations withdrawn. In the case of reservations in respect of VAT, it proposes the solutions it considers appropriate to the Member States and encourages them to find better data where necessary. For GNP, the Commission has already adopted a number of decisions which were essential as regards statistical methodology and is closely monitoring the work being done by statistical institutes to solve the problems subject to a reservation.

1.149. The Commission recently presented to the GNP committee a new draft decision setting time limits for sending in any changes to GNP estimates in respect of points brought to its attention.

The failure to charge arrears interest when own resources have been made available late

1.150. The time needed to lift reservations depends on the technical constraints on the Member States. These vary from case to case so that it is impossible to set a 'precise framework`, as envisaged by the Court, when expressing a reservation. The Commission is obliged to comply with the provisions of Article 9 of Council Regulation No 1553/89.

Default interest is demanded whenever a letter calling in funds is sent to the various Member States in anticipation of infringement proceedings with financial consequences.

However, no interest can be demanded in respect of problems relating to a capped VAT base.

The reasons why the Commission initiates infringement proceedings only when the directives and rules governing own resources have not been correctly applied are set out in the replies to paragraphs 1.137 and 1.138 above.

As regards the reservations in respect of GNP, the Commission is aware that the revisions of the national accounts to make them reliable, comparable and exhaustive at Community level require laborious and time-consuming work by the national statistical offices and Eurostat. The Commission has therefore considered up to now that priority should be given to setting methodological guidelines for this work and monitoring progress at national level.

The Commission scrupulously exercises the control powers conferred on it by the rules: improvements could, of course, be made, but experience shows that the vast majority of Member States are not at present inclined to amend Regulation No 1553/89 which strikes a balance between the various requirements.

1.151. The comments on paragraphs 1.137 and 1.138 have already described the actual scope of Article 9 of Regulation No 1553/89. The Commission would also point out that, in its experience, the period required for resolving most of the reservations in agreement with the Member States is as short as practically possible.

1.152. In the case mentioned by the Court, there is no contradiction with the practice usually followed since, in the case of both reservations and late payments, the Commission charges default interest when the conditions set out in Article 28(2) of the Financial Regulation are met.

Conclusion

1.154. The Commission considers that, while regrettable, the delays in recording debt estimates in the accounts have not affected the Community's finances since the bases are controlled and adjusted before the estimates are entered.

Since the adjustments made to the VAT bases because some reservations cannot be withdrawn until a late stage (see paragraph 1.133 of the Court's report) have only a very limited impact, the Commission considers that this does not jeopardize the determination of VAT own resources within the time limits laid down.

1.155. The Commission feels that the Court's proposals cannot be put into effect as the rules on VAT own resources stand at present. The Commission does not have the power to impose deadlines on the Member States except in cases which meet all the conditions for initiating infringement proceedings. Nevertheless, it takes note of these proposals and may consider them for the future system for financing the European Union.

1.156. The Commission considers that its pragmatic approach is most likely to achieve the objectives set out by the Court, which it fully endorses, and, as far as possible, helps to prevent pointless conflict.

Figure 1.1 - Financing of the Community budget

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PART II Common agricultural policy

INTRODUCTION

II.1. Part II on the common agricultural policy deals with budgetary management, the 1992 CAP reform of area aid for arable crops, beef and veal premiums and the integrated administrative and control system (IACS). In Chapters 3 and 5 the follow-up on tobacco and wine as well as the audit results for export refunds are also presented.

Budgetary management

II.2. Chapter 2, which concerns budgetary management, describes the use made of the 1996 appropriations of the EAGGF-Guarantee section. It highlights the divergence between actual expenditure and the initial appropriations and it emphasizes the importance of respecting the principle of annuality. The chapter also examines the implementation of the EAGGF budget over the period 1992-96 and comments on the increase in its appropriations.

The 1992 CAP reform

II.3. Chapters 3 and 4 contain observations on certain aspects of the Mac Sharry reform. These include the area aid for arable crops and the beef and veal premiums. Reference is also made to the IACS. As illustrated in these chapters, the shift from guaranteed prices to direct subsidies has increased Community budgetary expenditure.

Area aid for arable crops

II.4. The first part of chapter 3 deals with that part of the 1992 Mac Sharry reform devoted to arable crops. Even if the increase in budgetary expenditure can be considered as normal, when moving from a 'consumer-pays-price-support-system` to a 'taxpayer-pays-system`, opportunities for saving and safeguarding Community funds were missed. The aid for cereals, one of the main parameters, is out of touch with world market prices leading to overcompensation estimated at 3 000 Mio ECU in 1995/96. Statistics used for the establishment of the regionalization plans and the base areas are not reliable enough. Furthermore, imprecise implementing regulations and the incorrect application of the regulations caused increased expenditure.

Beef and veal premium

II.5. Chapter 4, which concerns the beef and veal premium schemes and selected BSE-related measures, describes the systems designed to compensate the drop in producers' incomes, both as a result of the Mac Sharry reform and of the special measures taken in respect of the 1996 BSE crisis. Chapter 4 concludes inter alia, that the compensation granted in this sector was too high and that the Commission did not take due account of the downward phase of the 1992-95 production cycle. It also contains observations on the management of BSE related measures.

Integrated administrative and control system (IACS)

II.6. The evaluation of the implementation of the IACS for arable crops is included in chapter 3 and for beef and veal premiums in chapter 4. It reveals that the initial deadline of 1 January 1996 for Community-wide implementation of the IACS could not be met. It also highlights the need for further improvements in controls on the beef and veal premium schemes and land used for arable crops.

Follow-up on tobacco and wine

II.7. Chapter 3 also deals with the follow-up of the Court's 1993 Special Reports of the Community market organizations in raw tobacco and wine. Most of the tobacco produced in the Community continued to be of low quality which requires a high level of subventions relative to market value. For wine, the existing structural surpluses have not been successfully dealt with by grubbing up and distillation policies.

Export refunds on beef and veal

II.8. Chapter 5 contains the results of a number of audits on export refunds for beef and veal. The chapter examines the audit procedures for the importation of beef under the Poseican programme. Chapter 5 also focuses on veterinary certificates of origin for meat from adult male cattle imported from Belgium. It also looks at the procedures applied in France and the Netherlands to control the reimportation into the European Union of Community exports rejected by Egypt.

REPLIES OF THE COMMISSION

Budgetary management

II.2 The Commission explains in its replies that the appropriations in the budget are forecasts and that under-implementation does not necessarily mean that the measure has not achieved its policy objective. The Commission is aware of the importance of the principle of annuality and endeavours to lay down deadlines for payment which ensure full compliance with it. The increase in appropriations from 1992 to 1996 also coincided with the gradual introduction of the reform of the CAP, implementation of the GATT agreement and the accession to the Union of three new Member States.

Area aid for arable crops

II.4. The Commission's calculations show overcompensation as regards aid for cereals resulting from the fact that the out-turn was more favourable than the assumptions underlying the basic Council Regulation. The Commission intends to return to this question when it considers reform of the arable crop sector as part of Agenda 2000. The Commission considers the statistics underlying the regionalization plans to be sufficiently reliable, since complete accuracy is an unattainable target. The Commission explains in its replies why it believes that its implementing regulations follow the basic Council Regulation accurately.

Beef and veal premium

II.5. The themes highlighted in the Courts' observations on the beef market organization are taken up by the Commission in the Agenda 2000 initiative. Careful consideration will be given to the Court's comments and observations in the run-up to the future reform of the sector.

Follow-up on tobacco and wine

II.7. In its replies, the Commission acknowledges that the scheme of specific aid to improve the quality of tobacco as conceived at present has not had a marked impact since it has left certain weaknesses which a future reform of the sector will overcome. While stressing that the system of abandoning vineyards has reduced the productive potential of the wine-growing sector, the Commission would point out that some amendments will be required as part of the forthcoming reform to make it more effective.

CHAPTER 2(87\*) Budgetary management

2.0. CONTENTS Paragraph reference

Introduction 2.1

Initial appropriations 2.2

Amendments to the initial appropriations 2.3 - 2.5

Budgetary implementation 2.6 - 2.10

Principle of annuality 2.11 - 2.13

Trends 1992-96 2.14 - 2.15

Conclusion 2.16 - 2.18

INTRODUCTION

2.1. This chapter concerns the European Agricultural Guidance and Guarantee Fund (EAGGF), Guarantee Section, appropriations, as well as those in Chapter B2-51 'Completion of the internal market, controls and other operations in the agricultural sector` and, lastly, the corresponding provisional appropriations, which were entered in Chapter B0-40. The allocation of these appropriations is shown in Table 2.1. The chapter includes an examination of the initial appropriations, of the amendments made to these appropriations (by the supplementary and amending budget, on the one hand, and by transfers, on the other hand), budgetary implementation, the principle of annuality and the trends for the period 1992-96.

INITIAL APPROPRIATIONS

2.2. The appropriations earmarked in the general budget for the financial year 1996, as adopted by the European Parliament on 21 December 1995(88), for the EAGGF, Guarantee Section, amounted to 41 258,5 Mio ECU, of which 500 Mio ECU was for the monetary reserve. The total of Titles 1 to 5 of subsection B1 amounted to 40 758,5 Mio ECU, which is less than the amount foreseen in the agricultural guideline (40 828 Mio ECU) laid down by the Council Decision of 31 October 1994 on budgetary discipline(89).

AMENDMENTS TO THE INITIAL APPROPRIATIONS

2.3. Supplementary and amending budget No 1/96 permitted a substantial readjustment of the initial appropriations and allowed the use of the 54,5 Mio ECU of provisional appropriations (see Table 2.1). Furthermore, a number of transfers between items (727,5 Mio ECU), between articles (815,7 Mio ECU) and between chapters (523,5 Mio ECU) were made during the financial year (see Table 2.2), so that the distribution of the final appropriations was as shown in Table 2.1.

2.4. The total amount after this new distribution of appropriations between the titles of subsection B1 was still below the amount of the agricultural guideline (see paragraph 2.2). In terms of absolute value, these amendments to the initial budget amounted to 5 306 Mio ECU, 12,8 % of the initial budget (see Table 2.2).

2.5. The main amendments (see Table 2.2), in relation to the initial budget, concerned the following chapters:

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BUDGETARY IMPLEMENTATION

2.6. Subsection B1 expenditure for the financial year 1996 amounted to 39 107 Mio ECU (see Table 2.3), which was less than the final appropriations ( P4,1 %, excluding the monetary reserve), despite the increase in expenditure caused by BSE (1 229 Mio ECU, i.e. 3 % of the initial budget). The monetary reserve (90) was not used, because the amount of the variations in the US dollar/ECU market rate was lower than the 200 Mio ECU neutral margin.

2.7. Expenditure by chapter and the divergence between this expenditure and the initial appropriations on the one hand, the appropriations finally available, on the other, are presented in Table 2.1. The outturn was lower than the final appropriations for all the chapters and below the initial appropriations for all the chapters except 'Olive oil`, 'Beef and veal`, and 'Other measures`. The most significant divergences (in Mio ECU and %) in relation to initial and final appropriations concern the following chapters:

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2.8. In certain cases, the under-implementation - which involves important divergences in relation to the objectives of the policies concerned - is at the level of the budgetary item:

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2.9. The expenditure for 1996, broken down by nature and Member State, is presented in Table 2.4. A summary of the EAGGF Guarantee Section accounts is shown in Table 2.5.

2.10. For lack of available appropriations on Item B1-1890 'Aid to the Caucasus and Central Asia`, 17,9 Mio ECU in transport costs for food aid was committed on Item B1-1011 'Technical costs of public storage`. When Item B1-1890 was endowed with the amount of the necessary appropriations, the expenditure which had initially been committed on Item B1-1011 was transferred to Item B1-1890. The initial commitment was not in line with the principles of the Financial Regulation, since it was committed against a budget heading other than that provided by the budget.

PRINCIPLE OF ANNUALITY

2.11. According to this principle, expenditure is authorized only for one financial year and all the expenditure of one financial year must be charged to the corresponding budget. EAGGF Guarantee Section expenditure is covered by non-differentiated appropriations which, in principle, are authorized for a period not exceeding the financial year. This type of appropriation is suited by nature to respect the principle of annuality. However, the imprecision of the agricultural regulations inevitably leads to a lack of stringency in applying this principle.

2.12. For example, the accounts for 1996 include:

(a) some expenditure, which relates to prior financial years:

- 14 Mio ECU relating to the ewe premium for the 1994 marketing year, paid by Greece, Spain, Ireland, Italy and the United Kingdom,

- 11,7 Mio ECU relating to the aid for hops for the 1994 marketing year, paid by Belgium, Portugal and the United Kingdom,

- 26,3 Mio ECU relating to the 1993 conversion premium for tobacco paid by Greece;

(b) certain expenditure relating to the 1997 financial year:

- 223,7 Mio ECU for veal and beef premiums (see Chapter 3, paragraph 3.64),

- 81 Mio ECU of expenditure relating to accompanying measures for Austria,

- 25,8 Mio ECU relating to the second tranche of the agrimonetary aid for the Netherlands;

(c) a number of outdated expenditure items, the oldest of which goes back to 1989;

(d) and conversely, the financial year 1996 does not include:

- 110,2 Mio ECU relating to the first advance on the ewe premium for the 1996 marketing year, paid by Spain and Italy, which will appear against the 1997 financial year,

- 64,5 Mio ECU of expenditure by Italy on accompanying measures relating to the financial year 1996 will be charged to 1997.

2.13. This situation is linked to several factors, for example:

(a) many regulations do not stipulate any payment conditions or time-limits: 84 % of the Commission's sub-items (accounting sub-division of the budget item) do not contain any;

(b) payment conditions or time-limits may be stipulated which go beyond the duration of the financial year, as is the case for the accompanying measures;

(c) the Commission Regulation (EC) No 296/96(91):

- exempts late payments from any penalty, where the late payments represent no more than 4 % of the amounts paid within the time-limits, such as the expenditure referred to in paragraph 2.12 (a);

- provides that the Commission may remit all or part of any penalties.

TRENDS 1992-96

2.14. An examination of the way in which the final budget and its implementation have changed over the period 1992-96 (see Table 2.6) revealed that:

(a) over the five years, the budget (implementation) increased by 7 793 Mio ECU (24,9 %), as against 30,1 % for payment appropriations (and 33,5 % for commitment appropriations) for the total budget;

(b) most of this increase was absorbed by:

- B1-10 'Arable crops`, including set-aside (6 016 Mio ECU: +58,1 %), even though the Commission's estimate(92) reckoned on an increase only half as large for the same period (3 162 Mio ECU),

- B1-21 'Beef and veal` (2 273 Mio ECU: +52 %),

- B1-50 'Accompanying measures` (1 852 Mio ECU) which started in 1992; and, to a lesser extent, by:

- B1-15 'Fruit and vegetables` (335 Mio ECU, +27 %),

- B1-39 'Other measures` (225 Mio ECU), which did not exist in 1992,

- B1-38 'Rural development schemes`(194,4 Mio ECU, +64 %),

- B1-25 'Other animal products aid measures` (110 Mio ECU) and in particular the programme of options specific to the remote and insular nature of certain regions (Poseidom, Poseima, Poseican, Smaller Aegean islands) which practically did not exist in 1992;

(c) conversely, expenditure fell in respect of the following chapters:

- B1-22 'Sheepmeat and goatmeat` ( P428 Mio ECU, P24 %),

- B1-16 'Products of the vine-growing sector`( P305 Mio ECU, P28 %),

- B1-30 'Refunds on certain goods obtained by processing agricultural products`( P208,5 Mio ECU, P30 %), B1-33 'Refunds in connection with Community food aid` ( P192,9 Mio ECU, P87 %), and B1-24 'Eggs and poultry meat`( P54,4 Mio ECU, P28 %) of which refunds constitute the major part.

2.15. Forecasting is, admittedly, a difficult exercise, especially in agriculture. Nevertheless, if a comparison is made of the initial budget and its implementation for the same period 1992-96 (see Table 2.6), it is found that:

(a) the budget has been constantly overestimated since 1992 with an overestimate decreasing from 1994 (+9,3 %) to 1996 (+4,0 %);

(b) five chapters were also constantly in surplus:

- B1-16 'Products of the vine-growing sector`: by 2 % to 77 %,

- B1-17 'Tobacco`: by 6 % to 17 %,

- B1-25 'Other animal product aid measures`: by 11 % to 33 %,

- B1-33 'Refunds in connection with Community food aid`: by 23 % to 188 %,

- B1-35 'Distribution of agricultural products to deprived persons in the Community`: by 15 % to 96 %;

(c) two chapters were also in surplus during the last two or three years:

- B1-50 'Accompanying measures`: by 11 % to 65 %,

- B1-11 'Sugar`: by 6 % and 13 %;

(d) the average divergence per chapter as a percentage of initial appropriations remained practically stable from 1992 to 1996 (see Table 2.6), which shows that the quality of the forecasts did not improve.

CONCLUSION

2.16. The initial appropriations earmarked for EAGGF-Guarantee Section in 1996 amounted to 41 258,5 Mio ECU, thus respecting the ceiling of the agricultural guidelines (see paragraph 2.2). The amendments of the initial appropriations were relatively substantial (see paragraphs 2.3 to 2.5). The outturn was below the appropriations finally available ( P4,1 %), without recourse to the monetary reserve (see paragraph 2.6), but with substantial divergences on certain chapters (see paragraphs 2.6 to 2.10). The outturn was higher than the initial appropriations for three chapters only: 'Olive oil`, 'Beef and veal` and 'Other measures` (see paragraph 2.7).

2.17. However, certain expenditure relating to another financial year were charged to 1996, while others items pertaining to 1996 do not appear in 1996 (see paragraphs 2.11 to 2.13). The Court recommends that the Commission re-examines the question of annuality and ensures that payment deadlines are stipulated in the regulations.

2.18. The examination of the budgetary management over the period 1992-96 shows a continued increase in the EAGGF budget and permanent overestimate of the appropriations on certain chapters (see paragraphs 2.14 to 2.18). Lastly, the development over the period 1992-96 of the divergences by chapter, or of the average divergence between initial appropriations and outturn (see Table 2.6), shows that the quality of the forecasts still needs to be improved.

REPLIES OF THE COMMISSION

AMENDMENTS TO THE INITIAL APPROPRIATIONS

2.3. The substantial adjustment of the appropriations, shown in SAB No 1/96, was due to the urgent need to tackle the BSE crisis. The costs incurred, amounting to some ECU 1,3 billion, were met without any increase in the budgetary allocation, owing to underutilization in other sectors on account of the steadiness of the markets.

BUDGETARY IMPLEMENTATION

2.8. The allocation is an estimate and underutilization does not necessarily mean that the policy goal of the measure has not been reached. The examples given concern measures which were not yet fully operational, especially those involving early retirement and afforestation for which Member States have not implemented the programmes. In the case of afforestation, weather conditions slowed down implementation of the programmes, especially in Spain, where drought was particularly severe in 1995 and 1996.

2.10. On 27 July 1994 the Council made provision, by Regulation (EC) No 1999/94, for ECU 165 million for the supply free of charge to certain countries in the Caucasus and Central Asia of agricultural products from intervention storage. Delivery took place mainly during winter 1995/96. Some of the appropriations were not committed, however, until late 1995. A sum amounting to ECU 55 million remained to be committed from the allocation for 1996.

As the original budget made no provision for expenditure to be charged to 1996, the appropriations needed to cover the part to be taken up in 1996 were not entered under the specific heading. The mobilization and transportation of the products could not be suspended pending a budget transfer without running the risk of failing to attain the objectives of the Regulation. The expenditure was charged therefore to heading No B1-1011 'Technical costs of public storage`.

PRINCIPLE OF ANNUALITY

2.11. The Commission takes the view that the budget rules have been observed.

The allocations for each budget item do not refer to a specific financial year but to payments which are likely to be made in respect of a particular measure in the light of the foreseeable rate of actual payments (see budget assumptions on which the budget is based).

Where the rules do not set a payment deadline, the Commission cannot reject expenditure that has been notified during a financial year, for the simple reason that the operative event may date back several years.

It goes without saying, however, that the Commission has no desire to see a backlog build up. For several years, therefore, it has been increasing the number of payment deadlines and adopting rules under which payments may be reduced gradually where there is an overrun.

2.12 (a) - The ECU 14 million referred to by the Court was included in the 4% tolerance provided for in Regulation (EC) No 296/96.

- The production aid for hops for the 1994 harvest is payable on 15 October 1995 at the earliest, although the rules do not set a time limit (Regulation (EEC) No 1696/71, Art.12).

- Under Article 6 of Regulation (EEC) No 3616/92, payment of the premium for conversion measures in respect of tobacco for the 1993 harvest may be spread over the three financial years 1994, 1995 and 1996.

(b) - In order to provide relief for beef producers affected by the slump in the beef industry as a result of the BSE crisis, the Commission, acting in accordance with the Council's wishes, brought forward to 1996 the date for the start of payments for the advances on the cattle premiums. This was made possible by the availability of funds which had not been used in 1996.

- The Commission approved a request from Austria to raise the maximum applied to the tranches for 1995 and 1996.

- This payment complied with the rules under which the second tranche could be paid from August 1996.

(c) Regulation (EC) No 296/96 on budgetary discipline could not be applied to events that pre-dated its entry into force.

(d) Payments for the first advance on the ewe premium and the goat premium for 1996 were made in 1996 (ECU 390.3 million) and 1997 (ECU 110.2 million) by the deadlines set in the rules.

The comment in the Early Warning Report refers to the view expressed that there had been a slowdown in the rate of payments by Spain and Italy compared with previous years and not to expenditure which was considered not to have been made within the deadlines.

2.13. The Commission is continuing to impose discipline as regards payment deadlines in all sectors where this is possible.

(a) and (b) Many of the rules governing the various market organizations date back to before 1988 and do not always provide therefore for payment within the budget year (16 October in one year to 15 October of the following year). The Commission took steps, however, during the 1992 reform, to introduce mandatory payment periods for direct aids for arable crops and beef. It did the same subsequently in the case of payments of production aid for olive oil, cotton, tobacco and dried fodder.

Plans for the reform of the market organization for hops include arrangements linking payments for a financial year to a budget year.

(c) The aim of Regulation (EC) No 296/96 is to reinforce budgetary discipline in Member States' paying agencies.

The 4% tolerance is intended to cover expenditure whose eligibility is not in question but for which payments have not been made within the deadline because of difficulties.

However, if the Commission required additional checks in order to verify that the expenditure is justified or if for reasons of force majeure the deadlines are not observed, it would be inadmissible for national budgets to be required to bear expenditure which has been delayed through no fault of the Member States. For that reason the Regulation provides for the possibility of remitting any penalties.

TRENDS 1992-96

2.14. Regarding changes in expenditure between 1990 and 1996, the Commission wishes to make the following comments which are necessary for a proper understanding of developments.

(a) and (b) Increases in expenditure between 1992 and 1996 on arable crops, beef and accompanying measures (which did not exist in 1992) are the result of the 1992 CAP reform which was based on the principle of lower prices offset by direct aids reflecting the Council's desire to reduce price support and replace it with per hectare aid and livestock premiums no longer linked to production. This led to the stabilization of the markets concerned and of the relevant expenditure. The switch to a system of direct aids reduces the burden on the consumer but transfers it to the Community taxpayer.

- The increase in expenditure on beef is due also to the cost of the BSE measures (ECU 1.3 million) in 1996.

- The reason for the increase in expenditure on fruit and vegetables is the introduction after 1992 of a market organization for bananas and measures for the restructuring of nut plantations.

- Chapter B1-39: Other measures received an allocation in 1996 to finance agrimonetary aids adopted by the Council in 1995.

- The increase in expenditure on Chapter B1-38: Rural development scheme, is the result of the raising of cattle premiums in less-favoured areas following the 1992 reform.

- Finally, new expenditure in the animal products sector on programmes for the most remote areas of the Community has been charged to Chapter B1-25: Other animal products aid measures.

(c) - Expenditure on Chapter B1-22: Sheepmeat and goatmeat, fell in 1996, mainly as a result of the payment in 1995 of a significant proportion of the second advance for 1995.

- For a number of years the wine sector has been going through a period of low table wine production, resulting in less recourse to the Community distillation arrangements. The fall in production is due largely to weather conditions but also to the policy of grubbing up vines in recent years.

- Expenditure on Chapters B1-30, B1-33 and B1-24 consists of refunds only. These have been falling, mainly on account of the drop in cereal prices intended under the 1992 reform, but also (Chapter B1-24) to keep within the budget ceilings imposed as a result of the agreement under the Uruguay Round multilateral trade negotiations.

2.15. The Court agrees that agricultural forecasting is difficult. The Commission shares this view, particularly at a time when agricultural policy arrangements are undergoing profound change.

(a) The Commission points out that in the period 1992-96 the 1992 CAP reforms were being introduced gradually (1994, 1995, 1996), the GATT agreement was being implemented and in 1995 the Community was enlarged to include three new Member States. These years also saw the introduction of a substantial number of new measures, the large-scale disposal of products from intervention storage and the management of the BSE crisis in the beef sector. In addition, there were agrimonetary adjustments and the recasting of the system. Weather conditions, lastly, in particular drought going on for several years in certain Member States and favourable world market conditions added to the difficulties of drawing up budget forecasts. In most cases these factors intensified, with the result that the appropriations were not fully used up.

This underutilization was aggravated by the way the paying agencies administer the files and resulted in a backlog, which proved particularly difficult at the end of the year. The Commission considers that it is very difficult therefore to improve the quality of budgetary forecasting until these factors can be controlled better.

If item B1-6 is excluded, the original allocation in 1993 is below expenditure for the year. The overall percentages in point (a) must be revised therefore.

(b) - Chapter B1-16 covers the wine sector where distillation and alcohol storage measures, designed to dispose of surpluses of table wine produced during a wine year, account for the main expenditure. As harvesting takes place in autumn, it is very much dependent on weather conditions. The preliminary draft budget is drawn up in the early months of the year and is based on likely yields. The Commission believes it is difficult to make accurate forecasts, given the timetable constraints of the budget procedure. An improvement could be expected if the Commission were to present a letter of amendment systematically each September, following the Council's first reading of the budget, or a supplementary and amending budget in the early months of the year.

- Chapter B1-17 covers expenditure on tobacco, principally production premiums. The rules governing the operation of the market organization were fundamentally revised in 1992 to eliminate serious malfunctions noted in the preceding years. These are now interlinked with/grouped under an overall allocation and are in the form of national production quotas conferring entitlement to the premium. The production for an eligible year is only known at the beginning of the following summer, more than a year after the budget is drawn up. In view of the fact that the combined experience of the new system is not sufficient to date, the Commission has always assumed that the quotas will be used up fully when preparing the PDB, even if expenditure in 1996 corresponded to underutilization of the quotas of around 5%.

- Chapter B1-25 comprises mainly expenditure on the Poseican programme, for which actual requirements were difficult to assess at the implementation stage.

- Expenditure under Chapter B1-33 depends on the choices made by the Commission during the year to implement the Community section of the world food aid programme and the level of the refunds paid. The rise in world cereals prices, starting in summer 1995, resulted in a change of direction in the programme together with a cut in the rate of refunds.

- The rapid disposal of all the products from intervention was followed here too by amendments to the implementing rules allowing purchases to be made on the market. This change of direction/policy for the national programmes, in 1996, led to implementing delays, justifying a request for an appropriations carryover from 1996 to 1997. The Commission points out also that the budget allocation for this chapter was set by the European Parliament at ECU 200 million and is not the result of an estimate.

(c) - The forecasts for the accompanying measures concerned programmes that were still largely being negotiated or adopted. For that reason, it is difficult to forecast precisely the level of future expenditure on launching these programmes and getting them operating, although financial guidelines were put in place setting the maximum level of expenditure for the period 1993-97.

- Expenditure on Chapter B1-11: Sugar, exceeded the original allocation in 1993. Favourable market conditions consisting of world market supplies falling behind demand for the first time in years and rising Community output stimulated exports and resulted in refund expenditure beyond the forecast.

(d) The Court says that the quality of agricultural forecasts has not improved. The Commission considers that agricultural forecasting is too complex a matter to be subjected to a general evaluation.

The Commission believes a distinction should be drawn between forecasts of direct aids in the broad sense and those for market intervention measures (refunds and storage).

In the case of direct aids, which account for over 60% of expenditure, the CAP reform adopted in 1992 introduced arrangements (direct aids per surface or livestock unit, accompanying measures, maximum aids for limited quantities) which mean that expenditure forecasting should become more accurate. The Commission has found this to be true. For example, for cereals the gap between the forecasts and the outcome as regards areas qualifying for payment of the per hectare aid fell from 2.8 million hectares in the case of the 1993 harvest to 0.9 million hectares for the 1995 harvest. Admittedly, several years were needed for farmers to become accustomed to the new procedures and consequently to confirm an improvement in the forecasts.

The Commission acknowledges, on the other hand, that market intervention measures (refunds, storage, withdrawals) are difficult to forecast precisely.

Certain aspects of forecasting cannot necessarily be expected to improve in view of the extremely hazardous nature of the circumstances (production, world prices). On the contrary, for example, in the cereals sector, the reform has made forecasting more uncertain in that stocks in intervention have fallen substantially and it is no longer possible for prices to be influenced significantly through the management of stocks in storage.

When presenting the PDB for a year, the Commission relies on the best possible information available concerning the markets. One way of improving forecasting in this area would be to delay as long as possible the submission of letters of amendment to the PDB. The timetable set by the Financial Regulation is such, however, that for the EAGGF Guarantee Section, letters of amendment make little improvement to the situation other than to ensure that account is taken of changes to the rules. On account of this, Parliament and the Council agreed that the Commission could present a letter of amendment up to 31 October so as to reflect the latest changes on the agricultural markets.

CONCLUSION

2.16. The substantial adjustment of the appropriations, shown in SAB No 1/96, was due to the urgent need to tackle the BSE crisis. The costs incurred, amounting to some ECU 1,3 billion, were met without any increase in the budgetary allocation, owing to underutilization in other sectors on account of the steadiness of the markets.

2.17. The Commission is endeavouring as far as possible to set payment deadlines in a way such as to ensure compliance with the principle of annuality of EAGGF Guarantee Section expenditure (see answers to points 2.11 to 2.13).

2.18. During the period 1992-96 the 1992 CAP reforms were being introduced gradually (1994, 1995, 1996), the GATT agreement was being implemented and in 1995 the Community was enlarged to include three new Member States. These years also saw the introduction of a substantial number of new measures, the large-scale disposal of products from intervention storage and the management of the BSE crisis in the beef sector. In addition, there were agrimonetary adjustments. Weather conditions, lastly, in particular drought lasting several years in certain Member States and favourable world market conditions added to the difficulies of preparing budget forecasts. In most cases these factors intensified, with the result that there were budget savings.

The level of underutilization was aggravated by the difficulties the paying agencies faced in managing the files which resulted in a backlog that was particularly heavy at the end of the year. The Commission is taking action with the Member States to control the various factors hampering improvements in the quality of budgetary forecasting.

Between 1992 and 1996 forecasts improved for most expenditure; the circumstances, moreover, in which forecasts are made are quite uncertain so it is rash to claim that a particular approach could help improve them.

A recent report from an expert outside the Commission shows that overall underutilization in the period 1990-96 was increasing slightly (up from + 6,1% to 7,6%) but not as a result of any deterioration in the quality of forecasts. On the contrary, the quality of the forecasts for individual budget Chapters had improved; however, 'errors` which, prior to the reform, were negative or positive and consequently cancelled one another out have, more regularly since the reform, on account of the new arrangements (MGQs, basic surface areas, livestock quotas) been positive.

The Commission will take these findings into account in future years in particular in the context of SEM 2000.

It should be emphasized lastly that agricultural forecasting is not a unilateral act on the part of the Commission; the ad hoc consultation procedure introduced by inter-institutional agreement involves both Parliament and the Council in this difficult exercise.

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CHAPTER 3(93\*) Market organizations - Plant products

3.0. CONTENTS Paragraph reference

Area aid for arable crops 3.1 - 3.79

Review of budgetary expenditure 3.5 - 3.8

The basic parameters of the aid scheme 3.9 - 3.31

The area aid payment 3.9 - 3.12

Base areas and treatment of overshooting 3.13 - 3.19

The regionalization plans 3.20 - 3.23

Equalizing of yields and irrigation ceilings 3.24 - 3.26

Yield stabilizer 3.27 - 3.28

Reliability of the statistics 3.29

Farm income 3.30 - 3.31

Integrated administrative and control system (IACS) 3.32 - 3.69

The set-up 3.32

Total cost of IACS 3.33

Aid applications 3.34 - 3.37

The computerized database 3.38 - 3.40

The alphanumeric system for parcel identification 3.41 - 3.42

The integrated control system 3.43 - 3.69

Conclusions 3.70 - 3.79

Follow-up of observations made in the Court's reports 3.80 - 3.117

The CMO for raw tobacco 3.81 - 3.99

The reform of 1992 3.81 - 3.82

Market balance and budget situation 3.83 - 3.86

Complexity of the new scheme 3.87 - 3.91

Follow-up of specific irregularities identified in the Court's reports for the marketing years 1988 to 1992 3.92 - 3.94

Direct income support 3.95

Conclusions 3.96 - 3.99

CMO for products of the vine growing sector 3.100 - 3.117

Market balance and budget situation 3.102 - 3.103

Controlling the volume of wine in the market 3.104 - 3.106

Management information system 3.107 - 3.108

Vineyard registers 3.109 - 3.112

The specialized Commission control body 3.113

Conclusions 3.114 - 3.117

AREA AID FOR ARABLE CROPS

3.1. The following deals with that part of the Mac Sharry reform of 1992 devoted to arable crops. In the two main arable crop sectors, cereals and oilseeds, the 1980s were characterized by increasing production surpluses. At the high internal support price levels a part of the cereals production remained unsaleable. This increased the budgetary burden for disposing of cereals on the world market (export refunds) and/or for keeping them in public storage (intervention cost). For oilseeds, protection against cheap imports was excluded by the GATT, and a steadily increasing processing aid to oil mills levelled out the price difference between world market and higher internal support prices.

3.2. In its Annual Report on the financial year 1989(94) and in its Special Report 1/92(95) the Court drew attention to the fact that measures so far introduced to contain production and to stabilize budgetary expenditure (maximum guaranteed quantities, limited price cuts, co-responsibility levies) were not yet sufficiently effective. In 1991 the Commission concluded, inter alia, that 'existing price guarantees, through their direct link to production, lead to growing output` and 'rapidly rising budgetary expenditure`(96).

3.3. Against this background, and taking into account GATT negotiations during the Uruguay round, the Commission suggested a more competitive agricultural policy through continuing action on prices while at the same time directly compensating farmers for lower prices. In May 1992 the Council agreed on the Commission's proposals for a new market organization for arable crops: cereals, oilseeds (rape, sunflower, soya, later extended to linseed) and protein plants (peas, beans and sweet lupins). In June 1992 the relevant regulations were adopted(97). These established a common arable crops scheme, to be introduced during a transitional period of three years from the 1993/94 marketing year onwards based on:

(a) an area aid scheme with different aid rates for cereals, oilseeds and protein plants which should compensate the farmers for income losses due to the abolition (oilseeds, protein plants) or the reduction (cereals) in institutional prices;

(b) the introduction of the integrated administrative and control system (IACS), a common system for administering and controlling all area linked aid, applicable also to the animal sector (see Chapter 4).

3.4. Audit efforts were concentrated on the implementation of the main elements of the reform at Commission level and in the five Member States (Germany, Spain, France, Italy, the United Kingdom) which together receive about 90% of all area aid. The audit results are presented in two parts. Paragraphs 3.9 to 3.31 deal with the main elements of the new scheme for payments. Paragraphs 3.32 to 3.69 deal with the implementation of the integrated administration and control system, which was expected to be introduced in parallel with the new basis for payment.

Review of budgetary expenditure

3.5. During the four-year period 1990-93, i.e. prior to the common agricultural policy (CAP) reform, EAGGF guarantee expenditure on arable crops increased from 7 835 Mio ECU in 1990 to 10 611 Mio ECU in 1993 with an average increase per year of 10,6% (see Table 3.1A).

3.6. From the same table it can be seen that over the three-year period 1994-96 after the new CAP, EAGGF guarantee expenditure on arable crops increased from 12 652 Mio ECU in 1994 to 15 018 Mio ECU in 1995 (18,7% higher than the year before) and to 16 362 Mio ECU in 1996 (8,9% higher). These figures can be compared to the expectations of the Commission in 1991 concerning the budget development(98). The total expenditure forecast of the Commission for the years 1994-96 was, on average, 9,0% lower than the actual expenditure (see Table 3.1B). The difference is mainly caused by the later inclusion of aid for silage other than maize, higher premium for set-aside, higher base areas and yields, agrimonetary adjustments and the expansion of the Community. The Commission also predicted a decrease in total arable crop expenditure in 1997. Whether this will occur remains to be seen.

3.7. As direct subsidies to cereal farmers were accompanied by a decrease in the target price, it was expected that part of the cost for producing cereals would be transferred by the reform from the consumer to the budget. It was also expected that agricultural spending for the sector would increase in the short term, but that this increase would be partly offset by the expected effect of reducing intervention and export refund. As can be seen from the Table 3.1A, this took place. While in 1993, export refunds were 26,3% of total expenditure on arable crops, they only accounted for 2% in 1996. Intervention storage costs, which, in 1993, were 25,7% of total arable crop expenditure, have, in 1996, become negative because of proceeds from sale of stocks.

3.8. The average increase of 13,7% per year after the start of the new CAP can be explained to a large extent by the planned increase of the basic amount for cereals which was deemed to offset the decrease in institutional prices.

The basic parameters of the aid scheme

The area aid payment

3.9. In the cereals sector, institutional prices(99) were reduced in order to bring EC market prices closer to the world market level. This was gradually done within the first three years of reform. Thus the target price was reduced in two steps from 130 ECU/tonne in 1993 to 110 ECU/tonne in 1995. In order to compensate farmers for this income loss, a compensation (a basic amount) is granted, calculated as the difference between the target price set before the reform (155 ECU/tonne in 1992) and the new target prices. Consequently, the basic amount was to increase from 25 ECU/tonne in 1993 to 45 ECU/tonne in 1995 (54,34 ECU/tonne after the adaptation of the green rate). After 1995 the basic amount is supposed to remain fixed for the following years. By multiplying the basic amount with the appropriate regional yield and the number of hectares sown with cereals by an individual farmer, one obtains the individual area aid payment.

3.10. While in the cereals sector the institutional price system was maintained, it was abolished in the oilseeds and protein plants sectors. The old production aid, which was used to level out the difference between lower world market prices and higher institutional prices, was replaced by an area aid scheme like that of the cereals sector.

3.11. The compensatory amount for protein plants was set at 1,44 times the amount for cereals, thus arriving at 78,49 ECU/tonne from 1995 onwards. The compensatory amount for oilseeds was based on:

(a) a reference price for the world market, corresponding to the expected medium-term equilibrium price on a stabilized world market;

(b) an estimated equilibrium price relationship between oilseeds and cereals which should not provide a particular incentive to opt for one crop as opposed to the other.

The final reference amount was 193,1 ECU in 1993, 183,3 ECU in 1994 and 222,3 ECU in 1995. The yearly aid rate is calculated by the Commission for each region.

3.12. The aid for oilseeds is paid in two parts. The first part is paid in advance on the basis of area cultivated. The second part is paid as a complement at the end of the marketing year and takes into account the evolution of world market prices as compared to the reference price.

Base areas and treatment of overshooting

3.13. The base area criterion is an expenditure stabilization mechanism. Base areas are established by the Member States as an average of the hectares which, in 1989, 1990 and 1991, were cultivated with cereals, oilseeds and protein plants, or were set aside in accordance with a publicly funded scheme. Member States can also apply an individual base area system for each producer, but so far this has not been done. It is up to the Member States to determine whether one base area covers all its territory, or whether the base area is to be split into a number of different regions. Member States may also fix separate base areas for maize. The area aid is granted in full only if the total area declared per state or region does not exceed the base area(s) determined. Should it do so, compensatory payment is reduced proportionally for each producer and, in the following marketing year, an extraordinary set-aside is applied without any compensation.

3.14. On 18 October 1993 the Commission issued a regulation covering the implementation of the basic regulation with regard to the management of the regional base areas(100). This regulation stipulates that the calculations of overshoot of the base area(s) have to be carried out, at the latest, on 15 September each year, at a time when figures are only provisional. The Member State informs the Commission without delay and at the latest on 30 September. The regulation does not foresee a verification against final figures.

3.15. During the first three years of the reform, Germany, Spain, France and the United Kingdom notified overshoots, the analysis of which revealed some problems.

3.16. In the first place base areas were underestimated for certain regions:

(a) in the first year this was the case for the new German Länder and for Scotland; subsequently the Commission changed the regulation and increased partly permanently and partly temporarily the base areas; this led to a reduction of the overshoots in these regions and exempted Member States completely or partly from sanctions arising from overshoots; the financial impact of these amendments can be estimated at 469,7 Mio ECU for the first three years of the new CAP (see column C Table 3.2);

(b) in establishing its base area, Spain used, among other elements, its land register; as farmers pay higher taxes on irrigated land, they had apparently no interest in having the land register updated before 1992; this may be the reason why in Spain the irrigated base area is considerably exceeded each year (34% in 1996); the farmers have now, because of the area aid, updated the land register, but the regulation concerning the base area does not allow a recalculation of the irrigated base; as a result, the overshoots will continue.

3.17. In the second place, the implementation regulation lacked precision, leading to different ways of calculating of the overshoot:

(a) Spain, the United Kingdom and the majority of German Länder use provisional figures available at 15 September; France and Bavaria base their calculations on extrapolations taking into account applications not yet computerized and/or the foreseeable results of on-the-spot checks;

(b) in France the calculation of the overshoot of the maize base, where applicable, has to distinguish for forage areas between maize and other crops, the application form for small producers in 1993 and 1994 did not make this distinction, leading to an underestimation of the overshoot;

(c) some regions in Spain and in France, England and Baden-Württemberg (in 1995) used only the rotational set-aside(101) (the lowest figure) for the calculation of the maize base overshoot, thus other forms of set-aside were not properly taken into account and the overshoot was underestimated;

(d) five-year set-aside was only partly taken into account in Germany because some Länder failed to include hectares declared via the old set-aside system;

(e) according to Regulation (EC) No 2836/93, the percentage rate of overshoot should be calculated to one decimal place; Spain, France and the United Kingdom arrived at this by ignoring the second decimal whereas Germany uses mathematical rounding; the unusual method of rounding used in Spain, France and the United Kingdom leads to the application of lower sanctions;

(f) incorrect application of the regulations in Spain in 1993, in the United Kingdom in 1994 and in France in 1995 penalized farmers more than necessary as shown in column D of Table 3.2.

For 1993/94 to 1995/96 the global financial impact of overshoots relating to the lack of precision in the implementing regulation is estimated at 57,6 Mio ECU (see total of column D in Table 3.2).

3.18. Thirdly, two principles stated in the basic regulation are not properly reflected in the implementing regulation. According to the basic regulation:

(a) areas admitted for compensatory payments should not exceed the regional base area, but because sanctions are not imposed on small producers the result is that payments are made in respect of more land than the base area allows;

(b) fodder areas are to be deducted from the regional base area when calculating the overshoot: this rule was changed in the implementation regulation, which foresees that the fodder area has to be added to the total area declared and not deducted from the regional base area leading to an unjustified reduction of the overshoots in all Member States.

The financial impact of overshoots linked to this problem are estimated at 17,7 Mio ECU and are shown in column E of Table 3.2.

3.19. Documentation in the Member States, justifying calculations in relation to overshoot, is often incomplete. No copy of the database at the date when the calculation is made is retained except in France from 1995 onwards. In Germany, Spain and the United Kingdom several databases exist. Here, the calculation of the overshoot requires manual exchange of data between regional administrations, increasing the risk of error, because of the lack of overall checks at national level.

The regionalization plans

3.20. In order to take account of the diversity of the agricultural structures in the Community, compensatory payments are differentiated by region according to the different historical yields. The Member States had to establish regionalization plans based on relevant and objective criteria, such as fertility of the soil, irrigation, etc., from available detailed data of the region over the five-year period 1986/87 to 1990/91, by dropping the years with the highest and the lowest yields. For each region of production, an average yield for cereals (and, if possible, for oilseeds) had to be calculated.

3.21. Regionalization plans were established under the authority of the Member States' Ministries of Agriculture and were based on sources which were in practice not directly verifiable by the Commission. In order to check the regional yields used in the Member States' regionalization plans against objective data, the Commission compared, on a global level, the national average yields resulting from the regionalization plans with Eurostat's figures.

3.22. For the five Member States concerned by this chapter, the comparison shows that only the United Kingdom regionalization plan conformed with the Eurostat averages. In the four other Member States, the average yields derived from the regionalization plans always exceeded the figures from Eurostat by about 1% on average. As these differences are small in relative terms, the Commission accepted them. However, these differences are not caused by generally acceptable standard errors in statistics, but by inconsistent application of the regulations in the Member States. For example:

(a) although according to the regulation the new German Länder should have used the average yields of the old Länder for cereals, they did not respect this provision and applied a higher yield;

(b) according to the regulations, the Member States have to give details of the areas and of the yields for each production region; the Italian regionalization plan contains 255 different yield regions; because of inconsistencies like transfers of areas and of production from one region to another, yields with enormous fluctuations over the reference period and the non-availability of reliable data for the whole reference period for some regions, it was not possible to ascertain whether the calculation method used was in accordance with the basic regulation. The same was observed in all regions of Spain and in one German Land (Lower Saxony).

Although the margins are small in relative terms, they are quite substantial in absolute value (see Table 3.3). The total financial impact of all such differences can be estimated at as much as 152,1 Mio ECU for the marketing years 1993/94 to 1995/96.

3.23. Furthermore, the following was observed:

(a) in the west German Länder the average oilseeds yield was calculated by taking into account only winter rape; although this crop covers more than 90% of oilseed production in Germany, the regulation does not allow the exclusion of summer rape; as winter rape has a higher yield than summer rape, the oilseeds yield in Germany is overestimated; the financial consequences can be estimated at an overpayment of 4 Mio ECU for the 1993 to 1995 harvests;

(b) in 1994 and 1995 France twice modified its regionalization plan; each time, the average yield was increased for certain departments, leading to increases of the national average yields which were not in accordance with the regulation. The financial impact of these changes can be estimated at 1 Mio ECU for 1994/95 and at 1,3 Mio ECU for 1995/96.

Equalizing of yields and irrigation ceilings

3.24. In August 1992, France presented an outline of a regionalization plan defining major options. This outline plan used two concepts which did not exist in the basic regulation: equalizing of yields(102) and irrigation ceilings. While the equalizing of yields should be neutral in budgetary terms, it goes against the requirement of the basic regulation that regional yields should be based on the actual detailed statistical figures. The irrigation ceilings, however, are not neutral in budgetary terms since they affect basic parameters. Although the ceilings imply individual sanctions in the event of overshoot, by including areas of planned irrigation projects outside the initial reference period, they increased the irrigated area eligible for support.

3.25. The Commission accepted that France could use this plan, on a temporary basis, during the marketing years 1993/94 and 1994/95, under the condition that a revised plan was presented for the marketing year 1995/96, before 30 April 1993. However, the definitive regionalization plan presented by France in March 1993 was still established according to the outline plan and no revised plan was presented. Instead, in May 1993, the Commission introduced ceilings for irrigated land in Greece and France by an implementing regulation(103). On 24 January 1994(104), both concepts, irrigation ceilings and equalizing of yields, were introduced into the basic Council regulation. The change included a possibility of transferring the ceilings into an irrigated base area, including the planned irrigation areas. However, the compensatory aid was to be reduced if the average yield resulting from the change was higher than the one used in the 1993 regionalization plans (see paragraph 3.28).

3.26. The effect of these developments was to give France and Greece the benefit of additional irrigated areas with higher yields from the very beginning of the reform. In spite of this increase in the irrigated area analysis shows that overshoots have occurred. In France, however, these overshoots were never declared. The financial impact is estimated at 18,1 Mio ECU in 1994/95.

Yield stabilizer

3.27. In addition, a further yield stabilizer was introduced. The stabilizer envisages the adjustment of the compensatory payments in the following year if the actual average yield exceeds the stabilizer, calculated as an average yield resulting from the regionalization plan applied in 1993. This mechanism was introduced so that Member States which adopted complicated regionalization plans, like Spain and France, would not receive more compensatory aid than Member States which adopted simpler regionalization plans(105).

3.28. For France the Commission calculated the yield stabilizer to be 6,02 tonnes per hectare. This figure includes the effect of irrigation ceilings. Thus France benefits from increased yields after the reference period, which are not available to other Member States. The comparative advantage France drew from the regulatory change can be estimated at 16,5 Mio ECU for the marketing year 1995/96 onwards.

Reliability of the statistics

3.29. The statistical basis for the original calculation of the base areas and yields is not entirely satisfactory. Council Regulation (EEC) No 837/90(106) concerning the statistics to be provided by the Member States on cereal production required that, by 1994, the standard errors should not exceed 1% for areas and 2% for production. Eurostat's report to the European Parliament in November 1994 on statistical systems for measuring area, production and yield in the 12 Member States(107) indicated that at that time only Denmark, Germany, France and the United Kingdom were able to provide statistics of the required accuracy. Given that the reference periods for the calculation of base areas and yields antedated the effective operation of Regulation 837/90, the subsidy payments are inevitably founded on imprecise statistics in most Member States. As the statistical uncertainty is not spelled out in the above-mentioned report, the risk of over or underestimating the base areas and yields cannot be quantified. The persistent overshoots of some base areas observed in the United Kingdom, France, Spain and Germany as well as the consistent undershooting in other Member States may be the result of wrong estimations or changes in the areas cultivated with arable crops. However, more important and persistent budgetary implications are likely to result from consistent undershooting because of initial overestimation of the base area, which hides the real overshoots and thus saves the Member States from sanctions (see Table 3.4).

Farm income

3.30. The Commission acknowledged in its communication to the Council (108) that the farm support system before the new CAP was devoted, in large part, to a small minority of farms and provided no solution to the problem of farm income generally, a problem which has not yet been solved by the reform. No individual ceiling exists for area aid, at variance with the arrangement, for example, for the beef sector. Large sums are paid to very big producers in addition, of course, to the revenue accruing from normal sales which represents, on average, twice the amount of aid paid. This can be illustrated by the three biggest payments in the Member States visited (see Table 3.5).

3.31. While the rates for oilseeds and protein plants could be broadly kept within the evolution of world market prices, this was not the case for cereals. Rising world market prices pushed internal EC prices to levels exceeding the institutional prices both in 1995 and 1996. As compensatory payments are paid on the difference between old and new institutional prices, the higher market prices combined with the area aid, over-compensated farmers by more than 20% in 1995 and 1996. This estimation was confirmed by OECD(109), which reports that the overcompensation in the 1995 harvest can be calculated to be some 3 000 Mio ECU, which corresponds to more than 30% of the 1996 budget year expenditure of cereals (see Table 3.1A).

Integrated administrative and control system (IACS)

The set-up

3.32. Council Regulation (EEC) No 3508/92 of 27 November 1992(110) introduced an integrated administrative and control system to process and control some 3 Mio hectare-based aid applications a year. The main elements of the system are:

(a) aid applications; in order to be eligible for area aid each farmer must submit every year an application indicating all agricultural parcels, including forage area and parcels covered by set-aside;

(b) a computerized database which shall record for each agricultural holding the data provided by the aid applications;

(c) an alphanumeric identification system for agricultural parcels, i.e. a system to allow areas declared to be located so they can be monitored over time and so that computerized cross-checks can be organized and on-the-spot checks conducted;

(d) an integrated control system for administrative control and field inspections.

Total cost of IACS

3.33. Table 3.6 shows the implementation costs of IACS and the Community part of financing. However, according to a letter of the Commission dated 12 January 1993 (VI/7016/93) only costs for EDP structures, control structures and experts were eligible for Community co-financing(111). Other implementation costs and the costs of running the IACS are borne by the Member States(112). For example, data provided by Germany, show that only about 14% of Germany's total implementation costs were reimbursed by the Community. As part of the cost is covered by national funds, it was not possible to gather sufficient data in all Member States in order to determine the total cost of IACS. However, the Court has been informed that in some Member States the national audit institutions will continue to examine this area.

Aid applications

3.34. The whole system of compensatory payment relies on aid applications whereby the farmer declares parcels for which aid is claimed including those set aside. The introduction of aid applications represents a considerable amount of bureaucracy in sectors which, in the past, received revenue by the price support system rather than by direct public aid. A considerable amount of administrative work was required also from the national administrations who had to deal with quite a large number of erroneous applications. This situation could, to a certain extent, be expected when introducing a completely new system on a large scale.

3.35. In the second year of the implementation, most Member States preprinted the parcels' indications from the previous application on to the form for the new aid application, including eventual corrections made, and sent them to the farmers. These had then to indicate changes from one year to another without being obliged to repeat each year the whole parcel register.

3.36. In some German Länder and in France the forms do not allow the linking of fields, which are split into two or more different crops, to the cadastral location of the parcels involved.

3.37. In 1993 and 1994 France did not request aid applications to be accompanied by documents to enable the land claimed to be identified(113). The absence of documentation raises doubts about the conformity of the payments carried out to legal provisions.

The computerized database

3.38. Computerized databases will allow direct and immediate consultation of data relating at least to the previous three consecutive calendar years. Member States are allowed to set up a centralized or decentral-ized databases. In the latter case, they should be compatible and the administrative procedures for recording and accessing data should be designed homogeneously throughout the territory of the Member State concerned(114).

3.39. France and Italy created a single database. Germany, Spain and the United Kingdom created 16, 17 and 4 regional databases respectively. Most of these were developed without observing the abovementioned requirements.

3.40. Computer reviews were carried out in Spain (Andalucia, Castilla-La Mancha and central level), France, Italy and the United Kingdom (England). The examination focused on project management, physical and logical security measures, systems design and implementation. Weaknesses relating to the separation of duties were identified in Spain and France, and weaknesses in acceptance testing and testing of disaster recovery plans were found in Spain, France and Italy. It was noted that only the United Kingdom (England) applied adequate standards for computer developments.

The alphanumeric system for parcel identification

3.41. The alphanumeric identification system for agricultural parcels is a key element in the correct application of schemes linked to area. It should be established on the basis of land registry maps and documents, other cartographic references and/or on aerial photographs and/or satellite pictures or on the basis of more than one of them.

3.42. In Germany, Spain, France, Italy, Luxembourg and Austria the alphanumeric system is based on the official land register (cadaster). In general in the United Kingdom, maps from the Ordnance Survey are used (an official mapping body set up to make maps for the United Kingdom). In other Member States the official land register could not be used directly or could only partly meet the requirements of an alphanumeric system. In Belgium, Denmark, Greece, Ireland, the Netherlands, Portugal, Finland, Sweden and Scotland (fodder area) other systems have thus had to be created to meet the requirements laid down in the regulation. In France, despite a relatively favourable starting point, final design of the land parcels register was not ready until mid-1995, too late for being used before 1996.

The integrated control system

3.43. The integrated control system should cover all aid applications submitted, in particular as regards administrative checks, field inspections, which can be partly or fully substituted by remote sensing via aerial photos or satellite pictures.

Administrative checks

3.44. Administrative checks are to be made in such a way as to ensure effective verification of compliance with the terms under which aid is paid. They should include cross-checks which are a key element for the administrative controls as they are meant to detect double declarations of parcels.

3.45. The effectiveness of administrative controls is closely linked to the existence of the alphanumerical identification system and the computerized database. Neither element was sufficiently developed in any of the Member States in the first years of the reform. Where certain features of IACS were not yet in application, Member States had to take appropriate administrative and control measures in order to ensure compliance with the terms on which aid is granted(115). Thus manual check procedures had to be adopted on an ad hoc basis.

3.46. The speed of implementing the system of crosschecks varies in the Member States visited. Italy is the only Member State where cross-checks have been carried out since 1993. In England computerized crosschecking has been carried out each year since 1993, but the programme required for exhaustive area checking was found to need further improvements. The regions visited in Germany and Spain were ready in 1996 except for the exchange of data at national level. At the end of 1996, the database and the alphanumeric system were still not sufficiently developed in Greece, Ireland and Portugal, which makes efficient administrative checks such as cross-checks impossible.

3.47. Germany, Spain and the United Kingdom use several databases which are not directly linked together, making administrative control more complicated. Manual procedures had to be developed in order to make inter-database parcel checks at regional level. This worked satisfactorily in the United Kingdom. In Germany and Spain these checks were partly made before 1996. In France, administrative controls during 1993 to 1995 were not based on the land register but on the registers of the MSA (Mutualité sociale agricole), which were completed manually by the farmers and not supported by independent documentation in 20% of the cases. In France, no cross-checks, therefore, could be carried out before 1996. At the beginning of 1996, when computerized cross-checks were carried out for the first time, one parcel was declared four times without being detected by the system. As cross-checks of parcels are built into the computer system, such failure puts the whole system into question.

3.48. In Spain (Andalusia), France and Italy, for the comparison of the surfaces declared with the land register, tolerances of up to 5 000 m2 are allowed. While this could have been accepted during the implementation period, this tolerance should from now on be reduced to the smallest unit of payment of aid, i.e. the are (100 m2).

3.49. The basic Regulation (EEC) No 1765/92(116) states that Member States are allowed to pay the farmer between 16 October and 31 December. Some Member States have difficulties keeping this deadline, because they perform all required administrative checks before payment of area aid. In the first years of the reform, computerized cross-checks in Germany took place after payments were made and were only partly carried out. In France, only some basic administrative checks took place before payment. This explains why these Member States were able to carry out their payments before the legal deadline of 31 December (France even paid on 16 October almost 100% of the area aid) each year.

Field inspections

3.50. According to Regulation (EEC) No 3887/92(117), 5% of the applications have to be checked through site visits or remote sensing. By these checks the size of the arable area used, is determined and the crops and their status is verified. The selection of farms to be checked has to be based on risk analysis.

Selection of producers to be checked

3.51. Before 1995, in some German Länder the risk analyses were not based on the criteria laid down in the regulation, i.e. the amount of aid involved, the number of parcels and areas for which aid is requested, findings of checks made in past years and other factors defined by Member States. Contrary to the provisions of the regulation, the sample for on-the-spot checks was drawn by taking, for example, every 20th application. This contributed to a situation where some of the very biggest farms in eastern Germany (3 000 to 8 000 ha) were not checked. In the UK the risk assessment used was not sophisticated enough to ensure that very large holdings were checked according to their weight in the area aid system.

3.52. France does not include all applications in the population from which the sample is drawn. In the departments of Gers and Cher, about 1 000 applications out of 13 000, were not included in 1996, which casts doubts on the reliability of the selection.

3.53. A national German criterion for the selection has been the relation between simplified and main scheme applications (small and big farms). The relation was established to be 60 to 40, but this was not correct as a whole. In some German Länder, the actual relationship was inversed. In Saxony-Anhalt it was 28 to 72%. In Mecklenburg-Vorpommern, it was 24 to 76%. The actual figures for each Land should be used in the risk analysis.

3.54. In Spain, risk analysis does not always take into account the results of the current year's and the previous year's results for each control district. For instance, the autonomous province of the Balearic Islands processed 3 601 aid applications for the 1995/96 marketing year and found anomalies in 32% of the applications. However, the sample for the 1996/97 marketing year was decreased rather than increased as it should have been according to the regulation. A similar situation was found in La Rioja.

3.55. Furthermore, Spain included in the aid application for arable crops grain legumes (Council Regulation (EEC) No 762/89(118)). When selecting applications for on-the-spot checks concerning grain legumes and the other arable crops cultures, all plots of more than 30 ha of grain legumes and at least 5% of all parcels with this culture should be included in the sample according to the regulation. This gives a biased sample for arable crops, since grain legumes is an important crop in certain regions, and in this way dominate the sample selected for the overall field checks of 5% in these regions.

Announcements of field inspections

3.56. In Italy and in some departments in France the limit of 48 hours advance warning is not respected raising the risk of abuse of the area aid (see paragraph 3.62). In Italy, the farmers are normally given 10 days warning and in some of the audited departments in France it was observed that some producers asked for a delay beyond the 48 hours, and that this was normally accepted by the authorities.

Effectiveness of field inspection

3.57. In France the senior staff responsible for field inspections(119) in each region are often trained agronomists or agricultural engineers, but the majority of field inspectors are temporarily employed students from agricultural high schools. These employees have a few days of theoretical training and start the control work with an experienced field inspector, but after a couple of days they work on their own. During the financial audits of 1995 in the departments of the Ardennes and the Vosges, cases were found where students reported on checks which were, in reality, not performed. Inspections are paid per farm checked which increases the risk of such practice.

3.58. In Hessen 114 on-the-spot checks had been organized in 1995 by a regional farm office, but no errors had been found. During a random check of 23 control reports, it was found that no measuring had taken place. The inspector had only checked the parcels 'by sight`.

3.59. According to Regulation (EEC) No 3887/92(120), the competent national authority shall determine a tolerance margin applicable to the measurements made on the spot of area declared by the producers. This margin shall mainly take account of the technique used for measurement (e.g. tape, wheel, topofil(121)). The Commission has put forward a working document with recommendations for measurement of areas(122). The tolerances established in Spain are not based on this document but depend on parcel size and give larger margins. In Thüringen in Germany larger margins than recommended were also used.

3.60. In order to verify the crops during field inspection the checks should take place during the vegetation period(123). All Member States audited have had difficulties in adhering to this time limit. On-the-spot checks were even carried out after planting and sowing of a new crop for the next year. The Commission decision to extend the deadline for submission of aid applications to the first half of May, where the basic regulation suggested the first three months of the year, did not help to resolve this problem.

3.61. Pursuant to Regulation (EEC) No 1765/92(124) and the implementation regulations(125) the purpose of set-aside is to contribute to the stabilizing of the markets. Set-aside means leaving fallow of an area which has been cultivated in previous years with a view to a harvest. The area set aside must have been farmed by the applicant during at least the previous two marketing years(126).

3.62. In the autonomous region of Castilla-La Mancha in Spain and in France, these requirements were not checked administratively and not even during field inspections. In the French national rules these two requirements have been toned down. In Italy the rule is not even incorporated into the national instructions for field inspections. During the audit of on-the-spot checks in Italy, it was found, in two instances, that the farmers had declared a parcel as set aside, but the land 'set aside` had, just before the inspection, been undergoing agricultural treatment. In one case, fodder plants had just been cut and removed and in the other, traces of soya plants were found.

Inspection reports

3.63. The inspection reports must indicate, inter alia, which parcels were measured(127). An examination of several inspection reports in Spain for the 1995/96 and 1996/97 marketing years concluded that in the majority of cases the agricultural parcels measured were not specified. The same problem was found in French control reports. This type of report does not allow to revise the checks performed.

Remote sensing

3.64. Remote sensing is used by all Member States except Luxembourg and Austria. The methodology used has been developed by the Commission (Joint Research Centre Ispra (Italy) and DG VI). It involves an analysis of satellite images or aerial photos. The information contained in the farmer's aid applications is compared parcel by parcel with the images. Aerial photos can be used alone or be combined with satellite pictures.

3.65. In Italy, the obligatory 5% checks are essentially carried out by remote sensing. Crop control is carried out by satellite, but surface control is based on aerial photos. The results of this combined method seem to be quite efficient. In 1994/95, 56% of applications controlled by both aerial photography and satellite were penalized and 63% in 1995/96. In the Member States, which used satellite pictures for both area and crop checks only 8% of checked applications were penalized in 1994/95 and only 3% in 1995/96 (see Table 3.7 which is based on information from the Commission). This result compares badly with traditional physical checks where the correction rate was 30% in 1994/95 and 36% in 1995/96.

3.66. The satellite pictures for measuring the size of the area declared are not yet precise enough to be used alone for measuring area. A study carried out by the Joint Research Centre in 1994(128) states that the measurement accuracy of surfaces by using satellite pictures is situated between P20% and +20% for parcels smaller than 1 ha and P12% and +12% for parcels bigger than 1 ha. The study concludes that, for the time being, satellite pictures should not be used alone for the purpose of controlling surfaces but land register and ortho-photos should also be used. The satellite picture may be used to determine the crops, although this is also problematic. The Commission(129) acknowledged that at least 17% of the parcels checked by satellite had to be rechecked by physical inspections.

3.67. In its letter of 3 June 1996 the Commission asked the Member States to complete a questionnaire comparing the cost of the field inspections with the costs of remote sensing. It came to the result that the average cost per application checked by remote sensing was some 19% higher compared to traditional on-the-spot checks. This contrasted significantly with data collected in the UK, where remote sensing was assessed to be five times more expensive than traditional on-the-spot checks. Further information is needed to arrive at a definitive confirmation of the relative costs of the two methods.

The results of field inspections

3.68. The Commission's monitoring statistics show that 7% of all applications concerning area aid were subject to on-the-spot checks in the Member States in 1993-95 (see Table 3.7). The result of the on-the-spot checks was that on average 20% of the applications checked on the spot were found to be incorrect during this period. The monitoring statistics do not show by what amounts the applications were corrected or sanctioned and further figures provided by the Commission do not allow any reasonable quantification of irregularities. The Commission should provide more accurate statistics as to the economic effect of the onthe-spot checks and as to the total effect of the integrated control system (both on-the-spot checks and administrative checks).

Progress

3.69. Feasibility studies before the new CAP showed that the IACS could be implemented from February 1993 to 1 January 1996(130). The Commission, in a report(131) of April 1996, stated that none of the Member States had fully implemented IACS by the end of 1995. The Commission therefore proposed an extension of parts of Regulation (EEC) No 3508/92 for one year which was retroactively decided by the Council on 17 December 1996. Not only should the Commission have introduced its proposal of extension before the end of 1995, but, by the end of 1996, it was already clear that three Member States (Greece, Ireland and Portugal) would not be able to meet the new deadline of January 1997 (see paragraph 3.46).

Conclusions

3.70. The chapter has concentrated on the establishment of the basic elements for aid calculation and on the implementation of IACS. Total expenditure on arable crops increased since the introduction of the reform, but the increase and the change in the composition of expenditure can be considered to be within the foreseeable limits when passing from a 'consumer-pays` price support system to a 'taxpayer-pays` system. However, opportunities for saving and securing Community funds were missed. As the area aid system represents about 60% of total EAGGF Guarantee expenditure the parameters determining the compensatory payments should be realistic and appropriate. The basic compensatory amounts for cereals, one of the main parameters, determined by the Council in 1992, is out of touch with world market prices and this has led to overcompensation by 3 000 Mio ECU in 1995/96 (see paragraph 3.31).

3.71. The problems of managing the area aid system in the cereals sector could be solved by setting up a regulatory system like that established for oilseeds, with an advance and a final payment. Thus the final aid payment can take into account the real overshoot of the base areas and the overshoot of the historical yields. Moreover, the basic amount could be adjusted to the market price so that overcompensation of farmers is prevented in cases where the market price is higher than the target price (see paragraphs 3.9 to 3.12 and 3.30 to 3.31).

3.72. The Commission should address the problem of very large compensatory amounts being paid to individual farmers due to the lack of an individual ceiling as used in the beef sector. The income aspect of the new CAP should be examined more closely (see paragraph 3.30).

3.73. The regulations do not give precise enough instructions for calculating the overshoot in base area in a uniform and consistent way which makes the base area stabilizer system less effective (maximum area per region eligible for support - see paragraph 3.17). In addition documentation in the Member States does not allow a proper control of the calculations of overshoot and thus fails to provide the necessary audit trail (see paragraph 3.19). As is pointed out, an original overstatement of the base area, because of unreliable data for the reference period, could also lead to unquantifiable overpayments (see paragraph 3.29). Furthermore, the implementation regulation did not properly reflect some of the provisions laid down in the Council regulations (see paragraph 3.18). In addition, the Commission by also adjusting the area aid system diminished the sanctions and thus increased the total payments by 469,7 Mio ECU (see paragraph 3.16 and Table 3.2).

3.74. The Court asks the Commission to re-examine the base areas and the yields which are currently defined on the basis of inadequate statistics and to consider whether an alternative basis is available to re-specify both of them, taking into account, where appropriate, the impact of recent measures to improve the quality of relevant statistics. Any such re-specification of base areas and yields would need to ensure equitable treatment between Member States as well as contributing to the efficient implementation of Community measures and should be placed in the context of other measures aimed at reducing expenditure (see paragraph 3.29).

3.75. Concerning the integrated control systems of the new CAP, the Court criticizes the way the extension of the IACS implementation period was handled. By retroactively deciding to extend part of Regulation No 3508/92 for one year, Member States, initially not fulfilling their legal obligation, were suddenly acting again within the law (see paragraph 3.69).

3.76. Although it kept itself informed about progress, the Commission took no formal measures during the development of IACS to ensure that good computer practice was followed. This could have been done by reference to industry standards generally or by using guidelines issued by the Commission's own Informatics Directorate (see paragraph 3.40).

3.77. Some Member States do not comply with the regulatory requirements of traditional field inspection concerning risk analysis, announcement of field inspections, area and crop inspections, and report writing. The Commission should seek to ensure that correct procedures are used in future (see paragraphs 3.50 to 3.63).

3.78. Remote sensing by satellite has proved so far to be too inaccurate to be relied on for the measurement of areas, although it appears in most circumstances to be effective in checking the nature of the crops grown. Aerial photographs or traditional field inspections using accurate measurement techniques should continue to be used to determine areas until remote sensing by satellite can be shown to have attained the accuracy required (see paragraphs 3.64 to 3.66).

3.79. Without a fully operational system of area and animal aid payments (see chapter 4), the system cannot be effectively managed and controlled. The Commission should therefore take appropriate measures through the clearance system against those Member States which have not complied with this obligation.

FOLLOW-UP OF OBSERVATIONS MADE IN THE COURT'S REPORTS

3.80. In 1994 the Court published its Special Report No 8/93(132) on the common market organization (CMO) for raw tobacco and another report on the common market organization for products of the vine growing sector. The latter figured in its Annual Report for the financial year 1993(133). Both reports dealt with the implementation and effectiveness of the support measures in the markets and on the control procedures set up by the Member States and the European Commission to safeguard EAGGF Guarantee Funds. In order to establish whether action has been taken to improve market management and control procedures in accordance with its observations and recommendations, the Court has reviewed the measures taken by the Commission in response to the abovementioned reports.

(CMO) for raw tobacco

The reform of 1992

3.81. The Special Report of the Court covered the marketing years 1988 to 1992 and expenditure incurred until 1993. The report dealt therefore with the system in force during the audit. However, with effect from the 1993 harvest, the Council introduced several reforms to the CMO(134). In its Special Report the Court commented on some elements of the reform:

(a) the abolition of institutional prices, export refunds and intervention storage eliminated several of the problems identified in the Special Report;

(b) paying the full premium directly to the growers, and reducing the number of premium rates from 34 varieties to five groups of varieties (defined by the kind of curing) and three separate groups of Greek oriental tobaccos, made the premium system simpler and more transparent;

(c) introducing non-transferable quotas (fixed at Member State level by processor/producer and by variety of tobacco) as a temporary measure up to the 1997 harvest inclusive, ensured that production did not exceed a global maximum;

(d) requiring that tobacco control agencies be established in Greece and Italy (according to the importance of their production): these agencies were tasked with conducting a minimum number of checks;

(e) introducing a special conversion programme to facilitate the cessation of tobacco production, and encouraging the conversion of existing production to tobacco varieties more in demand;

(f) providing an aid to producer organizations (10% of the premium paid to their members) undertaking to improve quality;

(g) creating a research and information fund with the aims of developing and promoting the use of tobacco varieties less harmful to human health.

3.82. The discharge recommendation of the Council for the financial year 1993(135) required the Commission to report on the functioning of the new CMO, and to combat the fraud and irregularities found under the old CMO. The European Parliament (EP)(136) asked the Commission to:

(a) recover funds spent contrary to Community legislation;

(b) ensure that Member States benefiting from the EAGGF Guarantee Fund also put in place all necessary infrastructure for all products, i.e. cadastral maps, databases and control systems;

(c) control Community funds in a sound and proper way.

Market balance and budget situation

3.83. In global terms budgetary expenditure decreased from 1 233 Mio ECU in 1992 to 993 Mio ECU in 1995 and rose again in 1996 to 1 026 Mio ECU (see Table 3.8). This compared with 7 Mio ECU foreseen for the 1996 anti-smoking campaign.

3.84. While expenditure has decreased by about 20% since the reform, production in the same period also fell to 333 Mio tonnes in 1995. Tobacco grown in the European Union remains a highly subsidized product: the aggregate subsidy paid was more than five times the market value of the product; the aid rate per hectare was 6 837 ECU (based on 150 000 hectares of tobacco currently grown in the Community); and aid corresponded to 5 390 ECU per job supported (based on 190 000 jobs in the cultivation regions directly dependent on this product).

3.85. Although the CMO is now matching supply somewhat better with demand (in particular with regard to flue-cured varieties), Community production can still satisfy only 23% of total internal demand. With overall tobacco consumption remaining broadly flat and consumption actually rising in some population groups in some Member States, imports remain at traditionally high levels (approximately 500 Mio tonnes). The Commission in its report to the Council(137) on the future of the common market organisation for raw tobacco from the 1998 harvest onwards, considers that: '... to meet the consumption needs, the Community will in any event have to import certain types of tobacco that it cannot produce profitably on its own soil ...`(138).

3.86. On the other hand, about half of Community production for which no internal demand exists must still be exported. With the exception of certain sun-cured oriental varieties, the exported tobacco is of low quality, a fact reflected in low market prices. The Commission points out: 'the medium-term survival of Community tobacco is contingent on an improvement in quality`(139). Despite the importance of quality for the future of the sector the introduction of aid to improve quality has had no significant impact in the last four years.

Complexity of the new scheme

3.87. The Commission recognizes in its aforementioned report that: 'the scheme is also somewhat complex`; this comment is linked to the calculation, distribution and verification of individual quotas and registration of cultivation contracts(140). These features increase the difficulty of managing the whole system.

3.88. Furthermore, the Commission recognizes that the quota system introduces inflexibility to the market, which hinders the adaptation of supply to demand. From 1996 the Commission has permitted the temporary transfer of quota between processors and the transfer of quota from one tobacco variety to another. These changes were steps in the direction suggested by the Court: 'consideration should be given to whether it would help efficiency in the tobacco market if quotas were eligible to be leased and sold`(141).

3.89. Finally, the Commission has reported on serious abuses in Member States during introduction of the reform:

(a) by the end of 1993 the reform had been introduced in an irregular way in Greece: that is, quotas were attributed to 4 571 farmers without evidence of production during the set reference period; the controls in place did not correspond to the requirements of the new scheme; implementation deadlines were not adhered to; the conversion programme was not monitored; and checks on cultivated areas by the Greek authorities were not adequate, mainly due to the lack of land registers;

(b) in Italy basic documentation was not checked; fictitious producers were given tobacco quotas; and cultivated areas were wrongly declared;

(c) in Spain the legal procedure for the penalisation of false area declarations took so long to complete that in effect, no penalties were imposed on persons making false declarations;

(d) in Germany the Commission found in 1995 that the authorities had still completely ignored the control requirements of the new regulation.

3.90. The Community accounts for these years are currently subject to clearance procedures; the Commission should try to quantify the financial impact of identified irregularities, and recover amounts unduly paid.

3.91. Although the reform has helped to reduce the scope for abuse generated by the old CMO, it nevertheless gives reason for concern that the regime remains excessively complex. For example, tobacco quality must still be checked, elements such as moisture content must be verified and the tobacco has to be kept under state supervision, from delivery to processors until release on the market, many months later. It is therefore regrettable that the control agencies required by the reform have not been established by the Member States concerned.

Follow-up of specific irregularities identified in the Court's reports for the marketing years 1988 to 1992

3.92. A Spanish processor who had processed tobacco variety Burley F, but who had declared the tobacco to be the higher premium variety Burley E, has had to repay 375 Mio PTA (2,8 Mio ECU). This amount has yet to be credited to the Community budget. Another problem identified in the Court's report, i.e. premium paid for tobacco originating in non-eligible areas, was pursued by the Commission during the clearance of the 1991 expenditure in 1994/95.

3.93. It was found that when clearing advance premium payments, the French authorities had recalculated the premium payments on individual lots of a whole consignment sold during a certain period; for the recalculation, they applied the green rate applicable at the date when the last lot was sold, rather than using the actual rates applicable to each part of the consignment. In a particular case, this method resulted in increased payments of 0,45 Mio ECU. The problem is solved as the new regulation now specifies that the green rate for premium payments is the rate applicable on 1 August of the harvest year for deliveries up to 31 December. For deliveries thereafter, it is the rate applicable on 1 January of the following year.

3.94. The Court's 1993 Report criticized controls over export refunds for exports from Greece and Italy to Bulgaria and Albania. The Commission's special investigation in Greece in July 1994 further revealed the existence of suspected organized fraud concerning export refunds to Albania and Bulgaria. The Commission concluded that controls made by the Greek Tobacco Board were non-existent and that organized fraud was known to the authorities. In its clearance procedures, the Commission's final corrections of expenditure declared by Greece were 4 491 Mio GRD (23,43 Mio ECU) for 1990 and 3 531 Mio GRD (16,37 Mio ECU) for 1991. For the period 1986 to 1989, a supplementary correction of 7 305 Mio GRD (approximately 41,94 Mio ECU) was notified to the Greek authorities. For Italy, the corrections were 15 697 Mio ITL (10,39 Mio ECU) for 1990 and 12 156 Mio ITL (7,91 Mio ECU ) for 1991.

Direct income support

3.95. The Special Report of 1993 suggested that instead of the direct financing of tobacco production the Commission should consider giving tobacco farmers some kind of direct income support and integrating them into the structural aid system. Such a system might be easier to administer and control, and less vulnerable to fraud and irregularity than the present regime at a lower overall cost to the EU budget. While the difference between the cost of the existing system and an income aid system cannot be calculated with precision, it is a fact that much EU tobacco production is of low quality and therefore of a very low marketability and that this problem has not yet been addressed by reform of the CMO. The Court still considers that it would be worth investigating the possibility of an income aid system which would avoid some of the budgetary costs of growing tobacco of very low value and assist the farmers to find other remunerative activities.

Conclusions

3.96. While the reform has limited budgetary expenditure on support for tobacco production, it has not altered the high level of subventions relative to market value, hectarage or the number of jobs provided. Nor has the market situation of Community tobacco significantly improved. Most Community tobacco remains low quality, suggesting that aid for improving quality and conversion programmes have had no measurable effect to date (see paragraphs 3.83 to 3.86). The Commission should investigate why these programmes have not had more success.

3.97. By abolishing institutional prices, export refunds, intervention storage and reducing the number of premium rates, the reform simplified the CMO to a certain extent and eliminated the scope for some management shortcomings and irregularities which existed under the old system. Nevertheless, serious deficiencies in Member States' implementation of the reform have been identified by the Commission; for example, control agencies have not been established, and the new quota system has proved to be inflexible and cumbersome to manage (see paragraphs 3.87 to 3.91).

3.98. In general the Commission's follow-up of the irregularities reported in the Special Report is satisfactory. However, amounts disallowed following the Commission's investigations should be recovered (see paragraphs 3.92 to 3.94).

3.99. The Court continues to question whether direct subsidies (amounting to more than five times the market value of production) constitute the best form of support for tobacco growers. The possibility of some kind of direct income aid should be considered as an alternative.

CMO for products of the vine growing sector

3.100. In its 1993 Annual Report on the CMO for products of the vine growing sector(142) the Court concluded that:

(a) there was a serious imbalance between supply and demand in the wine market, and Community measures have had no effect in remedying this;

(b) permanent abandonment (grubbing up) had not helped to stabilize the market;

(c) institutional prices did not reflect the market situation, and this encouraged production for distillation;

(d) intervention for distillation did not significantly reduce structural surpluses;

(e) market management information was not reliable enough;

(f) there was a lack of progress in establishing vineyard registers;

(g) the body of specific Commission officials relevant to the CMO was not adequately staffed.

3.101. In its discharge resolution for 1993(143) the European Parliament and the Council supported the Court's conclusions.

Market balance and budget situation

3.102. Following increases in expenditure caused by continuing serious market imbalances, the Commission proposed the reform of the CMO on 11 May 1994(144). This proposal has not yet been approved by the Council because Member States have not agreed on such key parameters as reference quantities, quotas, enrichment(145), the treatment of quality wines or taxation rates.

3.103. Although the reform was not adopted, table wine production decreased during marketing years 1993/94 and 1994/95, but increased again in 1996/97 (Table 3.9). Following the low production in 1994/95 and 1995/96 budget expenditure decreased, but it is likely to rise again as production increases (Table 3.10). Taken together, Italy, France and Spain received about 92% of the budget of the CMO between 1993 and 1996.

Controlling the volume of wine in the market

3.104. The Commission has two instruments for controlling the volume of wine in the market. The first, distillation, is intended to balance the market in the short term. Distillation should counteract the impact of bumper harvests which result from unusually favourable weather conditions, by removing excess wine from the market. The second instrument, grubbing up, has a longer term goal. It aims at a permanent reduction in the Community's production capacity.

3.105. While distillation could balance markets in the short term, it provoked long-term structural surpluses, because it offered a permanently guaranteed market at a price which encouraged production. The Commission's proposals for a reform of the wine market envisage a significant reduction in the buying-in price for compulsory distillation. The proposed reform would therefore implement the policy intention of the Heads of Government, who in their 1984 Dublin Agreement aimed 'to impose compulsory distillation at deterrent price levels for all excess table wine production without leaving any scope for the disposal of part of the surplus by means of more costly optional distillation`(146).

3.106. The 1993 Report showed that grubbing up had no significant effect on wine production. In its evaluation(147) the Commission confirmed that grubbing up programmes were not very effective, in terms of both their cost and their ability to reduce over-production. Indeed incentives given by other support measures like optional distillation as well as the question of what to do with grubbed-up vineyards discouraged farmers from opting for grubbing up. Furthermore, taking low yielding vineyards out of production and increasing yields on the remaining areas partly counter-balanced the effect of grubbing up where it was applied. Under such circumstances the 1 682 Mio ECU spent on permanent abandonment since 1992 does not appear to have been cost-effective. In its CAP working notes of 1995(148), the Commission pointed out that recent low harvests were principally caused by bad weather conditions.

Management information system

3.107. Shortcomings in the market management information system were identified in the 1993 Annual Report. The Council Regulation (EC) 1294/96 of 4 July 1996(149) amended the basic Regulation (EEC)822/87(150) and introduced penalties for the delivery of inaccurate information on harvest, production, and stocks. Depending on the percentage of error in the information submitted, and on the extent of delays in delivering the information required, beneficiaries may lose part or all of the subsidies for the current and following year.

3.108. A shortcoming in the collection of 'average representative price` statistics which form the basis of institutional support prices was also identified. Member States are required to notify the Commission of average prices each week for six representative types of wine in different production areas. The 1993 Report pointed out inconsistencies in institutional prices due to incomplete information on the average representative price submitted by Member States to the Commission. This situation has not improved.

Vineyard registers

3.109. Council Regulation (EEC) No 2392/86(151), of 24 July 1986, obliged Member States to introduce vineyard registers within six years, considering that vineyard registers are indispensable to the management of the market and particularly to control of support measures and plantation rules. Under the implementing Regulation (EEC) No 649/87 of 3 March 1987(152), the Community finances 50% of eligible expenditure. The Community's budgetary contribution was estimated at 59 Mio ECU in total.

3.110. The Court drew the attention of the budgetary authority to the considerable delay in establishing registers, a task which should have been completed by the end of 1992. The Community reimbursement of expenditure declared by the Member States by that date amounted to 64,5 Mio ECU. Between 1993 and 1995 another 14 Mio ECU were paid as an advance to the Member States.

3.111. In its 1993 discharge resolution, the European Parliament asked the Commission not to pay any aid to those Member States where the vineyard register had not been satisfactorily established by 1 January 1998. However, Council Regulation (EC) No 1549/95 of 29 June 1995(153) extended the closing date for the establishment of vineyard registers to the end of 1998. This regulation also provided that instead of the register required by the 1986 regulation, a simplified vineyard register could be used for which co-financing is to be made available. However, the Commission's implementing regulation of June 1996, which should define what is meant by a 'simplified` register, has not yet been approved.

3.112. The postponement of the closing date, and the delays and failures in establishing registers, are symptomatic of poor management of Community funds in this case, by both Member States and the Commission.

The specialized Commission control body

3.113. The EP and the Council have consistently referred in their discharge resolutions to the need to strengthen the specific control body which was created by Council Regulation (EEC) 2048/89 of 19 June 1989(154). Its task is to combat fraud in the wine sector. The Commission's report to the Council on the activities of the control body(155) was welcomed by the EP, but in the opinion of the EP this body has never been given sufficient resources to carry out its job. Indeed at no point in time did the staffing of the control body reach the level of 32 controllers recommended by the EP. By August 1996 only one person was left and only one audit was carried out by the control body in 1996. The remaining controller has since been integrated into the Commission's clearance department. Since this body is required by the regulation, its de facto abolition raises the question whether the Commission considers that the tasks it was designed for are unnecessary. If the tasks are still necessary, the question is which body should be responsible for performing them.

Conclusions

3.114. The relatively low production of table wine during the last three years owes more to climatic conditions than to the grubbing up of vineyards. Production potential has not significantly decreased. The forecast for 1996/97 is for production to increase.

3.115. Shortcomings in the Community's management information system result in institutional prices being out of touch with the market, thus giving wrong signals to producers. The recent introduction of penalties for deliverance of incorrect and incomplete information by beneficiaries has yet to be proved effective.

3.116. The vineyard register seems to share the fate of the olive oil register. Since the initial deadline has expired without registers being established, a simplified vineyard register is now required of those Member States which did not complete the initial one. However, the Commission has to date failed to adopt concrete specifications for the simplified register, although continuing to co-finance it. The Commission should therefore explain immediately the characteristics of the simplified registers.

3.117. The specialized Commission control body, charged to combat fraud in the wine sector, did not reach the staffing level demanded by the Parliament and it is now merged into the Commission's clearance unit. Although the Court welcomes any attempt to strengthen the Commission's clearance unit, the de facto abolition of the specialized body calls into question the implementation of the particular controls it was intended to undertake.

REPLIES OF THE COMMISSION

AREA AID FOR ARABLE CROPS

The basic parameters of the aid scheme

Base areas and treatment of overshooting

3.15. The Commission has made a considerable effort to look into these matters within the clearance of accounts procedure. It has also done much work in Spain, France and Germany, where its findings largely coincide with those of the Court. Corrections are currently being considered within the 1995 clearance of accounts procedure.

3.16 (a) The Commission adopted the Regulations in question following the Council's decision in November 1994 to increase the base areas in Germany and Scotland.

(b) By adopting Regulation (EC) No 794/97 of 30 April 1997, the Commission accepted that the allocation of the base area to irrigated ('regadío`) and unirrigated ('secano`) areas should be adjusted. This adjustment could have been made earlier if Spain had accepted the consequence of the change, namely a reduction in the yields provided for in the regionalization plan.

3.17 (a) The calculation of overshoots and the statistics forwarded to the Commission are based on the same data. However, a slight discrepancy might arise because certain Member States forward statistics based on the situation at the time of the checks carried out several weeks before the rate of overshoot of the base area is fixed. If the checks are still far from completion, Member States fix the rate of overshoot later, to avoid fixing an incorrect rate.

Slight discrepancies may exist between the database communicated to the Commission and the database used to calculate the base area as a result of additional checks.

Setting 15 September as the date for fixing the overshoot of the base area takes account of the need to inform producers in good time of any extraordinary compulsory set-aside at the time of the autumn sowing.

(b) The Commission drew the attention of the French authorities at a very early stage to the need to distinguish forage areas. This shortcoming is also taken into account in the financial corrections currently being considered.

(c) Most of these shortcomings were also revealed in the clearance audits and will be subject to financial corrections.

(d) The Commission has given instructions to the Member States on the way figures should be rounded. Accordingly, figures cannot be rounded up, since this would unduly increase penalties. It is therefore correct to ignore second decimals.

3.18. The Commission believes that its implementing regulations correctly reflect the basic Council Regulation. It believes that it faithfully followed the spirit of the Council Regulation. Thus:

(a) small maize producers do not benefit from the higher yield in the framework of a base area for maize. The reason for the introduction of a specific area therefore does not apply in their case. Since small maize producers are compensated on the basis of the average for all cereals, only the base area for all arable crops, before maize is split off from the other crops, is justified as a point of reference.

(b) In the case in point, application of the proportionality principle meant that producers of arable crops should not bear the additional burden of the part of the overshoot of the base area caused by participation of livestock producers in aid applications.

3.19. The attention of some Member States has already been drawn in part to the need to keep appropriate documentation and back-up at EDP (electronic data processing) level. The importance of this has again been underlined in a letter to all Member States.

The regionalization plans

3.22 3.23. The statistics used by the Member States for determining yields were based on the years 1986-90. Under the levelling principle, different years had to be dropped depending on the yield regions referred to in the regionalization plans, and this resulted in slight differences at national level.

Equalizing of yields and irrigation ceilings

3.24 3.26. These matters arose from the political compromise needed to reach a general agreement to amend the arable crops scheme and, particularly, to implement the Community's international commitments.

The increase in the 'irrigated` base area in France in 1995 was based on Article 3(1) of Council Regulation (EC) No 1765/92 as amended in January 1994, which allows newly irrigated areas for which investments commenced before 1 August 1992 to be included in the irrigated base area.

The irrigation ceilings were abandoned and a real base adopted, after political negotiation, in Commission Regulation (EC) No 2391/95, which was adopted with a favourable opinion from the Management Committee for Cereals.

A financial correction for France is being considered in the context of the accounts clearance procedure for 1995.

Yield stabilizer

3.28. When the yield stabilizer was introduced, it was specified in Article 3(6) of Council Regulation (EC) No 1765/92 that the stabilizer should refer to the yield per hectare in the regionalization plan as applied in 1993.

Reliability of the statistics

3.29. Council Regulation (EEC) No 837/90 of 26 March 1990 lays down the confidence intervals to be complied with when determining areas and cereal production in order to ensure statistical reliability. In the case of areas, the standard error for the total area under cereal cultivation may not exceed 1% (or 5 000 hectares, at the discretion of the Member State). In the case of production, which depends on areas sown and yields, the standard error for production estimates at national level may not exceed 2% (or 50 000 tonnes, at the discretion of the Member State). In addition, for each species of cereal, the standard error for production at national level may not exceed 5% (or 20 000 tonnes).

No specific indication of reliability is required for regional data relating to total areas under cereals. Member States are, however, required to mention the regions for which the figures are unreliable and should therefore be used with caution in specific cases.

What is important is that data established at regional level from sources deemed to be sufficiently reliable should, when merged at national level, produce results which correspond to the areas and production observed at national level. Indeed, national figures are much better known and their reliability can generally be easily verified by contrasting several sources or by drawing up production/use balances. This type of reliability check provides a much more effective fail-safe than do theoretical calculations of random failure.

The fact that the occasional systematic overshoot is found in the declarations does not mean that compliance with the reference ceilings in the other regions is due to an initial overestimation of areas in those regions. Even if regional data has been properly readjusted at national level, it is not possible to state that initial underestimates for some regions automatically mean initial overestimates for others. Indeed, it is quite reasonable to believe that an initial underestimate of areas at national level (lower than the statistical standard fixed) is simply due to poor initial assessment of the areas in one or more regions. An error in assessment, however small at national level, could have originated in a much larger error of assessment in several regions. Statistical science is unlikely, either now or in the future, to protect us from such unfortunate phenomena.

The Council was responsible for fixing the base areas and yields.

Farm income

3.30. In its 1992 reform proposal, the Commission proposed that aid should be differentiated on the basis of the number of hectares farmed by individual producers. The Council did not accept this. The Commission will take account of the Court's comments in its deliberations on the imminent reform of the sector.

3.31. The Commission's calculations arrive at the same conclusions as the Courts: over-compensation is estimated at ECU 510 million for 1993/94; ECU 2 013 million for 1994/95; ECU 3 936 million for 1995/96 and ECU 2 001 million for 1996/97; the total for the four marketing years is thus ECU 8 460 million.

This matter was discussed by the Council in the context of the proposal to reduce aid to cereals producers in order to finance the special measures for BSE.

Integrated administrative and control system (IACS)

Overall, the report gives a clear and fair view of the implementation of the integrated system for area aid. In general, the Court's remarks are very similar to those made by the Commission in the context of clearance of accounts. Points raised by the Court which are not the subject of clearance remarks will be taken into account during future audits.

The Commission points out that most of the Court's remarks concern failures of application of the Member States' systems.

Aid applications

3.37. A financial correction is currently being considered also because France did not ask for the registers of the MSA (Mutualité sociale agricole) to be submitted, so no cross-checks could be carried out before the 1996 harvest.

The computerized database

3.39. Meetings have been held in the United Kingdom, Germany and Spain and national documents have been drafted in an attempt to achieve compatible databases. In addition, five German Länder use the same Profil program for the administration of aid.

The integrated control system

Administrative checks

3.46. At the Commission's request, Spain, Germany and the United Kingdom have assessed the needs for the transfer of data between regions. Such transfers are currently being carried out, but there is room for improvement in the work schedule.

With regard to the identification of parcels:

- the system has been in place in Ireland since 1996. Only the administrative checks posed a problem because of the validation of areas after the date of declaration.

- the system was used in Portugal in 1996 for the 49 priority 'concelhos`. It will be fully used in 1997.

- the system will not be ready in 1997 in Greece. To date, all the photographs have been taken, the orthorectification and outlining contracts have been signed and work is underway. There is every reason to believe that the 1998 declaration will be based on the new system.

3.48. The 50 are tolerance is normal, even outside of the implementation period:

- in no country does the cadastral register guarantee that areas are correct;

- the objective of cross checks, carried out at 100%, is to detect problems in applications. With a 1 are tolerance, the authorities would be snowed under with problematic declarations. Even using the current standards, the cross checks, which are very frequent, reject more than 20% of declarations;

- it would be possible to opt for a lower tolerance (10 to 20 ares), but the decision to do so should be based on a simulation of results obtained using the data from a previous year.

Field inspections

Selection of producers to be checked

3.51 3.63. See the reply to points 3.77 and 3.79.

Remote sensing

3.65. Only three Member States used satellite images without any help from aerial photos: Denmark, the Netherlands and the United Kingdom. Everywhere else, aerial photos were used alone or in combination, to a greater or lesser degree. Remote sensing gives a better overall picture of declarations than do field checks.

The Court states that the result of remote sensing compares badly with traditional checks as far as penalization of applications is concerned. While this is true, the situation in terms of the number of irregularities detected can be offset, despite the lack of accurate data, by the fact that the sites checked by remote sensing are often selected from large holdings and with large parcel sizes (representative samples) and so probably catch the most significant irregularities. Moreover, there are totally different classes of risk analysis involved. Some Member States explain the differences in results by the different strategies used to comply with the intentions behind the rules (Article 6 of Regulation (EC) No 3887/92): for sites checked by remote sensing there is a low risk (and good representativeness), whereas there is a very high risk for field checks without remote sensing (20%). Remote sensing tends to be used to select representative samples, not individual cases suspected of irregularities in advance; it therefore seems natural that the rate of errors detected should be lower.

3.66. Technical note I.94.105 (Avrain et al.) and another such note drawn up by the Commission in June 1993 (Da Vinci report) compared the measurements from satellite images to those in cadastral registers, which are presumed correct and used as a reference (experience gained since then has shown that this is not always the case). For this reason among others, these studies have today been outstripped by progress in methods. Moreover, in the Da Vinci study and for aerial photos (1-2 m pixel), used in 70% of cases in 1996 (see point 3.78), the difference was down to between 3 and 7%. In 1997, the Commission has access to a satellite providing a 5.8 m pixel and 1-2 m pixels will be arriving shortly (about equivalent to aerial photos).

Article 7(1) of Regulation (EEC) No 3887/92 requires on-the-spot checks of all parcels for which photo interpretation does not verify the accuracy of the declaration. Even the slightest doubt therefore leads to a field check. Remote sensing was never intended to replace physical checks completely. In addition, even if no anomalies are detected, current methods require at least 10% of field checks after remote sensing, to ensure a minimal presence of inspectors among the farmers.

The results of field inspections

3.68. Each year the Commission asks the Member States for statistics on the reductions and penalties they have imposed following administrative checks and on-thespot checks.

Most of this information has already been obtained for 1996. The Commission will ensure that all the Member States forward full information so that it can comply with the Court's requests.

Progress

3.69. See the reply to point 3.75.

Conclusions

3.70. From its own calculations, the Commission draws the same conclusions as the Court. The Commission estimates over-compensation at ECU 8 460 million for the 1993/94 to 1996/97 marketing years. This problem was also at the root of the proposal to reduce aid payments to cereal producers in order to finance the special measures relating to BSE. The Commission is contemplating reopening this matter when it debates the reform of the arable crops sector.

3.71. The Commission wishes to stress the technical difficulties which would be involved in replacing the current cereals arrangement with a scheme similar to that for oilseeds. There are fundamental differences between the two sectors regarding both the economic importance and the actual structure of the respective markets. The only outlet for oilseed production is the oil refining industry, for which the only parameter which need be taken into account is the world market, so that it is possible to fix a relatively representative reference price. Cereal production, on the other hand, can be intended for on-farm consumption, milling, the manufacture of compound feedingstuffs or industrial processing (starch and malt manufacture, energy production, etc.) and is sold on a plethora of local markets, each with its own peculiarities. Under such circumstances it is impossible to fix a sufficiently representative reference price.

Moreover, the need regularly to export part of the Community's output of cereals, which are always subject to a market organization, onto the world market, in the form either of grain or of processed products, brings yet another variable into the picture. And in view of the sums of money involved, it is hardly desirable to allow such decisions to depend merely on 'technical` factors.

3.72. The Commission included the plan to differentiate aid according to the number of hectares of individual producers in its proposals for the 1992 reform, but the Council decided against the idea at the time. The Commission will bear the Court's comments in mind when it debates the reform of the sector shortly.

3.73. The Commission is aware of the problems posed by the complexity of the rules for calculating the overshoot in base area (see the reply to point 3.17). With regard to checks on overshoots, the Commission will take the necessary steps in future accounts clearance procedures (see the reply to point 3.19). As for the regulations implementing the basic Council Regulation, the Commission believes that it has applied the provisions of that Regulation correctly (see the reply to point 3.18). Regarding the adjustment of areas, see the reply to point 3.16 (a).

3.74. Regarding the review of base areas and yields, the Commission wishes to point out that one of the cornerstones of the reform is that these parameters must be fixed and stable. Not only could a review cause an increase in expenditure but it would also run counter to the European Union's commitments under GATT.

3.75. The Commission completed its report (COM(96) 174 final) on the state of implementation of the integrated system at the end of 1995. To do so before the end of the implementation period (December 1995) would have been premature if progress were to be properly and fully assessed. The report was presented to the Council before Easter 1996, and thereafter sent to Parliament for consultation. In July and September 1996 Parliament's budgetary control and agriculture committees examined both the report and the proposal for a regulation extending the implementation period. The matter was finally included in the agenda of the December 1996 plenary session. The Council adopted the regulation immediately after Parliament had given its opinion.

3.76. The Commission has addressed this problem mainly by providing advice during the numerous monitoring and clearance missions carried out since the introduction of the IACS. Under the reform of the clearance of accounts procedure, Member States received guidance in the form indicated in the Annex to Regulation (EC) No 1287/95.

3.77. and 3.79 Based on the Commission's findings, the points raised are being followed up in the context of the clearance of accounts. Corrections for the 1994 harvest are currently being considered for France, Germany, Spain, the Netherlands, Portugal and Greece.

3.78. In 1996, 70% of applications were checked, either by aerial photo alone or by a combination of photos and satellite images. Moreover, the situations in the different Member States are not comparable. As stressed in point 66, the resolution of satellite images is making rapid progress: the accuracy of the images used in 1997 is substantially better than that of the images used in 1993.

FOLLOW UP OBSERVATIONS MADE IN THE COURT'S REPORTS

CMO for raw tobacco

The reform of 1992

3.82. As shown below, for cases where funds were spent contrary to Community legislation, the Commission has either recovered the funds by correcting the declared expenditure, or verified that they were recovered or not paid out by the Member States. In 1995 and 1996, the Commission carried out on-the-spot checks in all Member States to establish whether they possessed the database, control systems and cadastral maps required to ensure that funds are spent correctly.

Apart from the lack of cadastral maps in Greece and an inadequate control system in Germany, these verifications did not reveal any major failures in the control structures for the raw tobacco market.

Market balance and budget situation

3.86. It is true that the specific aid to improve quality has, in its present form, had no real impact. This is because it has two main drawbacks: the amount of aid is too low to really encourage high value production and the quality improvement criteria are not strict enough, so it is still possible to earn well from inadequate quality. By changing both of these aspects at once, the proposed reform should correct the shortcomings of the current system.

Complexity of the new scheme

3.89 (a) The allocation of quotas during the first year of the new market organization has caused many problems in almost every Member State involved. The Commission has checked the allocation of quotas, particularly its total outcome at both Member State and Community level. It has striven to ensure the fair treatment of all producers concerned.

The failure to meet deadlines has been due to the complexity of the new procedures and the large number of producers that had to apply them. The Commission therefore extended the deadlines and has been lenient during the first year of application of the Regulation.

The Commission is fully aware that the absence of land registers is the main reason why meaningful checks on cultivated areas are difficult. This is why the Commission, together with the Greek authorities, has sought additional information to overcome as far as possible the absence of a land register in parts of Greece. Cultivation declarations are now made in such a way that it is easier to locate the plot. In this context, it must be stressed that land registers are available for large parts of northern Greece, where most tobacco is cultivated.

(b) As concerns the incorrectly declared cultivated areas, the Italian authorities, on the instructions of and after preliminary checks by the Commission, have thoroughly checked the cultivated areas. This exercise resulted in a reduction of the 1995 premium payment for 674 709 kg and a reduction in the quota for the producers concerned in the 1996 harvest year. It is also noted that the number of incorrect declarations found during the field inspections for the 1996 harvest year has dropped substantially.

(c) The Spanish authorities have informed the Commission that the producers who made false cultivation declarations in the 1995 harvest year will have their quotas and premium payments reduced in the 1997 harvest year.

(d) The inadequate control arrangements in Germany have led to a 5% flat rate correction for the 1993 harvest year. A correction is being considered for the 1994 and 1995 harvest years.

3.91. In its report on the operation of the market organization for tobacco, the Commission proposed the following reforms with a view to simplifying administration of the system:

Quotas should be managed not at the level of the individual producers but at the level of producer groups. This would reduce the administrative burden from tens of thousands of operations to only a few dozen, even in the largest producer countries.

The quotas should be calculated and allocated every three years instead of every year.

The second allocation of unused quotas should be abolished, since it is no longer justified now that producers can transfer quotas among themselves.

Systematic measuring of the moisture content in each bale of tobacco should be abolished.

As regards the control agencies, see the reply to point 3.97.

Follow-up of specific irregularities identified in the Court's reports for the marketing years 1988 to 1992

3.92. Following further explanations provided by the Spanish authorities, the recovery of ESP 375 million was not considered necessary.

On the premium paid for tobacco originating in ineligible areas, a correction of ESP 29 073 478 was made for the 1991 financial year.

Direct income support

3.95. In its report on the operation of the market organization for tobacco (COM(96) 554 final, 18 December 1996), the Commission considered applying a system of direct income aid for tobacco growers. It rejected the scenario for the following reasons:

it would cost about the same as the current scheme,

it does nothing to improve the quality of Community produce,

it would have no impact on the level of tobacco consumption in the Community; the drop in Community production would simply be offset by an increase in imports.

Conclusions

3.96. In its report on the operation of the market organization for tobacco (COM(96) 554 final, 18 December 1996), the Commission dwelt in detail on the specific aid for conversion programmes.

In its current form, the specific aid has failed to stimulate improvements in the quality of production. This is because it has two main drawbacks: the amount of aid is too low to really encourage high value production and the quality improvement criteria are not strict enough, so it is still possible to earn well from inadequate quality. By changing both of these aspects at once, the proposed reform should correct the shortcomings of the current system.

Although participation in the conversion programmes introduced following the 1992 reform was high in Greece, the Commission proposes to supplement this instrument with other appropriate measures. Thus the report considers, on the one hand, helping producers to leave the sector voluntarily by means of a programme for buying up quotas and, on the other hand, setting up strategic local development plans to encourage producers to take up other activities.

3.97. Since 1996 the quota system has been made more flexible, as the Court itself mentions in point 3.88.

According to Article 9 of Regulation (EEC) No 85/93, 'until such time as the agency is in a position to perform all the duties and checks assigned to it, the Member States concerned shall carry out the checks laid down by Community rules in accordance with existing procedures`.

In 10 successive letters, the Commission has reminded Italy and Greece of their obligations under the rules. At the same time, it has also invited the authorities in question to intensify their checks.

The Member States concerned have made a satisfactory effort. Greece has 24 processing undertakings to cater for 63 000 producers. All of these are inspected by 340 permanent and seasonal EOK inspectors spread over the entire country. Italy has 80 processing undertakings to cater for 45 000 producers. All of these are inspected by 35 AIMA inspectors and 156 inspectors from the SGC, an international surveillance firm.

Although the national tobacco agencies have not yet been set up, the existing control arrangements meet the requirements laid down in the rules.

3.98. See the reply to point 3.92. The Commission has examined the cases raised by the Court; corrections did not appear necessary in all cases.

3.99. The Commission is not in favour of the system proposed by the Court for the reasons set out in its reply to point 3.95.

CMO for products of the vine growing sector

Market balance and budget situation

3.103. The budget impact of future production increases will be limited because there is now a ceiling on export refunds under the GATT agreement. Intervention spending could be controlled by introducing a more quota-oriented approach to deliveries of wine for voluntary distillation.

Controlling the volume of wine on the market

3.106. The scheme for the abandonment of vine growing areas with a Community premium, currently based on Regulation (EEC) No 1442/88, provides for the grant of premiums to individual vine growers. This is likely to make the scheme less efficient. To remedy this the proposal for the reform of the market organization for wine provides for such premiums to be granted under regional programmes for the adjustment of vine growing. Nevertheless, unless the vineyards concerned are grubbed up (approx. 500 000 hectares), a volume of 15-20 million hectolitres or more should be expected.

Management information system

3.107. Every week the Commission produces statistics on wine prices based on information forwarded by the Member States. The current system does not function satisfactorily for a variety of reasons, including the lack of price quotations for many exchanges.

Although the existing system is not very effective for collecting data on trends in wine prices, these can nevertheless be monitored relatively easily through the many specialized publications. The decision to carry forward the guide prices was dictated by general policy considerations relating to the CAP.

The Commission's 1994 proposal for a reform of the wine sector provided for guide prices and the prices derived therefrom to be scrapped. A new market assessment mechanism was proposed which would enable the Commission to use specialized agencies and firms to gather the information needed to manage the market.

Vineyard registers

3.111. It is true that the Commission has not adopted the implementing regulation for the simplified register, because of a shortage of resources. However, it did distribute a working document in April 1996.

3.112. The Commission does not agree with the accusations of poor management of Community funds.

During 1989-93, the Commission allocated the staff needed to set up the registers properly. Many follow-up visits were made and a technical assessment was made of the quality of the vineyard registers in Italy, France, Spain and Germany.

It should be noted that the decision to extend the period for setting up the vineyard register was taken by the Council when it adopted the 1995/96 price package.

In addition, a blanket judgment cannot be applied to all the Member States concerned, since the progress made in setting up the register varies greatly from country to country.

The specialized Commission control body

3.113. The Commission can confirm that it is both useful and necessary to coordinate and improve checks in the wine-growing sector, as defined in Regulation (EEC) No 2048/89. Moreover, it intends fully to play the role given it by that Regulation. It therefore agrees with the Court's opinion that the control body for the wine-growing sector needs to be strengthened. The fact that it has been integrated into the Clearance of Accounts Unit does not mean that it has been abolished. The Commission is simply attempting to regroup the control functions within DG VI. One of the reasons why it has not yet been possible to strengthen the control body is that priority has had to be given to other sectors in allocating newly available staff and that it is difficult to find candidates with the skills and experience stipulated by Regulation (EEC) No 2048/89.

Conclusions

3.114. The Commission believes that grubbing-up has reduced production potential (see the reply to point 3.106).

3.115. The Commission is aware of the difficulties being encountered by the Member States in gathering the information on the basis of which the guide prices are fixed (see the reply to point 3.107).

3.116. The staffing shortage has made it impossible to adopt an implementing regulation setting out the principles of the simplified vineyard register as worked out in the working documents distributed to the Member States in April 1996. For the most part, the definition of the simplified register can be found in the proposal for reform of the sector which has been with the Council since 1994.

The Commission has had to operate within the constraints of its resources, which have for some time now been allocated to other priorities, particularly the introduction of the integrated administrative and control system, the animal identification system and remote sensing.

3.117. The Commission shares the Court's view that it is necessary to strengthen the control body for the winegrowing sector (see the reply to point 3.113).

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CHAPTER 4(156\*) Common organization of the market - Animal products Beef and veal premium schemes and selected BSE related measures

4.0. CONTENTS Paragraph reference

Introduction 4.1 - 4.3

Principal features of the market 4.4 - 4.10

The reform 4.11 - 4.18

Background 4.11 - 4.12

Increasing the levels of existing premiums 4.13 - 4.14

New premiums 4.15

Restrictions applied to the premium schemes 4.16 - 4.17

The integrated administration and control system 4.18

The impact of the revised beef and veal premium schemes 4.19 - 4.44

Income compensation 4.19 - 4.26

Control of production 4.27 - 4.35

Deseasonalization of slaughtering 4.36 - 4.39

Extensification of production 4.40 - 4.44

Administration and control of premiums 4.45 - 4.60

Identification and registration of animals 4.46 - 4.49

Administrative document 4.50 - 4.52

Controls 4.53 - 4.55

Stocking density factor 4.56 - 4.58

Conclusion on administration and control of premiums 4.59 - 4.60

Measures taken in connection with the BSE crisis 4.61 - 4.75

Advances of 1996 premiums 4.64

The over 30 months scheme (OTMS) 4.65 - 4.66

Additional payments 4.67 - 4.70

Reactivation of the calf processing premium 4.71 - 4.74

Adequacy of controls concerning BSE related measures 4.75

Conclusion 4.76 - 4.83

Premiums 4.76 - 4.82

BSE related measures 4.83

INTRODUCTION

4.1. The reform of the common agricultural policy (CAP) in 1992 had a significant impact on the volume and structure of Community expenditure in the Common Market Organization (CMO) in the beef and veal sector as Community intervention shifted from a price towards an income support system. Because of the considerably increased emphasis placed on cattle premiums, total expenditure on these increased from 902 Mio ECU in 1992 to 3 376 Mio ECU in 1996 (EUR 12). These premiums, which had represented up to 25% of total Community expenditure on the CMO before the reform, amount to, on average (excluding bovine spongiform encephalopathy (BSE) related expenditure), 60% since 1994 (see Table 4.1).

4.2. During 1996, the Court examined the premium schemes in operation following the 1992 reform with regard to sound financial management, legality and regularity aspects. Checks were carried out at the Commission and in seven Member States which account for roughly 90% of expenditure - Germany, Spain, France, Ireland, Italy, Portugal and the United Kingdom. The results of this audit are set out in paragraphs 4.11 to 4.60.

4.3. The Court also examined during 1996 certain measures taken as a consequence of the BSE crisis. Expenditure on these measures in 1996 totalled 1 022 Mio ECU (EUR 15). The results of this audit are set out in paragraphs 4.61 to 4.75.

PRINCIPAL FEATURES OF THE MARKET

4.4. The CMO in the beef and veal sector was set up by Council Regulation (EEC) No 805/68 of 27 June 1968(157). By 1994, the EU was the second largest producer in the world after the USA with beef and veal production of 7,5 Mio tonnes.

4.5. Since the 1980s, the Community market has suffered an imbalance with production significantly exceeding internal consumption even at the lower points of the production cycle(158). The problem is compounded by the downward trend in consumption due, among other things, to health questions related to the use of hormones, BSE and to concerns about animal welfare. The self-sufficiency rate for the period 1990-95 varied from 103,1 to 115,2% which corresponds to a net surplus ranging from 219 000 to 1 152 000 tonnes (see Table 4.2).

4.6. Because of its cyclical nature, production declined by 7% in 1993 and 4% in 1994. This reversal in the market situation brought intervention buying-in to a halt. At the same time, exports remained stable at around 1,1 Mio tonnes (for which 1 700 Mio ECU of EU export refunds were paid annually), thus absorbing EU surpluses and allowing intervention stocks to be significantly reduced.

4.7. Accordingly, intervention stocks, declined from 1,1 Mio tonnes at the beginning of 1993 to 0,12 Mio tonnes at the end of 1994. Further reductions occurred in 1995 and stocks remained insignificant until the first quarter of 1996. However, production increased again in 1995 by 2%, putting downward pressure on market prices.

4.8. The BSE crisis that followed the United Kingdom Government's public admission, in March 1996, that there might be a link between BSE and a new strain of Creutzfeldt Jacob's disease (CJD), has had a significant impact on the market. Initially, consumption fell sharply but recovered progressively to within 85-90% of the 1995 level towards the end of 1996(159). Average carcass prices fell to 2,49 ECU/kg in July 1996 as compared to 2,93 ECU/kg in January 1996, recovering to 2,67 ECU/kg by December 1996. Production in 1996 was 4,4% lower than in 1995, partly as a result of the urgent measures implemented with EU financing (the United Kingdom's 'over 30 months slaughter scheme` and the 'calf processing premium` which have resulted in the elimination of 1,1 million cows and 522 000 calves from the food chain during 1996, i.e. about 2% of the EU herd) (see paragraphs 4.65-4.66 and 4.71-4.74).

4.9. However, intervention stocks had increased to 418 000 tonnes by December 1996, largely reflecting the net overall production/consumption imbalance (see Table 4.2).

4.10. The 1994 World Trade Organization (WTO) Agreement has a direct impact on the beef and veal CMO given the existing imbalance in the EU market. It foresees a reduction in the maximum value of export subsidies from 1 923 Mio ECU in 1995 to 1 254 Mio ECU in 2000 and in the volume of subsidized exports from 1,137 Mio tonnes in 1995 to 0,822 Mio tonnes in 2000.

THE REFORM

Background

4.11. In the context of the 1992 CAP reform, it was decided to reduce the institutional prices of cereals in order to enhance their competitiveness as an animal foodstuff vis-à-vis other substitute products which were frequently imported. As the poultry and pig meat sectors would particularly benefit from the reduction and because of the structural imbalance between supply and demand on the Community beef and veal market, it was necessary to introduce measures to maintain the competitive position of beef. The Council, therefore, decided to reduce the intervention price for beef by 15% over three years and to impose decreasing annual limits on purchases into intervention. At the same time, it was decided to counterbalance the effects of this decision on producers' incomes by progressively raising the levels of existing premiums and by introducing new premiums, with certain restrictions(160). In addition, a system was introduced to reinforce management and control.

4.12. The principal objectives of the reform in the context of the beef and veal market were therefore:

(a) to compensate producers for loss of income;

(b) to improve control over production;

(c) to encourage extensification.

Increasing the levels of existing premiums

4.13. The special premium (total expenditure 1996: 1 407,4 Mio ECU) was progressively raised from 48,3 ECU (1992) to 108,7 ECU (1995)(161) for male animals kept on the farm and, in addition to the first payment for animals of at least 10 months, a second payment of the premium for the age bracket from 22 months was introduced.

4.14. The suckler cow premium (total expenditure 1996: 1 632,4 Mio ECU) was more than doubled from 60,4 ECU (1992) to 144,9 ECU (1995)(162). To qualify for this premium paid annually, the cow must belong to a recognized beef breed or be born of a cross with a beef breed and belong to a herd intended for rearing calves for meat production. While dairy cows covered by beef breed bulls were henceforth excluded from eligibility, the maximum reference quantity of milk, below which dairy producers could benefit from the premium, was raised from 60 000 to 120 000 kg (see paragraph 4.32).

New premiums

4.15. A number of premiums with specific objectives were introduced:

(a) a deseasonalization premium of 72,45 ECU per animal (total expenditure 1996: 23 Mio ECU) paid in addition to the special premium in respect of male castrated cattle which were slaughtered between 1 January and 30 April; the purpose of this premium is to postpone slaughtering in order to avoid, during the 'off grass period` (1 September to 30 November), pressure on prices which could lead to excessive purchases into intervention; it is thus intended to counteract the present seasonality of beef slaughtering in the EU;

(b) an extensification supplement of 36,23 ECU per animal (total expenditure 1996: 507,3 Mio ECU); this supplement is payable on cattle eligible for the special and the suckler cow premiums where the farm stocking density is less than 1,4 LU/ha of forage area(163) and is intended to reverse the trend towards more intensive farming;

(c) an optional processing premium of 120,8 ECU per animal (total expenditure 1996: 24,4 Mio ECU) paid to producers in respect of young male calves of dairy breeds which are slaughtered before exceeding the age of 10 days; the aim of this premium is to reduce the number of young calves for fattening, thereby restricting market supply.

Restrictions applied to the premium schemes

4.16. In order to restrict overall increases in production, a system of quotas, limiting the number of animals eligible for premium, was introduced by means of regional ceilings for the special premium, and individual ceilings (expressed in terms of 'rights`) for the suckler cow premium(164). These ceilings were to be determined in relation to a reference year which could be selected by each Member State from the years 1990, 1991 or 1992. Another restriction was to limit, not only for the first age bracket (i.e. at age 10 months) of the special premium, but also for the second (i.e. at age 22 months), the number of eligible animals to 90 per holding.

4.17. In addition, the number of animals qualifying for the special and suckler cow premiums was limited at individual farm level by a stocking density factor (progressively reduced from 3,5 LU per hectare in 1993 to 2 LU in 1996).

The integrated administration and control system

4.18. At the same time as the number and amounts of direct aids to producers were increased it was decided to set up an integrated administration and control system (IACS)(165) relating inter alia to the identification and registration of animals(166). This system, to be set up in phases, was scheduled to become operational by 1 January 1996. This latter date was retroactively extended to 1 January 1997(167). See also paragraphs 3.32 to 3.69 concerning arable crops.

THE IMPACT OF THE REVISED BEEF AND VEAL PREMIUM SCHEMES

Income compensation

4.19. During an audit carried out before the 1992 reform, the Court noted that the special premium could represent up to 5% of the selling price of the qualifying animal(168). In 1995, it accounted for between 12% and 37% of the selling price depending on whether it had been paid for both age brackets together with the extensification supplement and the deseasonalization premium. In addition, farmers may receive the suckler cow premium and the compensatory allowance which is payable in less-favoured areas from the EAGGF-Guidance Section.

4.20. The Commission, in a document dated 2 May 1991 dealing with the impact on meat prices of a reduction of cereals prices, calculated that 'achieving a 15% price cut in the case of beef would involve a loss of revenue of around 30 ECU/100kg or 90 ECU/head`. However no assesment was made of the rise in premium levels necessary to compensate this drop in revenue and the actual increases were significantly higher than those proposed. The Court estimates that the rates for certain premiums were set at too high a level.

4.21. In the case of the special premium, the loss of revenue could be anticipated at 145 ECU per animal for 1996. In compensation however, producers taking advantage of the payment of the special premium for the two age brackets, received an additional amount of 169 ECU per animal. Taking into account the number of animals for which the special premium was paid for the two age brackets (2,9 million animals on average per year), the Court estimates the additional cost to the Community budget at 70 Mio ECU for 1996. For the period 1993-96 this additional cost can be estimated at 387 Mio ECU(169).

4.22. In the case of recipients of suckler cow premiums, the analysis is more complex because the animal attracting the premium is not destined for slaughter. In this particular case, estimates of over/under compensation are dependent upon the scenario established and the nature of farming undertaken by producers. However, the Court observes that, in the context of the 1992 reform, the suckler cow premium was first proposed by the Commission at 90,56 ECU per animal but the rate adopted by the Council was 144,9 ECU.

4.23. This analysis indicates that producers have been overcompensated for the drop in institutional prices in respect of certain categories of animals. However, this analysis does not take into account the savings for producers arising from lower feed prices(170) nor of the cumulative effects of the new premiums on producers' incomes. Reliable and up-to-date figures were not available to make the necessary calculations.

4.24. By 1995 beef and veal production had, in fact, passed the low-point of its cycle (see paragraph 4.7). Even though the fall in market prices from 1993 to 1995 did not occur with the expected severity, premiums were paid based on those expectations. By the end of 1995, instead of the expected market price drop of about 15%, the price fall was only approximately 8,8%, three quarters of which occurred in 1995 itself. Producers have thus benefited financially over and above what was envisaged at the time of the reform (see Table 4.3).

4.25. Table 4.4 shows the development of gross farm income, before and after subsidies, for all types of holdings and for both the dairy producers and those specialized in drystock-farming. As the latest data is only available up to 1994 and as there is a timelag before the effects of increased premiums impact beef producers' incomes, the table does not provide a complete view of the development of such incomes following the reform. It is clear, however, that the producers specializing in livestock-farming benefited from increased incomes in 1993 and 1994, even if these were lower than the Community average. However, the latter reflects significant overcompensation granted to cereal producers (see paragraphs 3.30-3.31).

4.26. The Court concludes that, in respect of certain categories of animals, the revised premium rates resulted in overcompensation for anticipated decreases in farm income. Furthermore, owing to the fact that in 1993 and 1994 prices were well above those postulated at the time of the reform, the increased premiums contributed to a rise in producers' incomes of about 10% compared to 1992, reflecting an incentive to increase production, contrary to one of the principal objectives of the reform.

Control of production

4.27. In Special Reports Nos 4/91 and 4/93, the Court reported on the disadvantages, in terms of economic effectiveness, of quota systems(171) and stressed the need to ensure a strict application of the quotas in view of the difficult management procedures which inevitably result for Member States.

4.28. In the beef and veal sector the regional and individual ceilings (see paragraph 4.16) were set at too high a level, without adequate regard to the numbers of eligible animals before and after the reform as illustrated in Tables 4.5 and 4.6. Whilst the reform was decided in June 1992 following discussions which commenced in July 1991, 1992 was accepted as a reference year for determination of ceilings thereby allowing producers the possibility of increasing their herds to maximize their entitlement to premiums.

4.29. The concept of using a reference year as the basis for the special premium was abandoned in 1994 and the regional ceilings for premiums were adjusted to a level closer to the situation existing before the reform(172). Despite a reduction of 11%, the level of the ceilings still remained higher by almost 20% compared with the numbers of animals for which premiums were granted in 1990 and 1991 (EUR 12). In 1996, ceilings were again reduced by 19,4% for the years 1997 and 1998(173).

4.30. With regard to the suckler cow premium, the Commission has since recognized the failure of the individual limit system(174). In 1995, the premium was paid for 9,9 million animals while the total of the existing premium rights was set at 10,8 million (EUR 12), leaving an important margin for expansion of cattle numbers which were increasing since the 1980s. The number of rights allocated on the reference year basis - 1992 was chosen by all Member States, except Greece - exceeded by 1,6 million, i.e. 20%, the average number of premiums paid in 1990 and 1991.

4.31. The suckler cow premium was established in 1980 with the aim of promoting quality beef and veal production at a time when the Community market did not yet have a structural imbalance. Since then the number of suckler cows has increased constantly particularly following the introduction of milk quotas in 1984. Despite the reform, growth was still 8,7% between 1992 and 1995 (see Table 4.7). In contrast with the adjustments made for the special premium, no action was taken to remedy the excessive number of existing suckler cow premium rights until 1996, when a measure to withdraw unused suckler cow premium rights was introduced.

4.32. The creation of 888 829 additional rights for the suckler cow premium - i.e. 9,2% of the rights allocated on the reference year basis - hindered the control of production. The fact that the maximum reference quantity of milk below which dairy producers could benefit from the premium was increased from 60 000 to 120 000 kg of milk simultaneously created additional premium rights (see paragraph 4.14). However, at the time of the creation of this premium, in 1980, milk producers could not benefit from it(175). Additional rights were also allocated to producers in less-favoured areas.

4.33. A further factor affecting production was the payment of the special premium for the second age bracket (see paragraph 4.13) in the case of non-castrated male animals which would normally have been slaughtered between 15 and 20 months. This encouraged producers to keep these animals a few months more in order to obtain this second tranche from 22 months onwards. However, this situation led to increased production due to increased carcass weights. The Commission, which had identified this undesirable effect, estimated at 870 000 a year the number of animals concerned(176), but was unable to provide any estimate of the effect on production. However, if one assumes a 10% weight increase, this would lead to an increase in production of about 30 000 tonnes annually. Expenditure on this category for the period 1993-96 is estimated by the Court to be approximately 350 Mio ECU. Despite the fact that the Commission had been aware of the above-mentioned undesirable effects of premiums, it was not until December 1996 that such payments were discontinued(177).

4.34. The Court has already pointed out(178), in the context of structural production surpluses, the lack of selectivity of the special premium. Although this premium is only paid for up to 90 animals, it is granted to all producers, without regard either to their farming methods or level of income, or to the impact on the market of the increased production. Because the suckler cow premium, together with the extensification supplement, could constitute an incentive to the maintenance of a rural population in less-favoured areas(179), the Commission should consider making it more selective.

4.35. In conclusion, the premium ceilings were established at too high a level, without regard to the number of premiums paid before 1992. In effect, the ceilings set have proved ineffective in controlling the structural production surpluses which have been characteristic of the market since the beginning of the 1980s and which the 1992 reform was designed to address. Furthermore, while corrective action to reduce the premium ceilings has been taken with regard to the special premium scheme, no such action has yet been taken to establish the premium rights for suckler cows at a more appropriate lower level.

Deseasonalization of slaughtering

4.36. The deseasonalization premium is applicable in Member States where the slaughter of male castrated cattle in the period from 1 September to 30 November represented 40% of total slaughterings during the year, subsequently changed to 35%(180) (see paragraph 4.15). Since its creation, the total expenditure on this premium was 85,1 Mio ECU and related to Denmark (0,3%), Germany (3,8%), Ireland (81,1%) and Northern Ireland (14,8%).

4.37. It is difficult to justify the introduction of the premium during a period of declining production, when, due to stable market prices, there was no need for intervention throughout the Community. It was, therefore, irrelevant given its regulatory objective (see paragraph 4.15).

4.38. Whilst the premium had the effect of smoothing slaughtering patterns to such an extent that it became no longer applicable either in Northern Ireland from 1995 nor in Ireland in 1997 (see Table 4.8), its effect on market prices is not conclusive. Whereas price increases during the September to November period would be expected and vice-versa for the January to April period, a comparison for Ireland and Northern Ireland (see Table 4.9), shows that such price movements did not occur. For Denmark and Germany, the premium concerns such a small number of animals that it can have no significant effect on market prices.

4.39. In conclusion, given that there was no requirement for intervention buying-in throughout the Community, the deseasonalization premium can scarcely be justified.

Extensification of production

4.40. For the calculation of the stocking density factor all the forage areas that the producer declares for use as animal feed are taken into account. Some producers keep their animals permanently in cattle sheds and fatten them using intensive farming methods while the producer's holding, comprised of land devoted to forage production for animal feed, is eligible for the special premium. The only difference existing then between this idea of extensification and commonly regarded intensive farming is that in the latter case the producer has to buy the forage fed to the animals.

4.41. The Commission has made no evaluation of the impact of the extensification supplement on bovine production methods in the EU. Table 4.10 shows a slight reduction in stocking density for dairy holdings whereas an increase was observed for drystock holdings.

4.42. The regulatory definition provides that only the animals for which cattle or sheep premiums are requested are taken into account in the calculation of the stocking density factor, instead of all those on the holding. Thus producers are encouraged to claim selectively in order to maximize the amounts they receive. Claims are frequently prepared with the assistance of professional associations and premium management services. As observed in Member States, it can be beneficial not to ask for any premium for certain animals in order to keep the calculated stocking density factor at less than 1,4 LU per hectare and thus obtain the extensification supplement for all animals claimed (see paragraph 4.15). Selective claims can increase a producer's premium payment by as much as 23%(181).

4.43. Furthermore, animals which qualify for compensatory allowances, which are granted to farmers in less-favoured areas from EAGGF-Guidance, are not included in the stocking density factor(182). In addition, in accordance with the Regulation(183), Member States, except Italy, limit the number of animals taken into account for the stocking density to the producer's individual quota for sheep and suckler cow premiums. The animals excluded from entitlement following administrative controls are also ignored, i.e. in France and in Ireland. Finally, because of the 15 LU limit which was created in order that small producers were not subjected to the constraint of the maximum stocking density factor, producers specializing in intensive livestock-farming can paradoxically receive premiums for up to 15 LU(184).

4.44. The mechanism introduced with a view to encouraging extensive production needs to be re-examined and improved upon, in particular by taking into account all the animals present on the holding. The consolidation of the integrated control system including the putting in place of reliable databases created from the identification numbers of the animals (see paragraph 4.54) should enable the Commission to propose a more relevant stocking density factor.

ADMINISTRATION AND CONTROL OF PREMIUMS

4.45. Since the reform of 1992 the beef premiums were subject to the IACS at Member State level (see paragraph 4.18). IACS entails the creation of a computerized database for aid applications, an alphanumeric identification system for agricultural parcels, an alphanumeric system for the identification and registration of animals, aid applications and an integrated control system(185). The last three elements should have been in place by 1 February 1993 and the first two by 1 January 1996. Despite numerous control visits and recommendations by the Commission, neither of these deadlines has been met in the Member States visited.

Identification and registration of animals

4.46. Experience has shown that the implementation of Directive 92/102/EEC has, on the whole, not been entirely satisfactory. The main weaknesses identified concern the lack of traceability of animals due to the absence of movement records in a centralized database and deficiencies in accompanying documents. Council Regulation (EC) No 820/97(186) on the identification and registration of bovine animals aims to improve the situation.

4.47. Since October 1993 each animal must be tagged with an alphanumeric code within 30 days of birth, or within six months if it is provisionally tagged before the age of 30 days(187). The code must be entered in a farm register, be cited by the producer on each claim for aid and is, therefore, the primary control element for administrative and inspection purposes. The register which should reflect all changes in the composition of the herd and be kept up to date and available for examination on the farm(188), should not only provide the means for tracking animal movements for health reasons but also to check that retention periods for premiums have been observed(189).

4.48. Visits to the Member States by the Court's auditors during 1996 have shown that they were either late in implementing the Community identification system or had yet to do so. Member States already had their own national systems, some of which were, however, optional and, when applied, heterogeneous. In Spain the national Regulation was not adopted until February 1994 but the autonomous communities had yet to finalize key elements of the arrangements. In France the Community system was adopted in March 1995 and consists of an initial tagging by the farmer followed by official tagging at the latest when the animals are four months old. In Germany the system was introduced in April 1995 but only applies to animals born after October 1995; previously there were more than 60 different systems in use. In Ireland the required national legislation was not introduced until April 1996. Italy did not incorporate the Directive's provisions into national law until August 1996; at the time of the audit only animals for which aid had been requested were tagged; employees of the producer organizations performed this task on behalf of the paying agency but not within the specified period of 30 days.

4.49. Only a provisional farm register was in use in Ireland until 1996. In Spain (Basque country) producers do not keep a register as required although the information is kept in a centralized database which militates against the keeping of registers up to date. In Portugal and the United Kingdom while large producers tend to have the required farm registers, smaller ones still have difficulties maintaining adequate records. In Italy the register records individual details of the animals for which premium is claimed, plus the total number of other cattle on the holding, but it does not record all individual movements.

Administrative document

4.50. An administrative document should exist for each animal for which the beef special premium is requested (190). This document should be issued at the latest when the request for the first payment is made and should serve as a means to ensure that a claim for an animal is submitted no more than once for each age bracket. The format and content of the administrative document is left to the discretion of Member States.

4.51. Since Member States are improving the databases relating to the applications for premiums which enable them to carry out crosschecks, the administrative document will be less important, in the future, with regard to the control objective of avoiding double payments of premiums. However, the administrative services of certain Member States visited (France, Ireland and the United Kingdom) retain, during the retention period, the administrative documents which are also important for animal health control purposes. These procedures serve to guarantee the respect of the retention period, since the administrative documents are required to be able to sell the animals. In these countries the document is marked to show that the premium was paid for the animal and the potential buyer is thus informed of the status of the animal regarding the special premium. Furthermore, in France and the United Kingdom a bar code is incorporated into the document making it easier and more reliable to capture essential data.

4.52. In the light of the above-mentioned developments, the Commission should re-examine the role assigned to the administrative document which has proved to be of limited effectiveness in certain Member States (Italy and Portugal). Above all there is a need for greater harmonization of administrative and control procedures across Member States.

Controls

4.53. The administrative controls are designed to check the eligibility of the animal for premium and to guard against double payment for the same animal. IACS requires that a database records all aid applications data(191). A cross-check between the tag numbers entered allows the identification of any duplicate claims. The creation of such databases in Member States will lead, when fully implemented, to a significant improvement in a situation previously criticized by the Court(192).

4.54. However, to carry out adequate checks on the existence and eligibility of the animal concerned a database that captures details of all cattle on a holding is required. Such a system was not fully operational in any of the Member States visited and is not foreseen under current IACS legislation. Recognizing the need for such a database, many Member States have made significant progress in setting one up. Moreover, the Council has recently adopted a regulation for the establishment of just such a database(193).

4.55. At least 10% of livestock applications, selected using risk analysis, must be subject to on-the-spot checks which should cover all the animals included in the application for premium(194). However, after selecting the suckler cow applications, some Member States (Germany, France and the United Kingdom(195)) examine only a sample of the animals on farm, based on either the herd size or the number of animals claimed.

Stocking density factor

4.56. The calculation of the stocking density requires inter alia that the following elements be taken into account:

(a) any reference quantity (milk quota) held by the producer (converted into a number of dairy cows using milk yields stipulated in the Regulation);

(b) the number of animals (cattle, sheep and goats) for which premium applications have been submitted;

(c) the forage area declared.

4.57. However, the information contained in the relevant database is sometimes unreliable. For example, in Spain (Galicia), out of 17 payments checked, four were found to be erroneous. The area declaration was not taken into account in two of these cases, limiting the payment of the premium to the equivalent of 15 LU(196). In another case, a milk quota was taken into account while the producer had none, resulting in the overestimation of the stocking density and in the non-payment of the extensification supplement. An extensification supplement was paid to another producer whose stocking density could not be calculated because he had not submitted an area declaration.

4.58. A further problem is that, in certain instances, the livestock units were wrongly calculated. In Portugal animals aged over two years have been counted as 0,6 LU instead of 1 LU as prescribed by the Regulation(197). In Italy, when the producer is not subject to the maximum stocking density limit of 2 LU per hectare, he is paid the premiums for up to the 15 LU without deducting any sheep and goats for which a premium is paid and dairy cows necessary to produce the milk quota in breach of the Regulation (198).

Conclusion on administration and control of premiums

4.59. Long delays were noted in the adaptation of the national management and control mechanisms relating to the premiums and in the development of the necessary computer systems. Given that the systems of management and of control set up by the Member States vary in effectiveness, the Commission should specify more precisely the requirements of the cattle register, the administrative document and the databases.

4.60. The Commission must also ensure that Member States record in the databases all the animals present on a holding on the basis of their identification. It will then be possible to eliminate redundant controls and to simplify the application process for premiums, thus avoiding multiple recording of the same information.

MEASURES TAKEN IN CONNECTION WITH THE BSE CRISIS

4.61. In March 1996, the United Kingdom government admitted the existence of a possible connection between BSE and CJD (see paragraph 4.8). Demand for beef meat plummeted throughout the EU and prices followed suit. Urgent action was required and on 19 April three Commission Regulations were introduced: on measures to promote and market quality beef and veal(199), adopting exceptional support measures for the beef market in the United Kingdom(200) (the 'over 30 months scheme`) and in Belgium, France and the Netherlands(201) (slaughter of calves imported from the United Kingdom). At the same time the calf processing premium(202) was activated in the United Kingdom and one month later in Portugal. In July plans for culls in the United Kingdom and Portugal were approved(203) and additional payments were granted for 1996 to all EU special premium and suckler cow premium recipients (204).

4.62. In September the Commission decided that an advance on the 1996 premiums could be paid(205). At the end of 1996 the Council introduced a number of changes to the CMO which will have an effect in 1997 and 1998(206) and 500 Mio ECU was made available for additional payment appropriations to be paid from the 1997 budget(207).

4.63. In terms of expenditure in relation to the 1996 budget, by far the most significant items, apart from the advances of 1996 premium payments, were the over 30 months scheme, the additional payments and the calf processing premium (see Table 4.1). The Court carried out a preliminary examination of these during 1996.

Advances on 1996 premiums

4.64. Under Commission Regulation (EC) No 1871/96, 223,7 Mio ECU was charged to the 1996 budget by way of advances on the 1996 premiums which, had they been paid in the normal timetable (after 1 November) would have been charged to the 1997 budget. Only Denmark, Germany and France were able to make the payments by the deadline of 15 October 1996.

The over 30 months scheme (OTMS)

4.65. Commission Regulation (EC) No 716/96 of 19 April 1996 adopted exceptional measures for the beef market in the United Kingdom. In effect it makes a key contribution towards the United Kingdom's programme to eradicate BSE. In particular the ban on sale for human consumption of meat from cattle over 30 months old (BSE rarely manifests itself in younger animals) results in the need to slaughter, render and incinerate such animals. The Community pays the United Kingdom 392 ECU per animal after it has been destroyed, i.e. incinerated.

4.66. Due to the number of cattle presented under the scheme (more than 1 million in 1996) the United Kingdom has faced severe incineration capacity constraints. Only 27 000 casualty animals had been incinerated up to October 1996. These were the only animals for which the United Kingdom could present a claim under the original legislation. However, in recognition of this difficulty the Commission agreed that, with effect from 26 September 1996(208), the United Kingdom could claim an advance of 80% of the Community contribution after the animal concerned had been rendered. On 27 November 1996 the United Kingdom submitted a claim in respect of 428 928 animals (134,5 Mio ECU) not included in its 15 October (EAGGF year end) declaration. Nevertheless, this expenditure was charged to the 1996 budget. Carcasses not yet rendered have been put into segregated cold storage facilities approved for this purpose.

Additional payments

4.67. Council Regulation (EC) No 1357/96 granted additional payments for the special beef and suckler cow premiums as well as specific amounts to Member States (261 Mio ECU in total) to make payments to producers in the beef and veal sector who are 'facing acute problems as a result of the market situation ...`. Member States could make payment supplements of 23 ECU per animal for the special premium and 27 ECU per animal for the suckler cow premium and/or distribute the specific amounts on a different basis.

4.68. In order to qualify for Community financing all payments had to be made by 15 October 1996. Most Member States chose to make enhanced payments per animal. An extra 192,9 Mio ECU was spent on the special premium and 250,5 Mio ECU on the suckler cow premium out of the 814,7 Mio ECU charged to the budget (see Table 4.1).

4.69. Since detectable infectivity rarely occurs in animals under 30 months of age, the United Kingdom eradication programme, endorsed by the Council(209), was designed to prevent animals over this age from entering the human and animal food chains. The United Kingdom was also allocated 34 Mio ECU which it used to finance a 'Beef Marketing Payment Scheme` (BMPS) to aid those producers who sold cattle for slaughter for human consumption between 20 March and 30 June 1996. The scheme instructions initially stated that 'any cattle over 30 months of age sold for slaughter after 28 March 1996 are ineligible` for the scheme. However, 1 695 animals (England only) for which there is proof that they were over 30 months old when accepted under BMPS on the basis of dentition should not have qualified for Community aid. Furthermore, the United Kingdom has extended the BMPS to cover cattle sold between 1 July and 9 November 1996, financed with 29 Mio GBP from national funds and cattle over 30 months sold during this period are not necessarily excluded.

4.70. In addition, the United Kingdom has introduced a national 'Beef Assurance Scheme` (BAS) which provides for 'animals born in registered herds to be sold for human consumption up to and including the age of 42 months`. As at June 1997, 59 animals over 30 months old have been slaughtered for human consumption under this scheme. Although one of the eligibility criteria for the scheme was that 'no feed containing meat and bone meal must, to the best of the owner's knowledge and belief and after checking with the suppliers of the feed, have been fed to animals in the herd during the previous seven years`, the respect of this condition is, prima facie, very difficult to verify.

Reactivation of the calf processing premium

4.71. The aid (see paragraph 4.15) is to be granted to 'operators`, defined as 'any producer or other physical or legal person exercising commercial activities in the live cattle sector`. The initial budget for 1996 was 1 Mio ECU but as a result of activating the premium in Portugal and the United Kingdom actual expenditure for the year was 24,4 Mio ECU.

4.72. The United Kingdom has taken 'operators` to mean processors (slaughterhouses). Aid is therefore paid to the abattoirs registered to operate under the scheme. Farmers and processors make their own contractual arrangements. One of the main producers visited received on average 75% of the aid whereas in Portugal where the aid is paid to producers net of transport and other costs incurred by the abattoir, they receive 80 to 85%.

4.73. In the United Kingdom since 1 July 1996 all new-born cattle require passports which include the animal's date of birth, but 46 000 calves were processed prior to the introduction of such passports when it was not possible to confirm their age. Conversely Portugal has abandoned the system it used during the first three weeks of the scheme whereby some 350 calves were tagged on farm by officials and a veterinary document was issued so there is no longer any documentary evidence of the calf's age.

4.74. In the United Kingdom, at the abattoir visited, there was no control to ensure that what left the abattoir arrived at the rendering plant. In Portugal controls at the two rendering plants visited were not operating effectively. In these circumstances there can be no assurance that the calves slaughtered were properly disposed of.

Adequacy of controls concerning BSE related measures

4.75. The examination of the over 30 months scheme, the calf processing premium and the beef marketing payment scheme has highlighted significant systems weaknesses in the controls implemented by the Member States concerned. Given the ad hoc and innovatory nature of many of the measures introduced to the CMO and the sums involved there is an urgent need for the Commission to enhance and broaden its monitoring of the application of such measures. Up to April 1997, these concentrated on the OTMS, this priority being fixed as a consequence of the expenditure involved compared with that of the other schemes.

CONCLUSION

Premiums

4.76. In view of the decrease in institutional prices as a result of the 1992 CAP reform a corresponding increase in the level of beef premiums was considered necessary to compensate producers. Such an adjustment in Community aid has had a significant impact on Community budgetary expenditure in respect of premiums which has more than tripled.

4.77. The Commission's documentation justifying the levels of the premiums set was not sufficiently detailed. The compensation granted to producers in respect of certain categories through increased premium levels was too high. For recipients of the special premium the Court has calculated that such overcompensation resulted in an increased charge of 387 Mio ECU to the Community budget for the period 1993-96. For recipients of the suckler cow premiums the estimation of the overcompensation is more complex, depending upon the scenario established and the nature of farming undertaken by producers. The Court notes however that the actual rate established was 60% higher than the rate initially proposed. Furthermore, owing to the fact that 1993 and 1994 corresponded to the downward phase of the production cycle, market prices remained well above those estimated at the time of the reform. Overall, producers' incomes increased by 10% from 1992 to 1994, the latest date for which figures are available. Account must also be taken of the timelag for the additional benefits to impact those incomes. In view of the significant consequences for the Community budget, any future reform of the beef and veal sector should be preceded by a detailed ex ante analysis of its impact on farmers' revenue (see paragraphs 4.19-4.26).

4.78. The premium ceilings introduced were established at too high a level, without due regard to the number of animals for which premiums were paid before 1992, and were thus ineffective in controlling surplus production capacity. While the ceilings for special premiums have subsequently been reduced, no downward correction has yet taken place for suckler cow premiums (see paragraphs 4.27-4.32).

4.79. In addition, the structuring of some of the new measures (the second payment of the special premium for non-castrated animals and the deseasonalization premium) encourages producers to hold animals for longer periods, thus inciting increases in production, contrary to one of the principal objectives of the reform. On the other hand, the processing premium is designed to restrict production capacity. Thus, there is an inherent contradiction in the overall premium package with the latter premium being necessary essentially to mitigate the effects of other Community premiums. The Court has estimated that the increased costs to the Community budget arising from the inducement for farmers to unnecessarily retain a certain category of cattle for longer periods amounted to 350 Mio ECU for the period 1992-96 (see paragraph 4.33).

4.80. As the circumstances used to justify the introduction of the deseasonalization premium, notably the need for intervention purchases, did not occur during the period 1992-95, because it was implemented in the downward phase of the production cycle, the budgetary expenditure on the premium, totalling 85,1 Mio ECU, was not justified. The Commission should have taken due account of the prevailing market conditions (see paragraphs 4.36-4.39).

4.81. The mechanism introduced with a view to encouraging extensive production also needs to be re-examined with a view, in particular, to incorporating a more relevant stocking density factor definition, taking into account, inter alia, all the animals present on the holding, instead of only those claimed (see paragraphs 4.40-4.44).

4.82. In so far as controls over the premiums are concerned the creation of the IACS system will, when fully implemented, form a reasonable basis for the identification of animals and the control over their eligibility for premiums. However, the effectiveness of the system was diminished by the delays which occurred in the adaptation of the national mechanisms and in the development of the necessary computer systems. Further improvements are needed in the cattle register, the administrative document and the databases for them to be effective (see paragraphs 4.45-4.60).

BSE related measures

4.83. Measures taken to support producers since the 1996 BSE crisis have and will place a considerable strain on the Community budget. The Court's audit during 1996 of the principal measures introduced has highlighted weaknesses in the management of the schemes at Member State level, a failure on the part of the Commission to respect the budgetary principles and a contradiction between the way animals aged over 30 months are treated under the United Kingdom's OTMS and BMPS. The thorough examination of the OTMS conducted by the Commission should be extended to other measures (see paragraphs 4.61- 4.75).

REPLIES OF THE COMMISSION

THE REFORM

Background

4.11. The reduction in cereal prices also affects intensive beef production. Consequently, the increase in premiums was specially intended for extensive farming, which was less likely to gain from the reduction in cereal prices.

THE IMPACT OF THE REVISED BEEF AND VEAL PREMIUM SCHEMES

Income compensation

4.19. The two premiums mentioned by the Court serve different purposes. It is therefore misleading to add the premiums together with a view to comparing the development of producers' incomes.

4.20. In order to make proper comparisons, the amount of ECU 90 referred to in the calculations mentioned should be multiplied by the monetary coefficient, which brings it up to ECU 108,7 per head.

The annexed table compares the increase in the amount of the premium with the decrease in the intervention price.

4.21. The increase in premium for male animals is ECU 60,4 in the more usual case of animals attracting only one premium, and ECU 169,1 for animals attracting two premiums. The average, weighted for the number of animals in each category (about 2/3 and 1/3 respectively in 1995), is ECU 96,6, i.e. less than the theoretical loss of income of ECU 108,7 per head (see above).

Moreover, following a decision taken in 1996 to the effect that the second premium would cease to be granted for animals that had not been castrated, only about 23% of animals still attract two premiums.

On the whole, therefore, the Commission does not agree with the Court's view of additional costs.

4.22. See reply to point 4.20.

4.23. On the basis of actual figures, there were no savings on cattle feed, since cereal prices to producers did not decline in the period in question.

On the cumulative effects, it should be borne in mind that as the other premiums mentioned in the Court's report are intended to achieve specific aims such as extensification, deseasonalization of production or development in regions that are lagging behind, they cannot be regarded as additional income support.

4.24. The price support arrangements in the beef and veal sector are based on flat-rate payments (for sheep and goats they are based on annual prices); consequently, assessments of real compensation must be based on a complete cycle of six years. This means that in the downswing of the production cycle (1992-95), the decline in supply generates good prices; in the upswing (1995-98) the surplus in supply should lead to a decline in market prices.

It is more meaningful to compare market prices obtained at the beginning of the marketing years concerned than to compare prices for calendar years. The drop in market prices from 1 July 1992 to 1 July 1995 was 11,6%, which can be compared with the expected drop of 15%.

4.25. As Table 4.4 shows, the situation of producers specializing in beef and veal deteriorated in relation to the average for farming as a whole (from 90% in 1992 to about 80% in 1994).

4.26. On the basis of the replies to points 4.21 and 4.25, the Commission does not think that there was overcompensation of expected decreases in farm income due to the forecast decline in market prices. In practice, it is difficult to extrapolate results based on the type of animal, since usually there are several types of animal present on a holding.

In fact, even if market prices were higher than was expected at the time of the reform, domestic production of beef and veal declined by about 8,5% between 1992 and 1995.

Control of production

4.28 4.30. The acceptability of 1992 as a reference year is part of the policy agreement reached at the time of the 1992 reform. In fact, the proposal made by the Commission in 1991 involved cuts in production with the introduction of strict limits on the stocking density factor and the application of the 90-head limit for the special premium and for the suckler cow premium. The Council introduced the concept of an individual limit for the suckler cow premium and the regional ceiling for the special premium, and gave the Member States the option of choosing 1992 as a reference year.

With regard to the suckler cow premium, the Commission has since recognized, in the report on the application of individual ceilings (COM(96) 430 final), that allowing Member States to take 1992 as a reference year led to delays in the stabilization of the suckler herd and thus hampered the process of taking control of the market. It should be borne in mind, however, that potential entitlement to suckler cow premium in 1996 (11 450 000 animals) was already lower than the number of suckler cows recorded in the EU (11 518 000).

With regard to the regional ceiling on the special premium, the Commission had already realised by 1993 that setting such ceilings too high could jeopardise control of production. That is the reason for the proposal for an amendment in the price package for 1994/95 presented at the beginning of 1994 and adopted in July 1994, which led to a reduction of about 11% in the overall regional ceiling. In the price package for 1996/97, the Commission proposed a further reduction in the regional ceiling, which led, once adopted in November 1996, to a reduction of about 19,4% of the regional ceiling from 1997.

4.32. Small producers with a mixed herd were given the opportunity to obtain suckler cow premium in 1990 (Regulation No 1187/90), to enable them to achieve an adequate income. At the time, a limit was set of 10 suckler cows and 60 000 kg of milk. In the political compromise of the 1992 reform, the Commission undertook to reconsider the limits. The Commission proposal provided for granting 700 000 rights, which the Council eventually converted into 821 160 additional rights to premium. The remaining rights created reflect concern over the problems of maintaining production in less-favoured regions.

4.33. The Commission had already noted this problem in 1993. In the measures accompanying the price package for 1994/95, presented in early 1994, it proposed the abolition of the second age bracket of special premium for non-castrated male bovine animals. The Council did not adopt this proposal. A new proposal drawn up in early 1996 led to the definitive suspension of the premium from 1997 (Regulation No 2222/96). Moreover, it should be borne in mind that the Commission had already introduced limits on the weight of carcases eligible for intervention in 1993 (Regulation No 685/93).

4.34. As regards the lack of selective criteria for eligibility for the special premium, it should be borne in mind that one of the purposes of this premium is to compensate producers for the consequences of cuts in intervention prices. These cuts affected all adult animals.

The draft reform of the beef and veal sector proposed by the Commission in 1991 did in fact tend to limit production through the following provisions:

- a limit of 90 heads on special premium and suckler cow premium,

- the application of a real density factor (number of LU on the farm per hectare of forage crops), excluding the producer from premium arrangements if this factor exceeded 1,4 LU/ha in a less favoured area, or 2 LU/ha in any other area, and

- suspension of the application of this density factor for suckler cow premium only for 6 LU or fewer.

The arrangements adopted by the Council are to some extent selective, to the advantage of certain producers (small producers, to whom the density factor is not applied; medium-sized producers, for whom the limit of 90 male animals is maintained, and extensive producers, owing to the introduction of the density factor).

4.35. The Commission agrees that the possibility of choosing 1992 as the reference year meant that production ceilings were established at too high a level (see points 4.27 to 4.34). However, adjustments to the regional ceiling for the special premium were proposed as soon as the problem was quantified. For the suckler cow premium the existence of individual entitlements creates additional problems that make it more difficult to adopt cuts. Nevertheless, measures to limit the use of this premium were taken by means of urgent measures adopted by the Council in November 1996.

Deseasonalization of slaughtering

4.37. In practice, the seasonal element is relevant only in the Member States where beef and veal production is mainly based on a forage diet, so that a large number of animals are slaughtered at the beginning of the off-pasture period, which can destabilize markets in the EU as a whole.

Figures for slaughtering in the period from September to November (see table 4.8) clearly show that seasonalization of production is a problem in certain Member States, jeopardizing the equilibrium of the sector as a whole in the EU. The premium is intended to change these production systems. This is bound to take some time, and would not be effective if the premium was introduced only when intervention opened.

4.38. The effectiveness of the premium is demonstrated by the reduction in slaughtering in all the Member States applying it during the off-pasture period (see table 4.8).

In Table 4.9, a comparison of the situation in 1995 in Ireland and Northern Ireland (where seasonalization is significant) shows a change in the market price trend that might well reflect a different approach to applying the premium. Moreover, one of the consequences of applying the premium has been to displace production, thus levelling off exports (which do not, moreover, increase substantially in the autumn peak period).

4.39. See points 4.37 and 4.38. In the Commission's view it might be worth considering whether the fact that there was no need for intervention buying-in in the countries concerned was not partly due to the existence of the deseasonalization premium. However, the Commission notes the Court's remarks, with a view to taking them into account in future consideration of these premium arrangements.

Extensification of production

4.40. It is up to producers to decide on the type of support for their land, whether for arable crops or forage to feed their animals. In the first case, they are eligible for aid for arable crops; in the second, compensation for the reduced intervention price is obtained via the special premium. It is never possible to qualify for both. Intensive producers purchasing forage can take advantage of a reduction in cereal prices, unlike those using their own forage.

4.41. In view of the long production cycle in the beef and veal sector, changes in production structures cannot be achieved rapidly. Impact evaluation as suggested by the Court must be based on a critical mass of data. The Commission is now in a position to begin this work.

4.42. In the Commission's 1992 proposal for reform (OJ C 303, 22.11.1991) the density factor was calculated on the basis of the number of animals on the holding, and the premium was not to be granted where density exceeded the limit laid down. The Council eventually decided to base calculations on number of animals which are the subject of premium applications, to enable proper checks to be carried out (since there is no valid identification system).

4.43. These two schemes (compensatory allowances and market premiums) serve different purposes. Consequently, there is no connection between the granting of allowances on the one hand and the granting of premiums on the other. Animals which are the subject of applications for compensatory aid are included in the calculation of the density factor if they are also covered by an application for beef premium.

It would seem logical, where the number of animals used as a basis for calculating the density factor corresponds to the number of animals appearing on the application for premium, since that application is limited by the number of entitlements, to use that number as a limit when calculating the density factor.

It is true that the Council Regulation takes account only of animals for which an application for premium has been made, not of the actual stocking density of the holding (as the Commission originally proposed). The reason the Council adopted this criterion, at the time of the 1992 reform, was the serious difficulty of checking due to shortcomings in identification and registration of animals. The reason for ignoring the density factor for producers applying for less than 15 LU was to simplify administration by removing the need to check the areas of smaller holdings.

4.44. The Commission will note the Court's remarks and take account of them in future in its work on the impact of the extensification measure.

ADMINISTRATION AND CONTROL OF PREMIUMS

4.45. The setting up of the integrated administrative and control system (IACS) was a major technical and administrative task for the Member States. This involved considerable investment and administrative reorganization. Despite the efforts undertaken by both the Commission and the Member States, and whilst good progress has been made in many areas, it is true that parts of the system were still not fully operational by the deadlines. For this reason the Commission, in its report COM(96) 174 proposed amendments to Regulation (EEC) No 3508/92 extending the final deadlines, which were adopted in Council Regulation (EC) No 2466/96.

In the beef sector the main weakness in the implementation of the system was due to applying different provisions on identification and registration to animals eligible for the premiums on the one hand and to other bovine animals on the other.

Identification and registration of animals

4.46 4.47. The Commission proposed a new Regulation for the identification and registration of bovine animals (OJ C 349, 20.11.1996, p.10), which will reinforce the provisions of the current Directive, in particular with regard to the introduction in all Member States of ear-tags to identify animals individually, computerized databases, animal passports and individual registers kept on each holding, for the purposes of tracing bovine animals for health reasons. These provisions were adopted by Council Regulation (EC) No 820/97 of 21 April 1997 establishing a system for the identification and registration of bovine animals and regarding the labelling of beef and beef products (OJ L 117, 7.5.1997, p.1).

In the light of the problems encountered with regard to identification, the Commission, with the technical support of the Joint Research Centre, is launching a large-scale field trial called IDEA to examine the feasibility of using electronic identification systems as a means of increasing the reliability of animal identification for bovine and ovine/caprine animals. In Article 4(7) of the recently adopted Regulation it is stipulated that 'Not later than 31 December 2000, the Council, acting on the basis of a report from the Commission accompanied by any proposals, shall decide on the possibility of introducing electronic identification arrangements in the light of progress achieved in this field.`

Administrative document

4.50. The Commission published a model for the administrative trade document (Annex I to Regulation No 3886/92) designed to avoid the special premium being granted twice when animals are bought and sold from one Member State to another. For animals remaining in their country of birth, the Commission applied the principle of subsidiarity, with a view to simplifying administration (in certain cases identity papers or veterinary documents are used as an administrative document).

4.52. The Commission considers that, while the administrative document could be improved upon, it will nevertheless be a vital means of tracing animal movements within and between Member States in the period up to the introduction of the database provided for in Regulation No 820/97 in 2000.

Controls

4.54. Under Regulation No 820/97, a database must be set up (see reply to points 4.46-4.49).

4.55. Given the requirements for the scheme, the Commission accepts the checking of ear-tags on a sample basis for suckler cows.

For the suckler cow and the special beef premium schemes the Commission has made it known that on-farm inspections should incorporate a full head-count, verification that all animals bear ear-tags, a visual check on eligibility and an examination of herd registers supported by a sample of invoices. Finally, it should be mentioned that the Commission considers it necessary to conduct computerized cross checks of all animal identification numbers to detect failure to comply with the rules or potential abuses for both the suckler cow and male animal schemes.

Stocking density factor

4.57. The Court's remarks are very similar to those made by the Commission in the context of its clearance of accounts audits in Andalusia (1995) and Castile-Leon (1996). The matter is being dealt with under the EAGGF clearance of accounts for the financial years 1994 onwards and the Court's remarks in respect of Galicia will naturally be taken into account.

4.58. The points raised regarding Portugal and Italy will be taken into account at the dialogue stage of the EAGGF clearance of accounts for the 1995 financial year.

Conclusion on administration and control of premiums

4.59 4.60. The Commission takes note of the Court's conclusions. Regulation No 820/97 establishing a system for the identification and registration of bovine animals and regarding the labelling of beef and beef products addresses the issues at hand and strengthens the provisions of Directive 92/102/EEC. It should be noted that the new deadline for the introduction of the database mentioned is now 2000 (see points 4.46 to 4.49).

MEASURES TAKEN IN CONNECTION WITH THE BSE CRISIS

Advances on 1996 premiums

4.64. The basic Regulation provides that premiums should be paid as soon as checks have been carried out. The implementing Regulation provides for the possibility of advance payments on the basis of checks already carried out, and this is usual practice at the end of the retention period. In 1995 changes were already being planned in the arrangements for advance payments. For 1996, in view of the problems affecting the market, the Commission, on a request from the Council, decided that, subject to the completion of checks, Member States in a position to bring payment dates forward should be encouraged to do so.

The over 30-month scheme (OTMS)

4.65 4.66. Due to the time scale involved and the additional conditions, the United Kingdom was unable to include the relevant claim for reimbursement in the initial declaration of expenditure for the year ended on 15 October 1996 submitted on 10 November 1996. The additional claim in respect of the 1996 financial year was submitted on 27 November 1996 and, in view of the appropriations provided for this purpose, this expenditure was correctly charged to the 1996 budget.

Additional payments

4.69. It should be emphazised that Regulation No 716/96, governing the over 30 months scheme, prohibits the entry into the food chain of animals over 30 months old only if they are purchased in accordance with Article 1 of that Regulation. The prohibition of entry into the food chain of animals over 30 months old is a national provision, mentioned as such in the preamble to that Regulation. At the time, the UK verified the age of animals by their dentition, which the Commission considers to be an acceptable method.

Concerning the beef marketing payment scheme, Article 4(a) of Regulation No 1357/96 allows Member States discretion as to how they distribute the sums set out in its Annex. In the context of its clearance of accounts work, the Commission will seek clarification from the UK authorities concerning cattle which were over 30 months old when sold after 28 March 1996.

Reactivation of the calf processing premium

4.74. As regards the UK, several audit missions conducted by the Commission have drawn attention to the weaknesses described and the matter is under examination in the clearance of accounts for both 1996 and 1997.

On its mission to Portugal the Commission inspection team was also critical of certain aspects of checks at slaughterhouses and rendering plants.

Adequacy of controls concerning BSE related measures

4.75. It is true that the clearance of accounts has concentrated, although not exclusively, on the over 30-month scheme applied in the UK. The results of these controls have been communicated in good time to the UK authorities and have consequently brought about great improvements in national control procedures. These improvements, notably, include seals on all transport from slaughterhouse to MBM stores and tallow stores, the presence of controllers at all intakes and outtakes from stores, and the use of standard forms in the administration of the OTMS scheme.

Other audits have been undertaken in the context of the clearance of accounts, in the Netherlands for the early marketing of calves scheme and in the UK in respect of the selective cull which began in February 1997. Similarly, implementation of the additional payments scheme under Regulation No 1357/96 is being examined in a majority of Member States during 1997 (Austria, Germany, Greece, Finland, France, Ireland, Sweden and the United Kingdom) with the remaining financially important Member States being visited in the course of 1998. The calf-processing scheme (the United Kingdom and France) will also be subject to audit during 1997.

CONCLUSION

General remarks

The Commission takes note of the Court's observations on certain aspects of the 1992 reform in the beef sector, a reform package that was the fruit of long discussions in the Council. The Commission will give careful consideration to the Court's remarks in the run-up to the future planned reform of the beef market organization.

Premiums

4.77. On the basis of its own calculations, the Commission does not agree that beef producers were overcompensated as a result of the reform (see points 19 to 26).

The Commission would make the following remarks about the Court's calculations:

- they are based on figures per animal and not per holding; a more general calculation per holding does not indicate overcompensation;

- the beef and veal cycle is characteristically a cycle of five or six years; any study must take account of ups and downs throughout the cycle, but the Court's analysis is limited to three years where output was falling, and prices consequentially rising;

- on the problem of overcompensation referred to by the Court for male animals eligible for two premiums, it should be pointed out that since 1996, the number of such animals has been cut by about a third, with the elimination of the second premium for non-castrated males.

4.78. The Commission recognizes the validity of the Court's observations but notes that the number of premium rights resulted from a political compromise in the Council. In the case of the special premium, measures to reduce ceilings were first proposed and adopted in 1994. A second correction of the ceiling was adopted on the basis of a Commission proposal in 1996. Measures have also been taken to withdraw unused rights to the suckler cow premium.

4.79. See the reply to point 4.33. The Commission recognized at an early stage that the second tranche of the second premium could constitute a problem and took steps from 1993 to correct the situation. Despite its efforts, agreement on abolishing the payment of the second tranche was only reached in 1996. Furthermore, the Commission proposed, and the Council accepted, Article 1(2)(b) of Regulation No 1588/96, which provides for the possibility of bringing forward the age for eligibility for the premium.

4.80. The deseasonalization premium achieved its aim in smoothing out slaughter patterns across the Community and so reduced the risk of market imbalance. However the Commission will take the Court's remarks into consideration and include them in its future consideration of this premium.

4.81. The Commission takes note of the Court's remarks on the extensification premium. It is true that further examination of extensification measures is needed. The matter is under review in connection with the possible future reform of the sector and the Court's remarks, notably on aspects of control and management, will naturally be taken into consideration.

4.82. The Commission would draw attention to Council Regulation (EC) No 820/97, which lays down detailed rules for the system of identification and registration of bovine animals, and in particular introduces the requirement for a central data base.

BSE related measures

4.83. As pointed out in detail in the reply to point 4.75, the Commission will continue to be active in monitoring and evaluating the application of BSE measures.

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Table 4.9 - Impact of the deseasonalization premium on market prices

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CHAPTER 5(210\*) Certain procedural aspects of export refunds on beef and veal

5.0. CONTENTS Paragraph reference

Introduction 5.1

Poseican programme of special measures 5.2 - 5.13

Introduction 5.2 - 5.7

Specific supply arrangements 5.8

Checks by the competent authorities 5.9 - 5.12

Checks on the products which have received aid 5.10

Checks on the passing-on of the aid 5.11 - 5.12

Conclusion 5.13

Issue of certificates for meat from adult male cattle in Belgium 5.14 - 5.19

Introduction 5.14 - 5.15

The slaughtering process in Belgium 5.16 - 5.17

Conclusion 5.18 - 5.19

Procedures applied to exports of frozen beef rejected by Egypt 5.20 - 5.38

Introduction 5.20 - 5.24

Observations in France and the Netherlands 5.25 - 5.35

In France 5.26 - 5.29

Customs checks 5.26

Veterinary checks 5.27 - 5.29

In the Netherlands 5.30 - 5.34

Customs checks 5.30 - 5.32

Veterinary checks 5.33 - 5.34

Consequences of the inadequate checks 5.35

Conclusion 5.36 - 5.38

INTRODUCTION

5.1. Based on the shortcomings of the Poseima scheme as described in its Special Report No 5/97(211), the Court examined the audit procedures for the special aid for the import of beef meat under the Poseican programme, and the issue of certificates for meat from adult male cattle imported from Belgium, one of the main suppliers of the Canary Islands. Finally, the Court also examined the procedures applied in France and the Netherlands to exports of beef rejected by Egypt.

POSEICAN PROGRAMME OF SPECIAL MEASURES

Introduction

5.2. In order to take account of the remoteness and insular nature of the Canary Islands, Council Decision 91/314/EEC(212) set up a programme of special measures, known as the Poseican programme, intended to safeguard supplies to the Islands whilst at the same time reducing the prices paid by the consumer. Following on from this programme, Council Regulation (EEC) No 1601/92(213) and Commission Regulations (EEC) No 1695/92(214) and No 2790/94(215) have laid down measures concerning certain agricultural products.

5.3. As regards the measures concerning beef, the national authorities can opt for the granting of either an exemption from import duties for the importation of products originating in third countries or an aid nearly equivalent to an export refund for products of Community origin with a view to maintaining their competitiveness in the Islands. Table 5.1 shows a breakdown of the quantities of meat imported (nearly 35 000 tonnes for the last three marketing years) by their origin (third country with exemption certificate, Community origin with aid certificate). It shows that from the 1993-94 marketing year to the 1995-96 marketing year the share of Community-origin meat imported decreased, and then rose again during the 1996-97 marketing year. Table 5.2 summarizes the aid paid since 1994 for beef of Community origin (22,9 Mio ECU in 1995 and 15,1 Mio ECU for the first six months of the financial year 1996).

5.4. Pursuant to Regulation (EC) No 2790/94 (216), the specific supply arrangements introduced by the Spanish authorities stipulate that:

(a) the forecast supply balance must be drawn up and regularly adjusted in order to define the quantities which may benefit from the exemption from import duties or from the aid;

(b) any trader established on the territory of the Canary Islands and entered in the register for the specific supply arrangements may benefit from these arrangements. Entry in the register is subject to certain conditions, in particular the trader must ensure that 'the benefits obtained are transmitted to the end-user and consumer` (217).

5.5. In application of the same Regulation (EC) No 2790/94 (218), the Spanish authorities must:

(a) take appropriate steps to ascertain the end-use of the products and check that the benefits derived from the exemption from import duties or the grant of Community aid are passed on to the consumer;

(b) notify the Commission, in particular, of all the control measures taken.

5.6. Moreover, Regulation (EC) No 2790/94 (219) stipulates that the Commission must evaluate the implementing rules for the specific supply arrangements by 31 December 1995. This evaluation had still not been made as of 1 April 1997.

5.7. The Court's on-the-spot audit covered the operation of the specific supply arrangements, the organization of checks on the products which are granted aid and the passing-on of the benefits of the aid to the end-user by the competent authorities.

Specific supply arrangements (SSA)

5.8. The SSA have the following shortcomings:

(a) there is no national legislation providing for the implementation of the obligations as defined by Article 10 of Regulation (EC) No 2790/94 (220) concerning the constraints and the penalties applicable to the importers. According to the Spanish authorities, internal instructions are being developed to penalize failures to meet the requirements laid down in Article 10 of Regulation (EEC) No 2790/94. However, the drafting stage has taken longer than planned;

(b) the register for the SSA has not been rigorously managed since the arrangements were introduced. The Court's audit on the six largest traders and the register revealed that one company involved in several export-refund fraud cases remained on the register and went on benefiting from all the advantages granted to approved traders and that another company which had filed for bankruptcy in early 1996 was still on the SSA register in November 1996.

Checks by the competent authorities

5.9. The checks carried out by the competent authorities on the products which have received aid or on the passing-on of the benefits of the aid are inadequate.

Checks on the products which have received aid

5.10. Checks on the products receiving aid are deficient in the following respects:

(a) Regulation (EEC) No 386/90(221) requires a specific risk analysis determined by the nature of the products which have to be checked. No such analysis is made;

(b) the customs department does not weigh or identify the beef of Community origin, despite the fact that the aid granted is about 20 ECU higher per 100 kg for meat from adult animals compared with veal. The only check made is to ascertain whether the certificate issued under Regulation (EEC) No 32/82(222) or No 1964/82(223) (see paragraphs 5.14 and following) agrees with the customs declaration;

(c) the ex post facto checks (under Regulation (EEC) No 4045/89(224)) made by the central customs investigation department in Las Palmas never cover the aid for products of Community origin;

(d) the central customs laboratory is located in Madrid and as the customs administration has no local laboratory of its own, it has to use the public health laboratory. The latter is not, however, officially recognized for customs classification purposes.

Checks on the passing-on of the aid

5.11. The regulations relating to the checks on the passing-on of the aid (see paragraphs 5.4 5.5) have not been followed. For example:

(a) the Spanish authorities have never notified the Commission about the way in which the checks were being organized;

(b) for the products imported with exemption from import duties, there have been no checks on their end-use or on the passing-on of the exemption at the level of consumer prices;

(c) as regards the Community-origin products which have received aid, an investigation on the passing-on of the aid to the consumer was launched by the Canary Islands' paying agency, but, due to the lack of authority, very little information was gathered.

5.12. A check on the six largest traders (out of a total of 48) who were granted aid involving 11,9 Mio ECU in 1993 and 9,7 Mio ECU in 1994 showed that:

(a) none of the six traders had been informed of his obligations under the Community regulations (see paragraph 5.4);

(b) their accounting and stock management systems did not make it possible to verify the end-use of the products granted aid (one of the traders no longer even had any accounting records available);

(c) in one case, meat had been declared as fresh meat and resold as frozen meat, but it had not been possible to ascertain whether this meat had in fact been imported fresh because there were no customs checks at the time of importation. Aid for imports of fresh meat is 178,5 ECU or 107,5 depending on the tariff heading that is declared (per 100 kg) as against only 93 ECU(225) for frozen meat.

Conclusion

5.13. In the light of the foregoing and taking into account various fraud cases uncovered by the British and Spanish authorities which are currently under scrutiny(226), the Commission should:

(a) ensure that the national authorities introduce all the checks stipulated by the Community regulations as soon as possible (see paragraphs 5.5, 5.8-5.12);

(b) reconsider whether there is any justification for the disparity between the rates of aid for fresh and frozen beef (see paragraph 5.12(c) and Table 5.3), which increases the risk of irregularities;

(c) make the assessment of the Poseican schemes (see paragraph 5.6);

(d) establish the amount of the aid which has been wrongly paid and take steps to recover it.

ISSUE OF CERTIFICATES FOR MEAT FROM ADULT MALE CATTLE IN BELGIUM

Introduction

5.14. As the rates of aid for beef vary considerably depending on its classification (see Table 5.3), the Court examined whether the weaknesses in the import checks were offset by effective export control procedures (see paragraph 5.10).

5.15. The audit in the Canary Islands showed that the six traders selected, to a large extent, imported the meat from Belgium. For this reason, an audit was made of the Belgian authorities' controls over the slaughtering process. These controls provide the basis for the issue by the Belgian intervention and export refund office of the certificates stipulated by Regulations (EEC) No 32/82(227) and No 1964/82(228) for the purpose of exports of meat from adult male cattle to the Canaries.

The slaughtering process in Belgium

5.16. The slaughtering process, which aims to guarantee that the exported products come from adult male cattle, has two stages:

(a) the identification, at the place of slaughter, of bone-in meat intended for export (certificate 32/82) in order to guarantee that the meat comes from adult male cattle with a live weight exceeding 300 kg or with an empty carcass weight (without the organs contained in the thoracic and abdominal cavities and without the kidneys) exceeding 150 kg (if the weight is less than 150 kg, the animal is classified as a calf);

(b) the identification and deboning at the place of slaughter of meat intended for export (certificate 1964/82).

5.17. The Court's audit enquiries at two of the six Belgian abattoirs showed as a consequence of applying an incomplete regulation that the checks to identify the male cattle are not carried out strictly:

(a) the carcasses are weighed together with the offal (kidneys, liver, etc.), which can weigh between 5 and 7 kg. This method of weighing means that cattle weighing less than the minimum can be regarded as belonging to the category of adult male animals. However, even though Regulation (EEC) No 32/82(229) and the customs nomenclature do not specify it, all other regulations defining the carcass of an adult male stipulate that the carcass must be presented without offal. In a document sent to the Court dated 3 March 1997, the Commission stated its view that the weight of a carcass presented for weighing with the offal should be reduced by at least 5 kg;

(b) contrary to Regulation (EEC) No 32/82, which stipulates that 'each product` must be identified, the veterinarian only makes sample checks to ascertain that the weights noted on the carcasses agree with the weighing list. The procedure, stipulating that any carcass or part carcass for which refunds could be claimed has to be identified, was confirmed by the directive issued by the Belgian veterinary authorities(230).

Conclusion

5.18. These weaknesses result, in part, from a lack of precision in the regulations governing systems for checking and identifying male cattle (see paragraphs 5.16-5.17). As a result some traders may have benefited from higher payments than they should have had when exporting to the Canary Islands or to third countries by virtue of the considerable disparity - some 20 ECU per 100 kg (see Table 5.3) - between the aid rates for meat from calves and the aid rates for meat from adult male animals. However, the relevant Belgian authorities could not provide the Court with the quantities and amounts at stake.

5.19. The Commission should therefore:

(a) inform the Belgian authorities, who must in turn notify all the relevant officials, that the offal may not be included when the cattle are weighed [see paragraph 5.17(b)] as offal is not eligible for export refunds;

(b) arrange for the Belgian authorities to assess and recover the possible export refunds paid for cattle whose weight including the offal was only slightly higher than the accepted minimum [see paragraph 5.17(b)], in cases of exports of beef using certificates 32/82 and 1964/82;

(c) prepare a regulation explaining the approved methods of weighing the carcasses.

PROCEDURES APPLIED TO EXPORTS OF FROZEN BEEF REJECTED BY EGYPT

Introduction

5.20. In conformity with Regulation (EEC) No 3665/87(231), export refunds are paid on presentation of the relevant export documentation (bills, export declaration, bill of lading, etc.), subject to the proof of arrival of the goods in the country of destination being presented at the paying agency within 12 months of the export.

5.21. Between 1992 and 1996, many export consignments of frozen beef (mainly from Germany, France and the Netherlands, but also from Ireland and Italy) for which export refunds had been paid were rejected by the Egyptian veterinary authorities either because the goods were not in conformity with their sanitary specifications, or because of their fat content. This frozen beef was usually re-imported into Union territory, stored and eventually re-exported. There are Community statistics on the total quantities of beef exported (which amounted to some 441 000 tonnes between 1993 and 1996) but none exist for the quantities rejected. For 1993, it can be estimated that about 3% of Egyptian imports were rejected (about 3 900 tonnes).

5.22. In view of the fact that rejections of frozen beef were becoming frequent, the Commission sent a factfinding mission to Egypt and, in 1993, instructed first the Directorate-General for Agriculture (DG VI) and then the Anti-fraud Coordination Unit (UCLAF) to monitor the regularity of these cases of rejection which did not result in the repayment of export refunds. Upon completion of its investigation, which covered the period 1992/93, UCLAF had found 48 cases giving rise to legal proceedings (of which about 30 involved fraud), concerning a total of 6 319 tonnes of meat and about 10 Mio ECU in export refunds.

5.23. In 1994, in response to a request from the German authorities, the Commission explained to them which identity checks were to be carried out in the event of the temporary re-importation of exported goods. According to this reply, the competent national authorities may, in exceptional cases, authorize the admission of these goods under a customs procedure involving the suspension of duties without requesting that the export refunds be repaid, on condition that:

(a) these authorities have ascertained that the original operation was a normal commercial export of a product of sound, fair and marketable quality;

(b) the exporter provides evidence, within the set time-limits, of the importation of the goods into the country of final destination;

(c) there is no doubt as to the identity of the product which has been exported, re-imported and re-exported.

5.24. Despite the lack of specific provisions in the Community regulations, the Commission neither sent a copy of this letter to the other Member States nor explained to them the procedure to be followed. As a result, disparities developed in the way the procedures and checks were applied. This led the Court to scrutinize the rules applied by the main Member States exporting frozen beef to Egypt (France, Germany, Ireland, the Netherlands) at the time of those cases of consignments rejected for sanitary reasons in 1994 and 1995.

Observations in France and the Netherlands

5.25. It seems that only France continued in 1994 and 1995 to be faced with rejections of goods. Most of the rejected consignments of frozen beef were re-imported into France via the ports of Le Havre and Caen (about 1 100 tonnes, for which 1,6 Mio ECU had been received in export refunds) or into the Netherlands via the port of Rotterdam (about 991 tonnes, for which 1,5 Mio ECU had been received in export refunds). The Court's audit enquiries therefore focused on 16 re-importations into France and 6 into the Netherlands.

In France

Customs checks

5.26. The way in which the rejected goods were dealt with was generally correct. The fact that the goods were systematically put into bonded warehouses, with duties being suspended, made it possible to carry out the necessary checks (in particular, the monitoring by the customs authorities of movements of stored goods) when the goods were re-imported and re-exported. However, these checks were not executed in a stringent manner:

(a) the goods were cleared through customs upon re-importation and re-exportation without any request for information about the original export operation being addressed to either the traders or the paying agency, Ofival (Office interprofessionnel de la viande de l'élevage et de l'aviculture); therefore the French authorities were unable to ascertain whether the original operation had been a normal commercial export of a product of sound, fair and marketable quality;

(b) the customs service did not inform Ofival of the number of rejected exports and so it was not able in its turn to inform the Commission.

Veterinary checks

5.27. The French veterinary services have set up a procedure which correctly defined the checks which were to be made.

5.28. However, in the period from 1994 to 1995 the port of Caen had not been approved as a frontier inspection post. Most of the rejected goods were therefore required to be unloaded first at the port of Le Havre for checking by the veterinary services. In two cases, this procedure was not followed and the meat was unloaded directly at Caen where veterinary checks were carried out by visual inspection of the goods. To regularize this situation, the national authorities (Ministry of Agriculture) issued an a posteriori authorization for the unloading and execution of the veterinary checks at Caen. As the Caen veterinary services were not informed by the customs authorities as to why the goods had been rejected, no bacteriological tests were carried out.

5.29. At the port of Caen it was possible for the repackaging operations prior to re-export to be carried out under the control of the veterinary services. The origin of the consignments was not, however, checked.

In the Netherlands

Customs checks

5.30. Because the Commission had not provided specific instructions for the handling of rejected goods, the Dutch authorities decided to place them under the external transit regime. This procedure does not stipulate that the origin of the goods is to be checked or whether these goods have received export refunds.

5.31. Thus, at the port of Vlissingen, the procedure applied was as follows:

(a) the consignments of frozen meat were stored with goods awaiting clearance, which could entail a risk of substitution;

(b) monitoring of the goods in store and checks on stock records were carried out merely on the basis of the data sent by the traders and not on the basis of customs checks;

(c) the consignments of repackaged meat were re-exported without undergoing any special physical checks (as they were regarded as goods not subsidized by the EAGGF), despite the fact that all these goods received export refunds when first exported to Egypt.

5.32. The lack of any identity checks on the meat meant that it was therefore not possible to guarantee that the re-exported goods were indeed the original goods exported to Egypt or that the quantities of meat rejected and re-imported into EU territory had been re-exported in their entirety. In fact, in most cases there were discrepancies between the number of packages and the quantities.

Veterinary checks

5.33. In those cases where goods were rejected on health grounds, it was therefore necessary to ascertain at the time of their re-exportation that they still retained their sound and fair marketable nature - which was the basis on which the refunds were paid. In the absence of any specific Community provisions on this point, the Dutch veterinary services drew up the certificate on the basis of the original veterinary certificate, taking the view that the meat of Community origin had been subject to a full check when it was first exported. Whatever the reasons for the rejection by the Egyptian veterinary authorities (too much fat or a bacteriological defect), no checks were made.

5.34. Furthermore, despite the provisions of the Commission decision(232) on the veterinary control procedures at the Union's frontier inspection posts, the Dutch veterinary services do not inform the veterinary authorities of the Member States which issue the original certificate of the fact that the goods have been rejected.

Consequences of the inadequate checks

5.35. The inadequacy of the checks led to the wrongful payment of export refunds, as shown by the following examples:

(a) in the case of one re-export operation from France (for which about 0,7 Mio ECU had been paid in refunds), part (3,8 tonnes) of the goods which were rejected owing to their bad bacteriological quality was eventually used for pet food, but there has been no repayment of the export refunds paid (about 6 000 ECU); however, the re-exported goods, which may also have been of the same bad quality, did not undergo the veterinary check stipulated in Council Directive 90/675/EEC.

(b) one French company re-imported via the port of Corinth (Greece) 61 tonnes of rejected goods originating in Ireland. This consignment was stored in Caen, then re-exported to Congo. This operation involves the following irregularities:

- in Corinth - which is not approved as a frontier inspection port - the consignment was subject to neither an identity check nor a health inspection by the responsible authorities;

- this consignment was shipped to Caen under cover of a transit document but without any veterinary authorization, then re-exported (des-troying or reprocessing it would have involved repaying about 0,1 Mio ECU in refunds) but no veterinary certificate was issued upon export;

- this consignment was first shipped from Greenore Port, Ireland, as part of a shipment of 455 574 kg net weight to Alexandria Port, Egypt, in October 1994. Court enquiries have established that the certificate of origin (CO), furnished by the French consignor, describing the goods as originating in Ireland, was issued by an unauthorized 'Chamber of Commerce`, allegedly from West County Dublin, Ireland. In addition, the number on the CO had previously been assigned to a totally unrelated consignor. This serious irregularity in relation to the CO has been brought to the attention of the Commission and the Irish authorities;

(c) at the Court's request, a department of the Dutch Ministry of Agriculture made an inspection of an export operation by a Dutch company (involving about 0,1 Mio ECU in export refunds); part of this consignment had been rejected by the Egyptian health authorities because of its poor bacteriological quality and its high fat content, re-imported into the Union's territory, unloaded at Antwerp and stored in Vlissingen, before being re-exported to Iraq. The re-export veterinary certificate was drawn up in Belgium on the basis of the original certificate. When comparing the veterinary certificate with the other customs and commercial papers issued at the time of re-exportation, the Dutch department noted that:

- this veterinary certificate bears the name of a different transport ship, a different customer and different dates of production and freezing from those shown on the labels attached to the repackaging boxes;

- the certificate was issued for goods being re-exported to Jordan and not to Iraq;

(d) on 23 February 1995, again at the Court's request, the Dutch Ministry of Agriculture inspected a re-importation operation at the port of Vlissingen involving 687 tonnes of rejected goods which belonged to several French companies (which had received nearly 1 Mio ECU in refunds):

- the quantities which were unloaded and declared to the Dutch customs (687 tonnes) do not agree with the quantities which were stored (675 tonnes). Furthermore, a part of the stored goods (6 tonnes) was destroyed on a decision by the veterinary services, because of its poor bacteriological quality;

- the Dutch authorities failed to notify Ofival of either the discrepancies found in the quantities or the fact that part of the goods had been destroyed;

(e) lastly, in March 1996, 200 tonnes of goods were exported by a French company. This consignment was rejected [because of the embargo on European beef decided by Egypt due to bovine spongiform encephalitis (BSE)] and sent back to Rotterdam, where it was put under the external transit system. In order not to have to repay the refunds received at the outset (about 0,3 Mio ECU), the French company sold this consignment, without informing Ofival, to a UK company, which shipped it to South Africa, where the checks which were made revealed that:

- the load consisted in part of meat of German and UK origin from abattoirs which were not authorized by the South African authorities and did not agree with the original French health certificate which stated that the entire cargo came from a French abattoir;

- in accordance with the Community legislation on checks on substitution, seals were placed on the 12 containers exported via Rotterdam but when the containers arrived in South Africa six of these seals had been broken.

Conclusion

5.36. The Commission informed only the German authorities about the control procedures to be applied in the case of the re-importation of frozen beef rejected by the Egyptian health authorities. As a result, the control procedures of the different Member States were not harmonized (see paragraph 5.24), thus making it easier for goods to be diverted to ports where checks were less strict.

5.37. The fact is that there are still no precise Community regulations concerning cases where goods are re-imported without the export refunds being repaid. This shortcoming is all the more significant in so far as, because of BSE, large exports of frozen meat for which refunds were paid were rejected in the wake of the embargo measures of March 1996 (780 tonnes representing 1,5 Mio ECU of refunds for the United Kingdom alone). The Commission ought to:

(a) rectify this shortcoming, for instance by proposing a change to the regulations in order to ensure better that the goods - for which refunds have been paid - have in fact been placed on a third market, and satisfy all the general conditions for eligibility for export refunds;

(b) arrange for the systematic notification of statistics on these rejections; and

(c) tighten up the veterinary checks at the time of re-importation of the beef in order to ensure that the goods are indeed of fair, sound and merchantable quality.

5.38. Lastly, the Commission must assess the amount of export refunds which have been wrongly received (see paragraph 5.35) and take steps to recover them.

REPLIES OF THE COMMISSION

POSEICAN PROGRAMME OF SPECIAL MEASURES

Introduction

5.3. In recent marketing years demand for beef and veal in the Canary Islands has concentrated on fresh and chilled beef to the detriment of frozen meat.

5.6. A working meeting involving Commission representatives and representatives of the national authorities was held on 21 June 1995 on the subject of implementing this Regulation. Its outcome and the changes to be made will be included in the general report currently under preparation.

Article 30 of Regulation (EEC) No 1601/92 provides for the evaluation of Poseican. The report on Poseican is currently under preparation.

Specific supply arrangements (SSA)

5.8 5.12. Regulation (EC) No 2790/94, laying down detailed rules for the implementation of Council Regulation (EEC) No 1601/92, included among its aims simplifying management of the SSA, strengthening control and monitoring, and providing the authorities with the means necessary to ensure that the objectives of the scheme were met.

The Court of Auditors has highlighted a number of specific problems arising from delays in the implementation of the measures provided for under the Regulation in question. The Commission has raised the issue with the Spanish authorities on a number of occasions and will address a new call to the authorities to ensure that all the measures provided for are fully implemented.

With respect to checks on the passing-on of the aid to the end-user in particular, the Commission and the Spanish authorities together looked at the system set up to monitor and control the passing-on of the aid in order to verify whether the conditions for fixing the level of aid retroactively for the period 1 July 1996 to 31 December 1996 had been met. This involved several meetings between the Commission and Spanish authorities between February and June 1997. Having judged the information submitted by the Spanish authorities to be satisfactory, the Commission adopted a Decision fixing the level of aid in July. The Spanish authorities were invited to continue this work in partnership with the Commission.

Conclusion

5.13 (a) The Commission has raised the issue of delays in the implementation of the regulations concerned with the Spanish authorities on a number of occasions. A further call will be addressed to the authorities to ensure the rapid implementation of all the measures concerned. On the particular issue of checks on the transmission of benefits to the end-user, a number of technical meetings were held in the first half of 1997, the outcome of which were judged to be satisfactory.

(c) Work is currently under way on the report to the Council and the Parliament on the Poseican scheme as provided for under Article 30 of Regulation (EEC) No 1601/92.

(d) The Commission will examine the possibility of recovering aid if appropriate in the cases cited by the Court.

ISSUE OF CERTIFICATES FOR MEAT FROM ADULT MALE CATTLE IN BELGIUM

The slaughtering process in Belgium

5.16 (a) + 5.17 (a) In its description of the basis for the establishment of the carcase weight, as well as the conditions the product must satisfy in order to attract export refunds, the Court of Auditors refers to the definition of carcases in Annex V of Regulation (EEC) No 2456/93, laying down detailed rules for the application of Council Regulation (EEC) No 805/68 as regards the general and specific intervention measures for beef.

In the case of export refunds, the definition to be applied is to be found in the conditions of the Customs Tariff (Annex to Regulation (EEC) No 2658/87). Carcases with specific organs attached may thus be presented for export refunds, without this constituting an infringement of the conditions of the Tariff.

The Commission shares the Court's opinion that in future, for the weight of the organs attached, no refunds should be paid. This is the reason why this item will be clarified in the regulations concerned.

5.17 (b) Regarding identification and weight, the Commission will verify, under its clearance of accounts procedure, that the system used in Belgium to check that carcases originate from male adult cattle is adequate.

Conclusion

5.18 5.19. As the Commission has pointed out, under current Community rules, carcases with specific organs attached may be presented for export refunds, without this constituting an infringement of the Customs Tariff. The Commission agrees with the Court, however, that in future no refunds should be paid for the weight of the attached organs. A proposal for the amendment of the Regulation concerned is currently under preparation. In the view of the Commission, under present rules, there is no basis for undertaking the type of recovery action suggested by the Court.

PROCEDURES APPLIED TO EXPORTS OF FROZEN BEEF REJECTED BY EGYPT

Introduction

5.20 5.21. When products exported from the Community with refund have been rejected in the country of destination (in this case Egypt), these products may either be reimported under the 'returned goods` system and the refund paid back, or placed under a customs procedure (generally customs warehousing, which permits simple handling procedures such as repackaging, rewrapping, etc.) with a view to sending them to a (different) third country; this process requires special customs supervision. Proof of arrival of the goods in the country of destination (required for a differentiated refund) is sufficient to close the payment file. However, if the paying agency has any doubts about the identity of the products on the basis of this document it may request additional proof. In some cases the rejected product may not return to the Community but handling may be carried out in an intermediary third country. The Commission points out that specific conditions have been adopted for cases where beef has been rejected on grounds of animal health (Regulation (EEC) No 773/96 and Regulation (EEC) No 793/97).

5.22. UCLAF's inquiry confirmed that, although this meat met the conditions for Community refunds, the Egyptian authorities had rejected most of it because the fat content did not meet the requirements of Egyptian legislation and not, therefore, for health reasons.

In fact, in 30 cases the meat rejected by Egypt did not qualify for refunds, in some cases because it did not meat health standards and in others because no proof of arrival in another third country was provided. The Commission has started the process of recovering the amounts of aid wrongly paid.

5.23. Following this investigation, the Commission warned the Member States of the difficulties they might meet in obtaining proof of import into Egypt, since this document did not show whether the products had later been rejected. The Member States concerned cooperated closely in the investigation mentioned by the Court of Auditors in point 5.22 and the terms under which this investigation was being carried out had been fully discussed. The German request was viewed as a request for written confirmation of the above.

Observations in France and the Netherlands

In France

Customs checks

Veterinary checks

General comments on points 5.27-5.29 and 5.33-5.34

Discussions between the Commission and the Member States on the application of Council Directive 90/675/EEC of 10 December 1990 laying down the principles governing the organization of veterinary checks on products entering the Community from third countries revealed that it did not specifically regulate the execution of veterinary checks on Community products re-entering the Community following rejection by a third country.

The Commission has therefore proposed specific rules to be implemented in this case as part of the process of amending Directive 90/675/EEC. These rules are set out in Article 14 of the Commission proposal currently under discussion within the Council.

In the Netherlands

Customs checks

5.31 (a) Products cleared for export are not in free circulation, but circulate under the external transit procedure. For verification purposes, it would have been more appropriate to store them separately.

5.36. UCLAF has been investigating the case described under point (e) for several months in cooperation with the authorities in the Member States. UCLAF will follow up the other cases mentioned by the Court.

Conclusion

5.36. As was mentioned in the response to point 5.23, the Member States concerned cooperated closely in the investigation mentioned by the Court of Auditors and the terms under which this investigation was being carried out had been fully discussed. The German request was viewed as a request for written confirmation of the above.

5.37 (a) (b) The Commission is willing to improve its system of informing the Member States to ensure standard treatment of cases where rejected products are returned from third countries.

Specific provisions (Regulation (EEC) No 773/96 and Regulation (EEC) No 793/97) have been adopted for cases where beef has been rejected on the grounds of animal health.

5.37 (c) The Commission's proposal for amendment of Directive 90/675/EEC is currently under discussion within the Council.

5.38. The Commission will undertake an examination of the cases highlighted by the Court of Auditors and take any action that may be necessary.

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PART III Structural measures

INTRODUCTION

III.1. This part of the report is devoted to the structural measures. It comprises four chapters, which, apart from information on the Cohesion Fund, are devoted to the European Regional Development Fund (ERDF), the European Social Fund (ESF), the European Agricultural Guidance and Guarantee Fund, Guidance Section (EAGGF-Guidance) and the Financial instrument for fisheries guidance (FIFG).

III.2. These chapters examine several aspects of the management of the Funds, with particular reference to the monitoring and control of the implementation of the operational programmes in the Member States. They discuss the partnership and the closure of measures, the ADAPT Community initiative and structural aids for agriculture, as well as projects for the production and marketing of agricultural products. The fisheries section considers the PESCA Community initiative and aid to the restructuring, modernization and adaptation of fishing capacity. In addition, comments on the expenditure for international fisheries agreements are included in this part. Several paragraphs also highlight the need for more appropriate procedures in order to increase the effectiveness and consistency of the measures to assist small and medium enterprises, both in terms of project selection and the choice of forms of aid, as well as monitoring, coordination and control. The comments regarding the various Funds have, of course, been formulated in terms of the fields covered by the audit; the fact that some observations relate to one Fund only does not, therefore, signify that the shortcomings identified are found in that sector only.

III.3. Table III.1 gives an overview of the implementation of the budget for the 1996 financial year for all the commitment and payment appropriations relating to structural measures (subsection B2 of the general budget). The overall rate of utilization for final appropriations reached 98% in terms of commitments and 95% for payments. The most significant increases were in the rates of utilization for the ESF commitment appropriations and the ESF, ERDF and Community initiative (IC) payment appropriations. More detailed information concerning budget implementation can be found in the individual chapters devoted to the various Funds.

III.4. The Commission's management of the 'second generation` of programmes under the reform, covering the period 1994 to 1999, began in 1994. At the same time it continued to administer the programmes that remained to be completed from the previous period (1989-93) and has not always found it easy to distinguish between the figures for the two sets of operations, in view of the nature of the documentation available.

III.5. On the basis of the working documents produced by the Commission, the overall allocation for the Structural Funds for the period 1989-93 was estimated to be almost 66 000 Mio ECU (1989 prices), approximately 50% of which was ERDF, 30% ESF and 20% EAGGF Guidance. At the end of the financial year 1996, commitments totalling 4 727 Mio ECU remained to be settled for that period, namely 2 518 Mio ECU for the ERDF, 1 783 for the ESF and 426 for EAGGF Guidance.

III.6. Table III.2 shows, by Member State and Fund, the state of progress of the structural measures for the period 1994-99 at 31 December 1996. At that date the utilization rate of the total allocation for the period was 45,7% for commitments and 32% for payments.

III.7. Under Article 20 of Council Regulation (EEC) No 4253/88(233) the commitments for measures to be carried out over a period of two years or more must, as a general rule, be entered in the budget accounts in annual instalments. The budget commitments do not, therefore, cover the total Community finance to be provided over the full duration of approved programmes. A statement of obligations, charges and potential claims at 31 December 1996 is given in Volume IV of the Revenue and expenditure account as a supplement to the year-end balance sheet. It shows aid, earmarked but not committed, to an amount of some 88 500 Mio ECU (at 1996 prices) for the Structural Fund period 1994-99, including 8 500 Mio ECU for the Community initiatives. The Court has issued a reservation in the context of the DAS on the reliability of these figures - see paragraph 19.20 of this report.

III.8. Under Article 21 of the said Council Regulation (EEC) No 4253/88, the majority of the payments effected by the Commission, for all the Structural Funds, are by way of advances. The payments passed to the accounts do not, therefore, reflect the true state of progress on the measures in questions. Due to the modification of the schedules and commitment and payment thresholds on which the opening of further tranches depends, the figure for advances may become artificially inflated as a result of re-programming and thus remain high, despite implementation delays.

III.9. The Community financial aid payments are sent to the national, regional or local authority or organization nominated for that purpose in the application submitted by the Member State concerned. As regards compliance with programme guidelines and the partnership established within the monitoring committees, it is that national, regional or local authority or organization that is responsible for adopting the individual decisions to grant aid from the Fund to the various projects. The Commission is not routinely informed of these individual decisions, even at a later stage, and under current circumstances the Community authorities only receive partial or occasional information about them.

III.10. During the financial year 1996, as part of the work associated with the SEM 2000 Initiative, the Commission continued to work on a number of texts which are intended to clarify certain aspects concerning the eligibility of expenditure in connection with the Structural Funds. The texts in question took effect on 1 May 1997. Similarly, pursuant to Article 23 of Regulation (EEC) No 4253/88, the Commission produced a draft regulation, which is currently under discussion, seeking to lay down detailed financial control procedures to be applied by the Member States for operations that are co-financed by the Structural Funds.

REPLIES OF THE COMMISSION

The Commission comments in detail, in its replies to the chapters on the individual Structural Funds concerned, on the Court's view that better-adapted procedures are required in order to increase the efficiency and coherence of the measures in favour of small and medium-sized undertakings.

III.4. The overlapping of financial transactions for successive programming periods is inevitable because payments in respect of a given programming period legitimately continue well beyond the start of the next programming period. The Commission considers that its accounting and management information systems provide sufficient possibility of making the necessary distinctions between the two programming periods.

III.5. There are three main reasons why certain operations of the first programming period remain open. The first is the insufficient quality of many Member State final reports; the second is the fact that the closure date of a number of programmes has been deferred for justified reasons; the third is that, in a number of cases, the national authorities have not clarified specific problems concerning, for example, the result of judicial examinations or the satisfactory settlement of control observations. In any case, all that remains to be paid in the majority of these cases is the balance of the final instalment.

III.7. The budgetary accounts legitimately reflect commitments in respect of annual instalments of the multiannual programmes and not the total Community financ-ing envisaged for the whole programming period. This latter information is, however, provided by the Commission each year in a supplement ('compte de gestion`) to the balance sheet.

III.8. It is clear that Commission advances for the part-financing of operations at variable rates cannot reflect precisely the actual implementation of these operations. However, for triggering advances subsequent to the first advance, Member States need to declare expenditure exceeding certain pre-defined levels. To this extent the Commission advances are indeed indicative of actual progress on the ground.

Financial reprogramming is often unavoidable given the complexity of the programmes and the fact that the annual instalments are only indicative estimates of the annual implementation rates. However, any modification of the financing plan requires a specific Commission decision, and the Commission examines whether the allocation of the unspent amounts to the subsequent years is reasonable, with a view to ensuring that the Member State does not receive an unduly high advance.

III.9. The Member States are required to keep this information available for any Community examination. The Commission requests and receives this information when it is needed, for example for the planning of a control mission. Given the number of the projects concerned, it is materially impracticable to require that all this information is automatically forwarded to the Commission, which does not need to have it on a systematic basis, given the division of responsibilities between Commission and Member State.

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CHAPTER 6(234\*) European Regional Development Fund

6.0. CONTENTS Paragraph reference

Introduction 6.1

Financial and budgetary data 6.2 - 6.8

Budgetary implementation 6.2 - 6.3

The new Objective 6 6.4 - 6.8

The closure of intervention schemes 6.9 - 6.42

General background 6.9 - 6.16

Data concerning closure 6.9 - 6.13

The legal and administrative background to interventions decided on after the reform in the context of the CSFs and CIs 6.14 - 6.15

The Court's audit 6.16

General observations 6.17 - 6.20

Administrative delays in the closure of programmes 6.17 - 6.18

The control system 6.19 - 6.20

Observations concerning programmes and measures that were closed 6.21 - 6.37

Reliability of final payment claims 6.21 - 6.30

Taking account of factors influencing the closure of programmes 6.31 - 6.33

Quality of final reports 6.34 - 6.37

Conclusion 6.38 - 6.42

The implementation of measures in favour of undertakings, SMEs in particular, in the context of the ERDF 6.43 - 6.104

General framework of measures in favour of SMEs 6.43 - 6.52

The Court's audit 6.43

The role and importance of SMEs 6.44

The definition of SMEs 6.45 - 6.47

Interventions in favour of SMEs in the regional sector 6.48 - 6.52

Support for the activities of undertakings 6.53 - 6.71

Support for aid schemes 6.53 - 6.59

Concurrent drawing and overlapping of aid 6.60 - 6.63

Compliance with the rules on competition 6.64 - 6.66

Industrial estates and technology parks 6.67 - 6.68

Services offered to SMEs 6.69 - 6.71

Support for the financing of businesses 6.72 - 6.80

Gaining access to capital 6.73 - 6.76

Obtaining loans 6.77 - 6.80

The implementation of measures 6.81 - 6.85

The SME initiative 6.86 - 6.91

The assessment of the impact of measures in favour of undertakings on regional development 6.92 - 6.95

Conclusion 6.96 - 6.104

INTRODUCTION

6.1. This chapter, which concerns the regional sector, looks at the following:

(a) budgetary implementation for the financial year 1996, with specific reference to the financial implementation of the new Objective 6;

(b) the procedures and operations for the closure of the forms of intervention;

(c) the implementation of measures in favour of businesses (in particular small and medium-sized businesses (SMEs)) in the context of the European Regional Development Fund (ERDF);

FINANCIAL AND BUDGETARY DATA

Budgetary implementation

6.2. Table III.1 shows the utilization of ERDF commitment and payment appropriations in 1996. They were utilized at a rate of 99,8% for commitments and 99,5% for payments (as against 99% and 87% respectively in 1995). Commitments for Structural Fund measures lasting more than two years were generally implemented in annual tranches(235).

6.3. Table 6.1 shows the monthly breakdown of commitments and payments relating to appropriations for the regional sector during the 1991-96 period. For the financial year 1995, the Commission justified the concentration of budgetary operations at the end of the year on the grounds of the late implementation of the new programming period(236). However, the data indicate that in 1996 this phenomenon was still persisting because 60% of the amounts committed and 49% of the amounts paid out under the financial year were committed and paid out during the last quarter of 1996, and two thirds of these were concentrated in December. Under conditions of this sort the process of appraisal, including controls, of the files concerning payments made and commitments entered into during the last quarter runs the risk of not being able to take adequate account of the principles of legality, regularity and sound financial management. The share of final payments, including all the tranches, amounted to 14,5% for the whole year and 20% for the final quarter. These proportions were normal, taking into account the fact that the advances paid out generally reached the limit of 80% of each commitment provided by Article 21 of Regulation No 4253/88.

The new Objective 6

6.4. Protocol 6 to the Act of Accession of the new Member States(237) created a new objective (O6), which consisted in promoting the development and structural adjustment of regions with a population density of eight inhabitants per km2 or less. This protocol lays down a list of regions affected by O6 and gives an indicative breakdown of commitment appropriations from the Structural Funds (SFs) and the Financial Instrument for Fisheries Guidance (FIFG), which, for the 1995-99 period, amounted to 511 Mio ECU for Finland and 230 Mio ECU for Sweden.

6.5. The Commission adopted only one single planning document (DOCUP) for each of the Member States, covering all of the regions that were totally or partially eligible for O6 (11 July 1995 for Finland (eight regions) and 6 November 1995 for Sweden (six regions)). The financial contributions from the SFs and the FIFG included in the DOCUPs amounted to 459,9 Mio ECU for Finland and 252 Mio ECU for Sweden (172,5 Mio ECU and 122,64 Mio ECU respectively from the ERDF). The difference between these amounts and the indicative amounts given in Protocol No 6 can be explained by the 9% deductions for Community initiatives and 1% deductions for projects under Article 10 of the ERDF Regulation, as well as by a transfer of 50 Mio ECU from Objectives 2 (O2) and 5b (O5b) to O6 in Sweden. In addition, in May 1995 15,8 Mio ECU of additional funds were transferred from other objectives to Community initiatives in the Finnish 06 regions.

6.6. In accordance with Article 4 of Protocol No 6, the legal provisions concerning Objective 1 (O1) are applicable to O6, even though the characteristics of the regions concerned are different. By way of example, in the O6 regions no funding for infrastructure expenditure was decided on, whereas in O1 regions 31,2% of the share of SF contributions was devoted to expenditure of this type.

6.7. The Court's examination of the financial implementation of the ERDF contribution provided for in the Finnish DOCUP shows that, in addition to the first (automatic) advance of 11,2 Mio ECU, a second advance of 6,72 Mio ECU was paid out in August 1996 on the basis of an amount of approximately 9,3 Mio ECU in substantiated expenditure. The amounts for eligible expenditure provided for the 1995 and 1996 tranches amounted to 44,8 Mio ECU and 61 Mio ECU. Expenditure carried out as of 31 December 1996 amounted to around 28 Mio ECU. With regard to the Swedish DOCUP, only the first (automatic) advance of 10,93 Mio ECU had been paid out in December 1995. As of 31 December 1996 no claims had been submitted and the expenditure carried out amounted to 1,8 Mio ECU, whereas the amount for eligible expenditure earmarked 1994 and 1995 was 42,22 Mio ECU and 44,21 Mio ECU respectively.

6.8. The delays observed in the two Member States were the result of the approval dates, the amounts laid down and implementation plans that turned out to be unrealistic in view of the fact that the measures were new. In Sweden, these deadlines may also be explained by the creation of a new system of regional monitoring committees and agencies responsible for collecting and distributing Community funds with as yet unspecified operating procedures, and by the fact that the payments were carried out on the basis of substantiated expenditure and not in the form of advances. The first payment by the Member State to a final beneficiary only took place in July 1996.

THE CLOSURE OF INTERVENTION SCHEMES

General background

Data concerning closure

6.9. The closure of ERDF co-financed interventions currently involves forms of intervention that are decided on in the context of Community support frameworks (CSFs) and Community initiatives (Cls) concerning the 1989-93 programming period, as well as interventions decided on before the 1988 reform of the SFs, these being non-quota (NQ) measures, national programmes of Community interest (NPCls), integrated development operations (IDOs), integrated Mediterranean programmes (IMPs), Community initiative programmes (CIPs) and projects governed by Regulation (EEC) No 1787/84(238).

6.10. The outstanding commitments concerning all these interventions amounted to 4 658,9 Mio ECU on 31 December 1995 and 3 286,1 Mio ECU on 31 December 1996.

6.11. This being the situation, the most important group of measures concerns the forms of intervention decided on after the 1988 reform, in the context of the CSFs and Cls for the period 1989-93(239). The amount still to be settled was 3 259,4 Mio ECU on 31 December 1995 and 2 524,3 Mio ECU on 31 December 1996, corresponding respectively to 11,4% and 8,8% of the 28 597,5 Mio ECU of commitments entered into during the financial years 1989 to 1995(240)(241), of which 362,8 Mio ECU had been cancelled and 24 975,4 Mio ECU disbursed by 31 December 1995. During 1996 42,5 Mio ECU and 689,9 Mio ECU respectively were cancelled and disbursed. In terms of numbers, the unsettled balances on 31 December 1995 and 31 December 1996 corresponded to respectively 753 and 613 measures still to be closed, compared with a total number of measures initiated of about 800. Of the 78 O2 measures concerning the 1989-91 period, 41 had not been closed on 31 December 1996. The unsettled balance represented, in broad terms, the balance of the last annual tranche of measures (i.e. 20% in general of this last tranche)(242).

6.12. As regards interventions co-financed by the ERDF in respect of which the initial co-financing decisions had been taken before the 1988 reform, the unsettled balance (1 399,5 Mio ECU on 31 December 1995 and 761,8 Mio ECU on 31 December 1996) concerned:

(a) NQ measures, IDOs, IMPs, NPCIs and CIPs (496,9 Mio ECU on 31 December 1995 and 384,5 Mio ECU on 31 December 1996); the unsettled balances concern:

- commitments entered into against the budget headings relating to CSFs B2 1200, 1201 and 1202 (287,8 Mio ECU on 31 December 1995 and 240,6 Mio ECU on 31 December 1996);

- commitments entered into against the budget headings specific to these measures (209,1 Mio ECU on 31 December 1995 and 143,9 Mio ECU on 31 December 1996);

(b) projects decided on by the Commission before 1 January 1989 under the ERDF and subject to the automatic cancellation provisions set out in Article 12 of the modified ERDF Regulation (842,4 Mio ECU on 31 December 1995 and 325,5 Mio ECU on 31 December 1996);

(c) projects adopted by the Commission in 1989 but governed by the old Regulation (EEC) No 1787/84 and not subject to the automatic cancellation provisions (60,2 Mio ECU on 31 December 1995 and 51,8 Mio ECU on 31 December 1996).

6.13. Table 6.2 shows the movements during the financial year 1996 of commitments still outstanding by budget heading (6.2.A) and by Member State (6.2.B), except for individual projects decided on on the basis of the old Regulation, for which the corresponding figures are given in Table 6.3(243).

The legal and administrative background to interventions decided on after the reform in the context of the CSFs and Cls

6.14. At Member State level, most of the legal and financial commitments under these measures had to be implemented before the deadline of 31 December 1993(244) except where an extension was granted. As a rule, the Member States have two years from that date to carry out the payments to the final beneficiaries. In the following six months, they have to forward the documents required for the closure of the measures, in particular, applications for the payment of balances and final implementation reports(245). Subsequently, the Commission has to pay the balance of the aid within a deadline that normally does not exceed two months as from the receipt of eligible applications(246). For all the measures, the application of these provisions therefore established 31 August as the closure date, with the exception of O2 measures. These were covered by two planning periods (1989-91 and 1992-93), the closure in respect of the first period being set at 31 August 1994.

6.15. The Commission may nevertheless extend the commitment and payment deadlines at the request of a Member State where the said request is submitted before the expiry of the deadline and is duly substantiated. In 1995, DG XVI adopted principles ensuring that a common approach would be applied in this context. For commitments, acceptable extensions were a maximum of 12 months as from the initial deadline for the commitments. For payments, acceptable extensions were defined as a maximum of 36 months as from the initial deadlines for the commitments. On this basis, following numerous applications for the extension of deadlines for commitments and/or payments, the Commission granted extensions allowing payments to final beneficiaries and Commission payments to the Member States to be implemented as late as 1996 and 1997. For Italy, the O1 programmes for the 1989-93 period were covered by a special arrangement that postponed the dates to 1997 and 1998(247) for some interventions.

The Court's audit

6.16. The aim of the audit of the closure of the 1989-93 programmes was to verify whether procedures complied with the principles of legality, regularity and sound financial management. Audits were carried out at the Commission and in five Member States (Spain, France, Ireland, Portugal and the United Kingdom). Given the delays in the closure operations, the Court selected operations that enabled it to appraise the working of procedures that had already been implemented. Given this background, this report can only contain an initial series of observations.

General observations

Administrative delays in the closure of programmes

6.17. Independently of any inherent difficulties that might exist with regard to planning new measures, administrative delays in the closure of programmes for the 1989-91 period in relation to the dates initially planned were partly due to the fact that certain Member States did not forward the necessary documents by the deadline of six months following implementation provided in the Regulations. The Regulations do not provide any penalties in these cases and the Commission had no means of inducing the Member States to comply with them.

6.18. Furthermore, the Member States' policies for clearing commitments were not active enough. This was also the result of the overlapping of different planning periods, which made administration very unwieldy.

The control system

6.19. In accordance with Article 23 of Regulation 4253/88, the Member States must take the necessary steps to verify regularly that the measures financed by the Community have been carried out correctly. The Commission is also entitled to carry out on-the-spot checks with regard to co-financed measures, in particular by sampling. It may also ask the Member States to carry out on-the-spot checks to verify the regularity of the payment applications. So far the Commission and the Member States have carried out or insisted on checks in connection with the closure only in exceptional cases, and the Commission has not introduced any systematic procedures for the implementation of the option of carrying out such controls, or having them carried out, with a view to examining the reliability of the documents on the basis of which the programmes are closed.

6.20. An effective control is indispensable in order to esure that the Commission's payments are legal and regular(248). Such checks ought, in principle, to be included in the more general context of the management and control systems used in the Member States and by the Commission. The draft implementing regulation for Article 23(1) of Regulation No 4253/88 thus rightly provides for the introduction of reliable management and control systems in the Member States, along with the coordination of the Commission's and the Member States' control programmes so as to optimize the use of the resources allocated to these controls at the national and Community levels. In this way the Commission would be able to check the reliability of the national systems. Regarding the measures and programmes not yet closed which were decided on under the old regulations and during the 1989-93 programming period, they should nevertheless be subjected to substantial controls in coordination with the Member States as the management and control conditions envisaged in the draft implementation regulation have not at present been satisfied.

Observations concerning programmes and measures that were closed

Reliability of final payment claims

6.21. The Member States' claims had to be drawn up on the basis of eligible expenditure which had actually been carried out by the final beneficiaries and for which supporting documents existed. This requirement was not always complied with. The problems observed concerned:

(a) justification of the expenditure declared at the level of designated authorities and managers (including the problem of the inadequacy of the expenditure declared to pay all of the amount claimed);

(b) justification of the expenditure at final beneficiary level;

(c) the eligibility of the expenditure.

Justification of expenditure declared at the level of the designated authorities and administrators

6.22. In Ireland, the lack of any form of financial control check or procedure by both the implementing departments and the designated authority on expenditure returns has been a reported audit finding of both the Court and the Commission services for a number of years, as evidenced by the high instance of irregularity found in the payment claims. The lead department for the industry and services multi-fund programme (MOP) 1989-93, which was the primary vehicle through which ERDF funding for industrial development was channelled in Ireland (589,2 Mio ECU ERDF funds) was unable to fully justify the expenditure amounts included in the last declaration of expenditure submitted to the Commission. Some official documents retained by the department as justifying the final declaration amounts had been written in pencil, altered using correction fluid or merely cancelled without explanation.

6.23. An examination of the CI Telematique (1991-93) in Ireland revealed that it was not possible to obtain a breakdown of the expenditure amount as presented in the last declaration (21,1 Mio ECU) down to project level, as an exact analysis of eligible expenditure by measure and project did not exist. The same problem was found concerning the CI Stride (1991-93) (expenditure declared: 18,2 Mio ECU). In addition, half of the expenditure concerning a project co-financed under the CI Telematique (1991-93) establishing a network linking six university libraries could not be audited owing to unavailable documentation. A grant of ECU 379 104 was paid.

6.24. With regard to the Basque country (E) O2 OP (1981-91), it was impossible to reconstitute the details of the amounts declared for measure 1.4 'Aid to SMEs` (26,76 Mio ECU).

Justification of expenditure carried out at final beneficiary level

6.25. The final claim concerning the Objective 2 (O2) OP 1990-91 for the East Midlands (UK) included approved expenditure of 6,76 Mio ECU for the construction of a street link. According to the request for the final grant payment presented by the final beneficiary, eligible expenditure reached 6,30 Mio ECU. Furthermore, this expenditure apportioned salary costs of 0,21 Mio ECU for which no justification or supporting documentation was available.

6.26. The original approval concerning the development of an industrial park under the same OP foresaw a two-phase scheme, but the project was subsequently amended and developed as a single phase. For this reason the approved expenditure of 0,98 Mio ECU was revised down to 0,67 Mio ECU. This modification had not been taken into consideration in the final declaration of expenditure submitted to the Commission. The declaration of expenditure concerning the development of a 'tourist trail` co-financed under the same OP was based on the total approved expenditure of 0,70 Mio ECU. According to the claim for final grant payment, eligible payments made by the sponsor only reached 0,62 Mio ECU (difference of 13,5%). In total, according to the results of the audit of a sample of projects of the same OP, the eligible cost certified to the Commission should be reduced by 1,32 Mio ECU. This represents 12,45% of the total cost declared for the seven projects concerned or 2,4% of the final declared expenditure.

Eligibility of the expenditure

6.27. In certain cases, complying with the legal formalities prior to the implementation of a project involves missing the deadline for eligibility. A case of this type was observed in Ireland in the creation of a business innovation fund managed by a semi-public company, which was to be financed under the MOP - ineligible expenditure amounted to 0,90 Mio ECU. Another case involved an urbanization project for a new industrial estate under the Basque country Resider CI (1990-91) under the responsibility of the local authorities, with ineligible expenditure amounting to 0,6 Mio ECU.

6.28. Expenditure (about 1 Mio ECU) was found to have been incurred after the deadline for the closure of the Basque country (1989-91) O2 OP.

6.29. The final claim concerning the CI Envireg Northern Ireland (UK) (1991-93) included the cost of two phases of a sewerage project. As the second phase was delayed until after the last payment date, this expenditure (144 946 ECU) was not eligible under the Envireg programme. Furthermore, the expenditure incurred concerning the second phase has been included in the 'single programming document (SPD) Objective 1 for Northern Ireland 1994-99` thus resulting in a double financing of the project. For another sewerage project the final cost declared exceeded the eligible expenditure by 215 825 ECU, again due to non-respect of the last payment date. For an environmental project, expenditure declared was found to be the amount originally approved and not the amount actually incurred (excess of 46 916 ECU). Overall, the Court's audit found the eligible cost certified should be reduced by 407 687 ECU. This represents 1,6% of the certified expenditure.

6.30. Another project involving a centre for skilled trades in Spain (about 4 Mio ECU) was not implemented. It was replaced by the construction of the computer centre for the body responsible for the implementation of the project. This change in intended use was reported to neither the Monitoring Committee nor the Commission and the expenditure for the computer centre was declared as referring to the centre for skilled trades. This is all the more worrying because the further enlargement of the computer centre (not included in the OP) led to accusations of presumed fraud (forged invoices) that in turn resulted in legal proceedings.

Taking account of factors influencing the closure of programmes

6.31. When the programmes were closed, the Member State and the Commission were required to take into account all the necessary factors (results of audit reports, findings concerning non-eligible expenditure, availability of supporting documents for expenditure incurred, reliability of the registration systems used by the authorities designated by the Member States and the final beneficiaries, etc.), so that, where applicable, they could make the necessary adjustments in order to guarantee the legality and regularity of final payments. The following examples illustrate the problems found in this field.

6.32. In Ireland, the industry OP (1989-93) was closed at the end of 1994, despite the reserves that the Financial Controller expressed to the management departments with regard to the reliability of the financial information system of the two specialized agencies. The payment was authorized on the basis that the Financial Control department reserved the right to ask for a recovery under Articles 23 and 24 of Regulation 4253/88 if necessary. The observations on the OP were only communicated by Financial Control in December 1995, at which time Financial Control stated that in the event of non-receipt of a satisfactory reply to their queries within two months, no further payments would be approved on the industry OP (1994-99). Consequently, the national authorities commissioned an independent auditor to reconcile the published accounts of the two agencies with the annual claimed expenditure. The audit resulted in the opinion that 'the system appears to be structured so as to provide an adequate reconciliation`. While this was accepted by the Commission, it was not possible for the Court to trace within a reasonable time the expenditure from the agency's grant payment system to the annual claimed expenditure, as no systematic reconciliation took place.

6.33. The government office (GO) for the East Midlands asked the Commission to calculate the amount recoverable from an ERDF assisted project which had subsequently been sold. This amount was then repaid by the beneficiary to the GO. However, less was recovered by the Commission than should have been the case. Furthermore, the final declaration of expenditure and corresponding claim as prepared by the GO had not taken account of the sale of the project. Thus, the declared expenditure exceeded the eligible expenditure by 0,2 Mio ECU. In addition, although having informed the GO of its intention to recover the amount from the final programme payment, the Commission failed to do this.

Quality of final reports

6.34. In the absence of specific instructions concerning the contents of final reports in Article 25(4) of Regulation 4253/88, the Commission attached procedures for monitoring and assessment to its decisions concerning the granting of ERDF aid. These provided that final reports should give a concise survey of the implementation of the programme and an exhaustive account of the realization rate for the physical and qualitative objectives laid down at the outset. Moreover, a preliminary economic impact assessment was to be carried out on the basis of predefined indicators.

6.35. In June 1995, the Commission established a pro forma document which Member States are expected to follow during the programming period 1994-99. For the period 1989-93 no such document was developed. Instead, each Monitoring Committee had to decide on the structure and content of the final reports. This resulted in a situation where the quality of the final reports being submitted to the Commission differed widely.

6.36. The contents of many final reports presented fell short of the abovementioned requirements and thus could not allow conclusions on the results of the programmes to be drawn. They are often limited to a description of the activities financed. Furthermore, in certain cases the financial information contained does not support the amounts in the final claim. This created delays in the closure, as the Commission had to refer back to the Member States for clarification.

6.37. For example, the final declaration of expenditure concerning the O2 OP East Midlands (1990-91) was sent to the Commission on 29 June 1995 within the deadline of six months. Due to discrepancies between the figures on the financial implementation contained in the final report and the revised financial plan relating to the OP, the Commission sent on 23 August 1995 a letter to the British authorities asking for clarification. On 14 November 1995 the government office sent a detailed reply and asked twice whether the information was sufficient. The Commission finally informed the Member State that it had approved the documents end of April 1996 and executed the closure in June 1996. This was one year after the final declaration was presented. A similar situation has occurred concerning the closure of the East Midlands Rechar programme (1990-93) where the final declaration of expenditure was presented in June 1996. Approval by the Commission was still outstanding at 31 December 1996.

Conclusion

6.38. The planning of the majority of the co-financed measures was modified, which often resulted in the extension of commitment and payment deadlines in the Member States. Their closure was therefore significantly delayed, thus extending the different planning periods and making administration very difficult. This also complicated matters with regard to the launching of the new measures. The Commission should carry out a more active settlement policy and a stricter policy as regards extending deadlines for commitments and payments at a national level (see paragraphs 6.11 to 6.15 and 6.17 to 6.18).

6.39. The absence of specific checks by the Commission and the Member States in connection with closure and the inadequate quality of the supporting documents for the final claims explain the numerous problems of legality and regularity found with regard to closed measures. The Commission and the Member States should set up a partnership involving real systems of verification in order to guarantee that expenditure declarations are reliable. The information systems underlying these declarations should also allow both national and Community audit authorities to follow the audit trail, linking the Community payment to the expenditure incurred by the final beneficiaries via the various levels of data collection and certification.

6.40. The characteristics of the management of the SFs involve the payment of significant sums in the form of advances against the realization of part of the measures planned. Consequently, it is at the moment of the payment of the balance that any ineligible expenditure in the declarations forwarded by the Member States risks being definitively financed by the Community budget. The Court found ineligible expenditure of this sort in its statement of assurance audits, This is why effective verification systems are indispensable at the level of the closure of the forms of intervention. Nevertheless, the verification of the eligibility of expenditure must be of a continuous nature, in particular with regard to the payment of the balances of the annual tranches.

6.41. With regard to the anomalies found by the Court and communicated to the Commission (see paragraphs 6.22 to 6.33), in accordance with Article 24 of Regulation No 4253/88 (amended), the Commission should carry out appropriate investigations and, where applicable, recover the amounts unduly paid out.

6.42. The majority of the final reports submitted to date contain essentially no more than a description of co-financed measures, even though effective assessment is indispensable for the purpose of evaluating and even strengthening the success of the cohesion policy. For this reason, the Commission should ensure that these final reports give a general view of the implementation of the programme concerned, analyse exhaustively the degree of realization of the physical objectives laid down at the outset and contain an initial assessment of the immediate economic impact on the basis of predetermined indicators (see paragraphs 6.34 to 6.37).

THE IMPLEMENTATION OF MEASURES IN FAVOUR OF UNDERTAKINGS, SMEs IN PARTICULAR, IN THE CONTEXT OF THE ERDF

General framework of measures in favour of SMEs

The Court's audit

6.43. In 1996, the Court carried out an analysis of Community measures on behalf of SMEs. In its Annual Report concerning the financial year 1994, it looked at aid to SMEs on the part of the European Social Fund (ESF) and the enterprise policy managed by DG XXIII(249). The audits, whose results are given in this chapter, concerned the measures implemented in the context of regional policy. They were carried out on the basis of samples designed to enable an appraisal of the financial management of the measures in 13 Member States (Belgium, Germany, Greece, Spain, Finland, France, Ireland, Italy, the Netherlands, the United Kingdom, Sweden and Austria) and at the Commission. This report also looks at SMEs in the fields of research and technical development (Chapter 10), and the European Social Fund, chiefly in connection with the ADAPT Community initiative (Chapter 7) and the MEDIA action programmes (Chapter 11).

The role and importance of SMEs

6.44. Article 130 of the EC Treaty, as amended by the Treaty on European Union, provides that the activities of the Community and the Member States 'shall be aimed at ... encouraging an environment favourable to initiative and to the development of undertakings throughout the Community, particularly small and medium-sized undertakings`. The decisive role of the SMEs in job creation and, more generally, as a factor of social stability and economic dynamism is now recognized and it was one of the constant themes in the conclusions of the presidencies of the last European Councils(250). The importance of SMEs in the European economy is shown by the fact that 99,8% of the European Union's undertakings employ fewer than 250 people, representing 66,5% of all jobs. The turnover of these undertakings constitutes 64,7% of overall turnover(251).

The definition of SMEs

6.45. In the context of the ERDF, where there is no legal definition of SMEs, a definition of the beneficiary undertakings on the basis of the objectives of each measure and the economic structures of the regions concerned should have been established within the partnership system. This would have made it possible to increase the efficiency of Community intervention. In actual fact, there is often no definition of beneficiary SMEs and, where one exists, it is often not selective. This was the case where only the number of employees (set at 500) was taken into account and there was no criterion of financial independence from large undertakings. Furthermore, any definition of SMEs loses its usefulness when the reference to SMEs in the regulations is preceded by the word 'in particular`, which broadens the field of intervention so as to include all undertakings.

6.46. In 1992, the Commission adopted the Community-wide framework for aid to SMEs(252), which lays down criteria defining SMEs in the field of competition policy. However, previous aid schemes were not always adapted and the Commission approved new schemes that did not comply with this definition of SMEs. This was found to be the case in the Wallonian region (B), where large undertakings benefited from advantages that were reserved for SMEs.

6.47. In April 1996, the Commission adopted a recommendation(253) addressed to the Member States, the EIB and the EIF concerning the definition of SMEs to be used in Community policies. Here, SMEs were defined as undertakings employing fewer than 250 persons with an annual turnover of up to 40 Mio ECU or a balance sheet total of up to 27 Mio ECU, and with less than 25% ownership by large businesses (see paragraphs 6.6 and 6.7 and Table 10.3 of the 'Research` chapter and paragraph 11.13 of the 'Industrial policies MEDIA` chapter). It should be noted that this recommendation provides for the possibility of not adopting the number of staff as the only criterion for the implementation of certain policies. As most of the interventions for the 1994-99 period (in particular for Objective 1 (01)) had already been approved, the short- term effects of this recommendation could only be minimal. Moreover, the limits set represent maximum numbers. Lower levels should be set where measures are directed towards a precise category of SMEs.

Intervention in favour of SMEs in the regional sector

6.48. In the field of measures in support of regional policies related SMEs, traditional forms of intervention were still dominant. The latter may be divided up into two categories: financing the supply of tangible services (industrial estates, breeding-grounds for undertakings etc.) or intangible services (technical assistance, financial engineering etc.) and support for regionally oriented aid schemes. Global subsidies are also a distinctive form of intervention in that intermediate bodies are charged with sharing them out amongst final beneficiaries in the form of individual subsidies. Furthermore, SMEs were able to benefit from innovative forms of intervention like, for example, the setting-up of business and innovation centres and the creation of seed capital funds. Moreover, in June 1994, the Commission set up a new Community initiative, concerning the adaptation of SMEs to the single market(254), with 1 000 Mio ECU from the SFs for the 1994-99 period.

6.49. As measures in favour of SMEs were not grouped together within the single planning documents (DOCUPs) or the CSFs, there was neither an inventory of measures in favour of SMEs nor a statement of the amounts provided or allocated for financing them, with the exception of the SME IC. For this reason, the Commission did not know, even approximately, how much money was spent on SMEs. It was only able to put forward estimates in its various reports. For example, the seventh report on the SFs(255) states that an average of 10% of ERDF resources were specifically allocated to measures in favour of SMEs, which, in 1996 would have represented an amount of around 1 200 Mio ECU. A percentage of the aid for SMEs, whose size could not be established, was in the budget provided for in the Objective 1 CSFs and DOCUPs for measures for the development of the productive environment in industry and the service sector. For the 1994-99 period, this budget amounts to 16 088 Mio ECU, or 17,1% of the total for all the SFs. Only in 1996 did the Commission decide to make a call for tenders to draw up an inventory of all the ERDF measures aimed at providing aid for SMEs in the assisted regions.

6.50. In some regions, efforts were made (sometimes supported by the ERDF) to draw up inventories of all these measures, their administrators, the relevant aid conditions and the implementing conditions. These efforts led to the publication of guides containing data whose exhaustiveness was not guaranteed - in particular for Community aid.

6.51. The existence of numerous ERDF interventions in the recipient regions (up to more than 100 measures for around 20 programmes that overlapped in time and content) resulted in a complex range of measures in favour of SMEs, to which the many different sources of direct and indirect funding of Community, national, regional or local origin must also be added.

6.52. Thus, the SMEs often needed to go to consultants for information concerning the existence of aid and the very variable conditions and formalities related to its allocation and also for help in preparing the files for submission to the administrators. The cost of these services reduced the aid actually received by a corresponding amount and made it more difficult for smaller undertakings to gain access to it.

Support for the activities of undertakings

Support for aid schemes

6.53. In the context of the ERDF, there were two possibilities for supporting existing or newly created schemes in aid of undertakings that were implemented in the Member States. The first, which is provided for in Article 5 of Council Regulation (EEC) No 2052/88, as amended by Regulation No 2081/93, was to use the specific form of intervention involving the co-financing of the aid schemes. The second was to give this support via operational programmes and global subsidies.

6.54. Only the latter possibility was utilized. The result was that the procedures set up enabled administrators to choose which projects to include in the various OPs or global subsidies among all the projects financed in the context of the national aid schemes. Therefore, monitoring, auditing and assessment were limited only to the chosen projects. In the event that, for certain projects that were selected, the aid conditions were not complied with, a simple substitution enabled the situation to be put in order.

6.55. The aid schemes could either have regional aims or be directed specifically at SMEs. In the former case, all undertakings established in the eligible areas could receive aid. Even where the texts of the OPs recognize, in general, that priority must be given to SMEs, this was not always taken into account in the selection of projects - the Member States applied the legal framework of the aid schemes, which did not necessarily provide for differentiated treatment according to the size of the undertakings. In the second case, even where the aid schemes in question were specifically for SMEs, the legal framework could allow for certain exceptions or derogations enabling the financing of undertakings of any size.

6.56. A particular situation arises where a regionally based scheme for aid to undertakings is provided for within an OP under a measure aimed specifically at SMEs. For example, in Italy, in the context of a regionally based aid scheme, large undertakings benefited from ERDF co-financing in the context of the industries and services OP under the 'aid for investments and innovation for industrial SMEs`.

6.57. In a given region, a national aid scheme may receive financial aid from different programmes or even funds. In this case, the charging of projects to each programme was only carried out on the basis of eligibility dates, the relevant budgets, the specific subjects and the areas of eligibility. Moreover, projects were transferred from one intervention scheme to another, thus casting doubt upon the rigour of the planning.

6.58. For example, the 1993 projects for a Spanish aid scheme in receipt of ERDF support were transferred in May 1994 to the Cohesion Fund. When the Court carried out its audits, it considered it inappropriate for the Cohesion Fund to have financed this scheme. The Commission, whilst it considered that the aid scheme was eligible for finance from the Cohesion Fund, subsequently decided that this fund was not the most appropriate instrument for financing the projects in question. As of 1995, the scheme benefited retroactively from ERDF support, following a decision of December 1996.

6.59. Because of these practices, the final beneficiary was either not always aware of what co-financing he was receiving or was only informed when the funds were paid out. This was also the case where the Member States' paying systems led to the utilization of Community funds for the financing of all the payments corresponding to certain projects and national funds for all those corresponding to others (alternate financing). Generally speaking, the rules on information and publicity(256) were not often complied with and, in several cases, the beneficiaries only found out about the Community intervention when the Court carried out its audits.

Concurrent drawing and overlapping of aid

6.60. It often happened that a given project benefited from aid from various sources. This means that there needs to be greater coordination between the relevant administrators in order to guarantee compliance with the rules on the concurrent drawing of aid and overlapping. Where coordination procedures did exist, they were often limited to the departments of a given administrative body or the sector of activity and did not have the verification of compliance with these rules at individual project level as their main aim. This was mainly carried out on the basis of the declarations and financing plans submitted by the beneficiaries, whose accuracy was not always checked.

6.61. For example, in Spain, for an investment project costing a total amount of 4 Mio ECU, an undertaking received funds amounting to 2 Mio ECU from seven different national and Community sources, including the ERDF. One of these aid grants, amounting to 1,2 Mio ECU, came from the LIFE financial instrument, which is not compatible with the SFs(257). As it was direct Commission aid, the competent national authorities felt that the Commission should have informed them. This file has yet to be regularized.

6.62. Moreover, it was difficult to draw a dividing line between the fields of intervention of the various SFs. Intervention for investments linked to the marketing and first-stage processing of agricultural and forestry products came under EAGGF-Guidance, whereas further processing of the same products was covered by ERDF(258). As eligibility conditions and co-financing rates were different in the two funds, the decision whether to allocate a given investment to one fund or the other was not unbiased. In one case, the construction of a building was financed by the ERDF and its depreciation was financed by the ESF, as was observed in the region of Flevoland (NL).

6.63. The procedures implemented for certain aid schemes enabled the ERDF to finance EAGGF projects to which ERDF rules had been applied. Cases of this sort were found by the Court in the regions of Murcia (E), Calabria (I) and Crete (EL). There needs to be a clearer definition of the fields of intervention, and this must be accessible to all participants, in particular with regard to the notion of first-level processing, which is not always easy to understand.

Compliance with the rules on competition

6.64. Measures in receipt of ERDF funding must comply with Community competition policy(259). It is the Commission's responsibility to ensure that each aid proposal complies with Articles 92 and 93 of the Treaty. If aid has not yet been approved, the Member State may not implement it. In these cases, the approval of Community aid contains a suspension clause, which must be accompanied by a reduction in the corresponding commitments and payments. However, the Court found a case for which the Commission departments had decided not to apply the commitment reduction clause provided for.

6.65. The rules on competition must also be complied with during the implementation of Community interventions. Thus, checks must be made on the maximum rates for aid authorized, the notification of individual cases of aid concerning sensitive sectors(260), the conditions laid down for the approval of the various aid schemes and whether or not an aid scheme is applied as notified. However, regional administrators of Community interventions did not always have a good knowledge of the complex rules and procedures concerning competition.

6.66. Among the cases found during the on-the-spot checks, the following example illustrates the inadequacy of the procedures for checking competition rules. Equal parts of a total amount of 24 Mio ECU were granted in national and ERDF aid to an undertaking in Lorraine (F). Following a judgment of the Court of Justice(261), the Commission decided, in January 1995, that part of the aid (4 Mio ECU) was illegal and incompatible with the common market. Because payments had already been made to the undertaking, it had to repay about 100 000 ECU in January 1996. However, in the March 1996 declaration of expenditure, this amount of 100 000 ECU was still on the list of eligible expenditure incurred. The undertaking had also received further national aid amounting to the equivalent of 6 Mio ECU, which was not taken into account for the calculation of the amount to be repaid.

Industrial estates and technology parks

6.67. ERDF co-financing of the costs of the development of industrial estates and the creation of technology parks clashes with the rules of competition policy and the objectives of regional policy. Actually, with the exception of authorized exceptions, industrial estates must be made available to undertakings at market prices. Because of this, the real beneficiary of the aid is the developer. Where aid is all or partly passed on to the sales price, this reduction is a form of State aid whose allocation procedures must be authorized by the Commission.

6.68. Businesses setting up in these estates could also benefit from ERDF aid, which paid for initial expenses. As a result expenditure for the purchase and development of land was included among expenditure declared for miscellaneous measures. Situations of this type should be avoided right from the planning phase in order to guarantee greater consistency and effectiveness in the Community interventions.

Services offered to SMEs

6.69. The ERDF participated in the funding of training measures and measures in support of the activities of SMEs as instruments for the development of the endogenous potential of the regions. As the Court had already stated on several occasions in its previous reports(262), the ERDF should give priority to financing demand corresponding to real needs expressed locally by the representatives of workers, management and the SMEs. The financing of the supply of services to SMEs was still significant and for a large percentage of these measures, declared expenditure corresponded to the financing of existing or newly created facilities, or even networks, and their operating expenses. In Lorraine, a newly created facility actually consisted of a simple physical grouping together of a number of regional public services and declared expenditure concerned the purchase of new buildings and office furniture. The current expenditure of public administrations is only eligible on certain conditions. The application of these eligibility rules may give rise to different situations in different Member States in accordance with the degree of public involvement in the management of economic development. Thus, in certain Member States it may encourage the transfer of the public authorities' activities to external bodies.

6.70. As some of these facilities did not have a sufficient amount of activity to be able to finance themselves, they could only survive if this type of aid were made permanent. This was the case, in particular, for the European Enterprise and Innovation Centres (EEICs)(263). These received aid during their launching phases and were subsequently required to look for additional funding - which often constituted their main activity. However, the Community programmes were still the main source of EEIC funding without there being any coherent approach behind this. It follows that their level of activity was directly related to the subsidies received and these subsidies were often justified as one-off allocations to the running costs of the EEICs. Keeping control of interventions in favour of the EEICs calls for strengthened control and coordination. Thus, in the context of a global subsidy, an intermediary body used ERDF funds to construct a reception building for companies. This intermediary had also received a Community subsidy to create an EEIC. The building was subsequently let to the newly created EEIC, which, in turn, declared the rent as an eligible item of expenditure.

6.71. In addition, the assessment of the results of the EEICs was entrusted by the Commission to the same undertaking that coordinated the EEIC network and which provided technical assistance for their members and the Commission. This undertaking carried out all its activities on the basis of agreements with the Commission, including a balancing subsidy. The result is that no independent evaluation of the activities of the EEICs has been carried out since they were set up in 1984.

Support for the financing of businesses

6.72. Current measures for the improvement of the financial environment of enterprises were designed on the basis of particular objectives, which explains the proliferation of independently implemented instruments. Despite this, SMEs always had problems in gaining access to capital and obtaining loans. The Commission felt that 'because of the inability of the traditional services offered by financial institutions to fulfil adequately the specific needs of a given type of undertaking, or a given undertaking in particular`, new techniques of financial engineering(264) had to be developed in the context of regional policy.

Gaining access to capital

6.73. The Commission supported numerous measures aimed at increasing the own capital of SMEs and facilitating their access to long-term financing. Various instruments with relatively complex technical characteristics were used (the creation of venture capital companies, acquisition guarantee funds, accompanying or participation funds, participating capital loans, seed fund promotion) (265). Generally speaking, the Community's intervention took the form of a subsidy which was granted to the beneficiary with a view to his participating in setting up or contributing to venture capital funds. Subsidies towards operating expenses were also granted. Given that the subsidies were not granted to the funds in question, the Commission was not, to date, involved either in managing the funds or in deciding how they were to operate.

6.74. Community support for this technique of financial engineering should have been accompanied by a precise definition of objectives and implementing procedures. However, important aspects were not always adequately specified. This concerned, in particular, the shareholding structure, the procedures for the selection of beneficiary undertakings, where they were situated, the funds' intervention procedures, the conditions for the utilization of financial results, operating expenses, the lifespan of the funds and the procedures for winding them up.

6.75. Deficiencies in the implementation of financial engineering measures were met with. For example, some shareholders of a cross-border venture capital company received Community aid amounting to 50% for several interventions, thus exceeding the rate of 30% provided for in the Regulation(266). The objective of this aid was to facilitate the SMEs' access to capital in an Objective 2 area. However, according to its articles of association, the venture capital company's objective was to gain a stake in any company carrying out an industrial activity within a range of about 200 kilometres around this area. Moreover, the Commission's conditions for not raising any objections from the point of view of competition were not complied with, in particular as regards the dominant position of private shareholders and the submission of annual reports.

6.76. Between 1990 and 1995, contributions had been allocated to a European association so as to guarantee the coordination of a network of seed capital funds. Instead of signing a contract for the provision of services, the Commission, every year, granted subsidies corresponding to 80% of the expenditure reported by the association. The subsidies were granted under two different budget headings managed by two different authorizing departments (DG XVI and DG XXIII). The amounts were decided in accordance with the amounts available under each of the headings on the basis of internal agreements. The subsidies were granted in the form of an agreement or letter of allocation for a given period, often at the end of the period in question or even behindhand. Also, they were not regularized file by file, but globally, as if it concerned a current account.

Obtaining loans

6.77. The low level of the SMEs' own resources, which often led to growing indebtedness(267) was the origin, on the one hand, of their difficulties in obtaining loans, and on the other hand, of the higher costs that they faced in terms of interest rates and the sureties that they had to put forward in order to gain access to those loans. ERDF intervention in this field mainly took the form of interest rebates in the context of measures under the OP or under global subsidies.

6.78. Global subsidies, which the Court discussed in its Annual Report concerning the financial year 1994(268), were managed by intermediaries who broke the amount down into individual subsidies, which could take the form of interest rebates. The global subsidies could not be used, as the Court found was still the case, to co-finance loans or compensate the intermediaries for losses in connection with the failure to repay loans that they had granted.

6.79. Agreements entrusting the administration of interest rebates to intermediaries should lay down, in a clear and detailed fashion, calculation and implementation procedures, as well as procedures for allocating funds to beneficiary undertakings and monitoring their obligations.

6.80. This was not always the case, as the following example shows. In Spain, in the context of a global subsidy of 210,6 Mio ECU adopted in November 1994 for the period between 1 January 1994 and 31 December 1999, the application agreement was only signed on 31 July 1995 although it added nothing to the decision. Moreover, the procedures for the application of the interest rebate by the intermediary body did not comply with the provisions of the agreement and amounts that did not correspond to payments to the SME beneficiaries were included in the declared expenditure. Moreover, under certain inadequately specified conditions, the failure on the part of the SMEs to repay loans led to the entry of the corresponding amounts, plus three months interest, among the eligible expenditure.

The implementation of measures

6.81. In addition to anomalies like those described in paragraphs 0.19 of this chapter, the Court's audits at the Commission and in the Member States concerning the implementation of measures in favour of undertakings revealed anomalies identical to those described time and time again in the Court's annual reports(269), special reports in support of the statement of assurance(270) and in the part of this chapter regarding the unreliable nature of final payment claims (see paragraphs 6.21 to 6.30). Similarly, the question of the inadequate attention given to the cost-effectiveness of revenue producing projects in the establishing of the co-financing rate, which was raised by the Court in its Annual Report concerning the financial year 1995(271) also arises in the context of measures in favour of SMEs.

6.82. The results of these audits were communicated to the Commission, which, in accordance with Article 24 of Regulation No 4253/88 (amended), was required to carry out an appropriate investigation under the partnership system and, where applicable, reduce or suspend Community aid. For example, in Italy, in the course of an audit of 14 specific projects, the Court found that two firms were already being investigated by the national administrative and legal authorities. For two other firms, the audit revealed irregularities which subsequently led to additional investigations on the part of the national authorities.

6.83. Where an undertaking that had already received some of the aid provided for the realization of a project did not implement it fully or did not comply with the conditions under which it had been granted, the amount paid out had to be totally or partially recovered and the corresponding amount deducted from the expenditure declarations. Often, either recovery procedures were not started or recovery was not possible, in particular because of the inadequacy of the required guarantees. Where recoveries were carried out, the amounts of expenditure declared were not always readjusted. In Spain around 9 Mio ECU, corresponding to amounts that had been recovered from the beneficiaries by the Spanish authorities, were only deducted from the declared expenditure following the Court's audit. Moreover, certain conditions, like the conservation of jobs, could only be checked several years after the closure of the programme concerned and there were no procedures for paying back this ERDF aid where applicable.

6.84. It was possible for individual projects to be totally financed by the ERDF, either because of the practice, for liquidity reasons, of alternative funding, because of the absence of Member State participation or because ERDF aid was intervening in parallel with national aid. These practices could result in the national rules not being applied and Community rules, in particular as regards State aid, also not being implemented. Where measures receive 100% ERDF funding, the Commission and the Member States should ensure that the procedures set up and their implementation should not be more flexible and national audit responsibilities should be clearly defined so as to avoid supervision being weaker or even inexistent.

6.85. The Court's audits once again showed that certain intermediaries systematically took a percentage of the aid as a management fee. This practice is against the provisions of Article 21(3) of Regulation No 4253/88, which states that payments must be made to the final beneficiaries without any deductions that may reduce the amount of financial aid to which they are entitled. The funding of administrative expenditure must comply with the principle that Community aid must be totally devoted to the financing of the expenditure of the beneficiaries. Where the financing of administrative expenditure turns out to be necessary, it must be provided for separately, and the amount and the nature of the expenditure must be verifiable.

The SME initiative

6.86. A Community initiative concerning the adjustment of SMEs to the single market was set up in June 1994 by the Commission with SF funds of 1 000 Mio ECU for the 1994-99 period. The Member States only had four months to put in their aid applications, an insufficient period to enable the regional and local players and the representatives of workers and employers to work actively together and identify their essential needs.

6.87. The consequence of this tight deadline was the submission of proposals that either put forward identical or similar measures to the ones in the CSFs or the DOCUPs or created new measures with the same objectives as the existing ones, which did not make it possible to clarify and simplify the situation or to render the strategy for granting aid to SMEs more coherent.

6.88. Table 6.4 shows, for each programme, the submission date by Member State, the date of approval by the Commission, the planned ERDF contribution and the implementation position as regards commitments, payments and expenditure as declared on 31 December 1996. In the majority of cases, the proposals were global ones drawn up at Member State level.

6.89. The six-month period provided for in the regulations for the Commission to approve aid decisions was rarely complied with. Thus, in the case of the two main programmes concerning Spain and Italy, adoption took 20 and 19 months respectively.

6.90. The appropriations allocated to this Community initiative were shared out among all the Member States on the basis of available statistical data, which did not make it possible to determine exactly the number of employees in the SMEs of the regions and areas concerned - the basic criterion for sharing out appropriations.

6.91. As of 31 December 1996, out of a total of 910,5 Mio ECU in ERDF appropriations allocated, 357 Mio ECU had been committed and 144,1 Mio ECU paid out to the Member States. Only one declaration of expenditure amounting to 3 Mio ECU had been submitted (by Germany). Nearly all the commitments and payments carried out corresponded to the amount for the first tranche and the first automatic advance. These financial data illustrate the significant delay in the implementation of this initiative, which contrasted with the speed originally planned.

The assessment of the impact of measures in favour of undertakings on regional development

6.92. The socioeconomic impact of the measures taken in favour of the SMEs can best be determined if, when they are adopted, objectives have been clearly defined, relevant quantitative and qualitative indicators have been established and ex ante appraisals have been carried out on this basis. Given that these appraisals were not satisfactory (as the Court had already pointed out(272)), the ex post assessments were compromised. Moreover, the selection of measures in favour of undertakings was not carried out on the basis of cost-effectiveness which would have enabled the adoption, among the various alternatives put forward, of those that were the most effective in terms of regional development.

6.93. Neither the Commission nor the Member States carried out many analyses of the socioeconomic impact of actual measures in favour of undertakings. Where they existed, they contained no more than elementary quantitative data like the number of undertakings assisted, the corresponding financial data, or the number of jobs created or preserved by the undertakings in receipt of aid. In actual fact, the latter data are the only ones used to measure the impact of the measures implemented on the development of the regions concerned.

6.94. Under these conditions, this partial approach does not make it possible to compare net job creation with what could have been achieved via the implementation of alternative measures. Moreover, the indicator chosen - the creation or preservation of jobs by assisted undertakings - must be used carefully if one wants to assess structural impact on the development of the regions and areas concerned. Indeed, given that aid is only one of the incentives in decisions to invest, it is the direct link between aid received and net employment created that must be measured. In numerous cases found by the Court, the decision to invest was prior to the decision to grant aid, and it was difficult to show that the aid was necessary for the promotion of the desired development. On the other hand, the immediate measurement, at the end of a programme, of the number of jobs created, must be reconciled with the high mortality rate for SMEs.

6.95. The following examples illustrate the difficulties found as regards the assessment of the impact of measures.

(a) the quantified data used in Flevoland (NL) at the planning stage were inconsistent as regards the number of SMEs. The same applied to the region of Merseyside (UK) as regards the data on businesses in receipt of aid;

(b) in a municipality in the Nord - Pas - de - Calais region (F), analyses of specific measures showed that 65% of the jobs that were created had been lost in a single year. Despite this, few changes were made in the measures in favour of SMEs-SMIs;

(c) in Ireland, the industrial development OP for 1994-99 included projects for which certain financing decisions went back to 1983. In Greece, delays in the payments to final beneficiaries of up to three years after the completion of the investments also endangered the assessment of the impact of the OPs on the period concerned;

(d) in several Member States and especially in Greece, as a result of unrealistic ex ante appraisals, innovatory measures in favour of SMEs had to be abandoned and replaced by other, more traditional measures;

(e) the assessments of the results of the seed capital fund pilot measure and the EEICs were based on the number of jobs created or preserved. Given that 15 of the 23 funds were set up via EEICs, these same jobs were also taken into account in the results of the pilot measure, as well as the EEICs.

Conclusion

6.96. The Commission should pursue its efforts to draw up an exhaustive list of measures in favour of SMEs and the resources devoted to them. A knowledge of existing instruments is a precondition for the development and management of an overall policy for SMEs (see paragraphs 6.48 to 6.50).

6.97. Studies carried out in the Member States showed that 80% of SMEs knew nothing of Community aid programmes for SMEs(273) and were therefore unable to make adequate use of these funds. The Court shares the opinion of the Economic and Social Committee(274) advocating a simplification of the financial facilities granted to SMEs and better information on the subject. The Commission should do what is necessary to increase the transparency and visibility of its measures in favour of SMEs (see paragraphs 6.51 to 6.52).

6.98. Given the large number of Community and national measures in favour of SMEs and their greater importance in financial terms, it is essential to increase coordination between these measures so as to render the resources mobilized more effective and avoid duplication and double financing. The Council's resolution on the coordination of Community activities in favour of SMEs and skilled tradesmen(275) declared the same need for coordination (see paragraph 6.51).

6.99. In 1996, the Commission presented a document concerning a new integrated programme(276), a global framework for Community measures, in favour of SMEs and skilled tradesmen, which intended to bring the 1994 one up to date and broaden its scope. This integrated programme did not take the place of measures implemented at a national or Community level and did not imply any changes in the decision-making process. The Court's observations concerning the previous programme may be reiterated, in particular with regard to the absence of procedures to ensure effective coordination and consistency in the implementation of measures contained in this integrated programme(277).

6.100. Uncertainties concerning the definition of SMEs made it possible for criteria to be adopted in the Member States that facilitated the utilization of Community funds for SMEs in favour of large undertakings. This constituted a diversion from the objectives laid down when the funds were allocated (see paragraphs 6.45 to 6.47 and 6.55 to 6.56).

6.101. Regarding the ERDF, the Court observed a failure to use the specific form of intervention for the co-financing of the schemes in aid of undertakings: the co-financing was via operational programmes and global subsidies (see paragraphs 6.53 to 6.54).

6.102. The measures implemented in order to improve the financing of SMEs were often complex in that they involved techniques of financial engineering. They, should have been defined precisely so as to guarantee that all the funds allocated were made available to the undertakings concerned (see paragraphs 6.73 to 6.76).

6.103. Efforts should be made to improve the implementation of measures in favour of SMEs, in particular with regard to the quality of the substantiation of expenditure, the application of eligibility criteria, compliance with planned cofinancing rates, taking into account cost-effectiveness for the calculation of co-financing rates and the elimination of deadlines for the payment of funds to final beneficiaries (see paragraph 6.81).

6.104. With specific regard to the ERDF, there was no useful assessment of the impact of the measures in favour of SMEs on the SMEs themselves and on regional development. It was therefore not possible to assess how far these measures actually benefited the SMEs or, for example, whether they led to a net creation of jobs, whether they stimulated the appearance of endogenous growth sites or whether they were an effective instrument for regional development. The Commission should therefore provide itself with the tools to enable it to assess and take into account the impact of the measures implemented. This would require a precise definition of the population concerned, an exhaustive knowledge of the measures and the corresponding funds, clearly defined objectives, a uniform methodology allowing coherent groupings and recent and appropriate statistics. Given that not all these factors applied, it is difficult (or even impossible) to assess the absorption of the SFs by the SMEs and therefore the effect that the funds may have had either on them (as was noted in the studies carried out in 1992 in the 12 Member States(278)) or on the objectives of regional policy (see paragraphs 6.92 to 6.95).

REPLIES OF THE COMMISSION

FINANCIAL AND BUDGETARY DATA

Budgetary implementation

6.3. Commitment and payment operations by the Commission in the course of 1996 were made in principle upon receipt of an acceptable Member State claim, together with a declaration of expenditure exceeding a pre-defined trigger point. The presentation of most of the Member State claims during the final months of 1996 reflects the actual progress of the programmes on the ground, which is still affected by the slow start-up of the new programming period. Furthermore, many of the commitments and payments for Objective 2 regions were made late in the year as a result of the time needed to negotiate the new 1997-99 programmes.

The Commission does not believe that the concentration of ERDF financial operations at the end of the year compromised respect of the principles of legality and regularity by its departments or the effectiveness of their financial administration. It notes for example that the Court's Declarations of Assurance have not revealed any payment errors caused by the Commission in the area of the ERDF. However, in the context of the SEM 2000 stage III action plan for improved budgetary forecasting and execution, a budgetary network with the Finance Ministries in the Member States has been established, focusing inter alia on achieving, by cooperation between the Member States and the Commission, a reduced concentration of commitments and payments in the latter part of the year.

The new Objective 6

6.6. Special legal provisions for Objective 6 are made in Articles 1-3 of the Protocol. It is appropriate for infrastructure to be treated differently under Objective 6 than under Objective 1.

6.7 6.8. The application of the Structural Funds in the new Member States inevitably required the setting up of new administrative systems and the adaptation of national systems to disburse and account for the expenditure of EU monies. Certain start-up problems arose but these have now largely been resolved. In Sweden, for example, the delays can be explained by the decentralized nature of the system which was adopted to include the partnership of regional and local authorities and to foster a genuine bottom-up approach. The Swedish central authorities also insisted on strict financial controls in accordance with Swedish national requirements. The Commission is in close contact with the Swedish authorities to eliminate remaining administrative obstacles to smoother financial implementation. It does not consider that there is any basic problem of absorption of Objective 6 credits in either Finland or Sweden.

THE CLOSURE OF INTERVENTION SCHEMES

General background

Data concerning closure

6.9 6.13. There are two main reasons why a significant number of pre-94 operations remain open. The first is the insufficient quality of many Member State final reports; the second is the fact that the closure date of a number of programmes has been deferred for justified reasons (see 6.38. below). In any case, all that remains to be paid in the majority of these cases is the balance of the final instalment.

General observations

Administrative delays in the closure of programmes

6.17. Although there is no regulatory provision regarding sanctions in the event of late presentation by Member States of the information necessary for the closure of the programmes, the Commission delays the final payment on the programmes as long as the Member States have not presented the necessary information.

6.18. The overlapping of financial transactions for successive programming periods is inevitable because payments in respect of a given programming period legitimately continue well beyond the start of the next programming period. Member States must equip themselves to cope with this.

The control system

6.19 6.20. As the Court states, Article 23 of Regulation (EEC) No 4253/88 places on the Member States the primary responsibility for ensuring proper financial control of the operations co-financed by the Structural Funds. The Commission Regulation to which the Court refers sets minimum standards for this financial control by Member States. This will include a requirement for Member States to present, at the time of programme closure, a statement providing an independent conclusion as to the validity of the request for final payment. Details regarding the application of this Commission Regulation may be regulated in the administrative arrangements on cooperation on control matters which Financial Control has concluded with eight Member States and intends to conclude with the other Member States in the course of the next few months. These administrative arrangements and the Commission Regulation are causing the Member States to review and, where necessary, improve their financial control systems and procedures, inter alia in respect of programme closure.

The Commission already carries out controls during the programme implementation period, ensures that any problems reported by national or Community controls have been satisfactorily settled before the closure of the programmes and makes ex post checks on a sample basis. All this helps to ensure the legality and regularity of the Community payments, including the final payment.

The fundamental need is to ensure that programmes are closed on a proper financial basis. The Commission takes the view that this can most efficiently be achieved by ensuring that programmes are subject to proper control throughout their currency, rather than by instituting extraordinary Commission control activity at the moment of closure: that is likely to be materially impracticable or at least uneconomic in its use of resources.

Observations concerning programmes and measures that were closed

Reliability of final payment claims

6.21. The Commission agrees that Member State declarations of expenditure, including those made on programme closure, not infrequently include ineligible or insufficiently justified expenditure. The Commission Regulation mentioned at points 6.19-6.20 above is aimed inter alia at reducing this problem. Since, however, the ERDF co-finances expenditure within the limits of approved budgets, any ineligible amounts declared do not necessarily have an impact on the Community budget and may finally be financed only from the national budget. The declared expenditure often considerably exceeds the approved budgets for ERDF co-financing and in such cases the Fund does not co-finance this additional expenditure. It follows that the observations included in points 6.22-6.33 of the Court's report, to the extent that they refer to ineligible amounts found in the declarations of expenditure, do not necessarily imply that the Commission made unjustified payments.

Substantiation of expenditure declared at designated authority and administrator level

6.22 6.23. The Commission is aware of the accounting problems encountered in Ireland and the subsequent difficulties in reconciling the summary amounts declared with the individual expenditure records and supporting documents. However, improvements have been made by the Irish authorities, especially when setting up the CSF for 1994-99. These include improvements in internal and external controls, the establishment of computer information links from approval data to payment data and the clear separation between approval process and payment process. The Irish authorities have also explained the further efforts now being made to tackle remaining weaknesses, the removal of which the Commission considers to be indispensable.

6.24. The national expenditure on the measure in question was considerably higher than the sum which could be co-financed under the programme. The national authorities limited their claim to that co-financeable sum. This explains the difficulty mentioned by the Court.

Substantiation of expenditure carried out at final beneficiary level

6.25 6.26. In order to form an opinion and decide on any necessary corrective action, the Commission needs to examine the replies of the national authorities to these observations. It has not yet received these replies.

Eligibility of expenditure

6.27. Ireland:See points 6.25-6.26.

Spain:The Commission will take the necessary steps for the correction of this Member State error.

6.28. The Commission will take the necessary steps for the correction of this Member State error.

6.29. The national authorities have accepted the validity of these observations and have undertaken to present a corrected declaration of expenditure to the Commission.

6.30. The Commission will take the necessary steps for the correction of this Member State error. The possible case of fraud does not appear to affect the project benefiting from ERDF assistance.

Taking account of factors influencing the closure of programmes

6.31. The factors referred to by the Court are taken into account by the Commission during the whole programme period and not only at closure, when a final check takes place that any known problems have been satisfactorily settled. The Commission Regulation under Article 23(1) of Regulation (EEC) No 4253/88 requires the Member States to provide, at programme closure, a statement reviewing how the programme has been controlled and providing a conclusion as to the validity of the final payment request.

6.32. The Commission has accepted that the financial system for the Irish Industry OP 1989-93 provides the possibility of reconciliation, even if the examination required appears to be laborious. As for the improvements introduced for the 1994-99 programming period, see comments on paragraphs 6.22.-6.23.

6.33. This problem was caused by a misunderstanding between the UK authorities and the Commission. The Commission is in touch with these authorities in order to decide how best to correct the situation.

Quality of final reports

6.34 6.36. Final reports for the period 1989-93 were indeed of variable quality. To resolve this problem, the annual report document (which also provides the basis for final reports) prepared by the Commission for the period 1994-99 and circulated to the Member States provides that both financial and physical implementation of programmes is to be examined. However, this is not a rigid framework imposed on the Member States: given the widely differing content of each programme, it will be for the national authorities to furnish the information set out in the document, but the layout of the presentation will be for them to decide.

6.37. Many final reports presented by the UK authorities for 1989-93 programmes were not of the required quality. Their examination by the Commission and the modifications required of the UK authorities often took a considerable time. However, the situation is now improving substantially as regions start to follow more closely the outline supplied to them for a model report.

The East Midlands Rechar programme has now been closed.

Conclusion

6.38 The Commission is quite rigorous where it comes to extending deadlines for commitments and payments. As the Court indicates in point 6.13, the Commission has drawn up rules to contain such extensions within acceptable limits while taking account of the realities of implementation at local level.

The payment extensions were granted because of the difficulties affecting identified projects and the resulting overlapping did not cause any serious administrative problems with the implementation or starting-up of new measures. In any case there is an overlap between successive programming periods even where there are no extensions.

The Commission is particularly aware of the need to contain extensions within the fixed limits. Where an extension beyond the deadline proves necessary the Commission makes sure that the Member State concerned initiates appropriate corrective measures. In Italy's case, for instance, the additional extension was only granted on condition that appropriate provisions aimed at increasing the effectiveness of national administrative structures were introduced.

Nevertheless, the Commission acknowledges the risk of complication linked to extensions to deadlines. Extensions have been granted only after duly substantiated requests by the Member States or regions concerned. In view of the complication, the Commission did not renew the system for the Objective 2 SPDs for 1994-96.

6.39 6.40. The Commission agrees that the time of programme closure is a particularly important moment from the viewpoint of financial management, and that the Member States' final payment declarations are not infrequently unreliable. That is why the Commission has included, in a Commission Regulation to be adopted under Article 23(1) of Regulation (EEC) No 4253/88, a requirement that these declarations be accompanied by a statement providing an independent conclusion as to the validity of the request for final payment. The same Regulation will also set specific requirements for ensuring a sufficient audit trail. Moreover, the Commission may carry out on-the-spot checks even after closure and make any necessary financial adjustments.

It is indeed in particular at the time of paying the final balance that possible ineligible expenditure risks being co-financed by the Community. Conversely, as the Commission has stated in its replies to the Court's Declarations of Assurance, the declaration by Member States of ineligible expenditure during the currency of a programme may well have no impact on the Community budget.

6.41. The Commission takes appropriate steps to ensure that any known problems, including those mentioned by the Court, are satisfactorily settled and that any necessary financial adjustments are made. Where appropriate it carries out the examination provided for under Article 24 of Regulation (EEC) No 4253/88 and takes any necessary formal decisions to reduce financial support.

6.42. The Commission has prepared an appropriate model for Member States' reports on programmes. However, the final reports are far from being the only source of information permitting programme evaluation. Moreover, given the complexity of attempting to identify, at the stage of a final report, the final economic impact of individual measures, a definitive appraisal of such impact needs to await an ex post evaluation of the programme concerned. The Commission has already carried out such an evaluation on each of the 1989-93 Objective 1 and 2 programmes closed so far.

THE IMPLEMENTATION OF MEASURES IN FAVOUR OF UNDERTAKINGS, SMEs IN PARTICULAR, IN THE CONTEXT OF THE ERDF

General framework of measures in favour of SMEs

The definition of SMEs

6.45. The ERDF's task, according to Article 130c of the Treaty, is to help redress regional imbalances and disparities. This is a general territorial objective, not a sectoral one in favour of SMEs alone.

Pursuant to Regulation (EEC) No 4254/88, the ERDF may help to finance aid for any productive investment, whatever the size of the undertaking. Assistance may also be given to measures which encourage and support the activities of small and medium-sized enterprises with the aim of developing the indigenous potential of the regions.

The regional programmes presented by the Member States are the framework within which the measures and aids are targeted at certain types of undertaking. However, the targeting will depend on the development objectives and regional development strategy in the programmes. This is something which has to be defined in partnership between the Commission and national authorities. The partnership is a requirement for the preparation of the programmes and the definition of measures and project selection criteria. The elements making up the targeting process must be included in a procedure for analysing and evaluating aid to undertakings in a specific regional context.

6.46 In accordance with Article 93 of the Treaty, the Commission keeps under constant review all systems of aid existing in Member States and may propose any appropriate measures which prove necessary. In that context, matters relating to the definition of SMEs in Belgium are currently being studied by the Commission's departments.

6.47 The option of 'not adopting the number of staff as the only criterion for the implementation of certain policies` is only granted to Member States, the EIB and the EIF, and is not available in fields to which the various rules on State aid apply. The Commission is obliged to respect all definition criteria. It is true that most of the measures already approved for 1994-99, in particular for Objective 1, are not covered by the new definition. Nevertheless, the guidelines prepared for the mid-term review for the 1994/95-99 operational programmes relating to Objectives 1 and 6 have as their main theme the development of indigenous potential in the regions and SMEs. They therefore refer to the new definition of SMEs. The Objective 2 guidelines for 1997-99 include this new definition and recommend that Member States refer to it so as better to target aid at SMEs.

Intervention in favour of SMEs in the regional sector

6.49. The Commission recognizes that the large number of actions within CSFs and SPDs has made it difficult to monitor the types of aid available to SMEs and to calculate precisely the amount of funding available from the Structural Funds to assist SMEs. The Commission has therefore requested the Member States to produce an inventory of actions available to SMEs from the different Structural Funds programmes. In addition, the Commission intends to launch this year a thematic evaluation of Structural Fund impact on SMEs which will assess this impact and analyse the results of the support from the Funds.

6.50. Regional programmes may make provision for information, technical assistance and training measures for officials of regional public administrations responsible for implementing certain measures. To that end, information leaflets and guides may be financed, as may the organization of seminars. In practice, it is scarcely possible to guarantee that all these texts are exhaustive.

6.51. Coordination between the various policies and measures in favour of SMEs does not always exist in Member States. That situation is clearly reflected in ERDF assistance. The SMEs are one category of Fund beneficiaries and are often only one of the factors in a more comprehensive regional development strategy.

With regard to simplifying and improving the environment for undertakings in their start-up phase, the Commission, following its concerted action with Member States in this area, sent to the Member States on 22 April 1997 a Recommendation identifying best practices and proposing measures to the Member States to reduce the bureaucracy involved in business start-ups, such as the setting up of a single contact point for business registration formalities. It also proposed reducing fiscal, social, environmental and statistical constraints.

6.52. Operations co-financed by the Structural Funds are administered by the Member States; it is their responsibility to guarantee information on the possibilities applying to the various types of aid the SMEs can claim. Often, accompanying measures and advisory structures are put in place at regional level as a result of ERDF support; they help to give beneficiaries a better overview of the aid for which they are likely to be eligible.

The Commission helps to disseminate to SMEs information on the various types of Community assistance via the Euro-Infocentres. This network of more than 220 centres, an enterprise policy initiative, is a valuable information network for SMEs, in particular with regard to their access to Community programmes. Within the network there is a sub-group specializing in the Structural Funds which is particularly active in information matters but also in monitoring the programmes with which the Funds are often associated (in particular the SMEs Community initiative). In addition, the Euro-Info newsletter, with a run of 60 000, systematically presents programmes in favour of the SMEs such as the Community SME initiative.

There was also the report, published in 1995 by the Commission in more than 20 000 copies, on the coordination of activities in favour of SMEs and handicrafts. Although not intended as a practical guide for SMEs, it made SMEs aware of all the Community actions in favour of SMEs and thus improved their visibility. The fourth such report will be presented by the Commission at the end of 1997 and a Commission Recommendation to Member States on how to improve SME access to Community programmes will be presented in late 1997 or early 1998.

Support for the activities of undertakings

Support for aid schemes

6.53 6.54. Community co-financing for aid schemes most often covers schemes in their entirety, never individual projects. This gives Member States the administrative flexibility to substitute projects.

Operational programmes allow a set of measures to be combined, including the co-financing of aid schemes with other accompanying measures. Such programmes allow specific categories of beneficiary to be targeted which need to be informed within the framework of regional policies, in particular when aid schemes are too general compared to the programmes' objectives.

6.55. The Commission gives priority to SMEs, particularly in promoting the development of the indigenous potential of a region. However, large undertakings can also make a significant contribution to the creation and preservation of jobs in a region and must therefore not necessarily be excluded a priori from ERDF aid.

6.56. In the past the Commission co-financed operations under Italian law No 64/86 which provided for aid to undertakings on the basis of the amount of the investment rather than of the characteristics of the undertaking itself. For the current programming period the Commission has been assured that the support measure for undertakings now takes account of the Community definition of SMEs and gives them priority where financing is concerned.

6.57 6.58. The Commission recognizes that a national aid scheme may receive financial aid from different programmes. That situation may reflect the need to ensure that there are no interruptions in Community aid or be because the scope of application of aid schemes is often very broad and does not always tally with the scope of assistance or with the priorities - including geographical - of each of the programmes.

6.59. Commission Decision 94/342/EC of 31 May 1994 concerning information and publicity measures lays down that the responsibility for information and publicity measures lies with the national, regional and local authorities competent for the implementation of the CSFs and other forms of assistance. The Monitoring Committees supervise the implementation of the measures. The Commission representatives on those committees regularly remind the administrators of programmes of their obligations with regard to publicity.

The Commission feels that use of the alternate financing method must be conditional upon compliance with publicity for the Community assistance regardless of the origin of the Funds financing each of the projects concerned. That principle was agreed with the Member States and detailed in the 'eligibility datasheets` approved by the Commission on 16 April 1997.

Concurrent drawing and overlapping of aid

6.60. The Commission agrees with the Court on this. It continues to urge Member States to introduce a computerized system automatically collecting all the amounts of Community aid which measures and projects receive.

6.61. The Commission has requested the Spanish authorities to put into operation a system which will allow verification that payments made are split according to the form of intervention, source (national and Community), Community fund and type (operational programme or Community initiative) at each level within the administration. This mechanism is first to be applied to the global grant 'Castilla y León` and a proposal will be made to the Member State, in the near future, to extend this practice to the financial management of all other relevant ERDF-funded interventions. These modifications are to be carried out within the framework of partnership and are subject to the technical feasibility of the adjustments requested.

As for the specific example mentioned by the Court, the Commission has now completed the necessary examination and will decide what corrective action to take.

6.62 6.63. The Commission realizes that it is not always easy to decide whether certain investments fall under first-stage processing or subsequent stages. However, the Commission makes express mention in the horizontal provisions accompanying the CSF and SPD decisions for the new programming period of the rules applicable to the EAGGF and of compliance with the selection criteria, including for ERDF assistance in favour of investments. It is not clear, in the absence of further information, that the case concerning Flevoland (the Netherlands) involves an irregularity.

Compliance with the rules on competition

6.64. The aid scheme identified by the Court for which the suspension clause was not applied concerns the SME/SMI development fund (FDPMI) (SPD 01 Nord-Pas-de-Calais 1994-99), which was notified to the Commission in 1994. Discussions between the Commission and the French authorities resulted in approval of the scheme on 1 February 1995. The FDPMI was one of the aid schemes implemented in the business investment measure where the amount for the first year was not determined a priori; it was not therefore possible to deduct the initial commitments. However, use of the amounts corresponding to the FDPMI was conditional upon approval of the aid scheme.

6.65. The need to respect competition rules when implementing Community assistance, including the special notification obligations applying to aid in certain sectors, is specified in the horizontal provisions which are an integral part of the CSFs and SPDs. The Commission feels that it is primarily the responsibility of the competent Member State authorities to guarantee that the approved aid schemes respect competition rules. Nevertheless, the Commission reminds the Monitoring Committees of those rules if it feels that certain proposed measures might infringe them.

6.66. The Commission will examine this case with the French authorities and take any necessary corrective action.

Industrial estates and technological centres

6.67 6.68. Business reception infrastructures help to improve the general environment of the productive activity. The Commission does not believe that there is a priori dual use between aid to infrastructures and aid to productive investments. These are two different operations: creation of a reception infrastructure, and aid for setting up a business. However, the programme administrators should ensure that there is no exceeding of the ceilings for State aids going to a single undertaking. The Commission draws Member States' attention to the need to avoid such overruns when negotiating the programmes and in the Monitoring Committees.

Services offered to SMEs

6.69. As the Commission explained in its reply to the 1994 Annual Report of the Court (point 4.60), most of the ERDF assistance to businesses takes the form of regional aid schemes, which respond, by definition, to demand for services or financing from the productive sector. This assistance should, however, be backed up by support to generating a supply of quality services, especially in the regions where such a supply is lacking (most of which are Objective 1 areas). Counselling and support services to businesses are essential to the proper use and effectiveness of the direct aid which they receive from elsewhere.

The Commission should also point out that, under the first indent of Article 1c of Regulation (EEC) No 4254/88, expenditure linked to the creation and maintenance over a specific period of an undertaking offering services to SMEs may be considered eligible.

However, the Commission, when negotiating the Objective 2 programmes for 1997-99, had to draw attention to the need to give priority to financing requests for services made by social and economic partners and SMEs.

The structure the Court mentions in connection with Lorraine corresponds to the creation of an 'SMI-SME strong point` intended to concentrate on one site various regional economic development bodies so as to give SMEs a single site containing intermediaries and to promote synergies between bodies.

6.70. The Enterprise and Innovation Centres (EICs) were not designed to finance themselves exclusively on the private market, that is, by selling their services to potential clients (undertakings and those creating them). Given that they are bodies with a task in the public interest, EICs also use public funds. It is therefore perfectly legitimate and consistent with the nature and tasks of the EICs that, during the start-up phase, public authorities should give them, as well as other bodies, funds in return for venture services that they can offer in the field of assistance to SMEs.

The specific case mentioned by the Court does not involve any irregularity concerning the BIC but the possible ineligibility of the expenditure incurred for the construction of the building which was co-financed by the ERDF under the global grant. The Commission will take any necessary action.

6.71. In addition to the evaluation exercise carried out by the EBN, the Commission has launched a broader EIC evaluation exercise to be carried out by independent experts selected by an invitation to tender published in the Official Journal on 7 May 1997.

Support for the financing of businesses

Gaining access to capital

6.73 6.74. The Commission agrees that the initial Community assistance in the field of financial engineering should have been accompanied by more precise provisions on the conditions and rules for its implementation. The Commission feels that that shortcoming was remedied by the adoption in July 1995 of precise and detailed rules governing the participation of the Structural Funds in venture capital funds and in guarantee funds. Those rules were subsequently incorporated into the 'eligibility datasheets` adopted by the Commission on 16 April 1997.

6.75. The Commission will examine this case and take any necessary corrective action.

6.76. From 1994 the finance for that measure was charged to a single budget line. The measure finished in 1996 and was the subject of an independent evaluation.

Obtaining loans

6.77. As the Court notes in point 6.73, the ERDF, to offset the low level of SMEs' own resources, also provides assistance in the form of various financial engineering mechanisms, in particular venture-capital funds, seed capital funds, guarantee funds and leasing.

6.78. If, as the Court stresses, ERDF assistance, whether or not linked to a global subsidy, cannot co-finance loans, it can, however, guarantee part of the outstanding loans granted to undertakings by financial institutions; this is the case for the funds guaranteeing traditional bank loans and for mutual guarantee schemes.

6.79. The Commission will take the Court's recommendation into account.

6.80. The Commission will be amending the agreement for the global subsidy in question so as to clarify all the technical aspects of the implementation of subsidized loans, including that of the criteria for selecting the financial intermediaries.

In any event, the Commission has already taken the precautionary measures needed to ensure that its financial transfers for the global subsidy will continue only after the amending decision.

The implementation of measures

6.81. The Commission recalls its comments at points 6.19.-6.20. and 6.39.-6.40. on its Regulation defining minimum standards of financial control by the Member States, with special reference to programme closure.

As the Commission stressed in its reply to the previous Annual Report, the financial viability of productive investments is not the only factor to take into account when selecting projects eligible for ERDF aid. The Commission, as part of the next reform of the Structural Funds, is studying the possibility of better combining loans with subsidies, particularly for financing major revenue-generating projects.

The rates of aid granted by the Member States must in any case respect the ceilings set by competition policy. However, in many cases, ERDF aid falls under the de minimis rule and concerns undertakings for which the aid amount does not constitute distortion of competition.

6.82. During the implementation of the programmes the Commission takes sufficient steps to ensure that any reported problems are satisfactorily settled; then before the closure of the programmes it makes a final check that there are no pending cases. When necessary, the Commission carries out the examination provided for under Article 24 of Regulation (EEC) No 4253/88 and makes any necessary financial corrections.

The Italian authorities have undertaken to inform the Commission regularly about the cases under examination.

6.83. When ineligible expenditure is detected (e.g. non-execution of a project, non-respect of the grant conditions, etc.), the necessary remedial action should be taken by the Member State authorities, including any necessary recovery of the aid granted to the final beneficiary. However, the Community funds which then no longer co-finance one element of expenditure may, if the programme is still running, normally be used to co-finance eligible expenditure arising elsewhere under the programme. This is particularly valid for aid schemes, where the final beneficiary is the organization responsible for the implementation of the scheme.

When the employment conditions extend beyond the closure of the programme, their verification cannot of course take place before the closure. In the event of non-respect of the grant conditions, the procedure is that the Member State should reimburse the Community aid to the Commission.

6.84. The Commission agrees with the Court; where the alternate financing technique is used the same eligibility, programming, publicity and control provisions must apply to measures 100% financed by Community Funds and to those 100% financed by national funds. That need is specified in the 'eligibility datasheets`.

6.85. The Commission agrees with the Court. It has followed up all known cases of reduction by intermediate authorities of the amount of aid reaching final beneficiaries and has insisted on the adoption by the Member State authorities of the necessary corrective action.

The SME initiative

6.86. The Member States had the opportunity, within the Management Committee on Community Initiatives, to discuss and suggest amendments to the Guidelines for the SME Community Initiative before the Guidelines were formally published on 1 July 1994. The deadline for the presentation of programmes was proposed as four months by the Commission in order to permit, in suitable cases, the commitment of the funds available for 1994. This was accepted by the Member States. In certain exceptional circumstances, the Commission was prepared to allow a two-month extension. However, it should be emphasized that the four-month deadline was for the presentation of the first draft programme, so as to make available as soon as possible a document on which the Commission and the Member State could negotiate.

6.87. The operational programmes under the Community SME initiative cover measures relating to an undertaking's socio-economic environment with a view to its integration into the single market. Measures in favour of SMEs developed under CSFs and based mainly on infrastructures and equipment are quite different. While it is true that some programmes under CSFs relate to measures proper to the SME initiative, that initiative has made it possible to systematize those measures, implement them within the framework of partnership and give them an international dimension.

6.89. The Commission accepts that it has not been able to approve most of the programmes under this Community Initiative within 6 months. However, this time period only applies as a general rule and provided that the requirements of Article 14 of Regulation (EEC) No 4253/88 are fulfilled. It is better to be late because of efforts to improve a programme than to respect the 6 months by approving a poor programme. Lengthy negotiations on many of the programmes were required before they could be considered satisfactory.

The delay in approving the Italian SME initiative programme was largely due to the need to review the dossiers several times with the Member State with regard particularly to descriptions of the measures and eligibility conditions.

The initial version of Spain's SME initiative programme did not correspond to the eligibility criteria indicated in the Commission communication. Following several meetings between the Commission departments and the national authorities responsible for implementing that measure and drafting the various texts for the programme, the assistance was finally approved in July 1996 - the initial text had been presented by the Spanish authorities in November 1994.

6.90. The Commission accepts that detailed regional figures for the number of people employed in SMEs were not available when the allocation of funding was made. It recognizes the usefulness of such regional statistics but emphasizes the difficulties involved in identifying accurate information and will continue to work towards the development of more detailed regional statistics. For example, in the Fourth 'Enterprises in Europe` Report, published by Eurostat and DG XXIII in 1996, a regional analysis by size and sectoral distribution of establishments at NUTS 2 level was carried out for the first time.

6.91. Many SME Community initiative programmes were only approved in 1996, and consequently they have yet to become fully operational. Once they do so the Commission expects that the payments will accelerate. The Commission believes that the delays in implementing the programmes are principally due to the variable quality of the initial proposals received from the Member States.

The assessment of the impact on regional development of measures in favour of undertakings on regional development

6.92. The Commission shares the interest of the Court in better targeting with relevant result and impact indicators and is constantly reminding the Member States of that need. Nevertheless, there has been much progress in the new, 1994-99, programming period compared to the former one, 1989-93. In addition, interim evaluations have reinforced the quantification of objectives and the evaluability of programmes; there is therefore more optimism as to the quality of future ex post evaluation work.

6.93. The Commission believes that analysis of the impact of measures in favour of undertakings is principally the responsibility of Member States. It has, however, continued with its more general analysis work on the socio-economic impact of measures beyond the work mentioned by the Court. A more detailed analysis is under way concerning the development of SMEs in zones eligible under Objective 2. This local analysis, under the auspices of the European Communities' Statistical Office, covers a number of micro-economic indicators.

A thematic evaluation has also been launched with the aim of comparing the impact and relevance of different part-financed measures at SME level. The evaluation will be carried out by independent experts on the basis of an invitation to tender. The effectiveness of measures relative to undertakings is a central element of the intermediate evaluations.

6.94. It is of doubtful value to compare the real effects of a chosen measure with the possible effects of other measures which might have been chosen but were not.

As part of economic and social cohesion policy, jobs created and preserved are an important indicator in evaluating the impact of the Structural Funds. The Commission is also aware of the fact that assessment of impact at the job level requires detailed assessments taking account of, alongside jobs created and preserved, the windfall and relocation effects and SME birth and death rates. With that aim in mind the Commission has prepared and disseminated to Member States a methodological document giving an exhaustive list of the different approaches to the measurement of effects and contribution to employment.

The Commission notes the difficulties in evaluating net job creation, with the considerable amount of data required. To encourage Member States better to define the various stages in evaluating the impact of projects on employment, particularly in the SMEs, the Commission is currently running a competition with the aid of a panel of independent experts to select measures which would demonstrate the best impact on employment. The intermediate evaluations will also concern a more detailed analysis and better understanding of the impact of measures on job creation.

In the procedure for adopting the Objective 2 SPD for the new programming period of 1997-99, the question of estimating the impact on jobs was a central element in negotiations with Member States.

6.95 (a) The monitoring of aids granted to SMEs was reinforced by the introduction of the relevant data in the monitoring system introduced for Flevoland. As for the Merseyside region, a misunderstanding resulted from the existence of the two different indicators: 'number of SMEs assisted` and 'cases of business support`. The final report of the MIDO I programme, approved by the Commission on 16 May 1996, contains the figure referring to 'number of SMEs assisted`.

(b) The measure in the commune of Onnaing related to the redevelopment of derelict industrial land to support undertakings in a second-hand market. The fragile nature of such a market partly explains why the undertakings in question did not successfully complete the project, hence the loss of created jobs.

Policy on derelict industrial land use has now been redirected towards the revegetation of the sites to recover them for the environment or towards developing them for a particular non-economic use such as playgrounds, public facilities, etc.

In addition, measures in favour of SMEs/SMIs are varied (investment aid, aid for advisory services, collective action, aid for the development of new functions, business equipment, etc.), and their evaluation cannot be reduced to the observation of individual cases.

(c) The Commission accepts that difficulties of evaluation can arise in such situations. However, such problems are rather limited and the relevant operations cannot be considered as ineligible.

(d) The Commission recognizes that measures in favour of SMEs have not always achieved the expected results. The strict rules imposed by the Commission (for example studies and technical assistance, being an integral part of the SME business plan, are financed only if the business plan is implemented, intermediary bodies should be self-financed in the long term, etc.) have sometimes resulted in delays or in the non-implementation of the relevant measures, the assistance concerned then being transferred to operational' measures. This was the case with Greece.

(e) The Commission will examine this case and will take any necessary steps to ensure the quality and accuracy of the indicators serving as a basis for the evaluation of the BICs and the pilot project 'Venture Capital Funds`.

Conclusion

6.96. The Commission is already taking the necessary steps for the complete identification of the measures in favour of SMEs.

6.97. The Commission recognizes the need to increase information and publicity measures for Community aid programmes to SMEs and the need for simplification; it believes, however, that these are first and foremost the duties of the national authorities responsible for drawing up and implementing the programmes. It is willing to provide Member States with all the necessary technical assistance to that end. The promotion of good practice in Member States with regard to making projects competitive is also encouraged by the Commission.

The Commission has developed a number of instruments to provide information to SMEs on Community programmes. These will be further enhanced through the implementation of the 1997-2000 programme for SMEs in the European Union and in particular the objective to develop the EICs into 'first-stop shops`, providing a single point of enquiry about all Community programmes.

6.98. The coordination of measures and the effectiveness of assistance are concerns shared by programme administrators in the Member States and by the Commission. The monitoring and evaluation mechanisms are implemented for each programme. The thematic and horizontal evaluation measure relating to the theme of the impact of the Structural Funds on SMEs will also help the Commission to identify more suitable assistance methods on the basis of an enumeration of existing good practices.

Recognizing the importance of strengthening the coordination of its activities in favour of the SMEs, the Commission restructured its departments in April 1996, creating a new unit in DG XXIII responsible for concerted actions, coordinating Community programmes in favour of SMEs and improving SMEs' access to Community programmes. Coordination is both external, with Member States via concerted actions intended, through the exchange of best practices, to make national SME policies converge and to transfer the best practices, and internal, via interdepartmental work.

6.99. The integrated programme adopted in December 1996 offers a global framework for Community measures in favour of SMEs, as carried out specifically under enterprise policy (under the third multiannual programme) and those carried out under other Community policies in favour of SMEs. It therefore ensures better consistency and visibility of Community SME measures.

As regards coordination, the programme includes concerted actions with the Member States, thus giving substance to Article 130 of the Treaty whose aim is to promote consultation and collaboration between Member States and between Member States and the Commission thus guaranteeing the exchange and transfer of good practices. In addition, there are internal procedures in place to ensure better coordination between Commission departments.

6.100. Those uncertainties have largely been lifted by the Commission recommendation on the definition of SMEs. Member States will have to respect that definition each time the Commission reviews aid schemes in favour of SMEs. Also, Member States, the EIB and the EIF will have to inform the Commission by 31 December 1997 of the measures they have taken to comply with the SME definition established by the April 1996 recommendation. In addition, the transitional arrangements from which current Community programmes benefit as regards the definition of SMEs will cease by 31 December 1997 at the latest.

6.101. In the Commission's opinion, the integration of aid schemes into operational programmes has helped to introduce a set of broader, more coherent measures for SMEs within a specific regional context.

6.102. The Venture Capital Funds and Guarantee Funds datasheets adopted by the Commission on 16 April 1997 contain provisions which will guarantee that 100% of the fund capital is actually used for measures in the undertakings.

6.103. The Commission recognizes that there is much still to be done. It believes that this must take the form of more rigorous administration and control by Member States and has adopted a Regulation pursuant to Article 23(1) of Regulation (EEC) No 4253/88 with a view to specifying the detailed financial control methods to be used by the Member States.

6.104. The Commission accepts the need to improve evaluation of the impact on SMEs of the measures designed to help them and co-financed by the Structural Funds. Studies to remedy the problems involved here are being launched or are already under way.

Table 6.1 - Distribution of commitments and payments during the 1991-96 period

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Volume of commitments (1991-96)

ECU

Year-month

Number of commitments (1991-96)

Number

Year-month

Volume of payments (1991-96)

ECU

Year-month

Number of payments (1991-96)

Number

Year-month

References to the 1996 budget: B2-12; B2-14; B2-182; B2-19; B2-2; B2-3; B2-6; B2-7 and B5-325.

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CHAPTER 7(279\*) European Social Fund

7.0. CONTENTS Paragraph reference

Introduction 7.1 - 7.5

Budget execution 7.6 - 7.14

Audits of particular aspects 7.15 - 7.34

The partnership 7.15 - 7.19

The private sector, Objective 4 and ADAPT 7.20 - 7.29

Additionality 7.30 - 7.34

Examination of systems 7.35 - 7.57

Conclusion 7.58 - 7.68

INTRODUCTION

7.1. The European Social Fund (ESF) is a major instrument for promoting the European objectives in relation to employment and training.

7.2. This chapter examines the implementation of the main regulatory changes for the application of the ESF 1994-99 Community Support Framework, hereafter referred to as CSF2. As such, it extends the audit reported on in the Annual Report of the Court concerning the financial year 1995(280), provides an assessment of the effectiveness of the changes and examines the reliability of the national control systems.

7.3. The main changes, set out in the regulations(281), reinforce partnership (between the Commission, national authorities and 'economic and social partners`), aim at ensuring additionality and at improving the monitoring and evaluation of the implementation of ESF at each level of management.

7.4. A new Objective 4 was introduced(282), which concerns the adaptation of workers to industrial changes and to changes in production systems. It extended the measures aimed at providing training for employees in work and foresaw private co-financing of the training effort. The emphasis of the objective is on small and medium-sized enterprises (SME). The Court's audit of this objective provided an initial assessment of its application and that of the related transnational Community Initiative (CI) ADAPT.

7.5. In order to test the overall effectiveness of the implementation of CSF2, audits were carried out in the Commission and in 10 Member States (Belgium, Germany, Greece, Spain, France, Ireland, Italy, Portugal, Sweden and the United Kingdom). The results should be examined alongside the results of the Court's Statement of Assurance audit.

BUDGET EXECUTION

7.6. During 1996, the third year of implementation of CSF2, the Commission continued to make commitments and payments in respect of CSF1 (1990-93). As already pointed out by the Court in its Annual Reports for 1994 and 1995, despite the extension of the period for payments of CSF1, the Member States have not used the available commitments. A total of 444 Mio ECU has been decommited since the closure of CSF1 operational programmes (OPs). However, 17% of OPs remain open, for an amount of 1 204,3 Mio ECU (see paragraph 7.10).

7.7. A higher proportion of available appropriations was spent in 1996 than in the two previous years. For the ESF as a whole, both commitment (7 150 Mio ECU) and payment (6 036 Mio ECU) appropriations were 100% utilized. However, the execution by objectives was very different. The consumption of initial commitment appropriations for Objective 3 was 126%, while it continued to be low for Objectives 4, 5b and 6 with levels of 69, 51 and 41% respectively. This demonstrates the difficulties of implementing programmes which do not always take sufficient account of the management capacity of the Member States nor of the complexity of the legal framework. The overall execution of commitment appropriations for the Employment and Human Resources Initiatives after transfers was 96%, but for the ADAPT Initiative, which has experienced the problems of implementation detailed in paragraph 7.29, only 65% of initial appropriations were spent. The NOW CI which relates to the integration of women in the workforce used only 10% of initial commitment appropriations.

7.8. The figures demonstrate the use of appropriations at Commission level. They do not take account of the additional delays involved in getting funds down to the project manager or delays in spending by the latter and, thus, do not reflect the real use for operational purposes.

7.9. Table 7.1 shows the take-up by Member States of the planned amounts in 1994, 1995 and 1996. The implementation of the budget increased in comparison with the two previous years but the amounts shown indicate low utilization for some Member States, most notably Greece and Italy, where there had been late implementation of OPs.

7.10. The Commission granted extensions until mid-1997 for an amount of 523,4 Mio ECU in respect of 12 Italian OPs(283) from CSF1 (1989-93). A Commission audit had found that 78 Mio ECU expenditure had been committed by the Member State after the date limit approved in the OPs and thus was ineligible for ESF funding(284). Despite this, the Commission then acceded to a request by the Italian authorities, made after the date limit set by the OPs and without the appropriate monitoring committees being consulted as required by Article 25, paragraph 5, of Regulation (EEC) No 4253/88, to extend the OPs and thereby 'regularize` the corresponding commitments. This is unlike the extensions to the United Kingdom operational programmes in 1995 where the amounts reallocated were funded from appropriations for the 1994-99 period(285).

7.11. Monitoring committees may reschedule amounts which remain unused in one year, over future years. Table 7.1 provides some indication of Member States where this has happened by comparing the original planned amounts with the commitments made. Rescheduling expenditure for the succeeding year, or later years, enables a Member State to obtain an advance for the succeeding year, despite its failure to spend the requisite proportion of the amount previously advanced(286). Such action, although not contrary to the current Structural Fund regulations, does not represent sound financial management.

7.12. The Regulation enables advances of less than 50% to be made(287). Nevertheless, examples have been identified where the Commission has again made advances which were unnecessary given the poor state of implementation for the Italian Objective 4 OP and delays by the national administrations in transferring funds for the Objective 3 OP in France. The amount involved for these two OPs was 84 Mio ECU. The Commission should make further efforts in line with its reply to the Court in respect of 1995(288).

7.13. The majority of Member States audited did not always pay the beneficiaries within the three-month period laid down by Article 21, paragraph 5, of Regulation (EEC) 2082/93(289). It may lead either to management difficulties for projects or to unused advances from the European Union budget.

7.14. The mismatch between needs and advance payments is particularly evident when the Commission makes a single commitment for multi-annual programmes under the terms of Article 20, paragraph 3, of Regulation (EEC) No 2082/93. These commitments may be up to 40 Mio ECU and normally cover the six-year period of CSF2. At the same time as the commitment is made, the Member State receives an advance payment of up to 50%. In reality Member States are unable to comply with the requirement to pay out the advance within the three-month time-limit. The total value of such advances is about 250 Mio ECU.

AUDITS OF PARTICULAR ASPECTS

The partnership

7.15. The reinforced partnership (see paragraph 7.3) is applied, inter alia, by Article 4 of Regulation (EEC) No 2081/93 which envisages that each Member State will designate the economic and social partners (hereafter referred to as the partners). The partnership covers: preparation and financing, ex ante appraisal, monitoring and ex post evaluation.

7.16. The interaction of the partners mostly takes place in the monitoring committees. There are monitoring committees for each Member State's CSF and OP or single programming documents (SPD), for each of the objectives and for the (CIs) ADAPT and Employment. Depending on the Member State, the monitoring committees for the various objectives and CIs may be national, regional and sometimes multi-regional.

7.17. In Portugal the monitoring committees consist mainly of public servants, although national representatives have signalled to the Commission their willingness to increase the participation of partners in the future. In the United Kingdom, monitoring committees include members from the various sectoral interests: local government, training and enterprise councils and the voluntary sector. However, while some monitoring committees have representatives from the industrial and service sectors, there are no employer and employee representatives as such. In the other Member States the partnership is cast wider and both sides of industry, employers' federations and trade unionists have been designated as partners but in some cases may be observers rather than participate fully in the monitoring committees.

7.18. In general, input from employers, employees and the disadvantaged may lead to more effective planning, appraisal, monitoring and evaluation and to a more ready acceptance of the decisions made. The Commission is encouraging Member States to move in this direction. However, in Spain, France and Italy, there are some monitoring committees of 50 or more members and one French committee has over 70 members.

7.19. Despite the positive impression that the Court has gained from the Commission's actions within the partnership, the audit revealed areas of monitoring where the Commission should have pushed for improvements to be made by the other partners and the national administrations in particular, namely:

(a) the partnership was intended to operate at the key stage of programming, including identifying the various measures needed; however, the consultation within the partnership consisted of giving an opinion on draft plans rather than a close involvement in identifying needs and solutions; an opportunity was thereby lost to involve partners fully in the planning process;

(b) many secretariats did not achieve the deadlines set for the distribution of documents in the committees' own rules of procedure;

(c) the members should also receive a strategic summary of progress and action to be taken; the audit identified one committee where this had been adopted, (United Kingdom, Objective 5b 'Rural Wales and the Borders`), but this appears to be the exception rather than the rule;

(d) in general the monitoring committees which are responsible for ESF are required to meet at least twice a year; in some Member States this has not happened, either due to an oversight(290) or because there was no progress to report(291);

(e) none of the monitoring committees of the OPs audited in the Member States by the Court were consulted about points raised in independent audit reports, thereby losing an important opportunity to examine problems that had been encountered and develop solutions, in order to assist sound financial management;

(f) although ESF, ERDF and EAGGF-Guidance funding made under Objectives 1, 2 and 5b are examined by the same monitoring committees in Member States or regions, an examination of the minutes of meetings showed that the coordination of effort between the funds needs to be improved; only in Ireland were the various Structural Fund measures examined in a coordinated manner;

(g) even after three years of the CSF, few monitoring committees have reviewed and developed the impact indicators, which measure the effectiveness of the ESF effort, which were set in the OPs or SPDs; moreover, there is still a basic lack of information on the effectiveness of the training given in terms of training-related employment.

The private sector, Objective 4 and ADAPT

7.20. As mentioned in paragraph 7.4, an element of the reform of the Structural Funds was the increased involvement of the private sector under the new Objective 4 which requires private sector undertakings to co-finance an approriate portion of the cost of the projects which benefit their own workforce(292).

7.21. Objective 4 measures aim at the adaptation of workers in undertakings to industrial changes and to changes in production systems. They are applied in all Member States except the United Kingdom which decided to use the other objectives for training delivery. In Objective 1 Member States they are subsumed in the Objective 1 measures. They have much in common with the transnational CI ADAPT which may be viewed as the transnational element of Objective 4. Both emphasize the importance of SMEs and a condition of ADAPT funding is that the projects should be innovative.

7.22. The total amounts planned to be spent during CSF2 were 2 350 Mio ECU (Objective 4) and 1 354 Mio ECU (ADAPT). However, there are delays in implementation requiring rescheduling of financing.

7.23. As described in the following paragraphs, the Commission has not given sufficient guidance on the application of the competition rules laid down in Article 92 of the EEC Treaty(293) and developed in the Commission document 'Community framework for State aids to SMEs`(294). The rules are applied differently by the Memb er States. The Commission has informed the Court(295) that the competition policy, Article 92 of the EEC Treaty, does not apply to ESF aid as it is granted for individual members of the workforce rather than the undertaking. However, each Objective 4 SPD or OP contains a clause stating that the Commission will suspend payment until it is satisfied that the competition rules are complied with. In addition, according to the 'Community framework`, the public aid authorized for training measures for employees of each undertaking is limited to 50% (this includes both national and Community co-financing). When the total aid to an undertaking exceeds 100 000 ECU over three years the Commission may grant derogations in exceptional circumstances, on the basis of a case by case notification by the Member State. This applies particularly to Objective 1 regions. The actual rates of public aid were 55% to 94%.

7.24. The Court had already pointed out to the Commission the inconsistencies in its interpretation of the rules. Following an audit in Germany, the Court drew the attention of the Commission to the problem in April 1995(296) and made reference to the matter in its Annual Report concerning the financial year 1994(297). The Commission has never replied to these observations and the Court's audits in 1996 and 1997 have confirmed these inconsistencies. In Germany, the rule is to use the notification procedure for Objective 4 projects. This is not the case in France, where several projects over 100 000 ECU had not been notified and were considered by the monitoring committee as not liable to be notified. The audit identified a similar case in Greece. On the other hand, in Belgium, because of the uncertainties, the Objective 4 monitoring committees, which include Commission representatives, excluded projects which would benefit a single undertaking. This is one of the reasons for the low rate of implementation of Objective 4 in Belgium. Thus, an inequality of treatment exists between undertakings in the different Member States.

7.25. According to the preamble of Council Regulation (EEC) No 2084/93 the Objective 4 measures are intended to cover the economy as a whole rather than specific sectors or industries. As a Commission report(298) states and as the Court has also noticed the trans-sectorial character has not been respected in most Member States.

7.26. In a number of the projects audited, the persons who received training under Objective 4 measures did not fall within the eligible category (employees in undertakings), but were in fact unemployed and looking for work. In Sweden, staff employed in the public service (hospitals), were receiving training under Objective 4. In Italy (Emilia-Romagna), 141 of the 1 105 Objective 4 projects approved for ESF funding consisted of courses which the undertakings organized for their employees for safety at work and which thus seemed not to be linked to the adaptation of workers threatened by unemployment due to industrial change or to changes in production systems and therefore were not within the scope of Objective 4 (Article 1, paragraph 2, of Regulation (EEC) No 2084/93). The eligibility of such expenditure should be clarified by the Commission and communicated to all Member States.

7.27. As mentioned in paragraph 7.21 emphasis should be placed on SMEs but, in Spain, France and Portugal there was substantial ESF funding of large companies, the notion of concentration on SMEs thereby being lost. Moreover, Article 5(3) of Regulation (EEC) No 2084/93 states that: 'enterprises whose workers of either sex are able to take part in training operations shall finance an appropriate portion of the cost of such operations`. National authorities in Belgium, Italy and Portugal have said that smaller SMEs could not fulfil this requirement to co-finance projects. The Court itself identified two such projects in Belgium where the undertaking had not made a financial contribution, and the Commission report mentions this difficulty, in respect of Spain. This condition poses problems, as by their very nature SMEs frequently do not have the resources to research funding opportunities, make applications, provide co-financing and ensure the release of employees for training. Indeed, Portuguese representatives have estimated that 80% of SMEs in Portugal are one-man-businesses. Mainly because of these structural difficulties, the Council underlined in Decision 97/15(299) the importance of making training available to SMEs.

7.28. In its answer to the Court's Annual Report concerning the financial year 1994(300), the Commission acknowledged that Objective 4 OP managers should take steps to facilitate access by SMEs to ESF assistance. In addition, the Commission undertook to carry out assessments of the impact of the relevant OPs, but this had not been done by the beginning of 1997. For a further examination of SMEs see Chapter 10 (research) and Chapter 6 (ERDF) of this report.

7.29. There were particular problems of coordination in implementing ADAPT measures. The approval of the partners was delegated to the Member States and there was no common timetable for the implementation of projects. Sometimes one Member State may approve the project partner on its territory whereas approval may not be given by the other Member State or given several months later, thus causing changes in the partners and contents of approved projects. Payments to the partners in the various Member States were not coordinated which also led to delays. Most ADAPT projects were affected to varying degrees, the most extreme examples being those where one of the partners was Italian, as 1995 ADAPT funding was not paid out to the national project partners until the end of 1996.

Additionality

7.30. Additionality is one of the pillars of the reform of the Structural Funds. It aims at ensuring that each Member State's financial effort under each objective is not diminished during CSF2 in comparison with the previous programming period (CSF1). The Court reviewed the data provided by Member States to the Commission to demonstrate additionality and examined the methodology used by the Member States, in order to assess its consistency, adequacy and reliability. Responsibility within the Commission for examining the information supplied, lies with different DGs according to the objectives concerned.

7.31. The Commission is not required to examine additionality by individual fund for Objective 1 countries. Nevertheless, for CSF1 (1990-93), an examination was carried out by DG V of ESF additionality for Objectives 3 and 4, within the Objective 1 regions (Ireland, Greece, Portugal and Spain). The conclusions of a DG V report on CSF1 Objectives 3 and 4 produced in February 1995 were that there was additionality in Germany, France, Luxembourg and Portugal; that there might have been additionality in Denmark, the Netherlands and Italy; but that it had not been demonstrated for Belgium, Greece, Spain, Ireland and the United Kingdom. Although, the report concluded that the examination of additionality for these latter five Member States could not be closed, the matter was not followed up in order to finalize matters. Furthermore, the results of the Commission's examinations of additionality for CSF1 Objectives 1, 2 and 5b have not even been published some three years after the end of the period and thus final conclusions have not been drawn.

7.32. The failure of the Commission to properly complete its examination of additionality for CSF1 gives cause for concern. Article 9 of Regulation (EEC) No 2082/93 requires that additionality be demonstrated by objective in comparison with the previous period (CSF1 1990-93). The fact that the Commission had not satisfied itself fully about the data for 8 of the 12 Member States makes an extremely poor foundation for its use in ascertaining additionality for CSF2.

7.33. The methodology used by DG II requires an examination of all structural spending for each objective, whereas DG V examines selected areas of ESF expenditure, to ensure that the national effort does not diminish. This latter approach to verify additionality is less accurate, as the measures and beneficiaries that receive ESF funding change from CSF1 to CSF2. They may also change during the course of CSF2 itself (e.g. measures may be introduced or deleted and beneficiaries may be eligible for funding at one point in time but not at another).

7.34. The examination of the data and methodology used by Member States to assemble and report expenditure has shown that improvements need to be made particularly in Greece in order to ensure its reliability for assessing additionality. In addition, the present allocation of duties between four Directorates General of the Commission does not ensure effective management and accuracy of data. This split in responsibility between DG V for the purely ESF objectives and DG XVI and DG VI with input from DG II, exacerbates the problem of double counting and differences in data where there is Objectives 3 and 4 expenditure in Objectives 2 and 5b areas.

EXAMINATION OF SYSTEMS

7.35. In its previous Annual Report for the financial year 1995(301), the Court underlined the need to have common eligibility standards adopted by Member States. As a result of discussions and negotiations with Member States, the Commission has adopted a Decision on this matter with effect from 1 May 1997(302). The following paragraphs show areas where further guidance needs to be given to Member States on the expenditure that is eligible to be certified for funding.

7.36. There is a serious problem concerning the replacement of expenditure found to be ineligible following audits or other checks, with other expenditure deemed eligible by the Member State.

7.37. If other expenditure is used to substitute, it must not concern projects which have already commenced or finished, or where the publicity criterion for ESF funding has not been met. Similarly, the prior approval of the course for ESF funding by the responsible authorities should be a condition, along with the ability of national and European Union auditors to check during implementation. Thus all ESF expenditure used to support a declaration would be liable to audit. At present these criteria are not systematically applied by the Member States.

7.38. Guidance is also needed on whether the rate of ESF participation may be increased to substitute for ineligible expenditure in a project. The Commission has notified the Court that ESF participation should be limited to the percentage or to the amount indicated when the project was approved, whichever was the lower. The Court agrees with this interpretation but not all Member States apply it.

7.39. Under CSF2, the ESF may fund secondary education which has a clear link with the labour market(303). ESF funding is being granted generally to schoolchildren in some Member States during their period of compulsory secondary education. In some cases the secondary education actions co-financed(304) are directed towards specific target groups or areas of target activities, whereas in other cases, they concern part of the compulsory secondary education programme whose content is considered by the Member State to be of a technological nature. This is the case for Spain which has spent 17,1 Mio ECU of ESF on these actions in 1995 and 23,9 Mio ECU in 1996. The Court queried with the Commission and the national authorities whether this secondary education is within the scope of the Regulation (305). In its reply, the Commission leaves the interpretation of this rule to the responsibility of the Member States, which does not ensure a proper application of the Regulation nor a homogeneous treatment by the Member States.

7.40. Some other training courses contain both theory and a practical element either in the classroom or in the work place. The Commission has confirmed that, although guidelines were laid down for CSF1, none have been set for current measures to indicate the expenditure that may be claimed for the practical part of the course. Such guidance should be given.

7.41. In Spain, Real Decreto 631/93(306), inter alia, lays down rules governing the eligibility of expenditure for ESF funding. It authorizes up to 10% of management and salary expenditure to be paid without any evidence in addition to expenditure justified by supporting documents. This does not comply with the Community Regulations.

7.42. Member States certify expenditure under the terms of Regulation (EEC) No 2082/93(307). The audit once again confirmed that some final claims are not based on expenditure actually incurred during a given period by training providers as required by the Regulation and further laid down in the standard clauses attached to OPs. Instead, certain Member States, most notably Spain, France and Italy, are declaring to the Commission amounts transferred to managing bodies by their administrations without ensuring that the expenditure on which the declarations are based has in fact been carried out and is supported by invoices or other accounting data. Indeed, expenditure has sometimes been declared without any supporting evidence at all (see also paragraphs 7.52, 7.54 and Table 7.2).

7.43. In Portugal a number of projects under the PEDIP(308) programme were managed by the Department of Industry and Energy. The latter sent to DAFSE(309), the responsible Directorate within the Ministry of Labour, a list including eight conditionally approved projects which had not been funded. DAFSE in turn included the amounts, which totalled 4,5 Mio ECU, in its final claims for 1995. The Portuguese authorities have decided to carry out a detailed examination of PEDIP following the Court's audit.

7.44. In order to reduce the risk of inaccurate declarations, the Commission must ensure that Member States base them on reliable evidence. The declarations made by the certifying agency in the Member State should always be based on a full and detailed list of the projects and related expenditure underlying the declaration. This would encourage Member States to ensure that appropriate accounting systems are maintained and that the various levels of administration involved fulfil their responsibilities as required by the financial implementation provisions of the OP etc. In addition, there is insufficient on-going and final verification of expenditure incurred by training providers and beneficiaries. Weak controls over the declarations give little confidence in the figures declared by the Member States (see paragraphs 7.46 to 7.49).

7.45. Under the terms of Regulation (EC) No 1681/94(310), Member States are required to report to the Commission irregularities with a financial impact of 4 000 ECU or over. Table 7.3 shows the number of ESF irregularities reported by Member States to the Commission for the years 1994-96. There has been a steady increase in their financial importance. The total number of cases is 309. The Commission has informed the Court that it is not possible at this stage to calculate the amount of interest applicable(311).

7.46. In addition to the cases of irregularities, there are other payment weaknesses in the Member States. In its Special Report in Support of the Statement of Assurance for the financial year 1995(312), the Court reported that the rate of substantial error in the Structural Funds is significantly higher than the average rate for the general budget as a whole (see paragraph 4.18), and that there was a very high incidence of formal errors (see paragraph 4.20). In 1996 the Court audited a sample of 69 ESF projects. The audits revealed errors having a potential financial effect in 31 projects. In addition, a further 19 projects had formal errors where, for example, publicity to beneficiaries, the trade and the general public of ESF participation was missing or separate accounts of ESF funding were not kept. These observations are broadly supported by the Commission's own audits.

7.47. The frequent over-declaration of ESF amounts by promoters and final beneficiaries is symptomatic of a system where eligibility was not always clearly set out and applied. Thus, there was a temptation for a claimant to give himself the 'benefit of the doubt`, relying on administrations to accept or query the amounts declared as part of their desk-checks. The Commission has now taken steps under SEM 2000 to counter this practice.

7.48. The Commission's controls should be supplemented by an audit and verification programme of beneficiaries by the responsible authorities in the Member States in order to provide assurance when declarations are made. More than half of the Member States do not have a separate verification and audit team within the responsible national authority.

7.49. The need to improve checking and audit procedures is demonstrated by the weaknesses encountered in the Member States:

(a) there were no agreed and generally available eligibility and audit guidelines;

(b) there was no clear and prompt follow-up of audit results to ensure that corrections and recoveries were made and identified in the reports and claims to the Commission;

(c) the weak coordination between inspection services of different government departments and regions leads to a risk that double financing will not be detected;

(d) an absence of a control programme based on risk analysis together with the resources to carry it out;

(e) a lack of review at management level of errors detected during desk checks, to assess whether audit should be extended.

7.50. In view of the results of the Court and Commission audits, a risk-based audit programme should be set and implemented by all Member States. Under the terms of Article 23 of Regulation (EEC) No 2082/93, the Commission should specify the minimum level of audit of projects by the national authorities. A vocational training database giving details of final beneficiaries and projects (including any subcontractors), should be developed by the Member States as part of a clear audit trail and in order to reduce the risk of double funding.

7.51. The Commission (DG XX) has entered into financial control protocols with the responsible audit services in eight Member States. However, the Commission needs to accelerate the adoption and implementation of the protocols for the ESF and ensure the rapid transmission of the corresponding audit reports. In addition, in France, a significant part of the expenditure declared to the Commission as eligible concerns national measures which receive ESF funding. However, in 1996, there was a lack of transparency in some of the national programmes and, as a result, the individual projects which receive ESF were not identifiable. The Court has drawn this to the attention of the national authorities and the Commission.

7.52. The Court, in its 1995 Annual Report(313), whilst drawing attention to the general problem of the reliability of the declarations of ESF activities by six Member States, observed that for one of them (France) the amounts declared for 1994 by the national administration far exceeded the actual figures and, for another (Italy), that 114,9 Mio ECU of national co-financing had been certified without sufficient documentary evidence. Following the audit of the Commission and the Court, the Commission blocked the ESF funding in the two countries. The 1996 audit in Emilia-Romagna (CSF 2 Objective 4) and in Sicily (CSF 1 Objective 1) revealed that the Italian authorities have continued their practice and not provided national co-financing in the operational year, although ESF funding had been made available. On 17 October 1996 the Member State submitted the final claim concerning the region of Emilia-Romagna based on a declaration made by the region in August 1996. The Commission accepted the certified expenditure as having been incurred in 1995, even though it was not paid in the operational year 1995.

7.53. The Italian authorities have informed the Court that the part of the declaration concerning national co-financing (fondo di rotazione) was made 'on the basis of commitments actually entered into calculated pro rata temporis`. The ESF regulations, however, require that all certificates of expenditure from final beneficiaries and Member States must be based on the expenditure actually incurred and not on commitments. The definition of final beneficiary has contributed to this situation.

7.54. The Italian decisions(314) for 1994, 1995 and 1996 authorizing national co-financing were not approved until 26 September 1995, 30 October 1995 and 25 July 1996 respectively. The supplementary decisions for the period 1994-96 were published in 1997(315). Moreover, the fact that an amount has been approved does not mean that the national Treasury makes the amount immediately available to a region. Table 7.2 shows the accounts of Emilia-Romagna for Objective 4 in 1995, the corresponding implementation certificate and the application for final payment. The national co-financing was correctly declared in the implementation certificate dated February 1996, the aim of which is to obtain an advance for the following year. However, the co-financing coming from the national budget had not been paid to the region when the application for final payment was made in August 1996. This practice obliges the region to pre-finance the national part. Nevertheless, this pre-financing did not take place in 1995. This is demonstrated by the fact that the co-financing coming from the national budget was only 1%. However, to that should be added the co-financing coming from the regional budget which amounts to 11,7 %.

7.55. These circumstances were known to the Commission. According to the files audited by the Court, correspondence from the region indicating the facts behind these irregular declarations was copied to the Ministero del Bilancio e del Tesoro and the Commission. No enquiries were made or financial corrections taken.

7.56. The Court has now audited co-financing in three Italian regions. In all three (Lombardy, Sicily, Emilia-Romagna) there was no State co-financing coming from the national budget, based upon expenditure incurred. Only those regions that have pre-financed national co-financing from their own funds will have satisfied the co-financing requirements. However, in the regions audited such pre-financing did not take place in due time. In at least one region it did not take place over several years (see paragraphs 7.52 to 7.54).

7.57. This situation may have an effect on the implementation and thus on the effectiveness of the relevant ESF measures in both CSF1 and CSF2. The Court requested the Commission to examine Italian co-financing. It therefore welcomes the steps taken in this direction by the Commission on 13 March 1997, when it requested the Italian authorities to provide full information on the amounts of national and regional co-financing made available for both CSF1 and CSF2, for all objectives and the dates when transfers of funds took place. Initial meetings aimed at resolving the issue have already taken place between the Commission and the national authorities.

CONCLUSION

7.58. There have been delays in budgetary implementation, substantial delays in the closure of CSF1, excess advancing of funds to Member States and delays by Member States in distributing those funds (see paragraphs 7.6 to 7.14).

7.59. The partnership commenced late. In some Member States, the participation of economic and social partners is limited and the involvement of the partners in programming was superficial. For monitoring committees to play an effective role in implementing CSF2, working practices and procedures must be refined and developed. Without this they risk becoming a superfluous layer of management, the main objective of which will be ensuring maximum European Union funding rather than effectiveness (see paragraphs 7.15 to 7.19).

7.60. The implementation of Objective 4 has not been satisfactory. Funding of measures has been delayed, private co-financing has been missing, trainees were ineligible as was the subject matter of the courses. In addition, public financing does not always take account of competition policy. Furthermore, the priority intended to be given to SMEs was not respected. The Commission should carry out an urgent and fundamental reappraisal of the implementation of this objective (see paragraphs 7.20 to 7.28).

7.61. The ADAPT objective experienced delays in implementation and an overall lack of coordination and management, mainly due to the difficulties in approval and funding procedures. There should be far more coordination of Objective 4 and ADAPT by the Commission and greater emphasis placed on this aspect by monitoring committees (see paragraph 7.29).

7.62. The Commission should urgently complete its CSF1 study of additionality and report on the first years of CSF2 after giving further advice to Member States on methodology. Monitoring and follow-up should be managed by one Commission DG to ensure efficiency and effectiveness (see paragraphs 7.30 to 7.34).

7.63. The Commission should give more guidance on the criteria to be fulfilled when substituting expenditure (see paragraphs 7.35 to 7.38)

7.64. The Commission should tackle the eligibility problems identified in paragraphs 7.39 to 7.41.

7.65. Certification remains a major weakness in some Member States' management of ESF funding, being based on transfers of funds rather than expenditure incurred (see paragraphs 7.42 and 7.43).

7.66. In view of the financial implications of the errors in final beneficiary claims, it is essential that the Commission takes early steps on the lines envisaged in the third stage of its SEM 2000 initiative to require improved standards of accounting, management and control of Structural Fund expenditure, within the framework of Article 23 of Regulation (EEC) No 2082/93. This should both enable it to reduce substantially the incidence of errors in expenditure declarations and provide the basis for effective corrective action where errors continue. For the next programming period the Commission needs to be in a position to impose net financial corrections, based on the extrapolated results of sample audits, on administrations which fail to implement Structural Fund expenditure programmes in accordance with the Regulations. The necessary preparatory work to amend Articles 23 and 24 of Council Regulation (EEC) No 2082/93 should be started without delay (see paragraphs 7.44 to 7.49).

7.67. In order to ensure that there is a sound basis for declarations of expenditure, Member States should introduce a risk-based audit programme of final beneficiaries. An adequate coverage of final beneficiaries and projects should be set by the Commission under the terms of Article 23 of Regulation (EEC) No 2082/93 (see paragraphs 7.50 and 7.51).

7.68. The Commission should examine the financial declarations, particularly the annual final claims, submitted by the Member States, including the amounts of co-financing declared, in order to ensure that the conditions for granting ESF funding, including the presence of national co-financing, are met (see paragraphs 7.52 to 7.57).

REPLIES OF THE COMMISSION

GENERAL

The matters underlying the comments on the partnership (7.15-7.19), additionality (7.33-7.37) and the protocols (7.56), as well as certain remarks on irregularities and SMEs, are not specific to the ESF, but relate to the Structural Funds as a whole.

BUDGET EXECUTION

7.6. The programmes that have not been closed are either OPs containing measures which are the subject of judicial investigations or financial corrections or programmes which have been extended and are still in progress.

7.7. The Commission succeeded in achieving 100% utilization of appropriations for the 1996 financial year as a result of a vigorous policy pursued together with the Member States (see reply to point 6.9 of the Annual Report for 1995).

The appropriation consumption percentages for each objective as quoted by the Court refer to the appropriations allocated to each budget heading at the beginning of the year. These amounts were fixed during discussions on the preliminary draft budget for 1996 in February 1995, in other words before details of implementation in 1995 were available. It would therefore seem normal for transfers to be made between budget headings in the same chapter, in order to top up headings under which payments were due.

The same mechanism applies to the Community initiatives, where the situation was made more difficult by the fact that no indication of the actual degree of implementation of programmes was available in 1995.

Selection procedures for ADAPT projects started in the last quarter of 1995 in all Member States, given that the decisions were taken in spring 1995. Projects were adopted at the end of 1995 or during the first half of 1996 and received their first advance payment thereafter. This explains why take-up was low in 1996.

7.10. Implementation of the Italian programmes was seriously delayed, partly due to the special situation in this Member State over the past five years, with major judicial investigations having a significant impact on ESF implementation.

In this connection, the Commission agreed to Italy's request for an extension of the deadline for the closure of commitments and payments for 12 OPs, as an exception. This agreement was set out in Decision C(95) 2999 def., which extended the deadline for financial commitment at national level until 30 June 1996 and the final date for payments until 30 June 1997.

7.11. Rescheduling is provided for in the regulations and must be based on the progress of measures in the field or other factors underlying any under-utilization of scheduled appropriations.

The fact that the ESF carries out an annual closure of tranches provides better information on each year's expenditure and thus makes it possible to assess the merits of rescheduling requests submitted to the monitoring committees.

The Commission makes the point that the rescheduling procedure is a lengthy one, meaning that the first advance payment for the following year does not reach the final beneficiaries at best until the end of the current year or during the following year.

In many cases, therefore, the Member States do not gain any financial advantage from this system.

7.12. The Commission already adjusted certain advance payments in 1996 and will endeavour to extend this practice. However, it makes the point that, as a result of the annual closure of ESF tranches, systematic compensation is carried out after rescheduling in order to take account of expenditure actually incurred.

In the case of France, remedial action was therefore taken in conjunction with the first advance payment for 1997.

In the case of Italy, the Commission paid the maximum amount authorized as the first advance payment for 1995, on the basis of the circumstances prevailing at the time. If the level of actual expenditure by the final beneficiaries does not progress as planned, the Commission will make an adjustment in conjunction with the first financial operation of 1997, in order to take account of the overpayment (SPD standard clause 8.2 §16).

7.13. The Commission will continue its efforts to ensure that payments of ESF appropriations reach the final beneficiaries within the period laid down by the regulations (three months), subject to beneficiaries' requests complying with the conditions necessary for payment to be made (see Article 21(5) of the Coordination Regulation).

7.14. In the case of measures lasting less than two years, or where Community aid does not exceed ECU 40 million (single tranche), the Commission adapts its advance payment procedures as follows:

If 50% or more of anticipated eligible expenditure is to be incurred during the first two years of implementation, the first advance payment may amount to 50%;

if this is not the case, the first advance payment may not exceed 30%.

AUDITS OF PARTICULAR ASPECTS

The Partnership

7.15. The regulations setting out the tasks of the Structural Funds state that it is up to the Member States to appoint the social partners who will be members of the monitoring committees.

The Commission agrees with the Court on the need for genuine participation by the social partners. It has strongly encouraged the Member States to ensure this, and some progress has been made.

However, the Commission would like to make the point that the social partners themselves sometimes find it difficult to ensure that they are represented on all monitoring committees. It is necessary to bear in mind the large number of programmes (CSFs and CIPs) and the frequency of meetings (twice a year).

7.18 7.19. The Commission shares the Court's concern about the need to improve the efficiency of the monitoring system.

(g) The impact indicators were partly defined in the programming documents and supplemented through the activities of the evaluation steering committees, taking account of the results of the mid-term evaluation reports. The latter, most of which were received during the first half of 1997, contain a general analysis of monitoring systems and proposals for impact evaluation methods, including indicators, to be applied in due course.

The private sector, Objective 4 and ADAPT

7.22. The delays in implementing Objective 4 are due to its innovatory nature, which necessitated awareness and information measures. Since the beginning of 1996, there has been a sharp increase in the number of projects submitted.

In the case of ADAPT, the nature of projects, particularly the fact that they are transnational, mean that they take longer to adopt and are slower in getting started.

7.23. In the initial stages of implementing Objective 4, there were indeed difficulties with the aspects linked to competition, but Community guidelines on State aids to SMEs were then discussed with the Member States at multilateral meetings and published in the Official Journal. The Member States will be reminded of these.

As regards the rates of public/private co-financing, the SPDs, before being adopted by the Commission, pass through an internal consultation procedure involving all the departments concerned; this has made it possible to take account of competition-related questions.

7.24. The Commission feels that ESF-co-financed measures, by their very nature, are not subject to the individual notification obligation for each training measure. This applies to all Member States, thus securing the principle of equal treatment. The decision to approve an SPD replaces the notification of measures in the context of competition policy.

Before the Commission's first decisions concerning Objective 4 in 1994, a number of Member States committed themselves to limiting the granting of ESF aid to measures complying with the de minimis rule. The procedures for SPD implementation were laid down after consulting the Commission. There is no infringement of competition rules, as the skills acquired through training were not specific to a single undertaking.

7.25. Given the limited funds available for Objective 4, it is essential to ensure that measures focus on the people most threatened by unemployment. The Commission undertakes to maintain this approach.

7.26. The Court's first comment refers to the participation of job-seekers in courses under Objective 4. Ineligible persons may attend courses as long as the costs arising are not met by Community co-financing. Nevertheless, the Commission will check the eligibility of training course participants.

In Sweden the SPD for Objective 4 earmarked 15% of funds for training SME employees in the public 'health` sector at regional and local levels. The vast majority of employees in this sector are women. In view of the severe budget cuts in the public sector, many aids were transferred to the private sector, giving rise to differences in treatment for women working in the public sector. This was an exceptional case.

In Italy (Emilia-Romagna), implementation of the recent Community directives on safety at work is posing major problems, particularly for SMEs. Training in this field is intended to help firms' workers adapt to changes in organization and production systems resulting from application of these directives, which means it is eligible, and the Commission will remind the Member States of this.

7.27. The rate of private-sector participation in OPs is laid down at the level of each measure. It may therefore vary from one undertaking to another, depending on their financial capacity. However, the regulations oblige beneficiary undertakings to ensure a minimum level of participation (Article 5(3) of ESF Regulation No 2084/93).

In the cases in Belgium mentioned by the Court, the rate of private co-financing is fixed at a maximum of 10%, which may be reduced depending on the undertaking.

It is perfectly normal that at the start of programming the most advanced projects are those of large and medium-sized undertakings. Even though SMEs find it more difficult than large firms to comply with the requirements of Objective 4, several measures aimed at assisting SMEs are being implemented in the Member States. Intermediary bodies such as the Chambers of Commerce help SMEs to put together the necessary documentation and obtain public funding. In Spain, under the most recent call for tenders from FORCEM, the Commission specifically emphasized the efforts to be made with regard to SMEs.

It will continue its efforts to foster access for SMEs to ESF co-financing under Objective 4.

7.28. The concentration of Objective 4 resources on SMEs in general and access for SMEs to ESF-co-financed projects and measures together constitute one of the main themes of the ongoing evaluation of Objective 4.

In November 1996 the Commission departments published a working paper(316) containing an initial assessment of the implementation of Objective 4 programmes, particularly as regards the targeting of, and concentration of measures on, SMEs.

The mid-term assessment reports also cover project selection procedures, including the level of participation of SMEs. Methods of assessing the impact of OPs are currently being developed within the steering committees responsible for assessment in the Member States, and also by the Commission. Bearing in mind the momentum of programmes and the time needed for them to produce effects, the first results of assessment will not be available before 1998.

7.29. Transnationality, together with innovation and the bottom-up approach, is one of the fundamental characteristics of the Community initiatives. The verification of transnational partners lies in the competence of Member States as part of the broader verification of project eligibility criteria.

A common timetable was agreed with the Member States on 24 January 1995 at a meeting of the ESF Committee for the Community initiatives. Some Member States did not adhere to the agreed calendar. Payments to the final beneficiary are the responsibility of the Member State, which generally pays the projects on or after their approval.

Additionality

7.30. Compared with Objectives 1, 2 and 5b, Objectives 3 and 4 are characterized by two special features:

- they cover the entire territory of the European Union;

- only one of the Structural Funds (the ESF) is involved.

Otherwise, the ESF combines with the other Structural Funds to co-finance measures under Objectives 1, 2 and 5b, which are limited to specific geographical areas.

The clauses on the verification of additionality included in the CSFs stipulate, in accordance with Article 9 of the Coordination Regulation (No 4253/88 as amended by Regulation No 2082/93), that additionality must be measured by Objective and at CSF (or SPD) level. The CSFs for Objective 1 regions include measures under Objectives 3 and 4, whereas those for Objective 2 and 5b regions do not.

7.31 7.32. Given the specific nature of Objectives 3 and 4 as described in 7.30, the Commission has asked DG V's 'Audit` departments to establish an ad hoc method of measuring the additionality of these two objectives during the 1990-93 programming period, to collect the corresponding data in the field (in the Member States), and to analyse the data. For the objective 1 regions (Ireland, Greece and part of Spain), the statutory and contractual provisions require verification only at the level of the CSF for this objective, which includes measures under Objectives 3 and 4, as well as Objectives 2 and 5b.

In the case of Belgium and the United Kingdom, the Commission will ask the Member States for additional information.

More generally, the question of additionality goes beyond the framework of the ESF. The question should be examined in the wider context of the Structural Funds as a whole (see also reply to 7.37).

While it is true that there were problems in assessing additionality in respect of Objectives 3 and 4 in the past, the new generation of CSFs imposes clearer and stricter requirements on the Member States to fulfil their obligations for the period 1994-99.

7.33. The methodology used to verify additionality under Objectives 3 and 4 is based on the scrutiny of documentary evidence relating the budget lines of vocational training establishments with a view to identifying the expenditure eligible under the ESF. The selected sample is representative in that it represents 70% of ESF-co-financed expenditure.

7.34. In view of the difficulties encountered during the previous programming period, the Commission included more precise conditions in the programmes and SPDs under CSF II, in a bid to obtain the most reliable measurement of additionality possible. Collection and analysis of data will have to be undertaken by the principal departments responsible for the objective concerned.

EXAMINATION OF SYSTEMS

7.36 7.37. The Commission confirms the validity of the information transmitted to the Court on the rules concerning the custom of replacing ineligible expenditure. Where cases of failure to comply with these principles are identified, corrective measures are taken. The Commission also makes a constant effort to remind Member States of these rules of good management, and guidelines on financial corrections are to be adopted in the near future. In the case of the ESF, the annual closure of tranches makes it easier to verify the eligibility of measures in the event of substitution.

7.38. The Commission confirms that in the case of individual projects it is the decision on assistance taken at national level which determines the rates of Community and national participation in total eligible expenditure.

ESF co-financing must be identifiable in each agreement entered into with beneficiary organizations.

7.39. Article 1(4)(a) of ESF Regulation No 2084/93 stipulates the restrictions on the co-financing of training within the secondary education system. The training provided must have a clear link with the labour market, new technology or economic development.

These three criteria are taken into account to determine the eligibility of measures, and it is the Member States' responsibility to apply them in respect of projects. In practice, the Member States have themselves concentrated their assistance on two types of measure:

- those designed to reduce the number of young people dropping out of school, which constitutes a serious handicap to their integration into the labour market (mainly school support),

- those involving the introduction of technological and innovatory teaching into secondary education in order to improve convergence between the education system and vocational training.

The Commission undertakes to remind the Member States of these rules.

7.40. On the subject of practical teaching, the new Structural Fund regulations (1994-99) are more flexible than their predecessors, owing to the need to take account of the worsening situation as regards long-term unemployment and the phenomenon of exclusion. This trend has led the ESF to finance more training courses which include a larger measure of practical training at the workplace than in the past, as job experience is regarded as an essential component in improving the integration opportunities for the most disadvantaged groups and young people.

However, the Commission recognizes the need to ensure that a proper distinction is made between training at the workplace and ordinary work. It insists, and will continue to insist, that Member States submit expenditure relating to training measures only.

7.41. The Member State has already been asked to justify the 10% of costs in question, on the basis of objective and verifiable criteria. It will delete these costs from the request for payment of the balance as from the 1997 tranche.

7.42. In Spain, the Commission has taken forceful action, leading to an agreement (dated 11 March 1997) on a new method of calculating expenditure incurred, so that this problem should no longer arise. In the case of France, the Commission is following up the matter in partnership with the Member State.

In Italy, following decisions taken by the monitoring committees and on the basis of the definition of 'final beneficiary` contained in Section 6 of the financial management provisions, the regions and/or provinces are the final beneficiaries of ESF assistance. The payments that they make therefore serve as the basis for compiling requests for balance payments. However, this does not remove the obligation to provide supporting evidence.

7.43. In the context of the PEDIP (integrated programme co-financed by several Structural Funds), the national authorities have decided not to approve the training component co-financed by the ESF until the entire industrial restructuring programme is approved. However, the PEDIP implementing legislation allows promoters to make a start on projects before the contract is signed, provided that the administrator is informed.

Beneficiaries are then subject to the same legal obligations (especially as regards checks) as if the project had been formally approved.

However, if final approval is refused, there is a risk that expenditure on non-approved projects will be included in the request for payment of the balance. This inevitably means the balance must be corrected. Under these circumstances the Commission will ask the Member State to discontinue the system of conditional approval for PEDIP projects.

7.44. The Commission shares the Court's opinion, as the verification of requests for balance payments is one of the essential aspects of Community checks. The lists of projects co-financed by the ESF must be available in the Member States. Some Member States even publish them. Where the administrator acts at regional level, lists are available at that level. The Commission will continue its efforts to improve identification of financial flows.

The Commission acknowledges the inadequacy of national controls, although genuine progress has been made. For example, audit units have been set up in Greece and the United Kingdom, and one will soon be established in Ireland. The 'Audit` directorate of the Portuguese DAFSE has been reinforced. A programme of checks on ESF-co-financed measures has been established in France, and the results forwarded to the Commission.

7.45. The Regulation quoted by the Court concerning the reporting of irregularities to the Commission by the Member States applies to all of the Structural Funds, having entered into force in July 1994. It is therefore perfectly normal that its gradual application should lead to an increase in the number of cases reported, which must be interpreted as an improvement in the transparency of the ESF management system.

The cases reported over the past three years account for a sum of ECU 34,5 million, or an average of 0,15% of the ESF's total budget. It should be emphasized that the majority of cases reported are only suspected irregularities.

7.46. The Commission confirms that its own audits reveal the existence of problems concerning the correctness of payments. In addition to the corrections made in conjunction with the annual closure of tranches, the Commission scrupulously follows up the observations made in the Court's Annual Report and the DAS Report, as well as its own checks and those carried out by the Member States. It is also continuing to support the consolidation of Member States' management and audit systems.

The errors identified in the Statement of Assurance for 1995 (10 out of the 31 mentioned by the Court) were already referred to by the Court in its last DAS report. Since then, all the errors have been rectified, with the exception of one which is currently being corrected. The other errors with a potential financial impact concern the DAS 1996 (6) and this Chapter 7 (15). The six errors of the DAS 1996 will be corrected immediately. The 15 errors mentioned in the Annual Report can be divided into two groups: the cases corrected by the Commission and the cases in which the Commission's replies show that there are no financial corrections to be made.

7.47. The annual closure of tranches means that any over-declarations (or under-declarations) by Member States can be corrected during the lifetime of a programme, thus protecting the Community budget.

7.48 7.49. The Commission acknowledges the fact that systems and controls could be improved considerably, particularly in the Member States. The extent of the improvements to be made in this field is one of the main points examined with the Member States in the context of SEM 2000. The themes of this initiative include the clarification of eligibility rules (which has already made progress - see 7.38), the guaranteeing of minimum control system standards, and the improving of the audit procedure. These improvements will be achieved through a new implementing regulation (see reply to 7.55).

For its part, the Commission has clarified the eligibility rules applicable to all the Funds, and is continuing its efforts in this direction.

7.50. The Commission shares the Court's opinion. It has initiated a consultation procedure on a draft regulation implementing Article 23(1) of the Coordination Regulation, the aim being to clarify the Member States' responsibilities in terms of controls (procedures, frequency, system). This implementing regulation is expected to be adopted very soon.

In the meantime, a major exercise has started, with the objective of clarifying 'audit trails` in the Member States (description of financial flows and management systems). The first results are already visible in the Netherlands and Portugal.

7.51. The Commission is already making every effort to sensitize the Member States in the direction advocated by the Court. In particular it has organized a large number of coordination meetings and seminars with the national audit and management bodies concerned with the protocols. The Commission is continuing its efforts in this field and expects to sign several more protocols by the end of the year.

The Commission has reminded France that ESF-co-financed operations must be identifiable. It has made corrections to the request for balance payments for 1996 where it has not found proper evidence of the expenditure claimed.

With effect from 1997, the measures for which identification problems had been noted have been deleted from the Objective 3 SPD by the Member State. Negotiations are being held with a view to introducing new measures, where the ESF will be clearly identified.

7.52. As regards the comments made in the 1995 Annual Report (6.53 and 6.54), the Court mentions France and refers to two Italian regions, Sicily and Lombardy.

(i) The problem concerning France has been solved. The organization concerned has corrected and resubmitted its request for payment of the 1994 balance on the basis of actual costs, following the introduction of a separate accounting system for each of its regional centres.

(ii) As for Lombardy, the Commission agrees with the Court about the declaration of expenditure. It had arrived at the same conclusions during on-the-spot audits. Subsequent payments were therefore frozen as a result of the Commission checks, and national legal proceedings were started. The balance payments requested were then recalculated, the amounts under investigation deducted, and the balance paid by the Commission. In any event, where the State's contribution was inadequate or late, Lombardy itself provided the full amount of national co-financing for ESF-co-financed training measures.

(iii) The problem with Sicily concerned the inadequacy of regional budget appropriations to co-finance a major reprogramming of the financial plan for 1992 and 1993. This was one of the reasons for suspending payments. To date, the State has paid ECU 13,5 to the region. The extent of the programming has meant that this amount has proved to be less than the total co-financing required from the State. The balance requests for the 1992 tranche (revised) and the 1993 tranche have been submitted to the Commission. An analysis of these documents has confirmed that part of the State co-financing for these two years is still outstanding and that the region was not in a position to pre-finance the amount. Under these circumstances, the Commission informed the Member State, on 19 June 1997 and 25 June 1997 (meeting of Objective 4 Monitoring Committee), that the payment of these two balances would not be made until it was shown that at least 80% of the State's contribution had been paid to Sicily over the entire programming period and that this had been transferred to the promoters.

(iv) In the case of Emilia-Romagna, the region is prefinancing the State's contribution for CSF II as soon as it can (see 7.58). The Commission has accepted the request for payment of the balance relating to activities in 1995, as, on the date on which it was received (17 October 1996), the national contribution had effectively been paid to the promoters (see 7.45 and 7.58). This situation cannot continue, and the Commission will ensure that declarations are presented on the basis of actual expenditure incurred during the year in question.

7.53. The definition of final beneficiary should be clarified. Following the decisions made by the monitoring committees (see 7.45), the Italian regions and/or provinces are effectively the final beneficiaries of ESF assistance for CSF II. Under these circumstances, the payments made by the regions are equivalent to expenditure actually incurred, regardless of the identity of the final beneficiary (public or private). This practice, although consistent with the Structural Fund Coordination Regulation, has not had the expected effects, as payments have been delayed until after the date of implementation of measures. It must therefore be modified.

A first step has been made in this direction, with the Commission's decision on 'eligible expenditure` datasheets, which defined the concept of final beneficiary for the ESF. This decision will in fact make it possible not to have just a single beneficiary (the region), but to have several (province, municipality, private operators). As from the 1997 tranche, balance requests will therefore no longer be based exclusively on the payments made by the region, but on expenditure actually incurred by the various final beneficiaries.

7.54. It is true that State co-financing for the 1994 and 1995 financial years reached the Italian regions with a considerable delay. 50% advance payments from the State to the regions were made on 30 April 1997 for 1994, and on 19 May 1997 for 1995. The situation seems to be improving, as the 1996 payment was made on 1 October 1996.

The Commission feels that the delays in payments by the State to the regions poses serious problems for the budgetary equilibrium of the Italian regions, which are obliged to pre-finance the sums due from the State. For example, Emilia-Romagna adopted regional commitment decisions on pre-financing for 1994 and 1995 on 7 March, 6 July and 9 November 1995 and 17 January 1996, and started to make the corresponding payments as soon as the national decisions mentioned by the Court were published (for 1995 on 30 October 1995). This meant that only a small proportion of the pre-financing of the State's contribution by the region of Emilia-Romagna for the 1995 financial year was paid in 1995. The rest was paid in 1996, though before submission of the request for the 1995 balance to the Commission.

The Commission would like to provide the following explanations regarding Table 7.3:

(i) The contributions of the private sector and 'altri pubblici` should appear beside them.

(ii) The amount of national co-financing includes the amounts prefinanced by the region in 1996 (ECU 2,4 million).

7.55. The Commission will ensure that declarations are based on expenditure actually incurred.

7.56. The Commission is aware of this situation and has strongly urged the central State authorities to transfer their contributions to the regions more promptly. In the case of Sicily, as the balance payment request was submitted without full coverage of national co-financing, the Commission decided to suspend the payment of the last balances. In the other two cases, the explanations are provided under 7.57.

7.57. Even though the regions pre-financed the State's contribution, the Commission recognizes that there was a fundamental problem. The regions had to bear an increased budgetary burden, and there was a real danger, given the present budgetary limitations, that they would not have been in a position to fulfil this role much longer. To prevent this situation from arising, the Commission asked the national authorities, in the letter mentioned by the Court, to provide all the information needed to establish the current status of financial flows between the States and regions.

As the advance payments from the State to the regions for the 1996 financial year were made on 1 October 1996, as the national decision on commitments for 1997 and 1998 was adopted on 21 March 1997, and as payments for 1997 must be made as soon as possible, the situation is well on the way to being resolved. The ultimate goal, of course, is still to ensure that financial flows from the Commission and the State reach the region at the same time, so that it can pay the operators.

CONCLUSION

7.58. ESF budget implementation achieved a rate of 100% for the 1996 financial year. The programmes which have not been closed are either OPs containing measures which are the subject of judicial investigations or financial corrections, or programmes which have been extended and are still in progress.

The reprogramming and payment system provided for by the ESF regulations should not lead to the payment of unwarranted advance payments, particularly in view of the time needed to implement reprogramming.

7.59. The Commission agrees with the Court about the need for genuine participation by the social partners in the monitoring committees. It has urged the Member States to ensure this.

The Court's observations on the composition and operation of the monitoring committees go beyond the framework of the ESF. Although the ESF is involved in co-financing measures under all objectives, it is the main player only in the case of Objectives 3 and 4.

7.60. The innovatory nature of Objective 4, the date on which the Commission decisions were adopted (end of 1994) and the need to create implementation structures and sensitize the players involved at Member State level mean that it is too early to draw firm conclusions on the concrete results of measures under this objective. In any event, the results of the mid-term evaluation of CSF II with regard to Objective 4 will be taken into account in the programming for future years.

Despite certain interpretation problems at the start of the programming period, the Commission feels that the rules on competition are being complied with, given the specific nature of ESF-co-financed measures.

7.61. The requirement that ADAPT projects must be transnational and innovatory certainly caused a number of delays at the start of the programming period. However, the Commission is continuing to work on the improvement of coordination between ADAPT and Objective 4. The establishing of a database of ADAPT projects is one of the main instruments here.

7.62. As regards Objectives 3 and 4, the Commission has carried out an extensive exercise based on thorough checks of the budgets of the major training establishments with a view to identifying the amounts of national cofinancing. In the two cases (Belgium and United Kingdom) where measuring the additionality of Objectives 3 and 4 in respect of the 1990-93 programming period did not lead to any firm conclusions, the Commission will ask the Member States for the information needed to complete the exercise.

It is, however, true that there were problems in assessing additionality in respect of Objectives 3 and 4 in the past, and the new generation of CSFs imposes clearer and stricter requirements on the Member States to fulfil their obligations for the period 1994-99.

The Commission will examine the internal organizational aspects, in order to complete this exercise.

7.63. The rules on substituting ineligible expenditure will very soon be supplemented by the adoption of a regulation setting out new guidelines (see 7.66). The Commission undertakes to continue its efforts to inform the Member States, so as to ensure that they apply the rules systematically.

7.64. Guidelines already exist on the eligibility of secondary education and the proportion of practical training to theoretical training. The Commission undertakes to continue its efforts to make them more widely known. The Court's remarks and the Commission's replies constitute a first step in this direction.

7.65. The ESF closes its tranches annually, which allows it to correct, where necessary, over-declarations and under-declarations during the lifetime of the programme, and not just at the end. Furthermore, the increased precision given to the definition of final beneficiary by the 'eligible expenditure` datasheets will have positive effects in this connection.

7.66. The Commission will very soon adopt a draft regulation based on Article 23(1) of Coordination Regulation No 4253/88 as amended by Regulation No 2082/93. This will make it possible to tighten up the requirements in respect of audits at Member State level, which will have a positive effect on the reliability on the amounts submitted to the Commission.

The Commission notes the Court's recommendation concerning the introduction of financial correction mechanisms during the new programming period.

7.67. The Commission shares the Court's opinion, but makes the point that its draft regulation mentioned in 7.66 will provide an adequate response to the problem raised.

7.68. Declarations must be based on expenditure actually incurred during the year in question. The balances of the ESF annual tranches are analysed when the balance payment application is received, and sample checks are carried out during on-the-spot auditing. The Commission will ensure that the Member States check the correctness of these declarations. This system allows corrections during the lifetime of the programme, and not just at the end.

Measures must be financed through the annual involvement of both sources, and not just through Community funding. The Commission undertakes to improve its procedures for implementing the Court's recommendation in conjunction with the revision of the Structural Fund regulations.

Graph 7.1 - ESF utilization of funds by Member State

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Table 7.1 - ESF utilization of funds by Member State and tranche

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CHAPTER 8(317\*) European Agricultural Guidance and Guarantee Fund, Guidance Section (EAGGF-Guidance)

8.0. CONTENTS Paragraph reference

Implementation of the EAGGF-Guidance budget in 1996 8.1 - 8.5

Commitment appropriations 8.1 - 8.2

Payment appropriations 8.3 - 8.5

Audit of administrative and control systems in selected Member States 8.6 - 8.67

Introduction 8.6 - 8.8

Audit of expenditure incurred under Council Regulation (EEC) No 866/90 8.9 - 8.30

Results of the audit 8.12 - 8.30

General observations 8.12

The viability of aided enterprises 8.13 - 8.15

Evaluation of potential market outlets 8.16

Capacity considerations 8.17

Monitoring and control arrangements 8.18 - 8.21

Exclusion of ineligible expenditure 8.22 - 8.28

Respect of payment delays 8.29 - 8.30

Audit of expenditure incurred under the provisions of Council Regulation (EEC) No 2328/91 8.31 - 8.46

System of aid for investments in agricultural holdings 8.32 - 8.40

Results of the audit 8.34 - 8.40

Audit of compensatory allowances 8.41 - 8.46

Results of the audit 8.42 - 8.46

Audit of operational programmes 8.47 - 8.67

Introduction 8.47 - 8.48

Results of the audit 8.49 - 8.67

Conclusions 8.68 - 8.74

IMPLEMENTATION OF THE EAGGF-GUIDANCE BUDGET IN 1996

Commitment appropriations

8.1. In 1996 the commitment appropriations (see Table 8.1) amounted to 3 934 Mio ECU, compared with 3 609 Mio ECU in 1995. This increase benefited above all the areas covered by Objective 5b, which received 508 Mio ECU compared with 249 Mio ECU in 1995. There was a considerable reduction in only the appropriations allocated to the LEADER II programme, which fell from 235 Mio ECU in 1995 to 83 Mio ECU in 1996.

8.2. There was a slight improvement in the utilization rates of the appropriations available in 1996 (an average of 98%) compared with 1995 (an average of 97%). Thus all the budgetary articles concerning the Community Support Frameworks achieved a utilization rate of 100%.

Payment appropriations

8.3. In this context the appropriations used (see Table 8.2) were 3 511 Mio ECU compared with an amount of 2 696 Mio ECU in 1995. This increase benefited in particular the areas covered by Objective No 1, where payments rose from 1 695 Mio ECU in 1995 to 2 158 Mio ECU in 1996. The Community initiative programmes also increased their expenditure, i.e. 103 Mio ECU in 1996 compared with 94 Mio ECU in 1995.

8.4. This increase in expenditure was not as large as anticipated since the utilization rates only rose from 83% in 1995 to 86% in 1996. The best rates of utilization were those for expenditure in areas covered by Objectives Nos 1 and 6, which reached a 100% utilization rate. The lower rates correspond to expenditure on horizontal measures - Objective No 5a - at 66%, as well as to expenditure concerned by the temporary measures and innovative schemes which remain at a very low level (32%).

8.5. Table 8.3 shows the development of EAGGF-Guidance expenditure since 1993 by country. The distribution of expenditure between the OPs and the horizontal measures are given in Table 8.4.

AUDIT OF ADMINISTRATIVE AND CONTROL SYSTEMS IN SELECTED MEMBER STATES

Introduction

8.6. In its examination of the reliability of the administrative and control systems implemented by the principal beneficiary Member States of EAGGF-Guidance Section funds the Court carried out audits in Germany, Greece, Spain, France, Ireland, Italy and the United Kingdom. The audit covered expenditure during the period 1993-1996. The selected countries accounted for some 87% of Community EAGGF-Guidance Section expenditure during the period under review (see Table 8.3). At least two regions per country and an extensive series of operations (827), both individual payments and entire projects, were selected with a view to covering the most representative aspects of agricultural activities and to take account of regions already audited.

8.7. The audit concentrated on expenditure incurred:

(a) under Operational Programmes adopted in application of Council Regulation (EEC) No 866/90(318) for the processing and marketing of agricultural produce;

(b) on specific measures provided by Council Regulation (EEC) No 2328/91(319) relating to the improvement of agricultural structures, namely:

- the system of aid for investments in agricultural holdings (Articles 7, 10 and 11)(320),

- compensatory allowances paid to farmers in disadvantaged areas (Article 19),

(c) under selected Operational Programmes adopted under the provisions of Council Regulation (EEC) No 2052/88(321).

8.8. For the second programming period of the reform of structural funds (1994-1999) the expenditure incurred under the three actions above is, in some cases, included in the same operational programmes. Because of the lack of available data, due to the reform, it has not been possible to provide an accurate analysis of expenditure incurred under Council Regulation (EEC) No 2328/91, for the entire period 1994 to 1996. Table 8.4 shows, therefore, an estimation made by the Court of the split of this expenditure.

Audit of expenditure incurred under Council Regulation (EEC)No 866/90

8.9. This regulation provides for Community assistance, either as capital grants or as interest rate subsidies, payable to industrial concerns for processing or marketing Community-produced agricultural produce. The grants are paid on eligible expenditure up to a maximum of 50% in Objective 1 areas and 30% in other areas.

8.10. Priority is given to investments relating to environmental protection or hygiene improvement measures, as well as to those with a high technological content. Investments must contribute to improving agricultural production and guarantee adequate and lasting economic benefits to the producers. Sufficient evidence must also be furnished that the investments will be profitable.

8.11. Specific investment items are excluded, notably the costs of purchasing land, second hand equipment, landscaping, intangible assets, preparatory work not directly connected with the project and, for the first programming period, work commenced more than six months prior to project approval. Also, specific exclusions are made for sensitive sectors where existing capacity is considered to be adequate.

Results of the audit

General observations

8.12. Both in terms of legality and regularity of operations and of the soundness of financial management the following particular weaknesses were noted in the evaluation and control procedures in operation :

(a) the viability of aided enterprises was not always sufficiently verified prior to approving the aid (see paragraphs 8.13-8.15);

(b) also, although the governing regulation stipulates that aided enterprises should be able to demonstrate realistic market outlets, this element had not always been sufficiently verified (see paragraph 8.16);

(c) likewise, consideration of capacity constraints in sensitive sectors does not always receive adequate attention (see paragraph 8.17);

(d) monitoring and control aspects, particularly relating to the eligibility of claimed expenditure, also needs to be improved (see paragraphs 8.18-8.28);

(e) the time limits established by the regulation for paying the aid are not always respected (see paragraphs 8.29-8.30).

The viability of aided enterprises

8.13. Although the regulation 'provides that sufficient evidence must be given that the investments will be profitable`, this should be examined in the light of the overall viability of aided enterprises. The importance of adequate assessment of applicants prior to approval of aid is to ensure that company plans are well-founded and that realistic market outlets exist for the proposed production. However, no written assessment reports were prepared by certain national authorities in Germany, Spain and Italy, while in Greece and, on occasions, in France and the United Kingdom, such reports were insufficiently detailed to indicate careful consideration of key elements.

8.14. In terms of the overall viability of aided enterprises the principal weakness generally noted was that national authorities accepted without further investigation:

(a) projected trading results, based on unrealistic trading margin adjustments or after crediting important exceptional revenues;

(b) on a number of occasions applications from companies having made no serious attempt to indicate expected future trading result;

(c) applications from aided enterprises which were unable to demonstrate any realistic prospects for improving weak current trading results;

(d) unaudited accounts containing unrealistic and unjustified profitability statements.

8.15. Overall it was found that a number of the aided enterprises were incurring substantial losses at the time of approval of aid and, in many instances, the projections of the enterprises gave no indication of realistic prospects for an early return to profitability. Thus, a key requirement of the Community regulation, that only viable enterprises are entitled to be aided, was not respected. In the intervening period certain grantaided enterprises have encountered serious financial difficulties to the extent that, for some, their very survival is in serious doubt, whereas at least seven enterprises which had received national approval for Community aid totalling some 4,4 Mio ECU have already collapsed or ceased trading.

Evaluation of potential market outlets

8.16. Such an evaluation is important, not only in the context of determining the overall viability of the aided enterprise, but equally to verify that the output from the aided facilities does not unduly risk ending up in Community intervention storage. Nevertheless, evaluation of potential market outlets for the produce of grantaided plants was inadequate. In cases where an evaluation was undertaken it was found that the main emphasis was on productive capacities rather than on abilities of the aided enterprises to procure market outlets. Furthermore, the submission of a comprehensive marketing plan was rarely required of aid applicants even for new and untested products.

Capacity considerations

8.17. Because adequate or surplus capacity already exists in many sectors, stringent capacity limits are imposed, with new capacity only being allowed if equivalent existing capacity is abandoned. The regulation imposes particularly severe restrictions in the meat and cereals markets. There is evidence, however, that these restrictions are not always adequately monitored by the national authorities. The following examples illustrate some of the findings in this area:

(a) in Italy in one case examined, the perceived need for new storage facilities for grain was not proven, nor was any evidence available that overall capacity limits were respected; it was noted that the beneficiary was subsequently using only some 30% of the facilities and was renting the remaining facilities;

(b) in France, one case was examined involving aid granted for the upgrading of a public slaughterhouse; although the capacity of the upgraded facilities were established at 5 000 tonnes the projected throughput after the investment, at 2 400 tonnes, was less than 50% of available capacity; while the authorities had insisted on an overall rationalisation of regional slaughtering capacity prior to approving the aid, further rationalisation would have been appropriate as evidenced by the fact that the majority of other public slaughterhouses in the region concerned were also experiencing similar capacity under-utilisations.

Monitoring and control arrangements

8.18. An adequate level of documentary and physical inspections by the designated national authorities is essential to ensure compliance with the governing regulations. Such checks are important to ensure both that ineligible expenditure is excluded from grant claims and to verify the reality of aided projects. A number of weaknesses were noted in this area as illustrated in the following paragraphs.

8.19. Many national authorities, placing considerable reliance on the attestations of aided enterprises' external auditors as to the accuracy of payment claims, restrict or discontinue the controls assigned to them by the governing regulation. While such supplementary certification procedures are useful, they cannot entirely exonerate the national authorities from carrying out controls.

8.20. In Spain, Greece, France, Italy and Germany, while the authorities indicated that inspections were undertaken, no inspection reports were prepared. Furthermore, there was little evidence of ineligible expenditure being excluded from grant claims, although the Court's audit indicated a number of instances where such deductions should have been made. In the circumstances, it is not possible to determine if the overall monitoring and control procedures are adequate.

8.21. Inspection visits were only adequately documented in the UK and Ireland. However in the UK the responsible authorities normally undertake only one physical inspection per project, even in cases where projects are implemented over an extensive period. This frequency is inadequate to detect items of ineligible expenditure, particularly in view of the limited time allocated to such inspections, during which documentary verification of expenditure is also undertaken. For one project examined no physical inspection took place due to staff shortages, while for another the invoices supporting the expenditure declared were unavailable at the time of the visit and were therefore not checked.

Exclusion of ineligible expenditure

8.22. In France, a number of items of ineligible expenditure were included in claims approved by local offices. While the authorities have indicated that all ineligible expenditure items have, or will be, eliminated at the final check carried out at central level prior to authorising payments, greater attention to the detection of ineligible items is also required at approval level.

8.23. In Germany anticipated expenditure is allowed for the payment of national aid. In one of the payments examined during the audit, the claim for Community aid was also based on expenditure which included a substantial portion (72%) of anticipated expenditure, contrary to the provisions of the regulations.

8.24. In almost all cases examined in Greece, the bulk of items declared as eligible expenditure represented payments made in cash, even for substantial sums of money. Thus, although copy invoices and receipts were presented, there was an overall lack of independent third-party evidence of payments declared.

8.25. Also in Greece, in cases of projects managed by public bodies, the public tendering procedures used give no reliable basis for controlling expenditure because of the inappropriateness of the standard costs used. The common practice of offering substantial discounts to procure the contract with subsequent authorisations that substantially increase the contracted amounts (see example at paragraph 8.57) further diminish the transparency of the system. Furthermore, the substantial use of cash payments, as indicated above, make it difficult to establish if all payments declared have in fact been made.

8.26. In Ireland, for a project involving cooked meat production facilities, a 10-year old extruder machine for an amount of 56 000 ECU was included and accepted to be aided, contrary to the provisions of the regulation.

8.27. In Italy, for two projects examined, the costs of purchasing land, totalling 117 000 ECU should have been excluded from eligible expenditure.

8.28. In the United Kingdom ineligible expenditure of 80 000 ECU for machine spare parts was accepted for one project examined, while for another, the project engineer's salary was accepted as eligible although he was part of the company staff. The responsible authorities have informed the Court that procedures to exclude ineligible expenditure have now been implemented.

Respect of payment delays

8.29. In view of the large sums involved for most of the investments, the regulation initially provided that payment to final beneficiaries must take place within six weeks after the application, supported by adequate documentation, is submitted to the designated authorities. Since 1993 the maximum delay was extended to three months.This regulatory provision is supported by the Community budget through the system of advance payments made to the national authorities.

8.30. However, payment delays of more than one year were noted, particularly in France and Italy, even after the responsible local offices had received complete documentation and had approved the payments.

Audit of expenditure incurred under the provisions of Council Regulation (EEC) No 2328/91

8.31. The various provisions of this regulation are aimed at individual farmers and have, as an overall objective, improvements in the viability of individual farm holdings. The measures are aimed at both existing farmers as well as young farmers setting up in agriculture for the first time. The regulation also provides a form of income support, or compensatory allowances based on specified criteria, for farmers in disadvantaged areas.

System of aid for investments in agricultural holdings

8.32. The investment aids provided under the regulation require farmers to present and have approved a farm improvement plan the importance of which is to ensure a structured development of the agricultural holding. This plan should set out a programme of investments to be undertaken with the intention of increasing or maintaining, within limits set to take account of the overall constraints of the common agricultural policy, the income per holding relative to the number of man work units (MWU) required to operate the holding. While individual amounts paid under these measures are relatively small, the large number of beneficiaries results in material total amounts paid in each of the Member States visited, representing some 15-20% of total expenditure incurred for the period under review.

8.33. Eligibility for aid is subject to a number of conditions, inter alia:

(a) to be engaged in farming as a principal activity,

(b) to have an income, prior to the investment, lower than a stipulated reference income,

(c) to have an appropriate vocational training or equivalent practical experience,

(d) for young farmers to be less than 40 years old.

Results of the audit

General observations

8.34. For investment grants and aids for young farmers it was noted that, notwithstanding the provisions of the regulations:

(a) the condition that applicants are engaged in farming as a principal activity is not independently verified but is accepted on the basis of the applicants' declarations;

(b) there is, in general, no follow-up to verify that approved farm improvement plans are fully implemented;

(c) investment projects were frequently implemented by the farmers themselves, with the result that it was often difficult for the authorities to establish realistic costs for the projects and to ensure acceptable quality standards for the work carried out;

(d) in a number of instances examined the calculations establishing eligibility, such as MWUs required to manage the holding and income per MWU, were incorrect, resulting in grants being paid to ineligible applicants; furthermore the farm income declared by applicants was frequently accepted without being supported by independent third-party evidence;

(e) with regard to the measures for the setting up of young farmers, the audit identified a number of instances where the physical arrangements made, rendered it impossible to establish if all the conditions attached to the receipt of the aid were respected;

(f) in a number of instances, significant delays occurred before the aid was paid to the final beneficiaries;

(g) the requirement to maintain simplified farm accounts was generally not verified;

(h) in certain Member States, expenditure declared for Community aid includes amounts for administrative expenses. In certain instances the aid payable is set off against other financial obligations of the beneficiaries.

Specific observations

8.35. In Greece,the only proof of payment of the aid is the signature of the beneficiary which cannot be independently verified. The introduction of a payment system by means of direct transfer to the bank account stipulated by the beneficiary would significantly improve the overall transparency of the system. It was also noted that for a number of projects related to agri-tourism, principally involving the construction of small hotels and tavernas in rural areas, there is not always an adequate assessment of the viability of such projects prior to approval, nor an appropriate marketing and support structure thereafter, to ensure the success of the projects.

8.36. In Spain, the audit revealed a number of errors in the calculation of key data, including that of MWU, to establish the amount of the aid, a lack of supporting documentation for expenditure claimed, considerable delays in paying the aid in a number of instances, as well as errors in the declaration of eligible expenditure to the Commission. Furthermore, the most frequent type of expenditure claimed for the setting-up allowance for young farmers related to the construction/renovation of farm dwelling houses, while the physical arrangements for such an installation were not always transparent, being based on simple collaboration agreements between individual family members. In the circumstances it was difficult to determine whether beneficiaries of the aid for the setting-up of young farmers had really so established themselves.

8.37. In France the aid normally takes the form of an interest rate subsidy. The latter arrangements are essentially administered by the banks granting the loans whose primary concern is monitoring that the agreed repayment schedule is adhered to. However, the arrangements for physical inspections by the regional administrations are weak, being based on a small sample of approved applications. Instances were noted where the beneficiaries had changed their farming activities without informing and receiving approval from the designated authorities for such changes, contrary to the provisions of the governing regulations.

8.38. In Ireland, because of weaknesses in the administrative records maintained by the local agricultural development services,numerous instances were noted where farm improvement plans had only partly been implemented or where new plans were approved before existing ones were fully implemented, contrary to the limits imposed by the governing regulation.

8.39. In Italy the system of aid for investments in agricultural holdings is only implemented in certain regions, largely due to the difficulty for farmers to respect all the required conditions and also because of national budgetary constraints. The cases examined indicated that excessive delays, sometimes as long as five years, occurred before the approved aid was paid to beneficiaries.

8.40. In the United Kingdom the required labour inputs in the declared MWU were not independently verified, but only subjected to a reasonableness check based on the number of animals declared. A cross-check with the number of animals claimed for other grants such as for compensatory allowances would increase the reliability of the system. Also, considerable delays were noted on a number of occasions before the aid was paid to beneficiaries.

Audit of compensatory allowances

8.41. The principal purpose of this measure is 'to maintain a viable agricultural community and thus develop the social fabric of rural areas by ensuring a fair standard of living for farmers and by offsetting the effects of natural handicaps in mountain areas and less-favoured areas`(322). Each Member State has a large degree of autonomy in applying this measure, within certain broad guidelines and constraints contained in the regulation. The aid may be paid either on the basis of the number of animals maintained by applicants or on the basis of usable agricultural areas. The aid is modulated per type and age of animal, and per crop cultivated, with no or restricted aid paid for certain animals producing a high level of income, such as milch cows. The individual aid payments are, with some notable exceptions, relatively small in value terms. However, the very large numbers of beneficiaries in each of the Member States results in a significant total sum of aid paid, representing some 30% of all EAGGF-Guidance section payments in any one year.

Results of the audit

8.42. In most Member States, the level of physical inspections is inadequate given the incidence of problems already detected and, in certain cases, is failing to meet the minimum percentages stipulated by the governing regulations, particularly in Greece, Italy and in Spain. In France, while the overall level of inspections carried out satisfied the minimum of 5% required, in the Department of the Drôme, the results of controls, with 18% of inspections resulting in amendments to the amounts paid, would have justified an increased rate of inspections to be undertaken. Likewise, in certain German Länder, while recent applications are based on the Community-stipulated Integrated Administrative and Control System (IACS), previous applications were largely accepted on trust as regards the number of eligible animals upon which Community aid was paid.

8.43. In Greece, the present administrative, control and payment arrangements are concentrated in the hands of the local advisory committees. Furthermore, the entire compensatory allowances are frequently paid in cash by the members of the same committees, and the only proof of payment is the listing of unverifiable alleged signatures of beneficiaries. In a number of instances the auditors noted alleged signatures which were identical for large blocks of beneficiaries. The system is open to abuse not only because the responsibility for approving and paying the aid, being vested in the same persons, does not ensure adequate segregation of duties, but also because such cash payments provide an inadequate audit trail to the final beneficiaries.

8.44. In Italy prior to 1994, when the Community introduced advance payments for compensatory allowances, a number of regions were unable to pay the aid because of financial difficulties in funding the scheme. Accordingly either no compensatory allowances were paid for a given year or, as more frequently happened, they were paid with significant delays of three years or more. Given that the aid is most frequently payable on the basis of animals kept, such delays mean that because of the lapse of time, there was no longer any reasonable possibility to verify the correctness of the claims. The low level of physical inspections add to the unreliability of the system. Furthermore, in the region of Calabria, the beneficiaries' declarations were considered as being valid, and accordingly provided the basis for aid payments, for the following five years, rather than the annual declarations provided by the regulation.

8.45. In Spain there was a lack of independent evidence to indicate that beneficiaries fulfilled key conditions required for the receipt of Community aid, such as practicing farming as a principal activity, with reliance being placed on the local knowledge of the responsible administrative services. Furthermore, the authorities did not respect one of the key requirements of the regulations, namely to carry out a minimum level of physical inspections of claims per annum. In effect, no such inspections were carried out in respect of 1994 applications. In addition, the selection of applicants for inspections in other years was based on samples rather than on the entire population.

8.46. Finally, one of the effects of the compensatory allowances together with similar EAGGF Guarantee measures, is to encourage the overstocking with sheep of mountainous regions, resulting in severe environmental damage in many fragile areas.

Audit of operational programmes

Introduction

8.47. The operational programmes (OPs) adopted under the provisions of the reform of the Structural Funds have, as their overall objective the resolution of the principal structural weaknesses noted in the individual regions. While the majority of the OPs are multi-fund in nature, the principal objectives to which EAGGF-Guidance funds are scheduled to contribute cover irrigation, land reform and forestry protection measures as well as environmental protection, forestry and rural development measures. Also, rural tourism is an important overall objective, while in the new German Länder, priority is given to measures for village renewal. Although certain programmes have a national application, the majority have been adopted for individual regions in order to prioritise specific local needs. Overall, a total of 376 OPs were approved during the period 1989-93 the first programming period, of which 319 received contributions from the EAGGF-Guidance Section.

8.48. In each of the Member States and regions visited the audit covered the most important OPs approved for the above-mentioned purposes.

Results of audit

8.49. In Germany the principal measures examined in the new Länder were village renewal schemes and rural tourism, while, in other Länder environmental protection measures and those relating to the encouragement of more extensive farming were audited.

8.50. With regard to village renewal it was noted that, in a number of cases, aid was approved on the basis of round-sum estimates which many Communes were subsequently unable to justify. Also, at the beginning of the programme, there were very wide discrepancies in the costs for preparing village development plans, even those of similar scale.

8.51. Concerning rural tourism there was no procedure to consult with the responsible tourist authorities to determine whether there was a perceived need for the facilities being funded. As the average occupancy rate for such facilities is frequently below 25%, a more thorough evaluation of needs is now necessary.

8.52. Regarding farm extensification measures, in view of the historically low rate of physical verification, the viability of the system is not assured. The overall importance of flexible land rental arrangements further diminishes the system's reliability.

8.53. In Greece, the principal measures audited were selected forestry projects together with irrigation measures, involving the construction of dams for the storage of surface water, and measures for locating (sinking of deep wells) and distributing water.

8.54. The results of the irrigation measures can be summarized as follows:

(a) the use of water for irrigation purposes is not restricted to specific crop cultures; olives and grapes are extensively irrigated; such extensive irrigation risks upsetting the balance between supply and demand with as the ultimate consequence, the need to have recourse to buying surplus production into public intervention storage, furthermore, it is contrary to the declared policy of the Commission(323) that only products that are not in surplus may be irrigated;

(b) also, the widespread recourse to deep wells for irrigation purposes, particularly in coastal areas as is practiced in Crete and at certain locations in the Pelopponese, risks exposing the affected zones to soil pollution in the long-term, through the seepage of seawater into the water table; there is already evidence of such pollution in certain areas; there is also the risk that in future, additional Community aid will be solicited to pay for repairing the environmental damage caused by the current aid allocations. The responsible authorities have informed the Court that environmental studies before project approval are now compulsory.

8.55. The audit revealed a particularly unsatisfactory situation with regard to the construction of a dam in the Pelopponese for irrigation purposes. While the application of public tendering procedures established a standard price for the project at 6,4 Mio ECU, the contract was awarded for a fraction of that amount for a sum of 2,3 Mio ECU. This reflects both the substantial discounts normally applied in Greek public tendering procedures and the legal obligation placed upon the public authorities to award the contract to the lower bidder. Once the contract was awarded, however, the contracted amount was increased to close to the standard sums set through price revisions demanded by the contractor and approved by the public authorities with the knowledge of the Monitoring Committee. A second contract later proved necessary because, despite the above-mentioned increases, the dam was far from being complete. The total cost of the project, for both contracts, is expected to reach 7,7 Mio ECU.

8.56. It is difficult, in this instance, to justify the principal price increases included in the second contract, notably the problems associated with the unstable rock strata and with the need to control the flow of a river. Those costs should have been foreseen from the outset through an appropriate preliminary study involving the use of normal sub-soil sampling procedures.

8.57. As illustrated by the above-mentioned example, the procedures applicable to public tendering in Greece are unsatisfactory. In particular, the establishment and publication of an indicative contractual amount using standard costs and the generalised practice by contractors of offering substantial unrealistic discounts of up to 75% of that amount for the sole purpose of procuring the contract together with the subsequent price increases, diminish the transparency of the contractual procedures and provide no reliable basis for controlling project costs. This has already been criticised by the Court on previous occasions(324).

8.58. In Spain almost all the OPs approved for the period 1989-93 were closed by the deadline set, (31 December 1995), with total certified expenditure exceeding in most cases the expenditure foreseen. The audit concentrated on the OPs approved for the region of Galicia. The following general observations arose:

(a) notwithstanding that the OPs were closed there was no clear overview of all the projects approved, incorporating all the modifications made during the programming period and taking account of abandoned or rejected projects. Also, none of the reports submitted to the Commission gave a sufficiently clear indication of the overall effectiveness of the measures;

(b) although it was indicated that the responsible local services had visited the approved projects on several occasions during their implementation, no reports were prepared to indicate the results of such inspections.

8.59. There was an overall lack of transparency in the procedures adopted for the management of OPs funded under the EAGGF-Guidance section expenditure in Galicia. The following specific remarks arise from the audit of individual files selected for audit:

(a) land reparcelling measures had, in large part, benefited non-agricultural purposes as numerous new houses had been built on the re-parcelled plots with certain plots having been sold for the construction of industrial buildings;

(b) a significant portion (26%) of expenditure incurred for a sub-programme for the improvement of Galician wine quality was for purposes other than those initially approved;

(c) undue delays were noted on a number of occasions before the approved aid was paid to the final beneficiaries.

8.60. In France the following weaknesses noted were:

(a) incomplete or inadequate supporting documentation in respect of forestry projects in Guyana and Martinique including lack of clarification concerning the nature and make-up of eligible costs;

(b) in the case of a university study on the potential for developing agriculture in Western Guyana, the global nature of expenditure amounts declared as well as the fact that the university sub-contracted a considerable portion of the field work to a local development group greatly diminished the possibilities for ensuring an effective control; furthermore, the amounts charged in respect of research assistants' salaries varied greatly from month to month and included amounts in respect of time periods extending to more than six months prior to when the contract was signed, while inconsistencies were also observed in amounts claimed for travelling expenditure;

(c) in the case of projects for the construction of processing and packaging stations and access roads for banana plantations, although there was good physical control of aid applications, it was not possible to reconcile the amounts approved for financing with the actual expenditure incurred and the actual payments made; furthermore, there was no justification for work claimed to have been undertaken by the plantation owners, which, in certain instances, represented a significant element of costs declared.

8.61. With regard to the modernisation of the strategically important sugar refineries, the present scale of operations of two of the three refineries audited falls far short of the minimum tonnages estimated necessary to assure the long-term viability of the projects. To support the important investments involved, some 13 Mio ECU to date, urgent measures are necessary to halt the steady decline in sugar cane production, in particular, by providing improved technical advice to growers. If the present production decline is not halted and indeed reversed, the medium-term prospects for the aided investments appears to be rather bleak. Furthermore, none of the three refineries is as yet in a position to respect EU Directives governing pollution control measures, an essential requirement for Community funding.

8.62. The total cost of a project involving the construction of a plant for the preparation of ground limestone in Guadaloupe was 6 Mio ECU of which 4 Mio ECU was accepted for Community financing, with Community aid totalling approximately 1,4 Mio ECU spread over two OPs. The following audit observations arise:

(a) although Community aid was only approved in December 1991, with expenditure scheduled to be undertaken during the period 1991-93, in reality some 3 Mio ECU had already been incurred at that date, including some 1,2 Mio ECU as early as 1989;

(b) the bulk of the actual expenditure declared 4 Mio ECU of the total of 6 Mio ECU related to ineligible operating expenses rather than the approved expenditure for capital investment and a contribution to transport costs; in total these latter expense headings only accounted for some 1,9 Mio ECU instead of the 4 Mio ECU as per the approved financing plan;

(c) copies rather than originals of invoices were furnished and only for a small part of expenditure declared, while no supporting documentation was furnished for the bulk (5 Mio ECU) of the expenditure declared;

(d) there was inadequate reporting of the implementation and results of the project contrary to the terms of the aid agreement.

8.63. Overall, inadequate supervisory arrangements were made in connection with the implementation of this project. While the French authorities have indicated that complete documentation was subsequently presented, at the time of the audit inadequate documentation was made available to the Court's auditors. There is an urgent need to carry out a thorough review of expenditure declared before any assurance can be given as to the correct utilisation of Community funds.

8.64. Although an agri-tourism project in Ireland had been executed in a satisfactory manner, serious doubts arise as to the categorisation of the investment as a group project, which significantly raised the ceiling of eligible expenditure and increased the grant payable by 32% to 41 000 ECU. While it is claimed that the other party, a relative of the principal applicant, makes available certain intangible assets, such as know-how, for the management of the project, such claims cannot be verified, nor is there evidence that the other party participates in the results of the investment. In the absence of tangible proof of the involvement of the other party in the project, the aid paid in excess of the limit applicable for a single project should be recovered.

8.65. In Italy the audit covered a number of forestry and flower cultivation projects in Sicily. For certain projects substantial amounts of ineligible expenditure were detected. Furthermore the final use of the aided investments was not controlled by the national authorities. Finally, it was noted that excessive delays occurred from approval of the projects to implementation, with further substantial delays prior to payment of the aid.

8.66. In the United Kingdom the principal area of application is in Northern Ireland where the OPs adopted, for the first and second programming period, were examined. In the early years, the take-up of the measures available was significantly slower than anticipated so that the eligibility criteria had to be relaxed to encourage greater participation. However, with the programme continuing to be under-utilised, the UK agreed on two occasions in the final year to reductions in funding for the OP amounting to 19,1 Mio ECU. This contrasted with the position relating to Structural Fund objectives in some other member countries, where periods of eligibility were extended to facilitate absorption of the funds available. Subsequently in the UK an unanticipated rush of late applicants resulted in a shortfall of funding available under the OP of 30,5 Mio ECU. The Commission agreed to allow an amount of 23,5 Mio ECU (EAGGF funding 11,75 Mio ECU) under the OP for the new programming period, subject to the condition that the expenditure transferred would meet all conditions.

8.67. The following observations arise from the above-mentioned procedures:

(a) the monitoring of the implementation of the OP during the first programming period must be considered as inadequate, as evidenced by the cancellation of funds in the final year, when the substantial over-run occurred;

(b) while the transfer of claims from one programming period to the other was approved by the Commission, these procedures failed to respect the principle of expenditure specification, in that projects approved under one OP were effectively funded under another.

CONCLUSIONS

8.68. The scale and diversity of EAGGF-Guidance section operations is such that, notwithstanding the relatively small individual sums involved in relation to other interventions of the Structural Funds, it is an area that does not lend itself to easy control. In view of the objectives set for the reform of the Structural Funds, the primary responsibility for the administration and control of co-funded operations rests with the designated bodies in the Member States. The results of the audit indicate that, in this important area, those bodies have not always fully respected their obligations. There is, in particular, a need for greater vigilance to ensure the respect of the provisions of Community regulations in the areas of physical controls. Also, it is necessary to ensure that the eligibility criteria are more strictly adhered to.

8.69. The individual grants in aid paid under the provisions of Council Regulation(EEC) No 866/90 and submitted for Community co-financing are substantial, amounting on occasions to several million ECU. Accordingly, it is essential, to verify that the requirements of the regulation are fully respected. The Court's audit observed weaknesses in the procedures implemented by the Member States in the areas of evaluating aid applications (see paragraphs 8.13-8.17) and in monitoring, controlling and paying Community aid (see paragraphs 8.18-8.30). Furthermore, as the applicants are almost exclusively private companies with stringent requirements to maintain proper accounting records, national authorities should not approve projects from companies which fail to demonstrate reasonable prospects for marketing their products and to show reasonable viability expectations. Nor should they accept expenditure declarations which are not fully justified.

8.70. The success of the Community system of aid for investments in agricultural holdings is important to ensure the viable development of agricultural structures. This development is essential to counteract significant pressures in rural areas notably the rural exodus and even the desertification of certain rural zones. Nevertheless the production constraints imposed by the common agricultural policy and incorporated into the EAGGF-Guidance section measures also have to be respected. This latter aspect requires particularly close control by the national authorities and by the Commission. The Court's audit revealed that the national authorities need to implement a number of improvements to ensure that applicants respect the conditions attached to the receipt of Community aid (see paragraphs 8.34-8.41).

8.71. Because of the very large number of applicants, it is not an easy task to effectively control compensatory allowance claims. The Commission, recognising the difficulties inherent in the scheme, introduced measures and gave material assistance to Member States, to implement what it regarded as a reliable control system- the Integrated Administrative and Control System (IACS). While this system will, when implemented, form a reasonable basis for an effective control system, over time, certain Member States have, to date, made little progress in implementing the system, although the timetable contained in the regulation provided that it would be fully operational by end-1995. Also, as the system is only as reliable as the data input, it is important to ensure either that a reliable database is already available or that an adequate level of checks is undertaken to underpin the system's reliability. The Court's audit revealed a number of weaknesses in the control systems implemented by the Member States (see paragraphs 8.43-8.48). For Member States where the levels of physical inspections have been historically low sufficient measures have not yet been taken to establish a reliable administrative and control system (for further observations on the IACS system see chapters 4 and 5).

8.72. Expenditure incurred under operational programmes is subjected to less stringent rules and procedures than that incurred under other EAGGF-Guidance Section measures. Supervision and control is largely left to the Member States and to the Monitoring Committees under the principle of subsidiarity. The Court's audit has revealed numerous weaknesses in these arrangements with the result that serious doubts arise, on occasions, as to the eligibility of sums declared and the adequacy of control over Community funds (see paragraphs 8.51-8.69). Finally the possibilities offered to Member States to substitute alternative projets for those found to have been ineligible mitigates the impact of controls on Community expenditure.

8.73. The Commission has an important role to play in monitoring the implementation of the regulatory provisions. In doing so, it undertakes a series of on-the-spot inspections, but is hampered by the lack of detail on underlying transactions available to it, in order to base such inspections on appropriate risk analysis. During 1996, the Commission services undertook 25 on-the-spot inspections, the principal conclusions of which largely coincided with those of the Court's audit.

8.74. In order to improve its information on underlying transactions, the Commission is also developing its information systems to gain direct access to standardised databases in the Member States. The completion of this latter project, scheduled for end-1997, will improve the prospects for effective controls. There is an urgent need to implement improvements in this area as the Court's audit revealed that the summary declarations of expenditure submitted by the Member States are frequently inaccurate. They are often based on budgeted rather than actual expenditure, the Member States accounting records are not sufficiently transparent to allow the sums declared to be traced, or the individual amounts paid simply do not agree with the amounts declared without any apparent reason. Finally, in view of the weaknesses highlighted by the Court's audit it is necessary for the Commission services to monitor the administrative and control procedures implemented by the Member States more effectively.

REPLIES OF THE COMMISSION

IMPLEMENTATION OF THE EAGGF-GUIDANCE SECTION BUDGET IN 1996

Payment appropriations

8.4. As the Court of Auditors rightly concludes, the use of payment appropriations increased in 1996 as compared to 1995, although the increase in the case of Objective 5(a) measures is low. This is mostly due to the very low take-up of advance payments by some Member States for reasons related to the management of their own national budgets, as well as the lower rate of finalization of the old measures under the Regulation on the processing and marketing of agricultural products envisaged at the time the budget was drawn up.

AUDIT OF ADMINISTRATIVE AND CONTROL SYSTEMS IN SELECTED MEMBER STATES

Introduction

8.8. The data for the period to 1996 referred to by the Court will, in accordance with the relevant regulations, be available only from 1998.

Audit of expenditure incurred under Council Regulation (EEC) No 866/90

Results of the audit

The viability of aided enterprises

8.13. The Commission considers written assessment reports a key requirement for verifying that Article 12(3) is respected. The Commission services are discussing the verification of profitability of projects at meetings of the Monitoring Committees in order to alert Member States' officials to this issue. The dialogue is intended to continue and to be stepped up.

8.15. Businesses, including those potentially eligible for part-financed aid, operating in competitive markets, inevitably and continuously face risks, including business failure. Such risks cannot always be foreseen when decisions are taken to grant aid to a beneficiary. The Commission has no evidence that the rate of business failure amongst aid beneficiaries is out of line with that for similar firms, frequently making innovative investments, but which have received no such aid. If such evidence were available it could indicate weaknesses in analyses carried out prior to aid decisions being taken. That said, the Commission would see dangers in a policy of restricting aid to lowest risk beneficiaries. Such a policy would tend to act against innovative investments and those undertaken by newer operators, and possibly also against those in the regions. Moreover, because the Commission does not decide on individual projects and has still to take final decisions on part-financing under the operational programmes, it is not possible to know now whether any will be taken into account for a Community financial contribution. On the wider policy aspect, the Commission does not consider subsequent business failure to be sufficient grounds in itself to exclude part-finance but each case needs to be considered on its particular merits including whether at the time aid was granted the prospects for the enterprise were not assessed or gave an indication of likely failure. Concerning the seven cases mentioned it is not clear from the Court's comments whether they were incurring substantial losses at the time of approval of the aid or whether assessments gave no indication of realistic prospects, or indeed were not made. If such losses were present and/or realistic prospects of profitability were not demonstrated at the appropriate time, for each of the beneficiaries, the Commission will pursue the matter with the Member States concerned.

Evaluation of potential market outlets

8.16. In the context of the drafting of Regulation (EEC) No 866/90, and in particular of its selection criteria laid down in Commission Decision 94/173/EC, precautions have been taken to eliminate the risk of output from assisted enterprises ending up in intervention. Thus, certain types of investments and certain sectors with the inherent risk of surplus production are fully or partially excluded from support. Nevertheless, the responsible national authorities have to verify compliance with the first indent of point 1.2 of the selection criteria, namely the existence of realistic potential outlets for each individual project.

Concerning the assessment prior to the approval of projects, it should be mentioned that support for innovative investments is one of the priorities of Regulation (EEC) No 866/90. The assessment and implementation of such projects bear more risks than 'traditional` investments as they are highly dependent on expectations concerning the future development of the sector. In this area, moreover, markets change rapidly, and this increases the risk of failure.

Capacity considerations

8.17. Given that Structural Fund measures are administered by Member States and take a decentralized approach, the Commission does not systematically inquire into individual cases and is not aware of all individual cases highlighted. The Commission takes note of the Court's remarks and will address the points in the relevant Monitoring Committee and bilateral meetings with Member States. If the Court's findings are confirmed, the financing of the ineligible expenditure will be refused.

Monitoring and control arrangements

8.18 8.21. The Commission recognizes that recourse to external auditors does not exonerate national authorities from carrying out controls themselves. It is clear that, under the Structural Funds Regulations and in particular Article 23(1) of Regulation (EEC) No 4253/88, as amended, the primary responsibility for ensuring proper financial control of operations part-financed by the Funds lies with the Member States. Closer partnership between the Commission and the Member States is a main theme in the third stage of the SEM 2000 (Sound and Efficient Management) initiative. Financial Protocols addressing these issues have already been signed with about half of the Member States. The Commission is preparing to adopt a Regulation under Article 23(1) of Regulation No 4253/88 with a view to defining minimum standards of financial control to be achieved by the Member States. Ensuring the best possible financial management and control will also be an important concern when the Structural Funds Regulations are revised for the next programming period.

Beyond this, the Commission services carry out controls themselves in Member States and do their utmost to follow up irregularities which are brought to their attention, for instance through on-the-spot controls, through complaints on programme implementation or through written questions from the European Parliament. These cases are systematically taken up with the Member States.

Exclusion of ineligible expenditure

8.22 8.28. The Commission takes note of the Court's remarks and will make any necessary adjustments in the appropriate cases.

8.23. In their response to the Court's observations, the German authorities acknowledged the incorrect advance payments and agreed to reimburse the relevant amount.

Respect of payment deadlines

8.29 8.30. The Commission agrees with the Court that the payment deadlines defined in the Regulation must be respected. The competent departments will discuss this matter with the responsible national authorities at Monitoring Committee meetings.

Audit of expenditure incurred under Council Regulation (EEC) No 2328/91

System of aid for investments in agricultural holdings

Results of the audit

General observations

8.34 (h) During the examination of national legal provisions implementing the Community Regulation, the Commission checks systematically to determine whether provision is made for deductions for administrative expenses. Should this be the case, it is clearly stated in the respective Commission decision that those expenses are not eligible for Community financing. The Commission will examine the cases highlighted by the Court, and take appropriate action on a case-by-case basis.

Specific observations

8.35. Greece: Aids to investments in diversification of agricultural holdings towards agri-tourism are only granted if these investments are included in the requested farm improvement plan. The aim of these plans is to show that the investments are justified from the point of view of the situation of the holding and its economy and that the implementation of the plan will bring about a lasting improvement of the situation. This is the only obligation in the framework of Regulation (EEC) No 2328/91 to prove the viability of such investments. The comments of the Court give rise to the question of how viability could be checked, in particular in the context of diversification of farm holdings. Furthermore it should be pointed out that investments in agri-tourism in Greece are concentrated on less favoured areas and are only allowed if there is a close connection to the agricultural holding, e.g. use of agricultural products in the referred to tavernas. The same philosophy lies behind the construction of 'small hotels` (mostly rooms and flats).

8.36 8.38, 8.40. The Commission takes note of the Court's observations and will raise the issues highlighted with the Member States concerned.

and 8.39. Italy: The Commission is well aware of the problems concerning the partial implementation and the delayed payments for investment aids and is making particular efforts to clear up these files.

Audit of compensatory allowances

Results of the audit

8.42. The Commission notes the Court's comments on the level of checks carried out by Member States under the Integrated Administration and Control System. Regulation (EEC) No 3887/92 does provide for an increase in the number of checks should a significant number of irregularities be found in any particular year. Should the Member States concerned not come forward with remedial action, the Commission will take account of the Court's observations when establishing the priorities for future control programmes.

8.43. An on-the-spot inspection carried out by the Commission in 1997 confirmed that more farmers had been encouraged to open bank accounts to facilitate the receipt of compensatory allowance payments, which are all made through the Agricultural Bank of Greece. Farmers may also collect cash payments from a payment list at the Bank. In remote areas, an authorized member of the local committee may collect payments for groups of farmers.

The system provides for payments to be then transmitted to beneficiaries directly once these latter have signed the receipt list. The Commission, however, takes note of the Court's observations on the specific case highlighted. It will raise the matter with the Greek authorities and draw the conclusions which may be necessary.

8.44. Italy: As for the investment aids under Regulation (EEC) No 2328/91 (point 8.40), the Commission is aware of the irregularities concerning the payment of compensatory allowances and is undertaking investigations in the Member State.

8.45. Spain: See point 43.

8.46. The Commission is fully aware of the problem highlighted and has already examined the problem of overgrazing/overstocking in certain areas of Ireland arising from sheep headage and ewe market premiums. Several discussions with the Irish authorities have led to concrete proposals, to be implemented from 1998, that are aimed at reducing the negative environmental impact of compensatory allowances. Similar problems have been encountered, although not to the same extent, in Scotland and Greece.

Audit of operational programmes

Results of the audit

8.54 (a) Production within an irrigation zone does not consist of single-crop farming and it is difficult therefore to exclude totally from it the irrigation of certain existing crops. Irrigation is the main tool for converting to other forms of production and the Commission took steps to ensure, in the period 1989-93, that it should not lead to increased production of products which are sensitive from the point of view of the CAP. This approach covered sector-based changes at regional and programme level; It is clear that special conditions may apply at individual level. Crop improvements do not occur immediately an irrigation network has been made available, particularly in the case of traditional multiannual crops. In the majority of market organizations applying the system of maximum guaranteed quantities has the effect of establishing balance on the market and preventing increases in the production of sensitive products.

In order to improve even further the evaluation of the effect irrigation is having on the agricultural markets, the Commission is examining, in the context of the CSF for 1994-99, foreseeable cropping plans within each zone, using the project data sheets. The examination is being carried out within the Monitoring Committees for each programme.

(b) The salinization of the water table is not a new phenomenon, especially in certain coastal farming areas of the Pelopponese and Crete. The ground water overdraft is recognized in Greece as being related to the large number of wells bored privately without public funds, with some 60% of consumption coming from wells of this type. The sinking of wells for group irrigation schemes whose construction and operation are to be checked by the authorities should remedy the situation.

The Commission, in partnership with the Greek authorities, has established its priorities for water management in farming. Under the 1994-99 CSF, the emphasis has been placed on exploiting surface water rather than ground water, and on reducing losses and, consequently, on rationalizing water management.

8.55 8.57. The Commission is aware of the problem that created the major difficulties in 1989-93. The 1994-99 CSF offered a framework for the revision of the public works system in Greece to bring it into line with the applicable law. The Joint Steering Committee set up to examine the shortcomings in the system tackled all the questions raised, from the quality of the technical studies to the tendering, award and price review procedures following the award of the contract, along with the quality and acceptance of the work.

8.58 (a) The final report includes all the projects financed during the whole of the period 1989-93. The comment on presentation was made at a Monitoring Committee meeting and there are plans to improve the presentation from 1993 showing expenditure classified by project following the recent IT installation.

8.59. The role of the Commission in implementing the OPs is set out in the Regulations and standard clauses attached to the Decisions approving the OPs. During the examination of the OP the Commission considered the management structure suggested by the Member State and found it satisfactory. It may be that the implementation of certain measures is difficult to understand and action may be needed to clarify it.

(a) The locating of houses within plots that have been reparcelled is not authorized save in exceptional circumstances. Spanish law on reparcelling does not require plots that have been consolidated following reparcelling to be used for agricultural purposes only.

Reparcelling is an instrument of Community rural development policy that has wide applications through an integrated approach which is not confined to the agricultural sector.

(b) The measure on quality improvement was expanded partly to include participation in tasting events and shows in order to keep pace with consumer demands and tastes. Participation in technical exhibitions under the conditions approved by the 1992 OP Monitoring Committee was accepted.

(c) Payments with lengthy delays are unjustifiable without satisfactory grounds. Cases must be examined on an individual basis.

8.60 8.63. The Court raises a number of questions to which the Commission will devote particular attention in future, both as regards the profitability of projects and environmental protection. In the case of Guadeloupe in particular, it must be emphasized that the integration of the cane sugar-rum industry (one plant on Basse-Terre, one on Grande Terre) is not made easier by the archipelago nature of the region.

8.64. Ireland: The Commission will ask for the Member State's comments on the issues raised by the Court.

8.65. Particular attention will be paid within the partnership and the Monitoring Committees to the final checks on investments, their eligibility, and the payment deadlines.

8.66 8.67. Expenditure of the funds was closely monitored and in the later phase of the implementation the CSF and OP Monitoring Committees came to the view that some expenditure had not and would not take place. It is accepted that subsequent uptake of the measure resulted in an overrun of ECU 11.748 million of EAGGF expenditure.

In order to meet the Community commitment to the United Kingdom and the Northern Ireland farming community it was agreed to fund expenditure made after 31 December 1993 for investments which would be eligible under the new measure in the period 1994-99, as the farm investment measures in both phases were the same.

CONCLUSIONS

8.68 8.69. The Commission recognizes that the use of outside auditors does not exonerate the national authorities from carrying out controls themselves. It is clear that, under the Structural Funds Regulations, and in particular Article 23(1) of Regulation (EEC) No 4253/88, as amended, primary responsibility for ensuring proper financial control of operations part-financed by the Funds lies with the Member States. Closer partnership between the Commission and the Member States in the area of controls, audit trail and the promotion of common audit methodologies is a main theme in the third stage of the SEM 2000 initiative launched by the Commission in 1995. A number of Financial Protocols addressing these issues have already been concluded with a number of Member States. The Commission is preparing to adopt a Regulation under Article 23(1) of Regulation (EEC) No 4253/88 with a view to defining minimum standards of financial control to be achieved by the Member States. Ensuring the best possible financial management and control will also be an important concern when the Structural Funds Regulations are revised for the next programming period.

In the spirit of subsidiarity, the role of the Commission is clearly targeted, following conformity checks and approval of national legislation, at taking an active part in monitoring and control. Where irregularities are brought to the attention of the Commission, as a result of its own on-the-spot inspections, individual complaints, or written questions from the European Parliament, these cases are systematically brought to the attention of the Member States in the Monitoring Committees.

Control results are a regular item for discussion on the agenda of the Monitoring Committee meetings in the case of Regulation (EEC) No 866/90 and of bilateral meetings with Member States in the context of Regulation (EEC) No 2328/91, including checks on compensatory allowances. For the monitoring of Regulation (EEC) No 866/90, desk officers are explicitly instructed to discuss control results in the Monitoring Committees. Furthermore, Member States are required to report on control missions carried out by national or Commission services in the annual reports to be submitted to the Commission.

It should be pointed out also that implementation of Structural Fund measures often takes a regional approach. This differentiation can be readily justified on the grounds of the specific requirements of the various regions, but may of course complicate systematic control.

8.70. Conformity with Community regulations and objectives in the field of the common agricultural policy is systematically checked when the Commission examines national legal provisions for the implementation of Regulation (EEC) No 2328/91.

8.71. As mentioned above in points 8.42 and 8.45, the Commission is conscious of delays in the implementation and application of IACS. To the extent that the use of IACS brings to light cases of irregularities, the system can also contribute to combating similar situations in relation to compensatory allowances. Work continues in this area of control and the Commission services examine implementation and make recommendations during their control visits to Member States. The Court's remarks will be taken into account in the planning of future control programmes.

8.72 8.73. The Commission notes the Court's comment that the principal conclusions of the on-the-spot inspections undertaken by the Commission services largely coincide with the Court's audit. Where the Commission uncovers ineligible expenditure during this inspection work, or has serious doubts as to the adequacy of the control of Community funds, it excludes the expenditure in question from part-financing. The exclusion is not limited to a case-by-case basis, which would only affect the cases detected. A proportional system is applied. Thus, where, for a given action, Commission inspections detect ineligibility, payments of the Member State concerned for that entire action, are reduced by the proportion of such cases, expressed in value terms. In this way identification of ineligible expenditure, such as instances detected by the Court, does not necessarily mean that Community resources are used to support ineligible action.

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CHAPTER 9(325\*) Common policy on fisheries and the sea

9.0. CONTENTS Paragraph reference

Introduction 9.1

Budgetary execution 9.2 - 9.26

General 9.2

FIFG 9.3 - 9.12

Financial reprogramming 9.5 - 9.10

Certification of expenditure 9.11

Controls on the spot by the Commission 9.12

Community initiative PESCA 9.13 - 9.16

International fisheries agreements 9.17 - 9.22

Non-compliance with provisions of the Financial Regulation and budgetary principles 9.18 - 9.22

Conclusion 9.23 - 9.26

Follow-up of Special Report No 3/93 concerning the implementation of the measures for the restructuring, modernization and adaptation of the capacities of fishing fleets in the Community 9.27 - 9.49

The Community register of fishing fleet 9.29 - 9.33

Measuring engine power 9.34

Fleet tonnage 9.35 - 9.36

National controls of fishing activities 9.37 - 9.38

Data relating to aid granted 9.39 - 9.40

Impact of aid for the cessation of fishing 9.41

Coherence with programme objectives 9.42 - 9.46

Conclusion 9.47 - 9.49

INTRODUCTION

9.1. The Court's audit of expenditure in the fisheries sector concerned:

(a) budgetary execution at the Commission level in respect of the Financial Instrument for Fisheries Guidance (FIFG), Community Initiative PESCA and the international fisheries agreements;

(b) follow-up of the Special Report No 3/93 concerning the implementation of the measures for the restructuring, modernization and adaptation of the capacities of fishing fleets in the Community(326) (see paragraphs 9.27 to 9.49).

BUDGETARY EXECUTION

General

9.2. Table 9.1 shows the appropriations available for the fisheries sector in 1996 and their use. The total of commitment appropriations available for the year was 955,5 Mio ECU with a rate of utilization of 85,8%. The total of payment appropriations available for the year was 946,1 Mio ECU with a rate of utilization of 79,5%.

FIFG

9.3. The FIFG was introduced in 1993 in the framework of the reform of the Structural Funds(327), replacing the previous aid schemes governing the structural measures covered by the Common Policy on Fisheries (CPF)(328). Under the new legislation, the actions to be carried out(329) are now part of six-year programmes, beginning in 1994, which are presented by the Member States and approved by the Commission. These cover Objective 1(330), Objective 5a(331) and Objective 6(332) regions. The competences for granting and disbursing aid for selected projects have been completely transferred to the Member States. In line with the general rules applicable for the Structural Funds, a first advance amounting to 50% of the planned expenditure for year I is payable once the Commission has approved the programme with payment of subsequent advances dependent upon progress in using advances received to date. The balance relating to each annual instalment is payable after the action has been completed and the report on its implementation has been transmitted to the Commission by the Member State.

9.4. In 1996 the rate of utilization of commitment appropriations was 76,2% for Objective 1 regions (budgetary line B2-1100) and 73,7% for Objective 5a regions (budgetary line B2-1101), as against 100% for both budgetary lines in 1995. The rate of utilization of payment appropriations was 85% for Objective 1 and 58,1% for Objective 5a regions, as against 40,7% and 68,1% respectively in 1995. The inclusion in the Objective 1 budgetary line (B2-1100) of payments (19,8 Mio ECU for 1996) relating to old (pre FIFG) projects which have not yet been completed, is misleading and the ensuing lack of transparency has already been commented on by the Court(333). For Objective 6 regions (budgetary line B2-1102) none of the appropriations (2,8 Mio ECU for commitments and 2 Mio ECU for payments) were utilized in 1996.

Financial reprogramming

9.5. Table 9.2 shows that in certain Member States by the end of 1996 the implementation of FIFG was considerably behind schedule. The Commission accepted as single instalment programmes those with total planned FIFG contributions of less than 40 Mio ECU. Thus the entire amount could be committed for such programmes and a first advance of 30% could be paid(334).

9.6. The financial plans of the programmes relating to Spain, Ireland, Italy, the Netherlands (Objective 5a), mainland Portugal and the United Kingdom (Objective 5a) were revised in 1995 and 1996 in order to take account of the delayed start-up of the FIFG. The above-mentioned programmes account for 81,7% of the total planned FIFG contribution (1994-99) for Objective 1 and 46,6% of the total FIFG contribution planned for Objective 5a.

9.7. The reprogramming resulted in expenditure planned for 1994 being postponed to later years (see Table 9.3) and a decrease in the financial targets established in the initial period. As a result it was possible in the case of the United Kingdom to commit the 1996 instalment and in the case of Spain and Portugal, to pay the first 1996 advance. The larger advances which the Member States had already received pertaining to 1994 were not adjusted until subsequent payments became due. However, in the case of Italy, the adjustment was made more than one year later and the surplus available to the Member State was 22,7 Mio ECU between November 1995 and December 1996.

9.8. The reprogramming also complicated the management of the annual instalments, because the modified annual tranches no longer correspond to the initial commitments. The general practice of the Commission services to set off payments made against the longest outstanding commitments further complicates matters and significantly diminishes the transparency of the accounts by failing to show outstanding commitments for unclosed earlier tranches. As a result there was an increased risk of errors on the part of the administrative services of the Commission. In the case of Spain, the Commission paid the balance of the advance relating to the modified 1994 instalment (16,9 Mio ECU) prior to the receipt of the definitive annual implementation reports for the year contrary to the regulatory provisions(335).

9.9. Because of delays in the implementation of the programmes the planned 1996 commitment for the Netherlands could not be made. Indeed, total eligible expenditure certified at the 30 September 1996 by the Netherlands (Objective 5a) was only 8,7% of the total of the expenditure envisaged for the period 1994-99. No expenditure had been incurred for the measure concerning improved facilities for the fishing ports, which accounts for 32% of total expenditure planned for the period and 43,8% of the FIFG aid.

9.10. Likewise, for Italy, total eligible expenditure certified up to 1996 for Objective 1 represented only 2,7% of the total planned for the period 1994-99. For Objective 5a the realization rate was even lower, with total eligible expenditure certified up to 1996 being only 1,3% of the total planned for the period 1994-99. In addition, despite the fact that Member States are required to submit each year before first April an annual implementation report in respect of the previous year(336), at the end of 1996, the third year of the programme, the Italian authorities had not forwarded any such reports.

Certification of expenditure

9.11. Coincidentally, in France, where no reprogramming occurred, the FIFG aid programmed for Objective 5a in the period 1994-99 represents 22,7% of the total envelope envisaged. During an on-the-spot mission in June 1996, the Court noted that the certificate presented in 1995 by the French authorities to justify the payment of successive advances reflected the planned rather than the actual eligible expenditure, contrary to the provisions of the Regulation. As a result, irregular advances amounting to 25,3 Mio ECU were made. The French authorities have replied that the Commission had encouraged them to submit a request for the advances in question, in order to avoid the cancellation of the budgetary appropriations. A similar case also for France was mentioned in the Court's 1995 Annual Report(337).

Controls on the spot by the Commission

9.12. Because of the increased decentralization following the introduction of the FIFG, on-the-spot visits by the Commission services are increasingly necessary to ensure the legality, regularity and coherence in the FIFG management system. However, until the end of 1996 the Commission had carried out inspections visits on the FIFG management system in Germany, Greece and Ireland only.

Community initiative PESCA

9.13. The Community Initiative PESCA concerning the restructuring of the fisheries sector was created in June 1994(338). Faced with an almost generalized overcapacity, the aim of this initiative is to help the fishery sector to bear the social and economic consequences of the necessary changes and to contribute to the diversification of employment in the regions dependent on fishing. The total contribution of the Structural Funds planned for the period 1994-99 is 265 Mio ECU, with 40,9% financed by the FIFG, 45,5% by the ERDF and 13,6% by the ESF.

9.14. The start of this Community initiative was complicated by its multi-fund character, which involved constant coordination between the three Commission services involved and at national level between a multiplicity of organizations responsible for the implementation. During the first three years of application, the contribution of this Community initiative to the restructuring of the sector was, therefore, very limited. The slow rate of implementation is reflected by the fact that Member States accounting for 66% of the total financial assistance (Germany, Spain, France, Italy, the Netherlands, the United Kingdom) were not yet in a position to forward certified statements of eligible expenditure to the Commission at December 1996.

9.15. In 1996 the utilization rate of appropriations available for PESCA (budget heading B2-140) was 90,1% for commitment appropriations and 47,3% for payment appropriations. The bulk of the transactions were carried out in December 1996 (86,5% of the commitments and 44,7% of the payments), thus avoiding the cancellation of the budget appropriations. The Commission, therefore, committed entire multiannual appropriations in a single instalment for eight Member States (Belgium, Denmark, Germany, Greece, Ireland, the Netherlands, Portugal, the United Kingdom) thereby allowing it to pay the corresponding advances (30% of the amounts committed). While the budget appropriations were fully used for the FIFG, this was not the case for the other two Funds. Table 9.4 compares the commitments and payments made per Member State for the period 1994-96 with the planned amounts.

9.16. With the exception of Finland and Sweden, the granting of financial aid provided under PESCA may be suspended after the payment of the first advance if Member States have not provided additional information on the systems of follow-up, control and evaluation of the measures. As of January 1997, only three Member States (Denmark, Spain, Ireland) out of 11 had provided the required additional information.

International fisheries agreements

9.17. The initial budgetary appropriations for 1996 of 245 Mio ECU (commitments) and 235 Mio ECU (payments) were increased by 50,8 Mio ECU and 35 Mio ECU respectively primarily in order to cover the fishing agreements concluded with Mauritania and Argentina. The utilization rate of the appropriations available was 98% for commitment appropriations and 93% for the payment appropriations, as against 88% and 71% respectively for the 1995 financial year.

Non-compliance with provisions of the Financial Regulation and budgetary principles

9.18. With regard to fishing agreements, differentiated commitment appropriations entered into and attributed to the current financial year should include the total cost of the legal obligations entered into for operations whose implementation extends over more than one financial year, i.e. the totality of the Community financial contribution set out in the protocol to the agreement(339).

9.19. It was noted, however, that for the agreements with Angola, Guinea, Mauritania, Morocco, São Tomé e Príncipe and the Seychelles, the commitment appropriations of the financial compensation covered only the first annual instalment. Regarding additional expenditure(340) provided by the above-mentioned agreements, the Commission did not follow a consistent practice sometimes committing only the first annual instalment sometimes the entire multiannual allocation. As a result the total amount of commitments related to agreements referred to above amounted to about 205 Mio ECU in 1996, while, in accordance with the provisions of the Financial Regulation, they should have amounted to about 822 Mio ECU. The Court has previously made reference to similar breaches of the provisions of the Financial Regulation(341).

9.20. In 1996 the Commission committed an amount of 127 Mio ECU corresponding to the first annual instalment of the matching finance (financial compensation, training, scientific programme and development aid of fishing) arising from the agreement concluded with Morocco. As the agreement entered into force, provisionally, from December 1995 and the Council decision on the provisional approval of the agreement was adopted on 7 December 1995, the total amount of the matching finance relating to the agreement with Morocco, namely 500 Mio ECU, should have already been committed in 1995 instead of 1996.

9.21. The Court has also observed on several occasions(342) the non-compliance with the budgetary principle of annuality. It was noted, however, that contrary to the declared intention of the Commission the payment of two annual instalments were entered against the budget for the 1996 financial year for the fishing agreement with Guinea. The payment of the second instalment amounting to 1,3 Mio ECU made on 9 December 1996 related to the financial year 1997.

9.22. For the agreements and fishing protocols renewed in 1996 with Angola, Guinea, Mauritania, São Tomé e Príncipe and the Seychelles, the Commission did not respect the date fixed in the exchange of letters for the payment of the first instalment of the financial compensation with delays of between 10 and 68 days recorded, thereby risking interruption of fishing activities by European shipowners.

Conclusion

9.23. The foregoing analysis indicates that the Commission made available excessive FIFG funds to the Member States irrespective of their ability to absorb them. This is evidenced by the reprogramming, on numerous occasions, of the financial plans adopted for approved Operational Programmes in order to absorb excessive payments to Member States and/or to allow the payment of advances for subsequent annual instalments (see paragraphs 9.6 and 9.7). Also, the Commission paid advances to France, amounting to 25,3 Mio ECU on the basis of a certification of planned rather than actual expenditure (see paragraph 9.11). The procedures used are not conducive to the application of the principle of sound financial management of Community funds. Also, in view of the slow progress to date in implementing the programmes, there is a danger that the objectives set for the 1994-99 programming period will not be met.

9.24. In view of the decentralized nature of the FIFG management a more thorough follow-up by the Commission services is also required, particularly by means of on-the-spot controls, in order to verify the legality, regularity and reality of expenditure declared as eligible (see paragraph 9.12).

9.25. The Community initiative PESCA has had a very low utilization rate of the budget appropriations available, both for the financial year 1995 and for the financial year 1996. The cancellation of appropriations was avoided only by the creation of a global commitment for the totality of the financial assistance envisaged for eight Member States (see paragraph 9.15).

9.26. The analysis of the budgetary execution of the international fisheries agreements shows that, despite the observations of the Court in its previous annual reports, certain provisions of the Financial Regulation and the budgetary principle of annuality have again not been complied with (see paragraphs 9.18 to 9.21). The Court also observes that the Commission did not respect the dates agreed for the payment of the first instalment of the negotiated financial compensation (see paragraph 9.22).

FOLLOW-UP OF SPECIAL REPORT NO 3/93 CONCERNING THE IMPLEMENTATION OF THE MEASURES FOR THE RESTRUCTURING, MODERNIZATION AND ADAPTATION OF THE CAPACITIES OF FISHING FLEETS IN THE COMMUNITY

9.27. In its Special Report No 3/93, the Court examined the implementation of the measures aimed at the restructuring, modernization and adaptation of the capacities of the fishing fleets of the Community. The comments and recommendations of the Court covered the implementation of the management instruments, such as the Community register of the fishing fleet, and Multiannual Guidance Programmes for the fishing fleets (MAGP). In addition, the Court commented on the application of the criteria used to measure fishing capacity (tonnage and engine power), on the granting of the aid for the restructuring, modernization and adaptation of capacities and the coherence of such aid with the MAGP. During 1996 the Court examined the measures taken by the Commission as a result of the Special Report No 3/93.

9.28. Due to the overcapacity of the Community fishing fleet in relation to the fishery resources, the MAGP set intermediate and final targets from 1983 onwards for reductions in capacity that the various Member States had to achieve in terms of tonnage and engine power. The third generation Multiannual Guidance Programmes (MAGP III) covered the period 1993-96, with the objective of reducing fleet capacity by up to 20%(343). The Commission's annual report to the Council and to the Parliament, dated 1 July 1996, on the progress of the MAGP for the fishing fleet as at end 1995(344), stated that during the period 1991-95 the global objectives of MAGP III in terms of tonnage and power had been achieved. However, while some Member States have exceeded their targets, others have failed to reach theirs, or have even increased the capacity of their fleet. In 1996 the Commission proposed the adoption of the MAGP IV, with the aim of carrying out further reductions of the fishing fleet of up to 40% over six years(345).

The Community register of fishing fleet

9.29. In its report, the Court noted the unreliability of the Community's fishing vessel register (paragraph 2.3 of the Special Report) and the irregular and infrequent submission of data by the Member States (paragraph 2.42 of the Special Report).

9.30. Commission Regulation (EC) No 109/94(346) stipulates that Member States send each month full details of the changes that have taken place in their fishing fleet. However, the Commission report on the implementation of the MAGP at the end of 1995 could not include up-to-date data for Italy and the Netherlands as no information had been received for long periods. For Belgium, on the other hand, although the information was received on time, it was not incorporated in the report.

9.31. The fleet register is still incomplete in many respects. For example, as at 30 September 1996 the French authorities had not communicated the definitive data on the capacity of the fishing fleet of the overseas departments, which should have been established for 31 December 1995(347). For the United Kingdom, as at September 1996, 404 boats or 5% of the total fleet, were not classified by segment. For Ireland, the data on the file did not cover the entire capacity of the fleet(348).

9.32. When Italy carried out a verification of the engine power of vessels, it was discovered that the power actually installed was higher overall than that recorded. However, at the end of 1996 the Italian authorities had not yet communicated to the Commission the data concerning the working installed capacity on board each vessel. In its report on the implementation of the MAGP at the end of 1995, the Commission considers 'questionable` the reliability of the Italian data currently available, both in overall terms and by segment. In addition, the last communication received from the Italian authorities dates from August 1995.

9.33. To prevent the reduction in the capacity of the fleet from being offset by an increase in the level of activity, Commission Regulation (EEC) No 109/94 stipulates that Member States must submit annually to the Commission relevant data to allow the Commission to monitor activity increases per segment of the fleet from 1991 onwards. However, as at September 1996, only Denmark, Germany, Spain, Greece, Italy and Portugal had transmitted the required information.

Measuring engine power

9.34. In its report, the Court observed that the derating (limiting) of engines, which results in a reduction of the engine power, is a widespread practice and that it is very difficult, or even impossible, to make sure that such reduction, which is technically reversible, is permanently maintained. This situation generates uncertainties regarding the real engine power and the reliability of the overall statistical data available, which form the basis for the monitoring of the MAGP objectives (paragraphs 2.7 to 2.9 of the Special Report). In addition, the Court had noted that no indication of possible derating of the engine was recorded in the register of the Community fleet (see paragraph 2.10 of the Special Report). In its reply to the report the Commission referred to the introduction of new technology, the torquemeter, intended to allow the measurement of the real power of the engine in operation at sea. However, at the end of 1996 this technology is neither reliable nor fully operational for this type of verification.

Fleet tonnage

9.35. The Court also observed that the total declared tonnage of the Community fishing fleet is unreliable because of the heterogeneous measuring units used and noted that for two ships with almost identical physical characteristics, built by the same shipyard for shipowners in two different Member States there was a difference of 60% in the tonnage registered (see paragraphs 2.4 to 2.6 of the Special Report).

9.36. Council Regulation (EC) No 3259/94(349) and Commission Decision 95/84/EC(350) provided for the application of the internationally accepted measuring unit GT (or gross tonnes), for all the Community fishing vessels. Gross tonnage, measured on a uniform basis for vessels of more than 24 m in length between perpendiculars, had to be communicated to the Commission before 15 March 1995. For other vessels measurement must be progressively completed by the year 2003. As at September 1996, gross tonnage for ships of 24 m or more in length was still not available in France and Ireland and only partially available for Italy (38%), Greece and the United Kingdom (less than 70%) and Denmark (72%). The persistence of the different bases still being used and the delayed presentation of the required data lead to uncertainty regarding the capacity of the Community fishing fleet.

National controls of fishing activities

9.37. Council Regulation (EEC) No 2847/93(351) stipulates that Member States have to implement control systems, covering the fishing capacity and the adaptation of the activities of the fleets, in order to ensure the respect of the MAGP objectives. Member States have to establish a validation system comprising, inter alia, the crosschecking of the data concerning capacity and fishing activities, contained in log books, landing statements and in the register of the Community fleet.

9.38. The first Commission report on the implementation of the control of the CPF(352) indicates that most Member States have not yet given sufficient attention to the implementation of technical controls and that in certain cases these controls are carried out only when vessels are initially modified, while there appears to be little or no attempt at follow-up checking. Furthermore, there is, as yet, no reliable basis for carrying out the crosschecks required by the Regulation.

Data relating to aid granted

9.39. The Court also stressed the need for the Commission to have complete details concerning the assistance granted to a given ship so that an integrated management system could be implemented for monitoring overall aid to the fishing sector (paragraphs 2.45 to 2.50 of the Special Report). The Commission has indicated that such data will be provided by the Infosys system, which at the end of 1996 was still at a pilot phase. The key element of the system will be the allocation to each fishing vessel of a unique number which cannot be modified even in the event of change of registration. It is intended, once the system becomes operational that only ex-post controls would be carried out, on the basis of the data transmitted by the Member States in the annual implementation reports.

9.40. The Infosys system will incorporate data from 1994 onwards, the first year of application of the FIFG. On the other hand, the direct aid granted under the previous arrangements, in particular under the provisions of Council Regulation (EEC) No 4028/86, is registered separately according to the specific aid project number. This latter directory does not contain any reference to the unique internal number and it will not be referenced to either the fleet register or Infosys. As it will not be possible to establish the full amount of aid granted for a given boat, the Commission will not be in a position to carry out crosschecks with other financing schemes to ensure that no breaches of regulations occur concerning cumulative Community aid(353).

Impact of aid for the cessation of fishing

9.41. The Court highlighted the need to harmonize the definition of fishing activity in the context of this measure (paragraphs 4.14 and 4.15 of the Special Report No 3/93) in order to provide a proper basis for implementation and monitoring of cessation aid. Cessation of fishing is realized by the demolition of the vessel, the final transfer of the boat to a third country, or its final assignment, in Community waters, for purposes other than fishing. Only ships which have carried out a fishing activity for at least 75 days at sea for each of the two periods of 12 months preceding the date of the request, or a fishing activity of at least 80% of the number of days at sea permitted by national regulation in force(354), are eligible for the aid. However, the definition of fishing activity is still not harmonized, in particular, with a view to improving the desired impact on resource management and the fishing effort. Indeed, the Member States may still determine the definition of fishing activity at national level. In Spain, for example, the activity is certified on the basis of the 'Rol de despacho`, a document which only attests the maximum period during which a boat had a fishing permit.

Coherence with programme objectives

9.42. The Court had stressed the need to strengthen the link between adherence to the MAGP objectives and the granting of aid for construction, within the framework of the national and/or Community aid schemes (see paragraphs 3.1 to 3.6 and 3.17 to 3.25 of the Special Report No 3/93). Moreover the report recommended that if the MAGP objectives are not achieved by the Member State in question, financial assistance should not be granted for modernization projects which contribute to increased efficiency or which increase the overall fishing activities (see paragraphs 3.7 and 3.77 to 3.83 of the Special Report).

9.43. With the introduction of Council Regulation (EEC) No 3699/93 on the FIFG, the link between the attainment of the MAGP objectives and the granting of aid for construction and for modernization was strengthened. This regulation laid down detailed rules regarding the curtailment of activities which would conflict with the overall objectives of the MAGP.

9.44. The provisions referred to above, were invoked to block the part-financing of construction projects in Italy and in France for non-observance of the MAGP objectives. However, in France the construction and modernization projects, resulting in increases in engine power or in the tonnage, benefited from aid even after being blocked. According to the French authorities the cases in question arose from decisions taken prior to the Commission's action which were not implemented due to administrative delays. In the case of Italy, at the end of 1996 the Commission lifted its objection following an assurance from the Italian authorities that the MAGP III's objectives were respected and that the problems concerning the fleet register, described in paragraph 9.32, would be resolved during 1997.

9.45. For other Member States which, according to the Commission Report on the implementation of the MAGP at the end of 1995, did not respect the MAGP objectives, such as the United Kingdom and the Netherlands, the operational programmes did not provide for aid for construction projects. However, there was no evidence of coherence between the implementation of the MAGP objectives and the programming relating to the financial assistance of the FIFG. For example, in the FIFG programme (Objective 5a) of the Netherlands, the curtailment of the fishing efforts does not have priority and accounts for only 17,2% of the FIFG financial assistance envisaged (8 Mio ECU out of 46,6 Mio ECU). This amount was clearly insufficient to finance the measures for the cessation of fishing necessary to attain the MAGP III objectives, in view of the situation described in the Commission report that 'the Netherlands has failed to meet the objectives of the programme by a substantial margin.`

9.46. The situation arising in Portugal illustrates the lack of consistency with regard to the use of FIFG aid. According to the Commission's report, the available data concerning the engine power and the tonnage of the fishing fleet indicated, already at the beginning of the implementation of the MAGP III in 1992, that the overall fleet capacity of this Member State was lower than the objectives set for 1996. Nevertheless, the downward adjustment of fishing activities is the principal measure in the programme, with 42,3% of the FIFG financial aid envisaged (77 Mio ECU out of 182 Mio ECU).

Conclusion

9.47. The Court's follow-up of measures taken to overcome the weaknesses highlighted in its Special Report No 3/93 shows that, while progress has been made in certain areas, significant improvements are still required in a number of key areas.

9.48. The principal areas of weaknesses can be summarized as follows:

(a) the fleet register is, as yet, incomplete with important information gaps and inaccuracies, notably concerning engine power and tonnages of fishing vessels with the risk that the fishing capacities of the fleet are understated (see paragraphs 9.30 to 9.32);

(b) despite the provisions of Commission Regulation (EEC) No 109/94, the Commission does not yet have adequate data on fishing activities by segment for all Member States (see paragraph 9.33);

(c) cumulative details of financial assistance granted for registered fishing vessels have not yet been recorded and the system being implemented will only record details from 1994 onwards; in the circumstances the Commission will not be in a position to effectively monitor the adherence to key conditions established by the Regulations (see paragraph 9.40);

(d) there is a need to harmonize the definition of fishing activity so that the impact of cessation aid on resource management can be improved (see paragraph 9.41).

9.49. Overall, the management information systems envisaged for effective monitoring and control are not yet adequate in key areas in order to facilitate the efficient allocation of aid to the Member States, in accordance with the objectives of the MAGP. The Commission must take appropriate action against Member States which fail to respect the provisions of Community Regulations as regards the provision of complete, accurate and up-to-date information essential for the effective monitoring and control of Community adopted programmes.

REPLIES OF THE COMMISSION

BUDGETARY EXECUTION

FIFG

9.4. Payment of old projects from line B2-1100 is not misleading and there is no lack of transparency since each measure is identifiable in the computerized accounts system (Sincom) from its own specific sub-item within the line.

The decision to group together payments for action with identical objectives was taken by the budget authority to avoid multiplication of the number of lines.

Financial reprogramming

9.7. The Commission needed some time to put in place the financial reprogramming of FIFG funds for the programmes concerned.

It adjusted the amounts in question by considering the surplus paid as part of the first advance of the 1995 instalment. Following reprogramming it had to proceed rapidly to payment of that advance and adopted this solution rather than a recovery procedure that would have uselessly complicated financial management.

9.8. The Commission considers that financial reprogramming does not diminish the transparency of the accounts or significantly increase the risk of error, since the calculations made are notified to the Member State and the amounts in question made known to the other institutions both in the budget discussions and through the annual report on the Structural Funds.

In the case of Spain the Commission had paid 80% of the instalment initially scheduled for 1994. Following the financial reprogramming of November 1995 it emerged that the total amount of the modified 1994 instalment was less than the amount already paid. Since the 1994 implementation report had been discussed and accepted by the Monitoring Committee in February 1996 the Commission (in April 1996) treated the 1994 instalment as paid and the surplus as the first advance of the 1995 instalment.

9.9. The Commission shares the Court's concern at under-utilization of appropriations by the Netherlands.

It regularly reminds the Member States, in particular through the Monitoring Committees, of the need to make use of appropriations in line with the financial programming.

9.10. The Commission has several times called on Italy to send annual reports. One for the period 1994-96, received in May 1997, is being scrutinized.

The Commission sees to it that Member States send in annual reports.

Certification of expenditure

9.11. The Commission made the payments in question on the basis of the application made to it stating that 'the expenditure declared eligible has been effected` and 'the expenditure has been properly incurred`. It had no reason to question whether the application was in order.

In September 1995 it had reminded the French authorities of the financial execution rules for the FIFG. At that time France had not yet met any of the regulatory obligations on implementation reports or six-monthly expenditure statements. The Commission therefore asked the French authorities to put it in a position either to commit the 1995 instalment before the end of the year or reprogramme the appropriations.

In the case mentioned by the Court in its 1995 Annual Report the Commission made the payment in question in conformity with the financial execution provisions of the programmes.

Controls on the spot by the Commission

9.12. The Commission is aware of the importance of controls on the spot and plans to intensify its checks on FIFG-funded action.

In 1997 checks have already been made in Italy and are planned in Portugal, France, Spain, the Netherlands and Sweden.

Community initiative PESCA

9.15. Under Article 20(3) of Council Regulation No 4253/88 the Commission, given the budget resources available, modified the programmes to commit them in single instalments in order to simplify financial management. It was possible to modify one programme (France) in 1995 and to adopt two (Sweden and Finland) directly as 'single instalment` at the beginning of 1996. Additional commitment appropriations were needed for modification of the eight other programmes for which it was permissible to commit in a single instalment, i.e. those involving total Community assistance of less than ECU 40 million. Appropriations were made available at the end of 1996, hence the concentration of budget operations at the end of the year.

On the use of budget appropriations by the other Funds, the ERDF committed all its appropriations in 1996 but did not have time to make the actual payments, most of which occurred at the beginning of 1997.

In the case of the ESF, commitments and payments cannot be made until Member States have set up computerized files. This delayed implementation of the appropriations for the programmes converted to 'single instalment`. Most of the commitments and payments were however made at the beginning of 1997.

9.16. That the Commission is aware of the option pointed out by the Court is shown by the fact that no payment has been made after the first advance.

The fact that most Member States have not yet provided satisfactory information on follow-up control and evaluation of the measures is one of several indications of the difficulty that Member States have in managing multifund programmes such as PESCA.

The Commission will remind the Member States that have not yet provided the necessary information of their obligation to do so.

International fisheries agreements

Non-compliance with provisions of the Financial Regulation and budgetary principles

9.18. A distinctive feature of the international fisheries agreements is that while covering several years they specify by year the obligations of each party (Community and third country). The Community's financial obligation is clearly split into annual instalments in the basic text (the financial protocol). Accordingly for the year in question the Commission commits only the instalment relating to it.

It will nonetheless improve the wording of new and renewed protocols so that the amount to be committed each year is clearly indicated.

9.19. When the agreements provide for annual instalments in all sections commitments and payments are made annually.

Where funds other than for financial compensation have to be available throughout the duration of the agreement these are committed at the commencement of the protocol period and paid as required.

9.20. Although the Council Decision on provisional application of the Agreement with Morocco was dated 7 December 1995 (published in OJ L 306 on 19 December 1995) it provided (see the exchange of letters) that the first annual instalment of the compensation was to be paid by 13 May 1996. There was thus no need to commit funds from the 1995 appropriations.

9.21. The first payment was that of the first annual instalment, due by 31 May 1996. Current practice for all agreements is to pay the later instalments by at the latest the day before the anniversary of the protocol, in this case 31 December 1996.

In future the Commission will propose that the financial provisions of the agreements specify a six-month delay before the first financial compensation payment, with the later payments to be made on the anniversary of the first.

9.22. In all cases the commitments and hence payments require as the basic act indicated in Article 22(1) of the Financial Regulation a regulation adopting the agreement or a provisional Council Decision.

The Council Decisions for the agreements mentioned by the Court were adopted either a few days before or even after the final payment date, thus preventing the Commission from respecting it.

Conclusion

9.23. Member States were unable to use the available appropriations owing to delays in execution of their programmes. To deal with the situation the Commission had to carry out financial reprogramming in line with the actual implementation of appropriations.

The Commission paid advances to France on the basis of a declaration from the French authorities indicating that the expenditure was proper and had already been made.

Implementation of the FIFG programmes has been difficult everywhere but progress is now satisfactory in most Member States.

9.24. The Commission plans to intensify its checking of FIFG-funded action in the Member States. Following adoption of precise rules for all the Structural Funds on eligible expenditure, of protocols between the Commission and the Member States on control and of a regulation on detailed control provisions (being finalized) procedure will be better defined and quality should improve.

9.25. From early 1996 the Commission had planned to convert as many programmes as possible into 'single instalment` in order to simplify financial management as provided for in the rules. Reinforcement of commitment appropriations was necessary for this and it was not done to forestall cancellation of appropriations.

9.26. The Community's financial obligation is split up into annual instalments in the basic text (financial protocol) of each agreement. The Commission will nonetheless improve the wording of renewed protocols and those to new agreements so that the amount to be committed in each year is clearly indicated and also the payment time limits.

On failure to respect time limits the Commission must point out that it can only effect commitments and payments following adoption of a basic act. In the cases mentioned by the Court the Council Decision was passed on a date preventing the Commission from respecting the time limit.

FOLLOW-UP OF SPECIAL REPORT NO 3/93 CONCERNING THE IMPLEMENTATION OF THE MEASURES FOR RESTRUCTURING, MODERNIZATION AND ADAPTATION OF THE CAPACITIES OF FISHING FLEETS IN THE COMMUNITY

The Community register of fishing fleet

9.29. For most Member States the fleet register can be used to follow the evolution of the fleet with reasonable accuracy. This is due to continuing developments in the electronic communication of data between the Commission and the Member States, including the rapid notification and correction of reject or suspect declarations.

9.30. The Dutch register is now up to date. There has been no further development on the Italian register. Therefore, the Commission has agreed to assist the Italian administration in a series of technical meetings in order to resolve the communication problems.

In the case of Belgium, data were supplied in March 1996 on the situation of the fleet at the end of 1995, but were not processed in time to be included in the report. The data concerned just seven vessels and had a negligible impact on the situation of the fleet.

9.31. France has undertaken to supply fishing effort data and the data for the Overseas Departments following the procedures of the fleet register.

The UK still has a large number of unclassified vessels but this seems to be a communication problem, as there are no missing segment codes in the national register.

Ireland is in the process of including the vessels that were previously unregistered, the total capacity of which will be approximately 3 000 tonnes.

9.32. The Italian administration have indicated that the fleet register will be brought up to date before the adoption of the fourth set of multiannual guidance programmes (MGP IV).

9.33. The list of countries that have submitted effort data now includes the United Kingdom. The remaining Member States have been asked by letter in June 1997 to submit the missing data, indicating and justifying the means by which they were collected. No effort limitation programmes under MGP IV will be accepted if the Member State concerned has not submitted effort data for the MGP III period.

The Commission is considering the possibility of legal action against the Member States that do not comply.

Measuring engine power

9.34. Power figures may not be comparable between Member States. Differences in definition and measurement between Member States are of less importance for the MGP, which fix targets in terms of percentage reductions within one Member State, but can still be significant for comparisons over long time periods (due to the increasing importance of auxiliary engines, etc.). The ease with which power can be modified is a cause for concern that the Commission is keen to resolve.

The measurement of the actual power of the engine using a torquemeter is a promising possibility, but the technology is not yet fully developed.

Fleet tonnage

9.36. The decision to measure all vessels in units of gross tonnage (GT) was intended to improve the reliability of the tonnage statistics. The objectives fixed under MGP IV will be expressed in units of GT and will therefore be directly comparable with the real fleet capacity. To this end the Member States should have supplied GT values for all vessels in the fleet before March 1995.

The Commission is considering the possibility of legal action against the Member States that have not sent the required information.

National controls of fishing activities

9.37 9.38. All Member States have recently submitted a programme detailing the means by which they will achieve the MGP IV objectives. This includes the means by which they will control access to fisheries. The Commission is in the process of examining these reports.

Data relating to aid granted

9.40. The Commission has information by Member State and vessel, in computerized form, on aid granted since the FIFG began in 1994.

It will look at the possibility of cross-referencing aid granted before and since 1994 so that the aid granted on each vessel can be unequivocally identified.

Impact of aid for the cesssation of fishing

9.41. Fishing activity is defined in Regulation (EC) No 493/96 as the number of days spent at sea over the observation period. This is used to define vessel activity by segment in the MGP context and to define effort by fishery for the management of fishing effort under Regulation (EEC) No 685/85.

The Commission is examining the possibility of adopting a Community-wide definition of days at sea based on that given in Regulation (EC) No 2870/95 which specifies that entries and exits into an area must be reported, and that the number of days at sea is calculated on the basis of the number of 24-hour periods spent in the area.

Coherence with programme objectives

9.44. The fleet register data shows that France has not achieved its MGP III objectives. The Commission is examining the latest information sent by her.

It is endeavouring to obtain information, which is not yet adequate, on the Italian fleet, which it cannot therefore properly assess.

It will take any appropriate legal action against France and Italy.

9.45. The MGP sets the Community fleet reductions. The FIFG provides financial assistance for the action needed to obtain these.

The MGP and FIFG programming periods do not coincide. In 1997, despite the Commission's efforts to secure better coincidence in future, the compromise adopted by the Council on MGP IV relates only to the period 1997-2001.

For the present FIFG programming period (1994-99) it was necessary back in 1994 to anticipate targeted fishing effort reduction beyond the objectives of MGP III, which ended in 1996. FIFG programming will if necessary be adjusted in 1997 in line with the actual objectives set by MGP IV.

Concerning the Netherlands, the Commission is aware of the weaknesses identified by the Court. It must be remembered however that it is up to Member States to take the action needed to attain MGP objectives. The Dutch authorities asked the Commission in the MGP III context to incorporate other fishing effort measurement parameters. The Commission is looking into the possibilities.

9.46. The reductions fixed by the MGP III were not enough to bring the European fleet capacity into line with the available resources, so reductions beyond the MGP III objectives represent an advance on the MGP IV objectives.

Conclusion

9.48 (a) There are some gaps but the fleet register is reasonably reliable for most Member States and is being steadily improved thanks, in particular, to the development of teleinformatic links between the Commission and Member States.

(b) In June 1997 the Commission asked the Member States concerned to send the missing data on fishing effort. It will not accept effort restriction programmes under MGP IV until it has received from the Member States their data on fishing effort for the MGP III period, and is looking at the possibility of legal action against Member States not sending the missing data.

(c) The Commission will try to set up a system incorporating projects financed before 1994.

(d) The Commission is examining the possibility of adopting a Community-wide definition of days at sea based on that given in Regulation (EC) No 2870/95, which specifies that the number of days at sea is calculated on the basis of the number of 24-hour periods spent in the area.

9.49. The annual implementation report of each Member State (Annex II to Regulation (EC) No 1796/95) is the primary source of information for the Commission. It does not obviate the need for prior (not just retrospective) information on the individual projects, largely through the monitoring committees.

The Commission will, when necessary, remind Member States of their obligation to enable it to discharge its monitoring and control task adequately and will take any appropriate legal action required.

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PART IV Internal policies

INTRODUCTION

IV.1. Subsections B3 to B6 of the general budget are devoted to the various internal policies. They are concerned with the following measures:

- subsection B3: training, youth, culture, audiovisual media, information and other social operations;

- subsection B4: energy, Euratom nuclear safeguards and environment;

- subsection B5: consumer protection, internal market, industry and trans-European networks;

- subsection B6: research and technological development.

IV.2. The appropriations available in 1996 for these four subsections as a whole, including transfers, carryovers, appropriations for re-use and the participation of the countries of the European Free Trade Association that are members of the European Economic Area, amounted to 5 304 Mio ECU in commitment appropriations and 5 078 Mio ECU in payment appropriations.

IV.3. The outturn for these appropriations, total utilization of which was 96,5% and 85,8% respectively, is summarized in Table IV.1. In 1995, the corresponding appropriations available amounted to 4 959 Mio ECU in the case of commitments and 4 475 Mio ECU for payments. The utilization rates were 97,5% and 85,5% respectively.

IV.4. The chapters which follow in this part of the report discuss two specific aspects of the action taken under the heading of internal policy, namely research and industrial policy (MEDIA).

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CHAPTER 10(355\*) Research

10.0. CONTENTS Paragraph reference

Implementation of the budget 10.1

The participation of small and medium-sized enterprises in research, technological development and demonstration (RTD) programmes 10.2 - 10.55

Introduction 10.2 - 10.4

Identification of SMEs 10.5 - 10.8

Definition of SMEs 10.5 - 10.6

SME participation in EU RTD programmes 10.7 - 10.8

Obstacles to SMEs' involvement in RTD programmes 10.9 - 10.18

Coordination between DGs 10.9 - 10.12

Pre-competitive nature of RTD programmes 10.13

Access to information 10.14 - 10.15

Proposal preparation 10.16 - 10.17

Cash flow problems 10.18

Specific risks for the Commission relating to SMEs' involvement in RTD 10.19 - 10.30

Financial viability 10.19

Role of coordinator 10.20 - 10.21

Non-respect of own financial contribution 10.22

Difficulties in producing correct cost statements 10.23 - 10.29

Necessity of adequate controls 10.30

Efforts made by the Commission to promote SMEs' participation in RTD programmes 10.31 - 10.44

The two-stage submission procedure 10.33 - 10.34

Cooperative research action for technology (CRAFT) 10.35 - 10.39

Special information days for SMEs 10.40 - 10.44

Conclusion 10.45 - 10.55

IMPLEMENTATION OF THE BUDGET

10.1. The budgetary appropriations devoted to research amounted to 3 484 Mio ECU for commitments and 3 403 Mio ECU for payments in the financial year 1996 (see Table 10.1). The rate of utilization of the available appropriations (356) represented 96,76% of commitment appropriations and 87,86% of payment appropriations. The rate of utilization of appropriations carried over from the previous financial year was 60,38% for commitment appropriations and 37,69% for payment appropriations. The payment appropriations carried forward, amounting to 67 Mio ECU, against the budget heading B6-7113, 'Information technology`, were not used because of the delay in the forwarding by the contractors of their cost declarations to the Commission.

THE PARTICIPATION OF SMALL AND MEDIUM-SIZED ENTERPRISES IN RESEARCH, TECHNOLOGICAL DEVELOPMENT AND DEMONSTRATION (RTD) PROGRAMMES

Introduction

10.2. In 1994 the Court examined Community intervention in favour of SMEs under both the European Social Fund (ESF) and the enterprise policy managed by DG XXIII, 'Enterprise Policy, Distribution Trades, Tourism and Cooperatives`(357). This was extended in 1996 to cover the areas of European Regional Development Fund (ERDF) (see Chapter 6) and research, Technological development and demonstration (RTD) programmes.

10.3. The fourth RTD framework programme (1994-98) of the European Community adopted on 26 April 1994 sets out the activities of the Community in the field of research and technological development and demonstration(358). The framework programme is implemented through specific RTD programmes, which are set out in Table 10.2. As the EU has been giving increasing importance to the support of SMEs in all areas of its activities, it has consequently begun to attach importance to the participation of SMEs in RTD programmes and this is one of the six priority areas identified for the future fifth framework programme (1998-2002). The White Paper on growth, competitiveness and employment(359) highlighted the impact SMEs have on growth and employment in the EU, and above all, the potential of small, high-technology industrial undertakings for creating new jobs.

10.4. The objective of the audit has been to examine SMEs' participation in collaborative RTD projects (i.e., where SMEs carry out the research themselves). For this purpose 33 enterprises in six Member States (Belgium, Greece, Spain, France, Ireland, and the United Kingdom) were selected for audit. The audit covered the Commission's Directorate-Generals (DGs) III, XII and XIII and eight specific RTD programmes (see Table 10.2).

Identification of SMEs

Definition of SMEs

10.5. Under the fourth framework programme the Commission developed criteria for classifying enterprises as SMEs:

(a) the maximum number of employees;

(b) financial criteria;

(c) the degree of independence from larger enterprises.

10.6. The Commission applies different definitions of an SME in its specific RTD programmes. ESPRIT(360) for example, includes only industrial enterprises and the annual turnover threshold is 50 Mio ECU rather than 38 Mio ECU(361). The Telematics applications programme(362), on the other hand, includes hospitals and universities in its definition. On 3 April 1996 the Commission recommended for the first time a specific definition of an SME for all Community policies (see Table 10.3). As the fourth framework programme covers the period 1994-98, this recommended definition will not be applied before the fifth framework programme (1998-2002).

SME participation in EU RTD programmes

10.7. The Commission reports an increased number of SMEs participating in projects in the fourth RTD framework programme. According to its Annual Report 1996 on RTD activities(363) in 1995 the number of SMEs participating in contracts was 1 782 giving a relative share of 20% compared with 17% in 1994. The percentage share of funds going to SMEs actually decreased, however, from 19% in 1994 to 15% of the 1 426 Mio ECU contribution in 1995.

10.8. The examination of the underlying statistics and databases established by the Commission casts doubt on the reliability of the reported figures:

a) a review of the databases relating to certain specific programmes showed that many of the companies included as SMEs were multi-national groups or national research centres. There were also many cases of multiple counting, for example in the telematics programme the same group of companies was included up to 10 times;

b) from the 33 companies selected for audit and classified by the Commission as SMEs, 11 did not correspond to the independence criteria and one had over 2 000 employees.

Obstacles to SMEs' involvement in RTD programmes

Coordination between DGs

10.9. The Commission's responsibility for RTD programmes lies mainly with DGs III, XII and XIII. DGs XVI and V are also involved in RTD activities as far as Structural Funds programmes are concerned outside the fourth framework programme. One example is the Community Initiatives (CI) for SMEs in Saxony (Germany) devoting 16,65 Mio ECU (44% of the ERDF funds in that CI) to priority measures in technology development. DG XXIII is responsible for policy towards SMEs. However, it has few resources to devote to RTD.

10.10. The existing coordination between the DGs involved in RTD should be improved in particular as regards the exchange of information. One DG is not always aware of the contracts an enterprise has with another DG. Information concerning one contractor is not passed on systematically to the other DGs.

10.11. A significant proportion of audited SMEs complained that they had received different information from services within DGs regarding, for example, interpretations as to which costs are eligible even within the same programme.

10.12. The Structural Funds, in particular the European Regional Development Fund (ERDF), established Community Initiatives (CI) set up to support SMEs. These initiatives, as well as other operational programmes, include RTD actions. The decentralized programme approach of the Structural Funds, where the national authorities have the main responsibility for selecting projects, means that the responsible services of the Commission are not in a position to have detailed knowledge of the projects. This causes difficulties in the coordination with EU RTD programmes, and their ensuing projects, managed by the Commission.

Pre-competitive nature of RTD programmes

10.13. The fourth framework programme is not designed to support enterprises of a specific size but to concentrate on projects of scientific and technical excellence in the area of pre-competitive research(364)(365).Pre-competitive research is by its nature not immediately exploitable in the market. In some areas it is typically long-term research, and may not be marketable within the short to medium-term planning horizon of SMEs.

Access to information

10.14. The Commission has made efforts to disseminate information about RTD programmes. SMEs can receive information from many different places (focal points, Euro-Info Centres, Innovation Relay Centres, national ministries, chambers, federations, and consultants). However, there are now so many information points that SMEs find it difficult to identify the most suitable ones (see paragraphs 6.53 to 6.55). SMEs can have difficulties in identifying the specific programme most relevant to their needs. The only enterprises audited that claimed to be well informed about EU programmes attributed this to their own efforts.

10.15. EU RTD projects require a consortium of partners from more than one Member State. Many SMEs experience difficulties in finding partners. Although help exists at the Commission, the existing tools for partner matching could be expanded and better publicized.

Proposal preparation

10.16. The preparation of a proposal often involves a significant investment in both time and money. This is especially a burden for those SMEs located in peripheral regions for whom the cost of travel in particular can often be very high. These costs are not reimbursable by the Commission, even if the project is successful (except in the case of the new two-stage proposal) (see paragraph 10.33). Given the fact that typically only one in five proposals for collaborative research projects are accepted, SMEs may face an important financial risk when applying for a project. The Commission itself estimates these preparatory costs as up to 60 000 ECU per proposal (see paragraph 10.33).

10.17. The procedures for the implementation of RTD programmes are lengthy. Preparation for the fourth framework programme (1994-98) began in 1992 and the specific programmes were adopted and the first calls for proposals made in December 1994. An independent report assessing the last five years of framework programme activities, considered the 'long period, often longer than a year between calls closing and contract signing, as being completely unacceptable`(366). SMEs, whose involvement in projects is likely to be somewhat closer to the market, are particularly vulnerable to time constraints and run the risk of being overtaken by the developments of competitors.

Cash flow problems

10.18. SMEs are sensitive to cash flow problems. The Community financial contribution is distributed to the individual partners by the coordinator of the consortium. There is usually a first advance payment followed by reimbursements based on annual or six-monthly cost statements, payable within two months after the approval of the respective periodic progress reports and corresponding cost statements. This process can give rise to delays, sometimes lasting up to many months before the individual partner receives payment. The average time a contractor has to wait to receive a payment was estimated in a 1995 study as varying between six and eight months for periodic payments and between nine and eleven months for final payments(367). In one instance, a final payment was not made by the Commission until fifteen months after the end of the project. This can cause SMEs financial difficulties.

Specific risks for the Commission relating to SMEs' involvement in RTD programmes

Financial viability

10.19. SMEs often have limited financial resources. There are cases where SMEs received Community funds largely exceeding their share capital or turnover. One enterprise received funding of 78 000 ECU although it had an annual turnover of only 25 000 ECU. This situation leads to a serious risk of financial problems and even bankruptcy, a situation which will always cause disruption to a project, as was seen in two cases. Most genuine SMEs would not be able to afford to carry out several cost sharing contracts at the same time.

Role of coordinator

10.20. The coordinator or lead contractor is the main intermediary between the Commission and the other partners in the contract. One key task is the distribution of funds from the Commission to the individual partners. If the coordinator goes bankrupt, for example, after having received a payment from the Commission but before having passed it on this will seriously affect the other partners.

10.21. The administrative role of a coordinator usually requires project management experience on the part of the contractors concerned and considerable staff resources which can be underestimated by SMEs when they are preparing their proposals. It can be difficult for an SME without prior EU experience to act as the coordinator of a consortium, in particular if it was not the key party in proposing the projects, or if the project has a large number of partners in different countries. The Commission should give more guidance to SMEs concerning the role of the coordinator, particularly as regards the question of delegation of authority. For example, SMEs are not always sure how much pressure they can bring to bear on other participants to supply promised deliverables on time.

Non-respect of own financial contribution

10.22. SMEs often find it difficult to assure their 50% participation in the financing. Moreover, in five cases enterprises received most of their income from contracts with the Commission (varying from an average of 65 up to 100%) and so were in no position to provide 50% funding themselves. When the enterprise only has shared cost contracts, this is clearly irregular under the current funding system (see paragraph 6.73). When the enterprise's main income consists of Community funds, for example 100% funded contracts for technical assistance, the Commission should not allow it to take part in EU shared-cost RTD projects, due to a lack of reliable, long-term financial resources. The regularity of such a financing scheme must be questioned.

Difficulties in producing correct cost statements

10.23. The system of real costs contracts requires analytical accounts to be kept in order to complete cost statements (see paragraph 10.18) and avoid the misuse of Community funds. SMEs, by their nature, may have difficulties to comply with this requirement.

10.24. The audit also showed that even those SMEs with good accounting records often found the rules relating to the completion of cost statements complex. As a result, many irregularities occur, as SMEs either deliberately or accidentally do not respect the conditions of the model contract(368). Evidence was found of weak or inexistent systems at the contractors and of ineligible expenditure being claimed under labour rates, overhead rates, travel costs, as well as the use of budgeted rather than actual costs. Out of the 33 enterprises audited, one or more of the observations described in paragraphs 10.25 to 10.29 was applicable to 21 of them. All countries visited are concerned.

10.25. Five cases were found where companies claimed for budgeted rather than actual costs. In one enterprise visited an estimated amount of 1 200 000 ECU too much was claimed, of this 1 000 000 ECU relates to labour and overheads (see paragraph 10.28). In another case, accounting records were so badly maintained that it was impossible to ascertain what the actual costs would have been.

10.26. In six enterprises there was no system for recording time worked on projects. Staff did not fill out time sheets. In another six enterprises the systems existing were only approximate or were unreliable.

10.27. Nine enterprises could not provide proper justification of the labour rate used. One enterprise was charging a rate considerably higher than the local average for inexperienced staff, and longer hours than appeared reasonable for the work done. The rate claimed was not supported by valid documents. SMEs often have a limited number of employees and sometimes use external help for EU projects. Seven cases were seen where these external staff are claimed as if they were permanent employees and therefore unduly claimed overheads as well as labour costs.

10.28. In 13 cases enterprises had no proper documented justification for the overhead rate charged or errors were found in the calculation of these rates. In one case the contractor at the proposal stage envisaged an overhead rate of 17%. The Commission, however, accepted cost statements where they claimed 100%. In one enterprise an estimated amount of 1 000 000 ECU too much was claimed for labour and overheads (see paragraph 10.25).

10.29. In five cases travel costs did not agree to the amounts claimed in the cost statements or the supporting documents for travel expenses were so poorly maintained it was impossible to reconcile them with the amount claimed. In one of the cases, travel costs had been included for an employee whose time had not been charged to the project.

Necessity of adequate controls

10.30. The large numbers of payments dealt with by the Commission on a daily basis means that the amount of serious financial checks of cost statements that can be carried out is very limited. In many cases cost statements have been produced to be in line with the budget and they do not reflect the actual costs of the company. There is not always a comparison by the Commission between the rates charged in the cost statements to those included in the technical annex of the contract. Similarly, there is not always an evaluation of time spent on the project versus the time budgeted in the technical annex. This weakens the purpose of having an independent evaluation of proposals and reduces the likelihood of the Commission spotting irregularities. In addition, although many irregularities can only be found by on-the-spot audits, the Commission is still carrying out too few audits (see Table 10.4).

Efforts made by the Commission to promote SMEs' participation in RTD programmes

10.31. The Commission has introduced technology stimulation measures (TSMEs) designed to make it easier for SMEs to take part in RTD programmes of the European Union(369).

10.32. There are basically two types of TSME, a two-stage submission procedure and the concept of cooperative research action for technology (CRAFT).

The two-stage submission procedure

10.33. The two-stage submission procedure involves the presentation of an outline proposal by at least two SMEs from two countries. This proposal may be submitted at any time. On the basis of this outline of the future project (stage one) the Commission can grant SMEs an exploratory award of up to 75% of the cost of expanding the proposal, not exceeding 45 000 ECU in total, payable on presentation of a complete proposal (stage two), independently of the final acceptance of the project.

10.34. Proposals may be submitted for projects where SMEs carry out the research themselves together with other partners (collaborative research in the context of the regular Community RTD programmes).

Cooperative research action for technology (CRAFT)

10.35. The two-stage submission procedure may also be used to fund the preparation of a CRAFT proposal. A CRAFT project is specifically designed for SMEs who have little or no research capabilities of their own. A CRAFT project is one where the proposing SMEs commission a third party to carry out the research on their behalf.

10.36. Nine out of the 15 specific RTD programmes under the fourth framework programme indicate a percentage of the funds allocated to that programme to be used for specific measures for SMEs. This varies between 5 and 15% and in total comes to a minimum of 753 Mio ECU (see Table 10.2). The allocation is not always clearly described. The biomedicine and health programme states only that the funds include support for SMEs. The marine science and technology programme does not indicate any money for SMEs, although in its first call for proposals states that it encourages TSMEs.

10.37. The Commission's information brochure on TSMEs(370) incorrectly shows that the transport and biotechnology programmes do not allow CRAFT projects, although in the Council Decision of both programmes reference is made to CRAFT projects and a percentage is indicated as to be spent on TSMEs.

10.38. Even though it would be expected that enterprises which already have contracts with the Commission would be well informed about TSMEs, 10 out of the enterprises audited had no information at all about them.

10.39. The main problems perceived by potential contractors relate to the timing and to the level of detail required in the proposal. It is difficult for companies to prepare a proposal when the detailed subjects of future calls are not yet known and to assess the level of detail to be provided in the outline evaluation.

Special information days for SMEs

10.40. In 1996 DG XII organized the 'First SME Technology Days`, a two-day conference, held in Brussels, aimed at providing SMEs with information on Community RTD programmes. The total cost paid to the organiser was 228 000 ECU.

10.41. Although the Commission charged between 130 ECU and 250 ECU for registration, many participants did not pay. Each unit of the Commission involved in the conference was entitled to invite guests who benefited from a free entrance and the reimbursement of travel costs financed under various budget lines. Participants with contracts with the Commission were allowed to reclaim 50% of these costs on their projects also financed under various budget lines. As expenses relating to the same event are accounted for in different places, there is a risk that the full costs of the event will never be known.

10.42. The policy of providing completely free entrance and travel to some participants, reimbursing half the costs for others, making some SMEs support full costs and travel expenses (which will be those SMEs with no contracts with the Commission) must be questioned.

10.43. The report evaluating the conference, produced by the Commission's staff responsible for its organization, was not detailed enough to allow conclusions to be drawn for future events.

10.44. The Commission should also consider whether such information days are the best way to reach the targeted audience. New communication systems and in particular the on-line Community Research and Development Information Service (CORDIS), which can be accessed via the Internet, should be better used.

Conclusion

10.45. European RTD programmes are principally directed towards specific RTD themes rather than to specific beneficiaries such as SMEs (see paragraph 10.13).

10.46. The reported results of SME participation in RTD programmes are overstated as a result of errors in the databases maintained at various DGs (see paragraph 10.8).

10.47. Coordination between all services of the Commission involved in the funding of RTD measures for SMEs needs to be strengthened, including the Structural Funds, in order to streamline the EU's effort in this field (see paragraphs 10.9 to 10.12).

10.48. The specific procedural and contractual conditions governing the fourth RTD framework programme are not designed to facilitate SMEs' participation nor do they take into account the market and managerial environment in which they operate. Pre-competitive RTD projects do not correspond to SMEs' general orientation towards short and medium-term activities. The limited financial resources of SMEs is not easily compatible with the fact that there are often delays in receiving the EU funds. The high cost of elaborating proposals as well as lengthy decision procedures are particular constraints for small enterprises (see paragraphs 10.13 to 10.18).

10.49. Due to capital and cash flow restrictions of SMEs there is a specific risk of financial failure. The assessment of the financial viability of potential SME contractors should therefore be an essential step in the contract negotiation procedure (see paragraph 10.19).

10.50. The Commission should produce detailed guidelines concerning the role of the coordinator (see paragraph 10.21).

10.51. Weaknesses in SMEs' accounting systems and the complexity of the rules result in incorrect cost statements and consequent misuse of EU funds which the Commission must recover (see paragraphs 10.23 to 10.29).

10.52. The Commission must increase the number of audits carried out at contractors, both by its own services and by external auditors. The Commission should also consider introducing a policy whereby potential contractors provide a certificate from an external audit firm to confirm that they can meet the contractual requirements, notably as regards funding their share of the project. The audit fees could then be accepted as eligible project expenses (see paragraph 10.30).

10.53. The Commission could consider a different funding procedure for SMEs as the use of partial funding of actual costs does not appear to be a suitable vehicle for SME RTD activities. Possibilities include using another form of contract, for example pre-negotiated fixed price contracts(371) or continuing to partially fund actual costs but introducing flat rates for labour and overheads.

10.54. The Commission's efforts to facilitate project application procedures for SMEs via the two-stage submission procedure is a good approach, although improvements are still needed. TSMEs, however, are of little use if appropriate dissemination of information has not been provided. More attention could be devoted to improving the various existing decentralized information points in order to reach potential SME contractors; the use of CORDIS and its future applications should be extended (see paragraphs 10.14 and 10.15, 10.31 to 10.39 and 10.44).

10.55. If the overall promotion of SMEs, intended as a key factor for creating jobs, and the application and development of new technologies, is to be successful, the Community has to improve and simplify its procedures and to develop specific measures to cope with the needs of this target group without detriment to the quality of the RTD project itself.

REPLIES OF THE COMMISSION

THE PARTICIPATION OF SMALL AND MEDIUM-SIZED ENTERPRISES IN RESEARCH, TECHNOLOGICAL DEVELOPMENT AND DEMONSTRATION (RTD) PROGRAMMES

Identification of SMEs

Definition of SMEs

10.6. Following the Council conclusions of 29 April 1994, the definitions for SMEs have been set by each RTD specific programme after extensive consultations with representatives of industry and of the Member States on the programme management committees. The current definitions used are the result of this and indicate that, for the fourth RTD framework programme, the SME definitions are linked with the specific programmes' strategic objectives and may include different turnover thresholds or organizational forms for some programmes.

SME participation in EU RTD programmes

10.7. The report on 1996 will show that there were 3,273 SME participations, representing a relative share of 20%.

10.8 (a) The quality and reliability of the databases of RTD participants are continually being improved and up-graded. This is expected to continue with the phased introduction of financial and legal viability checks that also include the parent companies, as well as with the verification of the SME criteria with documentary evidence. By using external credit rating and financial information services to carry out these checks, the information on the participants is independent and of high quality.

Obstacles to SMEs' involvement in RTD programmes

Coordination between DGs

10.10. To improve communication between the different DGs in the Commission dealing with SME-related issues linked with RTD, an SME coordination group has been set up, bringing together seven DGs. Moreover, an interservice group on costs and audits, bringing together all RTD DGs, DG XX and UCLAF, is examining the pooling of information on RTD contractors in a common database. This should increase the efficiency of the audits being performed and facilitate a priori controls of proposers.

10.11. As regards eligibility, the interservice group on costs and audit has done considerable work: definition of the different categories of allowable and non-allowable costs, treatment of personnel costs and overheads, durable equipment, third-party assistance, consumables and computing, as well as VAT.

10.12. The Member States have information on RTD activities funded by the Structural Funds and Community RTD policy and are thus in principle in a position to co-ordinate activities at a project level. However, the Commission will investigate how to improve coordination in a cost effective way.

Pre-competitive nature of RTD programmes

10.13. Pre-competitive research should not per se be seen as a restriction to the participation of SMEs. Furthermore, this participation may take many forms, including concerted actions and accompanying measures, particularly for technology transfer and the dissemination of results.

Access to information

10.14. Under the fourth RTD framework programme, the Commission has disseminated information on Community RTD activities very widely. In order to increase the efficiency of the information provided, it is foreseen in the Commission proposal for the fifth RTD framework programme to rationalize and coordinate the networks providing information and assistance on Community RTD activities at the Community level. The Community RTD policy is based on two main principles: equal access for all interested parties and selection on the basis of objective criteria.

In order to help SMEs identify the most suitable RTD programme, it is proposed under the fifth RTD framework programme to set up a special entry point where SMEs can address their questions and proposals.

10.15. The Commission's RTD databases include a partner search service and have recently opened a Web site. Information about these databases is widely available.

Proposal preparation

10.16. The estimated cost of 60 000 ECU per proposal could only be reached for very large projects. Normally proposal costs are shared between the different parties and normally one would expect SMEs to contribute less than large contractors. Proposals with only SME participants would cost much less.

In order to reduce the level of oversubscription, the Commission has proposed different measures, such as better focusing and concentration of programmes and calls, developing pre-screening and two-stage mechanisms and improving the quality of the information and assistance networks.

10.17. The Commission has recently made special efforts to further reduce these delays, in particular for TSMEs. For these measures the SMEs receive the results of the project evaluation within approximately three months after the closing date for submitting proposals. Further improvements are being considered, namely in view of the fifth RTD framework programme. In the case of delays with regard to the start of the RTD contracts, they are often associated with the SMEs themselves. In several cases, it has taken the selected applicants up to several months to achieve a consortium agreement and agree on contractual terms.

Cash flow problems

10.18. The Commission report quoted by the Court also states that the long payment times experienced by the contractors are often a result of the need to fulfil all contractual obligations, and that a number of reasons for these delays are difficult to eliminate.

Commission studies indicate that payment delays have been reduced considerably over the past years. A Commission report issued in 1995 shows that DGs III, XII and XIII have payment times well within their contractual obligations, i.e. within two months of the approval of the progress reports and associated cost statements. The average time period for an RTD payment to the coordinator in 1996 was between 20 and 50 days. It is a contractual requirement for the project coordinator promptly to pass on the funds to the other contractors. The progress reports are being approved by the Commission within a contractual fixed delay.

Specific risks for the Commission relating to SMEs' involvement in RTD programmes

Financial viability

10.19. The interservice group on costs and audits has examined the strengthening of a priori controls of potential contractors' personnel and financial resources. General and harmonized criteria are being defined, and these can be made more stringent for potential beneficiaries of large Community contributions and for potential project coordinators.

Role of coordinator

10.20. This problem is also being examined by the interservice group mentioned under point 19.

10.21. The experience and resources required by a co-ordinator for the preparation of proposals, and the possible difficulties faced by first-time coordinators are not specific to SMEs but could apply to all potential new contractors.

Non-respect of own financial contribution

Difficulties in producing correct cost statements

10.22 10.29. The errors and problems described under points 22-29 are often related either in the sense that they concern the same contractors or that some of the errors are linked.

Three cases have been referred to UCLAF and are under investigation for possible fraud.

Out of the 21 contractors mentioned, in 15 cases additional controls are in progress and the appropriate adjustments and recoveries will be made.

For one case, the Commission's further examination found that the contractor did indeed have the funds to co-finance.

In two other cases the actual costs were not available at the time of the Court's audit but the necessary adjustments for actual costs were in progress (as stipulated in the cost statement form) and have since been made.

The Commission agrees that for some contractors the precise calculation of actual overhead costs may present difficulties. The option of a fixed overhead rate is under discussion for the fifth framework programme.

A contractor's means of co-financing may have different origins (e.g. capital or reserves) that are not necessarily dependent on the source of the commercially generated income. Providing services to the Commission and generating enough income to participate in shared-cost RTD projects is not considered irregular, even in the case where the Commission is the main source of income.

10.23. As a general rule RTD contracts provide for partial reimbursement of the full costs of the projects. In cases where potential contractors do not have the necessary detailed accounting structures, a feature particularly frequent with public administrations, universities, etc., the Commission may propose the full reimbursement of only the additional costs of the project.

A SME will normally have all the elements to calculate the costs of a project with sufficient precision and moderate effort using the accounts it is legally obliged to keep.

Necessity of adequate controls

10.30. The cost statements are declarations of actual costs incurred over a specific time period and for specific work packages or tasks. The role of the Project Officer (PO) is to compare these costs (stated in the Cost Statement) with the Technical Annex tasks, work packages, time, cost estimates, etc. The principle basis of a PO accepting or rejecting costs reported in the cost statement is the information in the Technical Annex.

However, the indicative amounts in the Technical Annex may change during project execution due to technical reasons and are generally made with the agreement and knowledge of the Project Officer.

Furthermore, the contract includes Article 18.2 whereby is stated that any transfer between categories and participants may be made provided the scope of the project is not fundamentally affected, which is verified by the Project Officer. Contractors are advised to report all their actual costs in the cost statements.

The Commission is continuing its efforts to increase the intensity of its audits. The interservice group on costs and audits is examining how to coordinate and harmonize work in the following areas: interpretation of financial provisions, a priori controls and risk analysis, audit procedures, administrative measures to be applied to defaulting contractors, and creation of a common database on contractual information.

Efforts made by the Commission to promote SMEs' participation in RTD programmes

Cooperative research action for technology (CRAFT)

10.36. The actual size of the Community contribution for SME measures (both collaborative and cooperative research), mentioned by the Court under point 10.7, exceeds the indicative amounts of the programme decisions (Table 10.2).

10.38. Currently, there are about 16 million SMEs in the European Union. About 200 000 to 300 000 of these are potential CRAFT participants. It is therefore unavoidable that some SMEs are not informed about TSMEs, despite the fact that the Commission has been widely disseminating user-friendly information about them.

10.39. The indicative deadlines for the submission of proposals under the TSMEs have been published in the information package in December 1994 and are available on Internet. With regard to the planning for submitting proposals for exploratory awards, it should be pointed out that the dates of the calls for collaborative research are included in the work plans. For co-operative research, there is even an open call. Furthermore, clear information on the level of detail required for proposals relative to exploratory awards are given in the TSME information package.

Special information days for SMEs

10.41. A financial overview of the conference has been made available, covering all infrastructure costs as well as the costs of experts invited to the workshops.

10.42. The policy with regard to the entrance fee for conference participants was that speakers had a free entrance, while those participating in a Community RTD contract could charge part of the cost to the project. In order to ensure a good participation of smaller companies, specific SMEs were selected and invited on the basis of clear criteria: no prior participation to a Community RTD programme, location in a cohesion country, active in traditional sectors. All other participants had to pay a fee.

10.43. Even though the contract for the organization of the conference did not contain specific provisions for a formal evaluation of the event, the Commission, in keeping with Article 2 of the Financial Regulation, conducted an evaluation, a copy of which was given to the Court. In the opinion of the Commission, this evaluation was sufficiently detailed to allow it to draw conclusions for the holding of future conferences. The evaluation of such events by the Commission also plays an important role in the shaping of policy, namely in view of the Fifth RTD Framework Programme.

10.44. There is no single and unique way of providing information to SMEs. Besides information on paper, such as brochures and leaflets, information on TSMEs is spread via Euro Info Centres and the CORDIS and Arcade electronic servers. Although SMEs are currently only modest users of Internet, the use of the RTD databases is picking up, including through indirect access via the information centres at the national level.

Conclusion

10.46. The quality and reliability of the databases of RTD participants are continually being improved and upgraded, namely through the use of financial and legal viability checks and documentary evidence.

10.47. In order to improve the coordination between all Commission services dealing with SME-related issues linked with RTD, an SME coordination group was set up in December 1994. In principle Member States have information to carry out coordination at project level for Structural Funds and RTD projects.

10.48. One of the main objectives of the RTD framework programme is to help enterprises, including SMEs, to achieve a high quality of R& D and fully to exploit the potential gains of the internal market. Several thousands of SMEs have so far participated in the RTD fourth framework programme, which is a proof that the criterion of pre-competitive research does not hinder their participation.

The level of funding for projects as set by the legislative authority and represents a balance between an adequate level of funding by the Community, the type of research undertaken and the respect of international regulations governing the granting of state aids.

The preparatory costs of an RTD proposal in the fourth RTD framework programme may be financed by exploratory awards in the case of SMEs.

The Commission has recently made special efforts to reduce delays, particularly for TSMEs. SMEs now receive the results of the project evaluation within approximately three months after the closing date for submitting proposals.

10.49. The Commission has examined the strengthening of a priori controls of potential contractors' personnel and financial resources. These controls take place at the time of the contractual negotiation.

10.50. The Commission will intensify its efforts to give guidance to SMEs concerning the precise role of the co-ordinator of RTD projects.

10.51. The Commission agrees that for some contractors, the correct precise calculation of the overheads may present difficulties. Following the audits carried out by the Court, the Commission is carrying out additional controls and is undertaking the necessary adjustments and recoveries.

10.52. The Commission is continuing its efforts to increase the intensity of audits carried out both by its own services and by external auditors. The coordination of the auditing activities is part of the work of the interservice group on costs and audits. The Commission welcomes the Court's suggestion to have an external auditor confirm a potential contractor's ability to meet contractual requirements. It will examine the legal and practical implications of this proposal.

10.53. Thousands of SMEs have so far successfully participated in the RTD fourth framework programme under the scheme of partial reimbursement of actual costs. Pre-negotiated fixed-price contracts could be used in some specific circumstances, and the Commission will examine this option in more detail, taking into account the fact that potential contractors may experience longer delays as a result of longer negotiations and more comprehensive a priori controls required by such RTD contracts.

10.54. The Commission has disseminated information about TSMEs very widely, including through many information points in the Member States. Further co-ordination of the information networks is foreseen under the fifth RTD framework programme. RTD databases are increasingly being used by SMEs, and the Commission has recently opened a Web site on the Internet.

10.55. The Community RTD policy is based on several key principles: equal access for all interested parties, selection on the basis of objective criteria, sound and efficient financial management, and the protection of the Community's financial interests. The Commission agrees that changes to Community procedures for the implementation of RTD activities must be fully in accordance with these principles.

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CHAPTER 11(372\*) Industrial policies MEDIA

11.0. CONTENTS Paragraph reference

Introduction 11.1 - 11.6

Execution of the budget 11.7 - 11.8

Observations 11.9 - 11.45

Problems posed by the multiplicity of cultural and economic objectives 11.10 - 11.13

Programme implementation and management 11.14 - 11.20

Overlap of activities and funding 11.21 - 11.24

System of controls 11.25 - 11.30

Repayments of loans, venture capital and interest earned 11.31 - 11.34

Disclosure of financial position 11.35

Programme evaluation 11.36

Closure of the programme 11.37 - 11.41

Expected developments in MEDIA II 11.42 - 11.45

Conclusions 11.46 - 11.52

INTRODUCTION

11.1. The MEDIA programmes (I and II) managed by the Commission's service 'Information, Communication, Culture and Audiovisual Media (DG X) cover the industrial aspects of Community audiovisual policy. This policy is concerned with the legal framework for the audiovisual sector, technological developments and industrial questions. The overall objective of MEDIA is to promote and strengthen the European audiovisual industry by improving its competitive position, in particular small and medium-sized businesses, and taking into account the cultural aspects of the audiovisual sector.

11.2. To achieve this objective, MEDIA I supported film distribution, the improvement of the conditions of film production, the stimulation of financial investments, the improvement of professional skills in business management and the development of potential in countries with low audiovisual capacities and/or geographical and linguistic constraints. MEDIA II supports the development of film projects to increase European productions, the distribution of European films (cinema, television, video) and the professional training of specialists in these areas. Some 85% of programme funding is allocated to project development and film distribution, 15% to professional training. The financing of these activities consists of conditionally repayable loans or venture capital (in the area of project development, film distribution) or subsidies (in the area of professional training, networking, conferences).

11.3. The MEDIA I programme was approved by Council Decision 90/685/EEC of 21 December 1990(373), and allocated funding of 200 Mio ECU for 1991-95 (revised to 236 Mio ECU)(374). According to the Commission(375), during MEDIA I, more than 2 000 projects were supported in their development phase, approximately 2 200 films were promoted in distribution and marketing and more than 2 600 professionals were able to participate in specific training measures; further indirect support of films was provided during about 60 fairs and conferences.

11.4. The MEDIA II programme for 1996-2000 was approved by Council Decisions 95/563/EC and 95/564/EC of 10 July and 22 December 1995(376). The total funding is 310 Mio ECU (project development and distribution 265 Mio ECU and professional training 45 Mio ECU). The overall objective of MEDIA I has not changed under MEDIA II. Differences between the two programmes are to be found mainly in the implementation and management procedures (see paragraphs 11.41 to 11.45) and also in the concentration of instruments and specific objectives (see paragraphs 11.1 and 11.2).

11.5. In addition to the Community support, the national film funding in the Community amounts to more than 500 Mio ECU per year of which in Germany it amounts to approximately 130 Mio ECU per year and in France to 300 Mio ECU. Other Member States, such as the United Kingdom, have only recently introduced a national funding scheme.

11.6. In addition to the technological aspects of Community audiovisual policy audited in 1995(377), the Court audited in 1996 the implementation and closure of the MEDIA I programme, its phasing out period (first half of 1996) and the transition to MEDIA II. Visits were made to the Commission as well as to 6(378) out of the 19 support agencies(379), most of them created within the framework of MEDIA I to act as independent bodies between the Commission and the final beneficiaries, which are separate legal entities (see paragraph 11.14). The support agencies audited received over half of the funds provided for MEDIA I. In addition, audits were carried out at six final beneficiaries, producers and distribution companies. The audits carried out by the Court lead to the following remarks.

EXECUTION OF THE BUDGET

11.7. Table 11.1 shows the execution of the budget of the MEDIA I programme from 1991 to the first half of 1996. As the table demonstrates, there are delays in the liquidation of the budgetary commitments due to the late signing of contracts between the Commission and the support agencies (see paragraph 11.16). MEDIA I outstanding commitments at the end of the programme (31 December 1995) amounted to 31,8 Mio ECU. One year after the end of the programme, the outstanding commitments amounted to approximately 13,5 Mio ECU.

11.8. Since the beginning of MEDIA I in 1991, budgetary execution has occurred mainly at the end of the year. The concentration of commitments at the end of the year leads only to advance payments in that financial year (40 to 60%, depending upon the contract). These advances give no indication of real progress in programme execution at all since they are made according to contractual arrangements between the Commission and the support agencies irrespective of a project's state of advancement.

OBSERVATIONS

11.9. The Court's initial assessment identified the following obstacles to the efficient and effective implementation of MEDIA I:

(a) the problems posed by the multiplicity of cultural and economic objectives;

(b) potential conflicts between Community and national schemes;

(c) the weak contractual arrangements for programme delivery;

(d) uncertainty over the form of Community support and the protection of the Community's financial interest; and

(e) inappropriate arrangements for the closure of the programme.

The Court therefore examined the extent to which these problems affected the implementation of MEDIA I, and examined the extent to which these problems were remedied in the design of MEDIA II.

Problems posed by the multiplicity of cultural and economic objectives

11.10. Whereas MEDIA I was based on the general implementing powers of Article 235 of the Treaty, MEDIA II refers expressly to Article 130 of the Treaty (Industry) in seeking to assist the development of the European audiovisual industry and also takes into account cultural aspects under Article 128 of the Treaty and vocational training policy under Article 127 of the EC Treaty. Moreover, MEDIA II seeks to support the adaptation of market structures with special regard to the requirement of small and medium-sized enterprises with a simultaneous use of synergies and economies of scale.

11.11. Within the framework of subsidiarity, the mainly market-oriented and Europe-wide MEDIA programme is supposed to complement and support national measures for film promotion, which, by contrast, are often culturally oriented and restricted to films made within national or regional boundaries. The Council decisions require that Community actions have to be coherent and complementary to the national measures, but the duality of the economic and cultural aspects may lead to conflicts when a project application has to satisfy both the commercial requirements for Community funding (project development, distribution) and the cultural aspects for national funding. In Germany and France, for example, the Court found that the conditions for national aid and Community support may conflict to such an extent that applicants opting for one scheme lose the other as a potential source of complementary funding.

11.12. In some Member States such as Germany and France the national aid is much higher than the MEDIA support or is given as a subsidy which is more attractive than a MEDIA loan, leading to unintentional competition between the national and Community schemes. Furthermore, the realization of objectives is impeded due to the wide geographical spread(380) of the programme in comparison to the relatively low level of funding.

11.13. In common with other Community programmes, MEDIA I has to take into account the specific needs of small and medium-sized enterprises. However, there was no clear definition of independent SMEs until 1996(381). The system of networking between SMEs (based on contracts and cooperation agreements), initiated by MEDIA, aims to make use of synergies and economies of scale and thus to increase the competitiveness of SMEs. The present market structure, dominated throughout the world by large film companies (for production and distribution), could be opened up in favour of independent SMEs by using the proposed European Guarantee Fund for the promotion of film and television production. This instrument might contribute to the reduction of the financial risk for individual SMEs and thereby strengthen their competitiveness(382).

Programme implementation and management

11.14. In implementing the MEDIA I programme, the Commission used 19 support agencies, delegating substantial functions, such as the evaluation and selection of applications, contracting with final beneficiaries, financial management and the monitoring of projects. This delegation of functions was not in the best interest of sound financial management. It led to a high level of administrative expenditure (on average 22%). The support agencies received funds to cover their own administrative expenditure and for the operational expenditure (loans, venture capital and subsidies).

11.15. All contracts with these organizations were made by private treaty, without a call for tender. Council Decision 90/685/EEC names 10 of the benefiting support agencies. For the choice of the other nine, a tender procedure should have been initiated, according to Article 56 of the Financial Regulation.

11.16. In all support agencies visited, the annual contracts between the Commission and the support agencies were concluded late in the respective year, in one case after the end of the year in question. This led to delays and uncertainties in the transfer of funds which, in turn, resulted in significant management problems at project level (higher finance costs, the withdrawal of other conditional finance, high administration costs, etc.), threatening project completion.

11.17. The contracts between the Commission and the support agencies were vague and inaccurate. Until 1994, the contracts had no clear provisions on eligible expenditure, the ECU exchange rate applicable and the rules for repayments of loans and interest to the Community budget (see paragraphs 11.31 to 11.34).

11.18. The terms of Article 6 of the Decision limit in general the Community contribution to 50% of the contractor's cost. This was not applied by the co-contracting agencies, with the consent of the Commission which interpretated the 50% rule as applying to the final beneficiary's contributions, which themselves had no contractual relationship with the Commission. Thus, the Community contribution reached on average 75% of the costs for the 19 support agencies.

11.19. For the phasing-out period of MEDIA I in the first six months of 1996 the contribution was generally 100% of the support agency's operational cost.

11.20. Due to the fact that the Commission was outside the contractual framework between the support agencies and the beneficiaries, it had no legal powers (including the right of inspection) concerning the support agencies' beneficiaries. This situation hindered the Commission in exercising important aspects of its managerial responsibilities of monitoring and supervision (see paragraphs 11.25 to 11.30).

Overlap of activities and funding

11.21. The risk of overlap and double funding arises in connection with either:

(a) actions funded under the national film aid schemes and the MEDIA programmes; or

(b) actions funded under MEDIA programmes and other Community actions.

11.22. A comparison of applications for both national and Community funding was not carried out systematically. In order to avoid inefficient funding or irregular over funding, coordination between the different funding sources is necessary.

11.23. The MEDIA strand for professional training partly overlaps with training measures under the European Social Fund (particularly Objective 4 and Community Initiatives) and with the Leonardo programme. For the ESF and MEDIA a final beneficiary in Belgium had received funds from both Community sources. Of some 80 000 ECU total project cost, the ESF contributed about 31 000 ECU and MEDIA supported about 32 000 ECU. Since 90% of this support agency's funding comes from the MEDIA programme, most of the national co-finance for ESF funding actually came from the Community budget, infringing the rules of co-financing as laid down in Articles 9 and 17 of the coordination Regulation for the Structural Funds(383).

11.24. Under the present arrangements, a multimedia project may benefit from five different sources of Community funding: multimedia research and development of DG III, the Info 2000 programme of DG XIII, the promotion of the educational multimedia instruments of DG XXII, the European Social Fund programmes of DG V and the MEDIA programme of DG X. This inefficient administrative structure within the Commission implies a high risk of overlapping of activities at Community level.

System of controls

11.25. In most of the support agencies visited project selection, administration and financial control were carried out without separation of the respective management tasks.

11.26. Although in some cases the Commission's representatives attended the board meetings of the support agencies, their role was limited to that of an observer.

11.27. The Commission required in its contracts that the support agencies be audited by an independent auditor appointed by the support agency. At one support agency the auditor was the father of the agency's treasurer and their offices were adjacent. In the case of another support agency, the accounts audited could not be reconciled to the declaration of expenditure sent to the Commission.

11.28. During MEDIA I, the contracts giving financial support to the final beneficiaries and signed by the beneficiaries and the support agencies did not provide for the auditing rights of the Commission and the Court (see paragraph 11.20). The final beneficiaries visited could have thus refused de jure an on-the-spot audit. Consequently, audit rights remained with the support agencies, but in practice they rarely carried out audits and in some cases very late (at the end of the programme or after the beneficiary was bankrupt).

11.29. Insufficient audits were carried out by the Commission on the support agencies involved in MEDIA I: audits were performed at the initiative of the Commission in only five of the 19 support agencies. The Commission's financial controller carried out no on-the-spot checks and limited itself to checks on the final claims sent by the agencies. Thus, a systematic audit of Community funds did not take place during MEDIA I.

11.30. Funding consists mainly of loans to the final beneficiaries and repayments which were re-used for new projects. However, the accounts prepared at the end of the programme by the support agencies do not always show the net financial position related to the MEDIA activities. The amounts not paid out by the support agencies due to the abandonment of projects and which were previously declared as expenditure incurred were not deducted from the yearly declarations. Despite this, the Commission has made the final payments each year, even though the support agencies may have used the funds for other activities or retained them on their own bank accounts without the Commission's knowledge.

Repayments of loans, venture capital and interest earned

11.31. The MEDIA I decision does not define the type of financial support by the Community budget. In contrast to the MEDIA II decision (Article 4) no distinction is made between loans, seed capital and subsidies. It was at the discretion of the support agencies to agree the type of financial support with the beneficiaries.

11.32. A clear contractual obligation for repayments to the Community budget of bank interest earned and loans granted was introduced only in 1994. Although no contractual provisions were made, the reimbursements of loans and interest relating to the years 1991-94 in general have been reused for new projects. During the audit, some support agencies even went so far as to put into doubt the Commission's right to reimbursement. The support agencies delivered the relevant data only between the end of 1996 and early 1997, with the result that the Commission was not aware of the amounts concerned at the end of the programme.

11.33. The repayments of the loans granted by the support agencies are linked to the financial success of the projects (conditionally repayable loans). Thus, the rate of repayments cannot be accurately quantified, merely estimated. Out of 115,9 Mio ECU loans granted under MEDIA I, less than 5% had been repaid by the end of 1996. Thus over 95% of the loans granted will need a follow-up of the repayments up to the year 2007.

11.34. At the end of 1996 the exact amount of outstanding debts was not known by the Commission. The calculation by the Commission of the amount of outstanding debt for the 1996 accounts was unsatisfactory due to difficulties such as weak contractual arrangements before 1995, insufficient data and the closure of some of the support agencies. In addition, most support agencies have neither the administrative resources nor instruction from the Commission to continue a proper follow-up.

Disclosure of financial position

11.35. It was only in 1996 that the Commission first made an attempt to disclose its financial position in the 1996 accounts. However, the way in which the Commission disclosed its potential debtors has given rise to some remarks from the Court (see paragraphs 11.41). In the preceding years, the Commission's net financial position resulting from loans and venture capital granted to beneficiaries through the support agencies during the MEDIA I programme was not disclosed as a potential receivable in the annual financial statements and related notes. This would have reminded the Commission of the need to ensure for the recovery of the funds after the MEDIA I programme.

Programme evaluation

11.36. In line with Article 8 of the MEDIA I decision the Commission carried out a mid-term evaluation after the first two years and a final evaluation on the expiry of the programme. The mid-term evaluation, based on a survey conducted by a firm of management consultants and consultations with representatives of the audiovisual industry, was available in July 1993. It assessed the MEDIA I programme's management in terms of its efficiency as well as making improvement proposals. The final evaluation undertaken during the course of 1996 could not have been taken into account for drawing up the MEDIA II-programme. The conclusions and recommendations made in the interim evaluation (such as improvements in budgetary procedures, organizational changes and more clearly focused objectives) are largely reflected in the MEDIA II decision. But while aspects such as project organization and management follow-up have improved, the objectives need to be further refined (see paragraph 11.11).

Closure of the programme

11.37. At one support agency 28 projects, involving an amount of 2,0 Mio ECU, were approved in January 1996, after the final date of the programme (31 December 1995). This expenditure is not eligible.

11.38. The Commission provided the support agencies with funding for administrative expenditure for a phasing-out period of six months after the official closure of the MEDIA I programme (31 December 1995). The Court's audit revealed that some MEDIA I support agencies continued using funds remaining from the MEDIA I programme for administrative expenditure beyond the deadline of the 30 June 1996 as staff, consultants, premises, etc.

11.39. The 1995 contracts between the Commission and the support agencies introduced specific clauses concerning the finalization of MEDIA I to protect the financial interests of the Community, by setting a deadline for new projects and a requirement for financial statements (cash flow, company net assets, etc). However, the support agencies have not yet delivered this data to the Commission nor has the Commission given clear instructions to the support agencies on how to deal with the cash balance and the amounts to be recovered at the end of the programme. As an example, at one support agency the remaining net cash balance at 31 December 1995 of 1,7 Mio ECU should have been transferred back to the Commission. It was only after the intervention of the Court that the Commission acted. At the time of the audit, the Commission had not set up a system to monitor this aspect.

11.40. No clear administrative instructions were issued by the Commission for an overall and effective day-to-day management after the administrative closure of the programme on 30 June 1996. The Commission allowed each support agency to continue de facto their own management. After that date no contractual framework was in place to undertake the necessary administrative work and follow-up with the beneficiaries to ensure the recovery of outstanding balances, of capital gains on venture capital and of loans granted; nor was there a framework to undertake legal action for the recovery of loans repayable where this is worthwhile.

11.41. The Commission's accounts and European Union consolidated financial statements at 31 December 1996, attempt to disclose its financial position. For the first time, the Commission has tried to identify and quantify the net value of its debtors from the agencies. The Court, while recognizing the efforts made by the Commission towards more visible disclosure, has analysed the actual situation of the Commission's assets and has concluded that further evaluation of true value and recoverability of these sums, as well as the presentation within the financial statements, is required before the Commission finalizes its accounts for 1997.

Expected developments in MEDIA II

11.42. The overall objective of the programme, the promotion and strengthening of the European audio-visual industry, remains unchanged in MEDIA II. Compared to MEDIA I, the specific objectives have been redefined and concentrated on three priority axes (see paragraph 11.2).

11.43. MEDIA II improvements are expected from the reduction in the number of the 19 support agencies to four intermediary bodies, leading to a tightening of administrative procedures and a substantial decrease of the administrative costs from the average of 22% of the funding in MEDIA I to the 5% target in MEDIA II. The responsibilities of the four new intermediaries are split according to the MEDIA II actions: project development, film distribution, professional training and an administrative unit coordinating the other three.

11.44. The contracts with the new intermediaries were concluded in line with normal tender procedures and do not delegate substantial functions and powers to the same extent as MEDIA I. Compared to the deficiencies in MEDIA I, financial control is better regulated in MEDIA II. The reorganization of the programme management should lead to stricter control over payments, since direct contractual relationships exist between the Commission and the final beneficiary.

11.45. However, little improvement can be expected in the budget execution for the first year of the MEDIA II programme:

(a) the contracts with the intermediaries responsible for the technical selection, monitoring and evaluation of projects were not signed until August 1996, so that most contracts could not be signed before this date;

(b) budget execution in 1996 consisted of a single commitment of funds of 58,3 Mio ECU (97% of the 1996 total budget allocation) made in November 1996 and for which in December 1996 a 50% advance 'payment` was made simply by a transfer to a bank account of an intermediary but not to final beneficiaries (see Chapter 19, paragraph 19.10). This manner of executing the budget gives no indication of the progress of the programme.

CONCLUSIONS

11.46. The support agencies and beneficiaries audited confirmed that MEDIA has assisted in setting up cooperation networks and working relationships between producers from different Member States, and that without MEDIA the production of certain films might not have been possible.

11.47. The multiplicity of the objectives and the duality of the cultural and economic aspects may affect the impact in terms of the individual objectives. Given the limited funding, specific priorities must be set, by which the results of the actions can be measured.

11.48. The MEDIA programmes, with their relatively low budget and broad dispersion of funding, have so far achieved little to counterbalance the economic power of multinational groups within the audiovisual industry. However, a successful application for MEDIA funding strengthens the beneficiary's negotiating position with the broadcasting stations (returning the broadcasting rights to the beneficiary after a given period). New instruments such as the proposed Guarantee Fund might reinforce the impact of MEDIA, by helping SMEs to obtain financial support (see paragraphs 11.12 and 11.13).

11.49. Improved coordination and exchange of information between the different Commission services is necessary. To definitively avoid double funding risks and promote sound financial management, the Commission should rationalize its budgetary management structure so that this dispersion of responsibilities is avoided. The Commission should thus consider whether it would not be more appropriate to develop a more coordinated financial and management framework for the administration of training actions such as those under the ESF and the Community Initiatives, especially ADAPT and Employment, Leonardo and MEDIA (see paragraphs 11.21 to 11.24)

11.50. The prevailing contractual model between the Commission and the support agencies during MEDIA I was inappropriate. Provisions were not always clear and the Community interests were often neglected (audit rights, ownership of assets). Contracts were often signed at the end of the year to which they applied. The audit of agencies' management and accounts and of financial aspects of projects was poor (see paragraphs 11.14 to 11.20, 11.27 to 11.29 and 11.40).

11.51. For MEDIA II, improvements in contracting have been introduced and further improvements are envisaged in the area of control as stated above (see paragraphs 11.41 to 11.44).

11.52. The net financial position for MEDIA I held by the support agencies should be correctly disclosed and necessary recovery measures should be taken. Clear instructions should be given for the administration of venture capital and the recovery of outstanding loans (see paragraphs 11.32, 11.35, 11.39 and 11.41).

REPLIES OF THE COMMISSION

EXECUTION OF THE BUDGET

11.7. The main reason for the delay in implementing the budget was that the Commission's internal procedures could not begin before approval was obtained from the MEDIA Committee on the allocation of funds on the basis of the applications submitted by the agencies.

In addition, an interim evaluation report led to substantial changes being made to contracts, which had to be approved in-house and also entailed difficult negotiations with the agencies.

Payment of the balances in 1995 and 1996 was suspended on the grounds that the agencies had not presented their repayment plans by 30 June 1996, as required under the contract. In the case of all the agencies which had fulfilled their obligations, the accounts were closed at the end of May 1997.

The Commission has had a number of audits made of the agencies' accounts. The Commission did not pay the balances until after the audits were completed.

11.8. Payments were made in separate instalments according to the work schedules of the agencies and beneficiaries. A beneficiary, supported by an agency, did not receive the second payment until it could demonstrate that the project was continuing and only after it had presented the specific supporting documents (development package, progress report, etc.). To ensure that excessive funds did not lie dormant with the agencies, the Commission geared the release of appropriations to the various agencies' payment methods.

OBSERVATIONS

11.9. The Court of Auditors identified a number of obstacles which might have hindered the smooth implementation of the programme. The Commission considers it has taken the appropriate measures, outlined below, to minimize the impact of these obstacles.

Problems posed by the multiplicity of cultural and economic objectives

11.10. The MEDIA I and MEDIA II programmes cover both industrial and cultural aspects of audiovisual policy. The objective is to introduce an industrial approach into an essentially cultural sector. This objective, underpinned by Council decisions, is given effect through the schemes supported.

11.11. The MEDIA programmes' support is complementary to national measures, and in accordance with the decisions establishing the programmes is allocated to areas not covered by national measures (e.g. subtitling, cross-national circulation). Since the objectives of national and Community measures are different, one project may be eligible for and receive funding from both sources.

11.12. Despite the limited funds at its disposal, MEDIA I fulfilled the objectives fixed in the Council decisions. Being a Community programme supplementing the national support schemes, MEDIA I provided the necessary value added to achieve European objectives while respecting the subsidiarity principle.

11.13. In the case of film producers and distributors, the European market is mainly made up of small and medium-size businesses. MEDIA I's main contribution has been to develop networking for these firms and a market structure.

The Commission shares the Court's view that the European Guarantee Fund will have a beneficial effect on the audiovisual market, by making it easier for producers and distributors to spread their risks. This is why it is promoting the idea of the Guarantee Fund as a tool complementing the MEDIA programme.

Programme implementation and management

11.14. The Council Decision provides that account should be taken of the lessons learned in the pilot phase, where a number (10) of these agencies were already involved. The method of management through agencies had stood the test in the pilot phase and was therefore retained.

The Council Decision of 21 December 1990 had specified that such a system should be established, in particular in Annex 1, which encouraged the establishment and development of agencies, some of which were named. A rough estimate was made of the amounts to be granted to each agency to carry out the various operations. Thus the Council was aware of the cost, even if it was high.

11.15. The nine other agencies not named in the Council Decision were selected on the basis of the same principles applied to the first ten. In this way the Commission promoted the grouping of professionals in areas not previously covered. The Commission did not consider that this amounted to awarding a contract within the meaning of Article 56 of the Financial Regulation.

11.16. Once the programme started, the contracts were concluded in the first quarter after the internal procedures were completed (availability of budget funds, commitment). Following the mid-term evaluation, changes were made to the management of the programme and this led to changes in the contracts. This entailed a considerable volume of work in-house, and also long and difficult discussions with the agencies, hence the delay in signing the contracts.

In one case, an inspection by the Commission uncovered a number of suspected irregularities, making it impossible to conclude the contract within the year. The Commission carefully examined the agency's accounts and commissioned an audit. On account of the dispute between the Commission and the agency, a new contract could not be concluded until the matter was settled. When the audit was completed, the Commission was able to determine the precise amounts to be paid to the agency and the problem was resolved.

11.17. Throughout the programme the Commission has improved contracts with the various agencies. The major changes made after the interim evaluation particularly concerned the points raised by the Court.

11.18. Drawing on the practice followed during the pilot phase, Article 6 of the Council Decision was understood by the Commission and those involved to mean that under MEDIA I the 50% funding rule applied not to the agencies, but to the total funds mobilized by the operations carried out by the agencies. Thus the 50% joint financing rule was generally observed.

11.19. In 1996, contracts signed with the agencies were confined to management costs. The aim of the contracts was to enable the agencies to close the accounts and present repayment plans.

11.20. The Court's observation is justified in the case of MEDIA I. One of the major changes under MEDIA II is that contracts are concluded directly between the beneficiaries and the Commission. Thus the Commission clearly appears as the co-contractor, and all the contracts provide for control by Commission departments, its representatives and the Court of Auditors.

Overlap of activities and funding

11.22. Under MEDIA I the agencies were responsible for monitoring funding. Under MEDIA II the Commission is responsible for checking the beneficiaries' budgets and the various sources of financing. A check is also made at the time of each payment.

11.23. The Commission wishes to establish a coherent audiovisual policy. This involves legislative measures to establish a comprehensive framework integrating all aspects of the sector and subsidy measures to provide coherent support in the chosen priority sectors. In this framework, the Council Decision provides for the inclusion of training measures in the MEDIA programme, even if other Community programmes can partly cover this aspect. Coordination and exchange of information between the programmes is assured.

With respect to the Belgian case specifically mentioned by the Court, it is very likely that double funding occurred. The Commission has asked the Belgian authorities to carry out a national on-the-spot check and to ensure that any double funding is repaid if the Court's conclusions are confirmed.

To avoid this type of situation, promoters have been required since 1991 in the case of projects under the Structural Fund Objectives (1 to 5b) and the Community initiatives, and since 1995 in the case of the Leonardo programme to declare any other Community subsidies that they receive. MEDIA II has incorporated similar clauses. Therefore the Commission considers that appropriate steps have been taken to prevent double funding of projects co-financed by the Commission.

11.24. Multimedia projects are an important aspect of audiovisual policy and must therefore be integrated in the MEDIA II programme. The Community programmes with responsibilities in this area operate in the framework of the decisions which established them, and have set up systems to avoid double funding, namely:

- requirement to declare other sources of financing

- systematic exchange of information with other programmes

- systematic audits of a sample of beneficiaries.

System of controls

11.27. Following the Court's audit, the Commission asked the agency in question to explain why the accounts audited could not be reconciled. A letter from the agency's accountant gave further explanations on the basis of which it would seem possible to reconcile the accounts.

All the same an outside firm was asked to make an independent audit of all the accounts and budgetary documents of the agency. One of the objectives of the audit was to check whether the expenditure declared corresponded to the amounts entered in the accounts by the contractor. The results of the audit will make it possible to make certain adjustments in expenditure claims submitted. In agreement with the agency, the Commission has suspended payment of the balance for 1995-96 pending the results of the audit.

11.28. This shortcoming has been remedied in MEDIA II, as stated in paragraph 11.20.

11.29. At the end of the programme the Commission realized that insufficient audits had been carried out on the agencies and took certain measures. Thus since 1995 the Commission has carried out an audit of another five agencies in addition to the five referred to by the Court. Currently, two more agencies are also being audited. These audits have been handled by outside audit firms reporting to the authorizing department and the Financial Controller. This approach was adopted because it was impossible to carry out so many audits with the internal human resources available.

A systematic audit procedure has been set up under MEDIA II. Following an invitation to tender, the Commission has selected a firm and entrusted it with the task of carrying out all the controls required on payment of Community funds and conducting audits of final beneficiaries at the Commission's request. A total of ECU 250 000 has been allocated for audits in 1997.

11.30. Each year the agencies presented an expenditure statement certified by an independent accountant. The statements set out, chapter by chapter, the expenditure for the year as laid down in the budget. However, the agencies also kept general accounts and presented their balance sheets in accordance with the rules in force in the countries where they were based.

The situation described by the Court is the result of the objective of the MEDIA I programme which was to furnish start-up capital for the audiovisual industry and to ensure that the agencies became autonomous. After the mid-term evaluation this approach was dropped. Financial assets obtained by the agencies have since been recovered. At the end of the programme, the Commission calculated the net cash balance of the agencies on the basis of the statements presented on 30 June 1996 and asked for cash surpluses to be repaid.

Repayments of loans, venture capital and interest earned

11.32. The Council had intended MEDIA I to continue where the pilot phase had left of. In this context one of the main objectives was to ensure the autonomy of the agencies. To facilitate this there was no provision to repay assets to the Commission. Besides, the Council Decision did not include any such requirement.

However, the report drawn up following the interim evaluation showed that no agency would be able to stand on its own feet by the end of the 1995 programme. Given this situation, after submitting the report to the MEDIA Advisory Committee, the Commission decided to alter the terms of the contributions to the agencies and to require that funds recovered on conditionally repayable loans, advances on revenue, and interest on the financial contribution should be repaid to the Commission.

Agreements with the agencies have included a requirement to repay interest on the Commission contribution since 1994, and interest on advances on revenue and interest on loans since 1995. The latter requirement is confirmed by the agreement for the first quarter of 1996.

To recover loans granted before 1995, the Commission considered it best to introduce the system of repayment plans. At its request, the agencies concerned presented statements and estimates of returns on investments. On this basis the Commission approved repayment plans with all the agencies concerned between December 1996 and June 1997 and is now in a position to conclude management contracts with them.

11.33. The agencies involved under MEDIA I were granted conditionally repayable loans or advances on revenue. Repayment of the loans or advances was linked to the financial success of the project.

After analysing the cases and applying the repayment ratios observed in the different agencies concerned, repayment plans were drawn up. It is expected that a total of ECU 26 million will be repaid.

Given the particular nature of the sector, the Commission considers that the estimated rate of repayment should be regarded as normal. It is comparable to that for other bodies operating on the same markets. The time limit for closing the various contracts is dependent on the completion date of the various projects. According to current estimates, 90% of the total will be repaid by 2000 at the latest.

11.34. The Commission and the agencies have drawn up a list of projects under way and worked out repayment plans as stated above. The agencies' financial situation and position with regard to outstanding loans is known to the Commission.

Disclosure of financial position

11.35. No provision for repayment to the Commission was made in the original instrument as stated in paragraph 11.32 above. Therefore there was no reason why the Commission should enter loans and advances on revenue granted by agencies in its financial statement. The requirement for the repayment of loans and advances by the agencies was not introduced until after the evaluation report in 1995. Since it was not introduced until the end of 1995, the Commission did not have sufficiently clear data to include the outstanding debt in the 1995 statements. The amounts of the outstanding loans have been determined and the Commission has entered them in the 1996 statements.

Programme evaluation

11.36. In accordance with Article 8 of the Decision, the Commission carried out a mid-term evaluation. As explained in paragraphs 11.16, 11.17 and 11.32 above, following this evaluation the Commission made significant changes to the management of MEDIA I and launched a number of studies and reviews, which were reflected in the Green Paper on audiovisual media. Based on this and on the recommendations in the evaluation report (improve procedures, refocus objectives, reduce operating costs) the Commission:

- clarified the objectives of MEDIA II,

- redirected its activities to three priority areas,

- dropped the system of decentralized management and concentrated decisions in its departments,

- improved budgetary management procedures and controls,

- reorganized organizational and project selection procedures.

This enabled the Commission to put forward a proposal for a radically amended and improved programme. The final MEDIA I evaluation report did not throw any doubts on this analysis.

Closure of the programme

11.37. The Court referred to one case where, for exceptional reasons, the Administrative Board meeting did not take place until after closure of the programme. Since the Administrative Board's decisions formally confirmed the decisions adopted at technical committee meetings the year before, the Commission considered that the projects approved at the meeting were eligible.

11.38. On several occasions the Commission has pointed out to the agencies that they could not finance their administrative expenditure using funds from repayable loans or the return on investments. The presentation of claims or repayment plans which include expenditure incurred after 30 June 1996 is not accepted.

11.39 and 11.40. To ensure maximum repayments, the Commission asked the agencies to draw up repayment plans which it then analysed.

The aim was to work out a system for the management of repayments with the best cost-benefit ratio. This took some time on account of the following:

- the agencies did not fulfil the terms of the 1996 contract as regards the presentation of repayment plans by 30 June 1996;

- analysis of the repayment plans proved complex and a preparatory phase was needed;

- the contractual framework depended on the number of cases to be handled and the total amount to be repaid.

The results of the process were as follows (May 1996):

- the agencies presented repayment plans for a total of ECU 26 955 272;

- four repayments have been made totalling ECU 2 870 598, of which ECU 2 542 056 was repaid in 1996 and ECU 350 222 in 1997.

The Commission also set up a recovery unit to monitor the repayment plans and the projects managed by the agencies.

11.41. The requirement to repay loans and advances on revenue was not included in the agencies' contracts until 1995, as stated in paragraph 11.34 above. On 31 December 1995 the available data was not sufficiently precise to enable the Commission to include repayable loans in its financial statement. Since then the Commission has established the figures for outstanding loans and entered them in the 1996 balance sheet. It will take account of the Court's comments regarding the presentation of financial statements.

Expected developments in MEDIA II

11.43. The organizations selected to assist the Commission will have a different role under MEDIA II. The tasks and responsibilities previously assigned to them will now be performed by the MEDIA unit. Thus the Commission will establish guidelines for invitations to tender, select projects, draw up contracts, be responsible for payments and recoveries. For these tasks the Commission will be aided by four technical assistance bureaux which were selected after an invitation to tender. They will not have any decision-making powers, and their role will be limited to giving advice and technical assistance. Therefore they are in no way comparable to the agencies operating under MEDIA I nor to the intermediaries under MEDIA II.

11.45. The MEDIA II programme started officially on 1 January 1996. Under the Council decisions (approval of the specification by the MEDIA Committee) the official selection procedures for the intermediaries could not be launched before this date. After completion of the invitation to tender procedures the contracts were signed in August 1996.

The implementing rules and new guidelines were formulated in 1995 and early 1996 to allow for calls for proposals to be published early in 1996. Following publication, contracts covering support for the beneficiaries were signed in line with the timetable for processing the applications.

All the appropriations under the heading for which a financial commitment was made were also the subject of a legal commitment in 1996, which was reflected in the signing of 737 contracts.

CONCLUSIONS

11.46. The Commission shares the Court's view that MEDIA I has had an impact on film producers and distributors and on professional cooperation within the audiovisual industry. The most important result of MEDIA I was its impact on structuring the European audiovisual industry. The industry has become more dynamic, and in certain sectors (e.g. animated film) it can compete with non-European producers.

11.47. MEDIA I had a twofold objective: industrial and cultural. The programme aimed to reinforce the European audiovisual industry while giving due weight to the cultural aspects. The twofold approach of the programme is the result of a deliberate choice. The Commission considered that improving the circulation of European works on the market would boost both economic revenue and their cultural impact. With these objectives in mind and in view of the amount of funding available, certain priorities were set.

The mid-term evaluation report noted the dispersion of funding of certain MEDIA I projects. While retaining the same main objective, MEDIA II has redirected projects to concentrate on three priority sectors.

11.48. Most European development and distribution firms are SMEs and one of the programme's objectives is to set up cooperation networks and promote structuring to counterbalance competition from outside Europe.

The Commission shares the Court's view that the proposed Guarantee Fund would reinforce the programme's impact. The Fund is one of the instruments which the Commission is currently trying to set up.

11.49. In the Commission's view MEDIA II should constitute a whole. Measures to promote development and distribution should be complemented by training aimed at giving professionals an opportunity to keep up with rapidly changing technologies in the industry. The Commission has decided on the vertical integration of all aspects concerning the audiovisual industry, rather than the horizontal integration of all aspects of vocational training as suggested by the Court.

11.50. The contractual framework set up under MEDIA I was the result of a Council Decision. The Commission has improved the contractual framework over the life of the programme to protect Community interests as well as possible. Late implementation was mainly a result of the decision-making process laid down by the Council Decision.

11.52. The Commission has entered the outstanding loans and advances on revenue in the 1996 balance sheet. In future it will take account of the Court's comments on the presentation of financial statements. The Commission intends to sign contracts with the agencies for the management of repayments.

Table 11.1 - Budgetary execution 1991-95/96

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PART V External measures

INTRODUCTION

V.1. The Community's external action is financed by subsections B7 and B8 of the general budget and by the European Development Funds, whereas common foreign and security policy measures are financed by subsection B8.

V.2. Chapter 12 analyses the implementation of the EDFs as at 31 December 1996 and deals with advances disbursed by the seventh EDF on behalf of the eighth EDF, which is not yet in force. It also includes an examination of the tendering procedures in the light of the principles set out in the Third and Fourth Lomé Conventions and the applicable regulations, as well as the terms of the contracts and the implementing conditions of the projects.

V.3. Regarding subsection B7, which is dealt with in Chapters 13 and 14, the appropriations available in 1996 amounted to 5 244,5 Mio ECU for commitments and 4 451,8 Mio ECU for payments. The rate of utilization for commitment appropriations was 99,1% and for payment appropriations 78,4%. Analysis of these rates has once again shown that the Commission experiences difficulties in managing and implementing the external aid programmes effectively.

V.4. For the CFSP (Chapter 13), financed from subsection B8, the commitment appropriations available amounted to 58,5 Mio ECU and the rate of utilization was 96,6%, whereas the payment appropriations totalled 67,8 Mio ECU and were 75,8% used up.

V.5. In the context of external actions other than those in favour of the CCEE and the NIS (Chapter 13), three specific topics were examined:

- the Commission's development and management of a computerized management system;

- the implementation of the FEPEX line of credit in Central America;

- an evaluation of bridging loan procedures in Central America.

V.6. Finally, Chapter 14 concerning measures in favour of the CCEE and NIS takes a horizontal approach to the problems of the strategy, definition, implementation and impact of the programmes to support agriculture in these countries.

CHAPTER 12(384\*) European Development Fund

12.0. CONTENTS Paragraph reference

Implementation of the EDFs up to 31 December 1996 12.1 - 12.10

Advances for eighth EDF 12.8 - 12.10

Tendering for works contracts financed by the sixth and the seventh EDF 12.11 - 12.80

Introduction 12.11 - 12.16

The legal framework 12.17 - 12.27

Structure 12.17 - 12.22

Competition and preferences 12.23 - 12.24

Management and executing agents 12.25 - 12.27

Audit findings and comments 12.28 - 12.75

Preparation of tender documents 12.28 - 12.32

Retendering 12.33

Selection of tenders 12.34 - 12.59

Main principles 12.34 - 12.37

Determination of eligibility 12.38 - 12.40

Determination of compliance 12.41 - 12.46

Tender clarification 12.47 - 12.50

Financial evaluation of excessively low tenders 12.51 - 12.53

Justification and assessment of the foreign currency requirement 12.54 - 12.59

Tax and customs arrangements 12.60 - 12.75

Application of the most favoured status clause 12.62 - 12.64

Tax and customs arrangements applicable to imported materials 12.65 - 12.68

Tender conditions and fiscal arrangements 12.69 - 12.71

Tender evaluation and selection 12.72 - 12.75

Conclusion 12.76 - 12.80

IMPLEMENTATION OF THE EDFs UP TO 31 DECEMBER 1996

12.1. The European Development Funds (EDFs) trace their origin back to international agreements drawn up between the Member States of the European Union and 70 African, Caribbean and Pacific (ACP) countries and to Council decisions relating to the association of 24 overseas countries and territories (OCT). The EDFs are endowed by virtue of internal agreements signed among the Member States of the Union and relating to the financing and administration of assistance granted to these countries. The Commission and the European Investment Bank are jointly responsible for managing the EDFs.

12.2. In 1996 the sixth(385) and seventh EDFs(386) were being implemented concurrently because although, in principle, each was limited to five years, there is no time-limit on the spending of the appropriations allocated. Only when the Commission considers that the implementation of a particular fund is nearing completion does it transfer the balance to a subsequent Fund. This usually happens after about 15 years.

12.3. Table 12.1 shows the implementation of the third and fourth Lomé Conventions as at 31 December 1996. The payments for the financial year amounted to 1 317,4 Mio ECU, whilst the net commitments of the financial year had reached 964,9 Mio ECU. The corresponding amounts for 1995 had been 1 563,7 Mio ECU and 1 520,1 Mio ECU respectively. Eleven years after it came into force, disbursements from the sixth EDF represented 83,4% of its resources; at the same stage of the fifth EDF they represented 84,5%. The payment rate for the seventh EDF stood at 47,1% at the end of the sixth year of implementation; for the sixth EDF it stood at 52,5%.

12.4. The Financial Protocol for the seventh EDF expired on 1 March 1995, and on 3 November 1995 the ACP-EC Council of Ministers decided that the balances outstanding for the financial instruments relating to the system for stabilizing export earnings (Stabex), to the special financing facility for mineral products (Sysmin), as well as to structural adjustment support, emergency aid and assistance for refugees, would all remain allocated to their respective objectives until used up.

12.5. On 4 November 1995, the ACP States and the Member States of the European Union, meeting in Mauritius, signed an Agreement amending the Fourth Lomé Convention. This Agreement was to be followed in 1996 by a Council and Commission Decision making it possible to deposit the formal notification needed for the procedure of ratification by the signatory States so that the revised Convention could come into force in good time (foreseen for 1997). In June 1995, in Cannes, the European Council fixed the overall amount of Community aid to the ACP States at 14 625 Mio ECU, for a new five-year period starting on 1 March 1995 (eighth EDF) and at 200 Mio ECU to the OCT for the same period.

12.6. The problem of the balances of closed EDFs mentioned in previous annual reports of the Court(387) was partly resolved in 1995, in that it was agreed that, of the resources allocated to the eighth EDF, 292 Mio ECU was to come from transfers from previous EDFs, namely:

(a) 111 Mio ECU from funds reserved for Somalia in respect of its national indicative programme for the seventh EDF;

(b) 142 Mio ECU from appropriations relating to subsidies from the seventh EDF which are to be considered unusable;

(c) 26 Mio ECU from the balances of subsidies from the sixth EDF;

(d) 13 Mio ECU from the balances of the fourth EDF.

12.7. The solution adopted in 1995, only partly resolves the problem of the utilization of the funds. At 31 December 1996 the outstanding balances from closed EDFs amounted to 395,0 Mio ECU, i.e. the funds transferred from the fourth to the sixth EDFs (124,7 Mio ECU)(388) and from the fifth to the seventh EDFs (456,9 Mio ECU)(389) had given rise to only 186,6 Mio ECU of payments, i.e. 32% of the transfers. This being so, the Commission should propose to the Council a suitable mechanism for solving this question once and for all in order to ensure that in future appropriations are not left unused without good reason.

Advances for eighth EDF

12.8. Following the ACP-EC Council Decisions 1/96 and 2/96 of 28 June 1996, subventions of the seventh EDF have been used to finance the budgets of the Centre for the Development of Industry (CDI) for the years 1996 and 1997 (25,3 Mio ECU) and to finance Stabex transfers for 1995 (76,2 Mio ECU) in order to ensure the continuity of these activities. These amounts, which are due under the eighth EDF, are made available as advances to the eighth EDF and will be reimbursed as soon as the second financial protocol of Lomé IV is ratified.

12.9. The ACP-EC Council Decisions lack a legal basis as no provision exists on transitional problems caused by delays in the ratification of a Convention covering the financing of an EDF. The same States, represented in the ACP-EC Council, which had not yet been able to ratify the second financial protocol of Lomé IV, nevertheless agreed to finance activities under this nonratified agreement.

12.10. The Commission has included the above advances, as well as the related payments executed, in the financial statements simply as utilization of the seventh EDF (see Table 12.1).

TENDERING FOR WORKS CONTRACTS FINANCED BY THE SIXTH AND THE SEVENTH EDF

Introduction

12.11. The construction and rehabilitation of ACP-States' physical infrastructure, such as buildings for education and health care purposes, communications infrastructure (roads, ports and bridges) and water engineering works (dams, water supply and sewage treatment) constitute an important and tangible part of the EDF-financed development aid.

12.12. In its 1995 Report on the results of the invitations to tenders and contracts financed by the sixth and seventh EDF(390), the Commission noted that works contracts, committed as at 31 December 1995, amounted to 1 774 Mio ECU. This represented 43% of all contract-related expenditure, 28% of the total programmable aid, and 15,6% of the total development aid, managed by the Commission(391).

12.13. In the past, the Court has commented on different aspects of works tenders and contracts, examined in the framework of thematic and financial audits. Observations concerned price revision, the nature, definition and preparation of regional road projects, the selection of works contractors, contract and payment currencies and payment conditions(392).

12.14. The objective of the present enquiry was to examine tender evaluation and contract award procedures and practice, in the context of the principles laid down in the third and the fourth Lomé Convention, and of the tender regulations and contract conditions applicable.

12.15. To that effect, the Court audited a sample of 18 sizeable works tenders(393), involving some 350 Mio ECU. In addition, a mission was carried out in Uganda and Kenya (October 1995).

12.16. To identify the potential impact of weaknesses in tender procedures, implementation of most of the ensuing works contracts was also examined. Financial closure of related contracts occurred on average about five years after tender publication. Because of this, the sample covers tenders launched in the period from 30 September 1987 to 13 November 1993.

The legal framework

Structure

12.17. Table 12.3 presents the legal framework(394).

12.18. Until May 1991, tenders were invited under four different regulatory frameworks: the Conditions of Contract for Overseas Works mainly of Civil Engineering Construction(395), the Conditions of Contract for Works of Civil Engineering Construction(396), and two editions of the General Conditions for Works and Supply Contracts financed by the EDF, the official text of 1973(397) and a revised draft document of 1983 (unpublished).

12.19. On 29 March 1990, under Decision 3/90 the ACP-CEE Council of Ministers adopted the new Regulations and Conditions, applicable to all EDF funded projects. The General Regulations for works, supply and service contracts financed by the EDF came into force on 1 June 1991(398).

12.20. In practice, the Commission granted exceptions and allowed the old tender regulations and contract conditions to be used for tenders launched after that date(399). This was explained by the fact that the date of entry into force was unknown at the time of tender preparation; changing long-negotiated tender dossiers would also have been impractical(400).

12.21. However, no evidence could be provided showing that the consultants involved in tender preparation were systematically and timely informed of this Decision and its consequences for EDF-financed tenders and contracts.

12.22. In June 1994, the Commission issued a User's Guide to Tenders and Contracts financed by the EDF(401), to promote a better understanding and a proper application of the rules. It was not intended as a handbook for the legal interpretation of these rules, but as a practical tool for officials of the contracting authorities of the ACP States, and for the Commission's officials, both at Headquarters and in the Delegations.

Competition and preferences

12.23. Competition on the widest possible basis, as a means of obtaining works at the lowest reasonable price and of transferring the technological know-how of the EC Member States is the basic principle underlying EDF-financed tender procedures(402).

12.24. This principle was formalized by the Lomé Conventions along the following lines:

(a) except for authorized derogation, participation in invitations to tender is open to natural and legal persons of all ACP States and of the EC(403);

(b) the ACP States and the Commission shall take the necessary measures for the widest possible participation on equal terms in invitations to tender for works(404);

(c) in order to permit the optimization of the physical and human resources of the ACP States, measures shall be taken to encourage the widest participation of the natural and legal persons of those States(405);

(d) EDF-financed works contracts are in principle concluded following an open invitation to tender(406);

(e) works contracts are awarded to the tenderer who offered the most advantageous responsive tender(407).

Management and executing agents

12.25. The primary responsibility for the preparation, negotiation and conclusion of contracts lies with the ACP States. In particular, their contracting authorities(408) are responsible for preparation, approval and issuance of invitations to tender, reception and the examination of tenders, submission of proposals for placing of contracts, and for the signing of contracts(409).

12.26. The Chief Authorizing Officer (CAO) of the Fund, appointed by the Commission, (i.e. currently the Commissioner in charge of development for the ACP countries) ensures that all tender operations are carried out in conformity with the rules and principles outlined above. The Commission is thus required to approve the various steps of the tendering and contracting process, as follows:

(a) prior to tender publication, approval of the tender dossier (410);

(b) the Commission ensures publication of the invitations to tender in the Official Journal of the European Communities(411);

(c) the Commission's Delegate is required to be present at the opening of tenders, and must receive copies of the tenders and of the results of their examination(412);

(d) after tender evaluation by the contracting authority, the Commission is required to approve, within 60 days, the resulting contract award proposal(413);

(e) finally, the works contract signed by the contracting authority and the contractor, must be endorsed by the Commission's Delegate(414).

12.27. In general, the whole tendering and contracting process - as well as the subsequent contract execution - is carried out in close cooperation between the contracting authority and the Commission. Throughout this process, the Commission's opinion is decisive, as the financing of the contract depends on its concurrence with the operations performed by the contracting authority.

Audit findings and comments

Preparation of tender documents

12.28. As is the case for all tender procedure phases, the ACP State concerned is responsible for the preparation of the tender dossiers which contain all administrative information and technical provisions relevant to prospective tenderers. Usually, the tender dossiers are prepared by specialized consultants, under EDF-financed service contracts. As a rule, tender dossiers for open and restricted tenders are submitted to the Commission for approval prior to tender invitation(415).

12.29. For the tenders examined in the sample, the Commission's comments varied considerably, from mere approvals to requests for significant amendments, depending on the quality of the draft tender dossier.

12.30. The Court considers that in nine cases out of the sample, the tender conditions and specifications could not be considered of adequate quality, and they needed to be modified, either during the tendering period or shortly after contract execution start-up. For example:

(a) in two cases concerning roads in Kenya/Tanzania(416) and Uganda(417), the Commission, after having approved the tender dossier, instructed the contracting authority to modify the published tender conditions during the tendering period;

(b) in two cases, a road in Zambia(418) and a water project in Jamaica(419), the Commission approved tender dossiers which were deficient. In the first case a study was financed at a relatively small cost to update a previously executed study for the construction of a road. The approved tender file was technically incomplete: after contract start-up, the supervisor's representative stated that 'the contract documents did not have the benefit of a full-scale topographic or soils survey`. Consequently, contract execution was marked by substantial modifications, disputes about the technical quality of the works, disputes about price revisions and contractor's claims for indemnities. In the second case, the consultant, when submitting the final tender documents, admitted that 'aspects of the design were now only marginally compliant with accepted standards`;

(c) in the cases of roads in Uganda(420) and Benin(421), the scope of the works to be performed was significantly modified in the period between the tender award and the contract signature (see paragraph 12.50);

(d) the execution of the contracts concluded in three tenders: an irrigation scheme in Mauritania(422), a road in Zambia (423) and a roads project in Uganda (424) was marked by serious conflicts concerning the application of tender conditions with respect to price revision (object, amounts, conditions of payment). This issue has been a recurring problem for almost 30 years(425). It is unacceptable that tender dossiers still may be approved with unclear, incomplete or contradictory conditions.

12.31. Well-prepared tender documents are essential for the efficiency of the tender procedure and of the contract execution. Disruptions of contract execution, resulting from inadequate design or incomplete administrative arrangements, may result in contractor's claims for compensation(426). No overall figures can be provided for the sample examined, as not all contracts were financially closed at the time of reporting. So far, in two cases substantial compensation claims were paid: 1,65 Mio ECU was paid in Uganda (427) and 1,8 Mio ECU was paid in Zambia (428); an additional amount was paid from the national budget.

12.32. Tender dossier deficiencies all too often lead to additional charges, to be financed by the EDF. Given its overall managerial and financial responsibility, the Commission should remind the contracting authorities of their responsibility in this area and should itself concentrate more efforts on the tender preparation and approval phase.

Retendering

12.33. For a waste water project in Jamaica (429) reten-dering was considered necessary by the Commission on the grounds that the financing allotted was exceeded by all tenderers. However, this motivation (not shared by the ACP State) was highly questionable, as this tender was launched before a financing decision was taken, with the aim to have more precise knowledge about the amounts involved (tender launched with suspension clause, providing a reliable estimate of the financing needed for the project).

Selection of tenders

Main principles

12.34. The third and fourth Lomé Conventions identify two main principles concerning the selection of works tenders:

(a) the contract must be awarded to the tenderer having offered the most advantageous responsive tender, as assessed on the basis of a number of criteria, which must be specified in the invitation to tender dossier(430);

(b) where two tenders are acknowledged to be equivalent on the basis of these criteria, preference must be given to the tenderer of an ACP State or to the tenderer who permits the best possible use of the ACP States' resources(431).

12.35. The tender criteria to be assessed include, inter alia, the price, the operating costs, the tenderer's qualifications and guarantees, the technical qualities, and the nature and conditions of contract implementation.

12.36. The contracting authority completes the evaluation within the tender validity period, taking account of the period required for approval of the contract, and forwards the proposal for placing the contract to the Delegate for approval(432). When the selected tender is the lowest of the responsive tenders and does not exceed the sum earmarked for the contract, the Delegate approves the proposal within 30 days. Where these conditions are not fulfilled, the proposal is forwarded to the Commission for decision within 60 days(433): the same procedure is foreseen in case of discrepancies regarding the budget or the compliance of the award proposed by the National Authorizing Officer.

12.37. The selection procedure calls for a detailed assessment of tenders in the light of predefined tender criteria, and should lead to the selection of the most advantageous tender, as assessed in the light of these criteria(434). The tender price being only one of these criteria, the procedure does not call for the automatic selection of the lowest responsive tender; this factor is only decisive in determining whether the Delegate should refer the approval decision to the CAO.

Determination of eligibility

12.38. One procedure highlighted a general question on the topic of eligibility in function of the source of financing. A first tender was launched under Lomé II conditions and financing. However, the tender procedure was cancelled on the grounds that the financing earmarked for the contract was exceeded. Because the funds were transferred from the fifth to the seventh EDF, and additional financing from the seventh EDF was proposed, the contract was retendered under Lomé IV conditions. According to Article 7 of the Lomé II Internal Agreement, fifth EDF funds continue to be subject to Lomé II procedures even after their transfer to a subsequent fund. This principle is also stated in Article 116 of Lomé II.

12.39. In the meantime the Lomé IV Convention was signed by two new Member States, which had not signed the Lomé II Convention. Companies of these two Member States became eligible for participation in the retendering as the Lomé IV conditions were applied.

12.40. Clarification is needed as to whether companies from new Member States can, without any restriction, participate in tender procedures relating to funds covered by Conventions which were not signed by those Member States. This is also relevant with regard to the imminent start-up of the eighth EDF, in which three new Member States will participate.

Determination of compliance(435)12.41. The contracting authority examines whether each tender conforms to all the terms, conditions and specifications of the tender dossier without material deviation or reservation. A deviation or reservation is material when it affects the scope, quality or performance of the contract, or when, in a substantial way, it is inconsistent with the tender dossier or limits the contracting authority's rights or the tenderer's obligations under the contract, and affects unfairly the competitive position of the tenderers. A material deviation or reservation is not subject to clarification, and cannot be withdrawn(436).

12.42. The extent to which each tender complies with the contract conditions and specifications is determined prior to its detailed evaluation. A tender found non-compliant is to be rejected by the contracting authority.

12.43. Although the new Regulations have somewhat clarified the issue of tender compliance, it is evident that this notion, as well as the term 'material deviation` remain subject to interpretation. In fact, the materiality of a tender condition may be evaluated differently in the light of factual circumstances, or of the national law and tradition.

12.44. Out of the sample examined, it appears that:

(a) in the cases of the Kampala water supply project and the irrigation scheme in Mauritania(437) the evaluation criteria were not clearly defined in the tender documents. As a result of this weakness, controversy arose between the contracting authority and the Commission concerning the evaluation methodology (determination of compliance, technical and financial evaluation) and the resulting selection of the most advantageous responsive tender. In one case, the Commission was not in a position to formulate a final conclusion on the contract award proposal, and simply referred the case back to the contracting authority for decision. In the other case, the Commission did not accept the award proposal (to the lowest tenderer). As this offer was, in the end, deemed by the Commission to be technically non-compliant with the tender dossier, the contract award was modified accordingly;

(b) in the cases of a road in Zambia(438) and a dam in Nigeria(439), not all tenders were evaluated, but only the three lowest. Apparently, this practice is favoured by those consultants who are familiar with FIDIC Regulations(440) and not with EDF Regulations;

(c) for two tenders in Kenya(441), the contracting authority selected and proposed a tender for contract award, but also expressed doubts on the financial and technical capacity of the tenderer. These reservations were lifted by the Commission, but later proved to be entirely justified;

(d) the lowest tender for a road in Burkina Faso(442) was rejected because it was based on the assumption that no customs duties were due on imported materials, whereas the tender conditions were unclear on this issue (see paragraphs 12.74(c)-12.75);

(e) tender compliance may be interpreted in extremely different ways:

- for the tender in Jamaica(443), the five offers received were all considered responsive by the contracting authority, whereas the Commission correctly considered that none of the tenders were compliant;

- for a tender in Kenya(444), none of the nine offers received was complete, yet no offer was rejected. For another tender (Guinée)(445), none of the nine offers received was complete, and all were correctly rejected, entailing tender cancellation and retendering. For this restarted procedure, a much wider interpretation of compliance was used: tenders, qualified by conditions deemed unacceptable, were this time not rejected.

12.45. These findings illustrate that tender compliance, in the context of EDF-financed tenders, is a 'moving target`: different interpretations may be given in every tender procedure. On the whole, this phase of the tender procedure lacks transparency.

12.46. Because of the severity of the sanction attached, namely rejection of the tender without further evaluation, and to prevent conflicting interpretations arising between evaluators, contracting authorities and the Commission, the important tender conditions, necessary for a compliant tender, should be clearly identified in the tender documents.

Tender clarification

12.47. Deviations, reservations, or simply lack of adequate information, which are not considered 'material`, are usually subject to 'clarification`. The issue of tender clarification is closely linked to the determination of compliance. Therefore, the same lack of transparency is present in this area.

12.48. The current General Regulations(446) allow tender clarification for one purpose only: the correction of arithmetic errors discovered. Otherwise, no change in the price or substance of the tender can be sought, offered or permitted. This clause is more restrictive than the 'old` regulation, stipulating that the contracting authority does not discuss with tenderers, except to specify or to complete the terms of their offers(447).

12.49. Even within the current narrow limits, tender clarification may vary (too) widely, leading to inconsistent treatment. This is illustrated by the following example: one tender for Uganda(448) and one for Kenya/Tanzania(449) were both launched in the same period (February 1992), in neighbouring countries, within the context of the same tender Regulations. In the first tender, the four lowest tenders were correctly deemed non-responsive, for one or more reasons of a technical and/or a financial nature; these four tenderers were not invited to clarify their tender, by producing the missing documents, or by providing additional technical information. In the other tender, the lowest tender was deemed responsive, although additional information was needed on 10 different issues(450); in this case, the tenderer was requested to 'clarify` his tender accordingly; his 'undertakings` on these items were included in the awarded contract.

12.50. Two cases were noted where the scope of the tender was significantly modified between the award decision and contract signature, following negotiations between the selected tenderer and the contracting authority. Strictly speaking, these modifications were not resulting from tender clarification, but rather from poor tender preparation. The negotiations are in conflict with the principle that the award of works contracts should be based, to a maximum extent, on the result of an open competition procedure, instead of negotiations with just one tenderer.

Financial evaluation of excessively low tenders

12.51. The Regulations governing the financial evaluation prescribe the verification of the arithmetical correctness and completeness of tenders(451). This verification should also assess whether the tenders are 'balanced`, i.e. whether the unit prices quoted correspond to the relative value of each item, in relation to the total amount of the tender(452).

12.52. In four cases, the selected tender was priced very low in comparison to the other tenders :

(a) for the Webuye-Malaba road in Kenya(453): the selected tender, 21% below engineer's estimate and 27% below the second tender, was evaluated as 'deliberately low in order to secure the local market`. The resulting contract was ultimately halted for non-performance of the contractor;

(b) for the roads in Kenya/Tanzania(454) the originally selected tender was 32% lower than the second, and 33% lower than the estimate. The contract awarded was refused by the tenderer, who according to the Delegate would probably have incurred losses on the contract as awarded;

(c) for the Lusaka-Kabwe road in Zambia(455), the selected tender, evaluated 'below the material cost` by the Delegate, was 30% lower than the second and third lowest bids, and 37% lower than the average (10 bids). A thorough financial examination was not carried out 'in view of the large price difference`. The contract execution was marked by significant deficiencies and disputes over the responsibility for these;

(d) for the Masaka-Kabale road(456), the selected tender was 29% below the average, and 45% below the estimate. Contract execution was satisfactory. In this case, the contract award was stated to continue an existing quasi-monopoly position(457).

12.53. The three out of four cases which resulted in serious problems and delays demonstrate that the financial evaluation exercise should not be limited to ensuring that the selected tender is arithmetically correct, complete and balanced. This exercise should also indicate whether the selected tender was sufficient, i.e. whether the tenderer correctly evaluated all risks, contingencies and other circumstances influencing or affecting the tender, as required under Article 20 of the General Conditions for works contracts(458).

Justification and assessment of the foreign currency requirement

12.54. Although tenders must be expressed in the national currency of the State of the contracting authorities, tenderers may request that a part of their tender be paid in foreign currency(459); these payments are to be effected at a fixed rate of exchange(460). The purpose of this system of exchange guarantee is to remunerate the contractor in the currency of his actual costs, incurred both locally and abroad; at the same time, the contractor is safeguarded against the depreciation of the tender currency.

12.55. This system is used in all EDF-financed works tenders; the requested portions payable in foreign currency generally amount to between 60 and 90% of the tender price.

12.56. The tender regulations stipulate that the part payable in foreign currency should be justified by the tenderer and assessed in the light of verifiable facts concerning the real origin of the works and the expenditure involved. The use of elements of foreign origin must be justified, and is therefore considered as the exception.

12.57. The examination of the sample revealed that the justification required was often not available(461). When available, it was almost never assessed. Consequently, the foreign part requested was never altered as a result of an assessment.

12.58. In this respect, the following is to be considered:

(a) tenders with a different 'currency split` are only comparable in national currency. Therefore, the tender regulations state that tenders are compared in national currency. However, in terms of real charges to the ACP State's National Indicative Programme and to the Financing Agreement (both expressed in ECU), such tenders are not comparable(462);

(b) when the foreign part requested does not match the real costs to be incurred by the contractor, the latter may easily realize undue 'windfall profits`, as he will be remunerated in hard currency for costs incurred in local, depreciated, currency;

(c) the determination of the most advantageous tender cannot be based solely on the price in national currency: also the payment conditions, and the adaptation to local conditions, must be taken into account.

12.59. Both the contracting authorities and the Commission should give more attention to the justification and assessment of tender conditions, with respect to payment in foreign currency. The preference for a wider use of ACP resources, promoted by the Convention(463), is largely neglected.

Tax and customs arrangements

12.60. Given the financial impact and an opposite interest of donors and beneficiaries, tax and customs arrangements are important. The principles governing the tax and customs arrangements applicable in the ACP States to works contracts financed by the EDF are outlined by the Lomé Conventions: Lomé III, Protocol 6; Lomé IV, Articles 308 to 310. The basic rule(464) is that the ACP States shall apply to contracts financed by the Community tax and customs arrangements no less favourable than those applied by them to the most favoured States or international development organisations.

12.61. It is further stated that, subject to the basic rule, '... all materials used in the performance of works contracts shall be deemed to have been purchased on the local market and shall be subject to fiscal rules applicable under the national legislation in force of the beneficiary ACP State`(465). For any matter not covered by the provisions of Articles 308 and 309, the ACP State's national legislation shall apply(466).

Application of the most favoured status clause

12.62. According to the Commission, the application of the most favoured status clause is realized, in all ACP States, through either a national law proclaimed on the basis of the Lomé Convention clause, or through an ad hoc agreement between the Commission and the ACP State. In practice, the Delegations seem to be required to prove that other donors receive a more favourable treatment, so that they can obtain the same conditions for EDF-financed contracts(467).

12.63. The Commission does not centralize the data available on the application of fiscal arrangements, under ad hoc agreements or national law. Therefore, tender conditions on fiscal arrangements, for any given tender, are not systematically compared by the Commission's central services with the terms agreed with or proclaimed by the ACP State concerned, nor with the regulations of the Lomé Conventions themselves. In theory, Delegations may be better informed of the prevailing situation, but no evidence was found of any systematic checking by them.

12.64. In conclusion, tax and fiscal arrangements defined in tender dossiers for EDF-financed tenders may vary from country to country. However, within a given ACP State, they may also vary from tender to tender which is not acceptable. In the absence of clear justification, the Court cannot establish whether EDF-financed works tenders were launched and awarded on the basis of the most favourable fiscal arrangements, as required by the Lomé Conventions.

Tax and customs arrangements applicable to imported materials

12.65. Most of the tender dossiers examined contained detailed instructions with regard to the fiscal arrangements applicable, especially for materials to be imported and incorporated in the works.

12.66. The majority of the tenders were invited with the condition 'imported materials free of customs duties`. In the absence of information regarding national (ACP) fiscal legislation on imported materials, and more generally, regarding the 'most favourable fiscal arrangements`, it is impossible to verify whether the tender conditions respect the Lomé Convention.

12.67. Furthermore, a customs duties exemption clause changes relative prices between imported and locally produced materials. This effect could be contrary to the intent of the Convention, promoting the use of ACP resources.

12.68. One ACP State (Kenya) is aware of this effect, and therefore prohibits, for the execution of works contracts, the importation of materials which are available from local companies.

Tender conditions and fiscal arrangements

12.69. In the following situations, inconsistencies were noted with respect to the definition of the contract conditions and to the tender procedure:

(a) the tender for the road Niamey-Say in Niger (tender No 3406) was launched 'imported materials exempted`, but after tender publication the contracting authority withdrew the exemption status. As this modification was contrary to the ad hoc agreement, concluded with the ACP State concerned on the application of the Lomé Convention, the Delegation requested to return to the 'most favoured status` granted previously. As a result the tender selected, exclusive of customs duties, was 8% lower than the same tender inclusive of customs duties;

(b) tenders for roads in Zambia(468) and in Uganda(469) were invited with contradictory instructions: on the one hand, it was stated that imported materials were exempt from duties(470); on the other hand, the Special Conditions governing revision of prices stated that the basic rates for imported materials, used for tender pricing, should include customs duties. The execution of both contracts, awarded on the basis of these tenders, was marked by disagreements on the payment of taxes and amounts claimed for price revision;

(c) during the execution of the contract awarded on the basis of tender for a road in Guinée(471), a law was voted by the national authorities, revoking the tax exemption granted to all ongoing contracts financed by international donors. Consequently, as gas oil was no longer obtainable duty free, execution of the contract was halted by the contractor.

12.70. In a number of cases offers were invited for two different administrative solutions (taxes included and excluded). This is not transparent and reveals lack of knowledge of the tax and duties exemption rules.

12.71. This situation occurred for two roads(472) (473), where offers were to be submitted in two versions, one inclusive and one exclusive of taxes and duties. In the first case, this procedure resulted from a request by the Commission(474), which feared that the financing available would be exceeded. This tender was awarded 'duty free`, 10% lower than the offer, duties included. In the second case, the tender awarded 'duty free` was 38% lower than the same offer, duties included.

Tender evaluation and selection

12.72. The received tenders' compliance with the tax and customs arrangements outlined in the tender Conditions was not always examined during tender evaluation. In these circumstances, it is rather difficult to arrive at a comprehensive judgment on the validity of evaluations.

12.73. Where examined, tenders evaluated as 'incorrect` were treated in different ways: some cases were considered non-compliant and rejected, whereas others were considered compliant and further evaluated. They were subsequently amended to make them compliant.

12.74. The outcome of three selection procedures was influenced by observations on tender compliance with tax and customs arrangements.

(a) in the tender on the Kenya/Tanzania roads(475), the three lowest tenders were submitted on the basis of duty free rates for fuel and bitumen; this was contrary to the tender specification that these materials were to be purchased in the ACP States concerned (Kenya and Tanzania), and therefore were subject to national taxes. These tenders were not rejected; for the purpose of contract award, the contractor's basic rates were changed to include national tax. In principle, submitted tenders cannot be modified and made compliant with tender conditions;

(b) in contrast to the above, the evaluation for the Kampala City Roads(476) showed that five out of nine offers evaluated were, contrary to tender conditions, priced on the basis of bitumen, exclusive of taxes and duties. These tenders were rejected as non-responsive; this rejection was one of the factors leading to the selection of the fifth lowest tenderer. This procedure is in conformity with the EDF Regulations;

(c) for the road in Burkina Faso(477), the lowest tender was evaluated 'non-compliant` because it did not include customs duties on materials to be imported for the execution of the contract. These duties were stated to amount to about 15% of the tender price; even with duties included, the tender was still the lowest. According to the Commission, backing the contracting authorities' proposal to reject this offer:

- the tax and fiscal arrangements were clearly spelled out in the contract conditions;

- the contractor did not seek to clarify but to modify his offer;

- it was impossible to verify the contractor's list of materials supposedly exempted.

Therefore, the offer was deemed 'not comparable to the other offers`.

12.75. The Commission's motivation raises doubts, for the following reasons:

(a) the contract conditions, simply quoting the Lomé Convention, were not at all explicit as to the tax and customs arrangements applicable to imported materials;

(b) shortly before this tender procedure, a works contract, which was being executed by the rejected tenderer in the same ACP State, had been granted 'total exemption status` with the approval of the Commission. Therefore, the rejected tenderer correctly claimed to have acted in good faith;

(c) for the selected tender (3,1 Mio ECU more expensive than the lowest) no verification was made to determine on which tax and fiscal arrangements it was based. The subsequent contract with the selected tenderer was explicitly concluded 'tax exempted`, although it is not clear whether or not this exemption implicitly covered customs duties.

Conclusion

12.76. The audit on tenders launched during 1988-93 showed that tendering for EDF-financed works contracts was marked by a relatively high number of weaknesses in the regulations and their application. However, the financial consequences of these circumstances were often absorbed by contingencies allowances, and thus did not always lead to requests for additional financing.

12.77. The contracting authorities and the Commission need to concentrate more efforts on the preparation and approval of tender dossiers, to ensure that these specify all tender evaluation criteria. The instructions to tenderers and the special contract conditions must be checked systematically, in order to prevent divergent interpretations (see paragraphs 12.28 to 12.32).

12.78. The adequacy and the transparency of tender evaluation practices need to be improved for the following reasons:

(a) current methods for determination of tender compliance and clarification are not transparent. The adequacy, coherence and transparency of these procedures could be enhanced by identifying more clearly the essential tender conditions, as distinct from those subject to clarification (see paragraphs 12.41 to 12.50);

(b) the financial evaluation of tenders does not always establish the sufficiency of the tender proposed for contract award (see paragraphs 12.51 to 12.53);

(c) the tender regulation is not applied with respect to the justification by and assessment of the foreign currency part. This situation should imperatively be addressed by appropriate instructions (see paragraphs 12.54 to 12.59).

12.79. The tax and customs arrangements applicable to works tenders are often not sufficiently clearly defined in the tender documents. To allow these elements to be checked, the Commission needs a centralized information system containing:

(a) all data concerning ad hoc agreements concluded with the ACP States for the application of the 'most favoured status` clause (Lomé IV, Article 308) (see paragraphs 12.62 to 12.64);

(b) the national (ACP) legislation concerning the fiscal arrangements applicable to imported materials (see paragraphs 12.65 to 12.68).

12.80. To reduce the possibilities of wide interpretation and incorrect application of existing rules, the evaluation of tenders should systematically include an assessment of their compliance with the fiscal and customs regulations stipulated in the tender file (see paragraph 12.72).

REPLIES OF THE COMMISSION

IMPLEMENTATION OF THE EDFs UP TO 31 DECEMBER 1996

12.7. The Commission keeps a careful watch on the use of outstanding balances from closed EDFs, particularly in the case of unallocated appropriations. However, the provisions of the Conventions are binding and rule out any prospect of a 'structural` solution to the problem.

Advances for eighth EDF

12.9 12.10. The eighth EDF is unlikely to be ratified until the end of this year or the beginning of next and thus it is impossible to enter any debts to its account. The sums involved were drawn from the seventh EDF reserves.

If the eighth EDF were not ratified the expenditure would be charged definitively and in full to the seventh EDF (see ACP-EC Council Decisions Nos 1/96 and 2/96), using uncommitted resources from other seventh EDF appropriations.

Once the legal provisions for the eighth EDF are in force the Commission will take the necessary steps to ensure that the balance sheet reflects the new position.

TENDERING FOR WORKS CONTRACTS FINANCED BY THE SIXTH AND THE SEVENTH EDF

The legal framework

Structure

12.21. Consultants preparing tender dossiers are contracted directly by the individual ACP State who as such is responsible for making the necessary information available for the consultant to perform his task. In addition, they are informed about the rules whenever the Commission believes corrections to a tender dossier are necessary.

Audit findings and comments

Preparation of tender documents

12.30. It may happen that tender dossiers have to be amended during the tender procedure, but the reasons for this are diverse, such as changing political and administrative requirements or developments in the technical requirements of the project. Depending on the scope and the importance of the changes to be introduced, it is in certain circumstances preferable to address the situation by modifying the dossier instead of cancelling the procedure outright.

However, the Commission agrees that the aim must be to issue tender documents that are as definitive as possible in order to avoid any confusion among tenderers. In this respect the Commission believes that the situation has significantly improved today compared to the period to which the Court refers.

(a) In the Kenya/Tanzania tender, it was discovered that the tender dossier contained a discrepancy between the bill of quantities and the technical specifications, the outcome of which in any case was settled by the tender dossier itself.

For Uganda, the tender was advertised for the first time on 14.2.1992, eight months after the entry into force of the new set of rules for EDF financed contracts. In that context, the beneficiary administration and consultants preparing tender documents had only a relatively brief period to adapt to new administrative practices. The corrigenda dealt mainly with administrative provisions, not technical weaknesses. The primary aim of the corrigenda was to bring the dossier into line with the rules.

(b) For the Jamaica tender, it has not been shown in what way the tender dossier was deficient or incorrect. The procedure was cancelled since the lowest offers for the two lots clearly exceeded the amounts available under the Lomé II Sysmin budget.

In the Zambia case it is the Commission's view that the tender was 'technically complete` because studies of traffic, materials, pavement strength and even a cost benefit analysis were carried out before the dossier was finalized. For the price revision cost, please see point 12.30(d).

(c) See answer to 12.50.

(d) For the tender in Uganda see point 12.69(b).

Regarding the tender in Zambia, there are essentially two ways to apply price revision clauses to the unit rates submitted by a tenderer. In the cases where reliable statistics are published regularly by an official institution of the beneficiary country, the common and very well known polynomial formula can be utilized. In Africa this is not always possible and the price revision is carried out item by item on the basis of actual prices paid to the supplier. The dispute about price revision quoted by the Court refers to a request from the contractor to have the price revision amount split into foreign and local currency in the same way as any other payment. The request was of course rejected. The substantial price revision claim was due to the high inflation experienced in Zambia during the execution of the work. Note that an audit was carried out in order to verify the authenticity of the figure which proved this point.

12.31. Even if the dossier is faultless, the contractor is free to make claims and see them rejected by the contracting authority on the basis of the contract documents. It has not been shown that in the two cases mentioned where substantial compensation was claimed, bad preparation of the tender dossier was the underlying cause.

12.32. These issues have been addressed by the Commission through the preparation and introduction of the new tender regulations and contract conditions approved by Council Decision 3/90, the drafting of new explanatory documents and standard tender dossiers, and training courses on EDF financial management.

Retendering

12.33. When the tender for the waste water project in Jamaica was launched, the financing proposal had already been submitted to the EDF Committee and the budget could not be modified. It should perhaps be pointed out that the allocation originally foreseen for the contract was ECU 20 million, or 80% of the total financing agreement. The lowest offers received exceeded the available budget by approximately 60% and there was no point in going on. The Commission's decision to cancel the tender for insufficient financial resources was therefore necessary. The project also had to be withdrawn from the EDF Committee.

Selection of tenders

Main principles

12.34. The Commission agrees with the Court that the tender price is only one criterion but would like to stress that all other aspects should, as far as possible, be addressed during the administrative and technical evaluation. In order to compare offers on the same basis, financially quantifiable matters should be grouped and assessed under the price aspect.

Determination of eligibility

12.38 12.40. Following the Internal Agreements on the Financing and Administration of Community Aid Under the Lomé Conventions, (7th EDF: OJ L 229 of 17.8.1991), companies from Member States which have not contributed to a particular EDF are not eligible to participate in projects financed from this fund. However, should a contract be co-financed from two EDFs, companies from Member States which have contributed to at least one of the funds would be eligible by way of a derogation granted in accordance with Article 125(4)(5) of Lomé II and subsequent Conventions. In practice, this matter has been clarified through the 'Manual of Instructions` (1988 version) created by the Commission for its Headquarters and Delegation staff, but only within the general context of 'derogations in favour of third countries` (Chapter III point 5.2). In addition, whenever a co-financing of this nature is foreseen, Member States, through the EDF Committee, are made aware of the implications for participation. Eligibility for participation is furthermore specified in the notice of invitation to tender.

Determination of compliance

12.42. The responsiveness of a tender is determined on different levels, generally speaking, in relation to administrative, technical and financial requirements as detailed in the tender file. The total responsiveness of a tender can only be stated at the end of the evaluation. However, as the evaluation of tenders is done progressively, it is possible that a tender may already be found non-responsive at an early stage without taking into consideration what might have been found if the evaluation had been completed.

12.43. The term 'material deviation` has necessarily to be open to interpretation in order to allow the evaluation of the tender in the light of its specific context.

12.44. As a general rule, incomplete tenders, missing essential documents, are rejected. However, an offer can be incomplete, but missing only minor details or needing clarifications on badly formulated statements. In such cases, it may be justified to request clarification from the bidder instead of rejecting him out of hand. This procedure is also in line with the objective of encouraging the participation of companies from the ACP States who do not necessarily dispose of specialized staff or have extensive experience in complying with international tender procedures. Depending on the scope and nature of the missing documents, the tenders have to be judged on their own merits and cannot therefore be compared. Taking different decisions in what may seem similar circumstances does not imply inconsistency since each tender must be judged separately.

(a) The tenders for Uganda and Mauritania were prepared and evaluated according to the regulations then in force, before June 1991 which did not require the evaluation criteria to be stated in the tender documents.

(b) In works tenders, the lowest-priced compliant tender is selected. A full scale - and costly - evaluation of all tenders is therefore not normally needed in order to locate the successful bidder.

(c) Two tenders in Kenya, see point 12.52.

(d) For the tender in Burkina Faso, we would point out that it is primarily the duty of the tenderers to ensure compliance of their bids with national laws. If the tender dossier does not contain specific instructions, and is therefore unclear, it is the tenderers' responsibility to request clarification from the bodies concerned, i.e. the contracting authority or the National Authorizing Officer.

(e) For the tender in Kenya, see point 12.49.

12.45 12.46. Under the 1991 General Regulations the Commission applies the principle that essential documents requested in calls for tender should be identified as such. This issue has been addressed in the standard tender dossiers prepared by the Commission and proposed to the ACP States. However, this is not specific to the Lomé environment and it is not possible to define down to the last detail. Also, for procurement in the internal market, definition can be a sensitive and difficult issue.

Tender clarification

12.47 12.49. If substantial information required by the tender file is not submitted with the tender, the tender cannot be made responsive by subsequent submission of the missing information. However, it is permissible to clarify information already submitted when the tender appears to contain contradictory or insufficiently clear information.

12.49. In Kenya, the lowest tenderer was selected since his offer was considered compliant after some clarification/confirmation on the bill of quantities. However, the Commission agrees that prices cannot be changed (in this case the offer did not include the tax and duties on local material) and should therefore have been rejected. Please see also point 12.74.a.

12.50. The Commission agrees that the tender dossier should as far as possible specify the scope of input to be provided. However, it is not unusual to find, with very complex works contracts, that some fine polishing has to be done at the end when the contract is awarded. The tendering procedure may have spanned a long time and the needs may have changed. The evaluation of tenders may have raised new ideas which the ACP State had not considered before. Therefore, rather than stopping the tender procedure and relaunching it with the changed requirements, it is more expedient to judge the tenders according to the original requirements and then negotiate the final details with the successful tenderer. What must remain intact is the scope and the aim of the contract and the financial compensation, if any, to either the contractor or the contracting authority must be agreed.

Financial evaluation of excessively low tenders

12.52 12.53. The financial offer always depends on the tenderer's commercial strategy, the proximity of his equipment to the site, general mobilization costs, etc. Therefore bids may differ between each other for very different reasons. Taking into consideration this difficulty and the fact that the General Regulations do not require the automatic exclusion of bids based on 'excessively low prices`, this question has to be addressed in a very prudent way. However, there are several examples, other than the ones mentioned by the Court, where choosing very low bids has resulted in successful completion (see the Court's example in 12.52(d).

12.52 (a) In the Webuye-Malaba project in Kenya, the non-performance of this contractor was not necessarily linked to his low bid but rather to his inexperience in working in developing countries.

(b) The roads in Kenya/Tanzania: While the contracting authority intended to award the contract to the lowest bidder, the award was conditional upon some clarifications by the tenderer. Since he failed to give satisfactory clarifications or a performance bond, the contract was awarded to the second lowest bid, which was close to the estimate.

(c) In the Zambia case, the contractor gave adequate assurances that his mobilization costs were very low because he had already both staff and equipment in place.

Justification and assessment of the foreign currency requirement

12.56 12.59. The Commission agrees with the Court that closer attention ought to be paid by the contracting authority to the justification given by a tenderer in his request for foreign currency. The Commission services will examine ways of improving the situation.

Tax and customs arrangements

Application of the most favoured status clause

12.62 12.63. While the Lomé Convention seeks to limit the application of local taxes and import duties, it cannot guarantee total exemption. That is why the level of exemption may vary from one country to the other. On several occasions the Commission has tried either directly with individual ACP States or through Member States' bilateral experience to obtain sufficient information which could be relied upon in the future with regard to taxation. Such information has, however, not been readily forthcoming up to now. That is why it has not been possible (point 12.63) to centralize data.

12.64. The Commission is aware of the incoherence and is examining ways to improve the present situation, including renewed enquiries with the Member States.

Tax and customs arrangements applicable to imported materials

12.66 12.67. Tenders are launched under the responsibility of the contracting authority, and if an ACP State wishes to make imports free of duties this would not violate the principle of minimizing duties and taxes as much as possible. The contracting authority may do so if the legislation under which it operates allows. Moreover, where such an exemption results from the application of Article 308, the exemption is the direct effect of the Convention's rules and not a deviation from them.

Tender conditions and fiscal arrangements

12.69 12.75. The Commission agrees with the Court that tender dossiers should be launched with clear information about the impact of taxes. However, in reality such an ideal solution is rarely available. Adhering strictly to this principle would probably result in a significant bar to tenders. At the same time, one must realize (see point 12.62-12.63 above) that information of this kind is not easy to obtain from ACP administrations even after sometimes lengthy discussions between the Commission's delegations and the responsible ministries. Only very few ACP States have at this stage adopted clear rules for all donors - or the EU alone - stating which are the applicable national tax rules and the exemptions which can be granted (especially in the context of Article 308). In addition - and under the IMF guidelines - most of the developing countries have recently initiated a thorough reform of their national legislation on taxes and customs and this has made the task even more complex, especially when the level of exemptions has been severely reduced (often close to the one foreseen in Article 309). However, the Commission continues to examine ways to improve the situation.

12.69 (a) In Niger, the Commission successfully enforced the most-favoured-nation status.

(b) Since the instructions were clear on the exemption granted in the tender in Uganda, and the prices were established on that basis (in the order of precedence of contract documents, the offer comes before the Special Conditions), it is rather difficult to understand on which grounds a tenderer/contractor can claim a revision of prices based on rates including the exempted taxes and duties. It was once again also the tenderer's responsibility to request clarification from the Contracting Authority.

(c) Due to the recurrent problem with taxation of contracts in Guinea, the Commission in 1995 suspended the launching of tenders. An agreement with the local authorities in June 1997 has now resolved this situation.

Tender evaluation and selection

12.74 (a) For the tender in Kenya/Tanzania the Commission agrees that prices cannot be changed and offers should have been submitted complete with taxes in this case.

(c) In Burkina Faso the lowest tenderer put forward his bid without seeking any prior clarification and assuming (in contradiction with the tender provisions) that total exemption could be applied on the basis of a precedent. The tender was correctly rejected since among other reasons the bid price cannot be modified in the course of the procedure (see Court's comment under point 12.74.a) Not only was the comparison of tender prices distorted, but the fact of being the lowest bidder in no way means the financial offer may be modified and the tender accepted as responsive.

Conclusion

12.76. The report refers to works contracts awarded during a period of transition from earlier procurement systems to the new one. Since the introduction of the new General Regulations in 1991 and following an initial period of adaptation to the new procedural environment, the quality of the preparation of tender dossiers has greatly improved. Standard tender documents exist and continue to be updated to reflect new developments and findings. Tender evaluation practices have also been clarified and have become more transparent. It was precisely in response to a number of comments made by the Court that a new procurement system was introduced in mid-1991. In addition, in many cases criticized by the Court, the procedures followed were both economically rational and regular.

12.77. The Commission agrees that all possible efforts should be made to ensure that the procurement documents are as complete and as clear to the tenderers as possible. This is why new procurement rules were introduced in 1991 making it mandatory for all evaluation criteria to be specified in the tender file.

12.78 (a) In the standard tender files now in use, the instructions specify the tender conditions which the tenderers should be particularly aware of, such as essential documents which, if not presented, will lead to disqualification.

(b) The 'sufficiency` of a tender is a question for the tenderer. As long as it is compliant, the tenderer takes the responsibility for whether he in fact can perform at the price he proposes. Depending on the tenderer's location and strategy, tender prices may well diverge substantially from the engineer's estimate.

(c) The Commission recognizes this problem and greater attention should be given by the contracting authority to the grounds on which tenderers justify their request for foreign currency. The Commission services will look at ways of improving the situation.

12.79. On several occasions the Commission has tried either directly with individual ACP States or through Member States' bilateral experience to obtain sufficient information which could be relied upon in the future with regard to taxation. Such information has, however, not been readily forthcoming up to now. That is why it has not been possible (point 12.63) to centralize data. However, the Commission is examining ways to improve the situation, including renewed enquiries with the Member States.

12.80. Information of this kind is not easy to obtain from ACP administrations even after sometimes lengthy discussions between the Commission's delegations and the responsible ministries. Only very few ACP States have at this stage adopted clear rules for all donors - or the EU alone - which set out the applicable national tax rules and the exemptions which can be granted (especially in the context of Article 308). In addition - and under the IMF guidelines - most of the developing countries have recently initiated a thorough reform of their national legislation on taxes and customs, and this has made the task even more complex, especially when the level of exemptions has been severely reduced (often close to the one foreseen in Article 309). However, the Commission is continuing to look at ways of improving the situation.

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CHAPTER 13(478\*) Cooperation with developing and third countries (except Central and Eastern Europe)

13.0. CONTENTS Paragraph reference

Introduction 13.1 - 13.2

Implementation of the budget 13.3 - 13.19

Humanitarian aid (B7-21) 13.4 - 13.5

Financial cooperation with Asia and Latin America (B7-30 and B7-31) 13.6 - 13.7

South Africa (B7-32) 13.8 - 13.9

Cooperation with Mediterranean countries (B7-40 and B7-41) 13.10 - 13.19

Information technology and management information systems 13.20 - 13.32

Development of MIS 13.22 - 13.28

Information technology in DG IB 13.29 - 13.30

Conclusion 13.31 - 13.32

Fondo especial de promocion de las exportaciones de Honduras y Nicaragua (FEPEX) 13.33 - 13.55

Introduction 13.33 - 13.35

Project execution 13.36 - 13.37

Management of the loan portfolio by the BCIE 13.38 - 13.41

Management of outstanding funds 13.42

Project monitoring 13.43 - 13.46

Project results 13.47 - 13.49

Accounting for credit lines 13.50 - 13.51

Conclusion 13.52 - 13.55

Bridging loans 13.56 - 13.64

Conclusion 13.64

INTRODUCTION

13.1. Expenditure on external policies of the European Community financed from the general budget includes food and humanitarian aid, financial and technical assistance with the countries of Asia, Latin America, the Mediterranean area, and South Africa, and various other policies such as the co-financing of projects implemented by non-governmental organizations (NGOs), environmental programmes, and supporting actions for the defense of human rights and democracy. It also covers the costs of the common foreign and security policy (CFSP) charged to the general budget as set out in Title V of the Treaty on European Union.

13.2. In this chapter observations resulting from an analysis of budgetary execution are set out. This is followed by observations concerning:

(a) an evaluation of the Commission's efforts to develop a management information system (MIS) for development cooperation measures in Asia, Latin America and the Mediterranean;

(b) a large credit line project (FEPEX) with a regional bank in Central America (the Banco Centroamericano de Integración Económica (BCIE)); and

(c) 'bridging loans`.

IMPLEMENTATION OF THE BUDGET

13.3. Table 13.1 summarizes budgetary implementation in 1996 for the whole area covered by this chapter. This shows that for subsection B7 of the final budget (except for B7-5 and certain articles of B7-8) overall utilization of commitment appropriations was 98,7%, and that of payment appropriations was 76,8%. For subsection B8 the corresponding figures were 96,6% and 75,8% respectively. Table 13.2 sets out for the main programmes how commitment and payments appropriations were used.

Humanitarian aid (B7-21)

13.4. Since its Annual Report concerning the financial year 1992, the Court has each year drawn attention to the manner in which, in the area of humanitarian aid, a systematic exception has developed to the rule that unused differentiated payment appropriations lapse at the end of the year. This is largely because, first, a substantial proportion of commitment and payment appropriations for humanitarian aid are initially placed in the emergency aid reserve (B7-91), and, secondly, the Commission, for reasons such as humanitarian crises erupting during the second half of the year, procedural delays, etc., each year receives very late in the year substantial amounts from the reserve. It can commit these amounts (see the very high level of commitments in December 1996) but it is not possible to make the payments before the year end. The Commission, faced in the following year with a limited amount of payment appropriations initially in B7-21, requests, therefore, a substantial carryover of unused appropriations. The payment appropriations provided for in the emergency aid reserve are not taken into account when the Commission decides on the amount of payment appropriations that it wishes to carryover. In 1996, as in 1995, the total payment appropriations provided initially in B7-21 and B7-91 combined (655,5 Mio ECU) largely exceeded total payment requirements for the year (575,9 Mio ECU).

13.5. The budgetary authority has called upon the Commission to limit its recourse to carryovers in this context(479). For this to be done, one or more of the following needs to be agreed:

(a) that more use should be made of transfers of payment appropriations from other budget lines under heading 4 of the financial perspectives (External Actions) before mobilizing the payment appropriations of the reserve. In 1996 actual payment requirements of 575,9 Mio ECU were 246,4 Mio ECU above the initial provision of 329,5 Mio ECU. 145,0 Mio ECU was transferred from other budget lines, and the remaining requirement of 101,4 Mio ECU could have been met from the payment appropriations that were not used in subsection B7 (e.g. 108 Mio ECU remained unused in chapters B7-40 and B7-41); or

(b) that a larger volume of payment appropriations should be placed initially on the specific humanitarian aid lines in B7-21, with a relatively small provision of payment appropriations in the emergency aid reserve; or

(c) that the payment appropriations in the emergency aid reserve can - and should - be mobilized independently of the commitment appropriations.

Financial cooperation with Asia and Latin America (B7-30 and B7-31)

13.6. As criticized in previous years, there was a very high concentration of commitments in the last two months of the year. This was very marked in relation to projects in Asia, where 336 Mio ECU out of 407,1 Mio ECU (83%) were committed in November and December.

13.7. On the payments side, there was a more even spread through the year than in previous years, although some large payments to projects in Asia resulted in a peak in December (30% of total payments for the year). It should be noted that the initial budget provision of payment appropriations was considerably lower than execution in 1995, and it proved necessary to request a substantial (27%) reinforcement.

South Africa (B7-32)

13.8. In its Annual Report concerning the financial year 1995, the Court noted the rapid increase in outstanding commitments during 1995 (69%), as a result of a low rate of payments(480). The situation was even worse in 1996: while almost all of the 130 Mio ECU in commitment appropriations was used, only 28,5 Mio ECU out of the initially budgeted amount of 110 Mio ECU for payments was used. Outstanding commitments rose from 191,1 Mio ECU at the end of 1995 to 290,5 Mio ECU at the end of 1996. Cancellation of unused commitments were very low (1,3 Mio ECU).

13.9. Such a low rate of payments is an indication of significant difficulties in the implementation of the European programme for reconstruction and development in South Africa.

Cooperation with Mediterranean countries (B7-40 and B7-41)

13.10. Initial budget provision under B7-410 (MEDA) was 403 Mio ECU in commitment appropriations, with a further 200 Mio ECU entered in the reserve B0-40(481). The budgetary authority specified that the reserve should be used under the 'Notenboom` procedure(482), before the European Parliament's first reading of the 1997 budget and on condition that 80% of the appropriations against B7-410 had been utilized. A further condition was that the reserve could only be transferred to the MEDA chapter if the 'negative reserve` of 200 Mio ECU(483) had been drawn down.

13.11. When the Notenboom transfer document was prepared, the Commission stated that, as at 26 September 1996, it had already taken financing decisions in respect of projects totalling 548,8 Mio ECU, and that decisions concerning a further 531 Mio ECU could be taken before the end of the year.

13.12. The Commission could not, however, commit fully all of these financing decisions because there were insufficient commitment appropriations available. Indeed, the 200 Mio ECU in the reserve of B7-411 was not available, as it was required, as part of the Notenboom transfer, to draw down the negative reserve of 200 Mio ECU(484). The Commission could only seek to increase the commitment appropriations for MEDA by 38,25 Mio ECU(485) without breaking the ceiling provided in the financial perspectives for appropriations for External Actions (heading 4). This increase was not approved by the Parliament(486).

13.13. The Commission, in the absence of sufficient commitment appropriations, decided to stage the commitment in the accounts of the amounts decided upon by the Commission for the individual projects. For 12 projects totalling 364,5 Mio ECU nothing was committed in 1996. For a further 7 projects totalling 416 Mio ECU, only 184,5 Mio ECU was committed in 1996, the rest was held for commitment in 1997 and 1998. In total, therefore, of financing decisions taken by the Commission in 1996 amounting to 780,5 Mio ECU, 184,5 Mio ECU was committed in 1996, 511,6 Mio ECU was to be committed in 1997, and 84,4 Mio ECU in 1998.

13.14. The appropriations of B7-41 are differentiated, which means that commitment appropriations should cover, for a given financial year, the total cost of the legal obligations entered into for operations whose implementation extends over more than one financial year(487). Article 36(2) of the Financial Regulation provides that financing decisions taken by the Commission constitute commitments of expenditure. Article 5(2) of the Financial Regulation provides that no expenditure may be committed in excess of the authorized appropriations. It is, therefore, irregular for the Commission to approve the total cost of a project in the absence of sufficient appropriations to permit the commitment in the accounts straight away of the full amount.

13.15. At the end of 1996 the accounts contained no reference to the amounts totalling 596 Mio ECU which were the subject of financing decisions by the Commission, but which were not committed. Within this total amount, for the projects which were partially committed in 1996, the outstanding commitments are understated by 231,5 Mio ECU(488).

13.16. The situation described above highlights the problems of compatibility between decisions concerning the overall size of the MEDA programme, the annual availability of appropriations within the financial perspectives, and the provisions of the Financial Regulation concerning budgetary implementation. The MEDA programme has a financial reference figure of 3 424 Mio ECU(489) for the period 1995-99. Many of the MEDA actions have large budgets. There is normally a tendency at the beginning of a programme such as MEDA for there to be an initial concentration of financing decisions, which in this case was increased by the delay in the adoption of the Council Regulation. The budgetary authority, however, was limited in the volume of commitment appropriations which it could provide on the MEDA line without breaching the financial perspectives, or cutting back on other external actions. The Commission, therefore, found itself unable to follow the procedures foreseen by the Financial Regulation for the commitment of multi-annual actions(490). As a result, it has taken financing decisions considerably in excess of the level of appropriations approved by the budgetary authority. Postponing the commitment in the accounts of all or part of a financing decision denatures the concept of differentiated appropriations as provided in the Financial Regulation. If the Commission finds that the rules no longer permit sensible management of appropriations in the external aid area, then it should propose amendments to those rules, rather than simply circumventing them. In its reply to paragraphs 13.13 to 13.16, the Commission's arguments on sound financial management and the efficient use of funds are not only unproven but also irrelevant as far as the legality/regularity of the transactions is concerned. Managing these appropriations as if they were liquid funds is inconsistent with both the intent and the letter of the Financial Regulation, where differentiated appropriations constitute the mechanism by which the budgetary authority authorizes the executive body to commit the Community for multi-annual financing. The approach put forward in the Commission's reply constitutes an important change in budget practice whereby the Commission takes over certain rights and prerogatives of the budgetary authority. The Commission should not have made such a change without first having sought modification of the financial rules. Moreover, since the Commission did not apply the approach consistently, the financial statements for the year are inconsistent and misleading(491).

13.17. In July 1996, the budgetary authority adopted supplementary and amending budget No 1(492) which introduced a framework for the financing of technical and administrative support for the MEDA programme. A similar framework was also provided for the PHARE and TACIS programmes (see paragraph 14.10 of this report). This provision, known as 'STAP` (Support Technique et Administratif pour les Programmes), allows up to 3% of the appropriations for the MEDA programme to be used to cover contracts with experts 'to provide technical and administrative support for the mutual benefit of the Commission and the partner countries`. The tasks of these experts are defined as 'the preparation of the terms of reference of projects, the evaluation of bids, monitoring and audit`, which are the normal tasks of staff in the Commission responsible for the implementation of development cooperation programmes. It is intended that this facility should enable the Commission to overcome the lack of capacity of its own services, both at headquarters in Brussels and in the delegations, to implement the MEDA programmes, which was commented on by the Court in its Annual Report on the 1995 financial year(493). The Commission intended to commit 22 Mio ECU (out of a total estimated requirement for the period 1996-98 of 70 Mio ECU) under this provision in 1996, but this was not done. As noted in paragraph 14.10 of this report, this facility is similar to the 'mini-budgets` system, which was criticized by the Court in its Annual Report for the 1990 financial year(494) for allowing operational appropriations from Part B of the budget to be used for expenditure which should be financed from Part A.

13.18. With regard to payments, the pattern of a slower than planned implementation of projects identified in 1995(495) was repeated in 1996. From the initially available appropriations of 424,6 Mio ECU, 52,1 Mio ECU (12%) were transferred out to other budget lines, leaving 372,6 Mio ECU, of which 264,1 Mio ECU (71%) were used. Of this, 176 Mio ECU (67%), was paid during the last quarter of the year, with 99,3 Mio ECU (38%) in December. The payments in October and December included large advances for the MEDA projects approved after the adoption of the legal basis. Payments on commitments brought forward into 1996 amounted to 12% only of their total value.

13.19. It should also be noted that in 1996 the Commission committed and paid 20 Mio ECU to the Palestinian National Authority to cover recurrent costs of the Ministry of Education (teachers' salaries), using the same procedure that was criticised by the Court as inefficient in its Annual Report concerning the financial year 1995(496).

INFORMATION TECHNOLOGY AND MANAGEMENT INFORMATION SYSTEMS

13.20. In its Annual Report concerning the financial year 1991, which examined procedures and resources for the management of appropriations for financial and technical cooperation in the Asian and Latin American countries(497), and in its Special Report on the Mediterranean protocols(498), the Court described the inadequacies of the Commission's systems for monitoring the financial progress of projects. It was not possible to establish the status of financial implementation of projects without manual analysis of raw data. The Commission recognized the weaknesses described by the Court. The Commission indicated that, as part of a strategic informatics plan, it was developing a system for the financial monitoring of projects, building on the various individual systems already in place(499).

13.21. The budget funds for which the financial monitoring system is needed are considerable. Annual commitment appropriations are in excess of 1 500 Mio ECU, and ongoing projects at the end of 1996 amounted to some 4 250 Mio ECU.

Development of MIS

13.22. The proposal to develop a Management Information System (MIS) was set out in the 'Strategic Information Plan for DG I North-South`. In July 1992 the Commission issued a call for tender, and in December 1992 a contract was concluded for a total of 513 120 ECU with a private firm.

13.23. In January 1994 the contractor delivered the MIS to the Commission. The system, however, was not operational. The design did not meet the needs of the users: it was excessively sophisticated and, since sizing and hardware constraints had been insufficiently taken into account, computer performance was poor.

13.24. During the development of the system warnings of problems were made by different parties. For example, in April 1993 the DG I informatics resource manager underlined the lack of a feasibility study and the lack of sizing of the application; in May 1993, the head of one of the user Directorates detailed concerns about unclear terminology, difficult structure, lacunae and approximations in the analysis. In August 1993 the contractor alerted the Commission that unless sufficient authority and resources were given to the project, it risked failure and the start of 'an open-ended maintenance cycle without proper management`. There is no evidence that the Commission considered these warnings or that it took specific corrective measures.

13.25. Since the delivery of the system in January 1994, an external computer expert (previously involved in the programming of the project) has been working on the application to make it more user-friendly. In addition, various measures have been taken to upgrade equipment and to improve performance. A simplified version of the MIS was made technically operational on 1 January 1997. The quality and amount of data provided, however, is not yet up to the desired standard, which severely limits its usefulness.

13.26. Although a number of steps had been taken during the year, at the end of 1996 there was no written document setting out a precise strategy (services involved, calendar, workload requested, actions to be taken, etc.) for implementing the application. Rectification of deficiencies and enhancements to the application were needed in several areas. For example, the financial module was not yet complete and essential sub-applications covering statistics, management of tendering and short-lists, framework contracts, etc. were missing.

13.27. There were a number of shortcomings in the financial management of the project:

(a) the contract provided for 5 partial payments: at signature, after the design of 1st and 1st phases and after the installation and training of each phase. Although these contract conditions were not modified, actual payments, totalling the full contract sum of 513 120 ECU were made in only 3 instalments. Moreover, although the Commission should have approved the design of each phase and the contractor should have installed the phases and provided staff training, this was not done;

(b) there was no provisional and final acceptance of the project by the Commission and a part of the guarantee was not released, but allowed to lapse.

13.28. The project to develop the MIS suffered from unsatisfactory management during all stages:

(a) the MIS lacked an effective project owner. According to the Commission's 'Guidelines for project management`, the project owner should take responsibility for the control of the project at strategic level and for mobilizing the resources of the organization to be brought into the project. He needs to arbitrate and settle any dispute between different groups of users and to ensure that the commitment of senior management is real. None of these functions were effectively carried out;

(b) there was no project board and it is not clear how project management functions were carried out;

(c) there was a lack of user cooperation and commitment: user group meetings were poorly attended and changes in representatives of the different units were frequent; this prevented the group from providing adequate back-up to the development of the project and giving a global users' view;

(d) there are no coherent files recording the management of the project and maintaining accountability for the sequence of decisions made and for the direct and indirect expenditure associated with them;

(e) a formal re-assessment should have been made, at some stage in the last 2 years, on whether the MIS can meet current user needs at reasonable cost: following the transmission of the Court's findings to the Commission in December 1996, a tender was launched to recruit an external computer expert who would carry out such a re-assessment;

(f) finally, there was no system for formal authorization and management of program changes made by the computer expert referred to in paragraph 13.25.

Information technology in DG IB

13.29. The situation described above in relation to the MIS reflects the unsatisfactory current situation regarding information technology (IT) in DG IB. A consistent computer development strategy accepted by all users is lacking. The various services are still operating and developing local databases and management applications on their own personal computers. Until January 1996 DG IB did not have its own unit with responsibility for IT matters, having to rely upon DG I, which did not give sufficient priority to the needs of DG IB. The new unit has been inadequately staffed, and it was not until December 1996 that an Information Resources Manager (IRM) was appointed.

13.30. The 1996-98 'Informatics Master Plan for DG I and DG IB` submitted by DG I's IRM in December 1995 illustrates the disadvantage to DG IB of not having its own capability. The Master Plan did not analyse properly the situation at that time of the IT organization in DG IB and the status of the various applications under development. For example, the Master Plan stated that the MIS was operational in the technical and financial units and that it would be extended to the rest of DG IB during 1996. However, as shown above, this was incorrect.

Conclusion

13.31. Five years after deciding to allocate substantial financial and staff resources to the development of the MIS, the Commission does not have a satisfactorily functioning management tool. The results obtained from this investment do not represent value for money. The Commission services were not well organized and suffered from a serious lack of capacity and capability to manage properly such a large and complex project.

13.32. The Commission should ensure that:

(a) DG IB has an adequate IT capacity and organization (paragraphs 13.29 and 13.30);

(b) DG IB's 1997 Informatics Master Plan prevents uncoordinated development of separate systems by different units in the DG (paragraph 13.29);

(c) a reassessment is made to establish whether the MIS can meet current user needs at reasonable cost before investing further resources in its development (paragraphs 13.22 to 13.26 and 13.28 (e));

(d) all future projects for the development of computerized applications are set up and managed in accordance with the Commission's Guidelines for project management: this should include ensuring that the project owner is fully briefed on his role, as summarized in paragraph 13.28 (a).

FONDO ESPECIAL DE PROMOCION DE LAS EXPORTACIONES DE HONDURAS Y NICARAGUA (FEPEX)

Introduction

13.33. A key part of the Commission's strategy for its development assistance in Central America is the fostering of regional economic integration among the countries of the isthmus. An important component in this is the implementation of projects since the mid-1980's through the Banco Centroamericano de Integración Económica (BCIE), which is a regional public financial institution. The BCIE is managing more than 100 Mio ECU provided by the Commission. In working through the BCIE, the Commission has sought to promote the development of an effective regional financial institution and to strengthen economic integration in Central America.

13.34. In 1991 the Commission signed a Financing Agreement (FA)(500) with the Governments of Honduras and Nicaragua and with the BCIE for the establishment of a revolving fund, known as FEPEX, to be used for loans to export-oriented firms in the two countries. Loans were to be awarded through three channels: directly by the BCIE, through the central banks of the two countries, or through private banks (intermediate financial institutions, or IFIs). In practice, only the channel through the IFIs was used. Total project cost was 32 Mio ECU, of which 30 Mio ECU was for the revolving fund, and 2 Mio ECU was for technical assistance. The project period was initially fixed at 3 years. At the end of 1994 the FA was extended to 31 December 1995(501). A FEPEX Management Unit was established within the BCIE, with co-direction between local and technical assistance staff.

13.35. As part of the audit work for the 1995 Statement of Assurance (DAS), the Court examined the last replenishment of FEPEX(502). In view of the importance of the project, and the extent of the Commission's involvement with the BCIE, together with the fact that in 1996 the Commission was negotiating an amendment to the FA with the bank(503), it was decided to carry out an overall review of the project's implementation. Also, the project is a credit line, which raises a number of particular issues concerning management controls and reporting.

Project execution

13.36. The rate of project execution has been slow. The first payment by the Commission to the fund (6,0 Mio ECU) was made in January 1992, the first loan disbursement to a beneficiary was made in November 1992. Replenishments were made by the Commission to the fund in January 1993, January 1994, November 1994, and finally in November 1995. By end-April 1996, gross loan disbursements (i.e. without taking into account loan repayments by beneficiaries) totalled 22,3 Mio ECU(504).

13.37. At the same time, the replenishment procedures provided for in the FA were not adapted to the type of instrument, as they were based on the level of gross disbursements(505) rather than on a cash-flow basis. As a result, large cash balances built up in BCIE: throughout the period of the project undisbursed funds at 30 June in each year were more than half of the funds paid out by the Commission. At 30 June 1996 undisbursed funds in the FEPEX accounts amounted to 18,3 Mio USD (14,6 Mio ECU).

Management of the loan portfolio by the BCIE

13.38. BCIE has not satisfactorily fulfilled its obligations under the FA with regard to the management of the fund. A general reason for this is that the BCIE applied its own internal rules and criteria rather than those provided for in the FA.

13.39. The BCIE did not have copies of the loan contracts between the IFIs and the final beneficiaries, nor did it have the quarterly reports required by the administrative instructions established at the beginning of the project, making it difficult to assess whether the loan conditions provided for in the FA were respected. On the basis of contracts between the BCIE and the IFIs, and between the BCIE and the beneficiaries (see (c) below), which were available in the Commission, the Court was able to identify a number of areas where the provisions of the FA were not respected:

(a) in some cases, the upper limits for loans set out in the FA had been exceeded;

(b) the FA set out different conditions for fixed capital and working capital loans. Several loan contracts examined did not identify separately fixed and working capital components, making it impossible to determine whether these conditions were correctly applied;

(c) the FA provided that BCIE's fee for loans it channelled through IFIs was 2%, and 3% on loans it arranged directly with final beneficiaries. Although in reality BCIE made no direct loans, it obtained irregularly a partial benefit of the higher fee by splitting loans into two contracts, one treated as direct, the other as an intermediary loan, even though the IFIs managed both loans with the final beneficiary;

(d) the grace periods for the repayment of the loan capital that were applied were not always in conformity with the FA provisions;

(e) at the beginning of the project, a commission of 0,25% was charged (comisión de compromiso) on each loan, although it was not provided for in the FA. This is a standard commission in banking, intended to cover the costs of the bank keeping available the undisbursed part of loans. In the FEPEX context, however, it is unnecessary as the funds are not from the bank's own resources. At the instigation of the technical assistance, this practice was stopped in 1993, but at the time of the audit the Commission had not taken any action in respect of the commissions that had been unduly charged.

13.40. The FA and the associated management contract between the Commission and the BCIE provided that the BCIE must manage the FEPEX funds in accordance with the objectives of the programme and the rules and conditions drawn up specifically for their management. These rules were to prevail over those applied by the Bank to its other resources. The objectives of the FA were focussed on development issues, notably the generation of foreign exchange as a result of strengthening the export capacity of Honduras and Nicaragua. The BCIE, however, failed to respect these provisions. It applied its own internal criteria for determining the eligibility of IFIs, which resulted in the notion of the security of investments being privileged over the development objectives of the programme(506). Problems in identifying eligible IFIs considerably delayed loan awards, and was a reason for the low execution rate in Nicaragua(507). The Commission continually put pressure on BCIE about this, but it was only in 1996 the Delegation persuaded the BCIE to give priority to Nicaragua for the award of new loans, in order to restore a balance in relation to Honduras. Also, it was not until July 1996 - more than 4 years after the start of the project - the BCIE explicitly stated that it would respect the provisions of the FA that the conditions and objectives of the FA should prevail over its internal rules.

13.41. A particularly weak element in the management of the loan portfolio by the BCIE concerns the repayments of capital and interest on the loans. The portfolio department of the BCIE has established a loan monitoring system. The information produced by this is passed to the accounting department where it is entered in the FEPEX accounts. The data, however, are based on planned rather than actual receipts. It was also found that data were incomplete, and that various schedules were produced at different dates and thus were difficult to reconcile. The FEPEX accounts provided by the BCIE were not systematically checked by the FEPEX management unit or the technical assistance. As far as repayments by beneficiaries to the IFIs are concerned, no information was available at BCIE level, and no checks were carried out to reconcile the data of the BCIE portfolio department concerning loan balances with those of the IFIs.

Management of outstanding funds

13.42. In light of the large balances of unused funds held by the BCIE, their management is an important consideration when assessing implementation of the project. Significant weaknesses, involving non-respect by the BCIE of the conditions of the FA were identified:

(a) the FA/management contract provided that the unused FEPEX funds were to be kept in ECUs, and placed on the market so as to obtain the best market return. The interest earned, net of the specified administrative fee (see (d) below), was to be credited in its entirety to the FEPEX funds. The BCIE, however, converted the funds to USD and integrated the funds into its overall treasury management. Although this did not respect the terms of the FA, it was understandable on the part of the BCIE, and the Commission should have agreed to a modification of the FA. The BCIE applied 3-month ECU interest rates to the FEPEX balances, even though the funds were deposited in USD and earned higher interest rates than those for the ECU (for example in 1995 the BCIE obtained an average return on its total USD deposits of 11,15%, whereas it credited 5-6% to the FEPEX funds). In this way, the BCIE credited less interest earned to FEPEX than it should have done under the terms of the management contract, and, in effect, increased irregularly the income to the Bank's own funds. The Court estimates the loss to FEPEX at approximately 0,4 Mio ECU over the period 1993-96. This does not take into account the loss of interest on FEPEX balances transferred temporarily to other Community projects in Central America under the 'bridging loans` procedure (see paragraphs 13.56 to 13.64);

(b) according to the FA, the BCIE was required to present regular reports and financial statements on the situation of the project, and on an annual basis, to provide the Commission with audited financial statements. It complied with the former, but not with the latter;

(c) in addition, regular checks were not made by FEPEX project management and technical assistance on the correctness of the outstanding balances reported by the BCIE. The importance of this, and the lack of audited financial statements presented by the BCIE is highlighted by the fact that auditors engaged by the Commission in mid-1996 to establish the level of outstanding balances were not able to give an exact amount. They could only compare the amounts reported by the BCIE with estimates they made of what should be the outstanding balance: the unexplained difference ranged between 0,4 Mio ECU and 0,6 Mio ECU;

(d) BCIE, under the terms of the FA, was entitled to charge an administrative fee on investment returns of 0,5% of investment earnings. In practice, however, the bank applied the 0,5% to the outstanding balance. Instead of some 14 000 ECU which it should have earned, the bank had charged, as of mid-1996, 0,2 Mio ECU(508). This constitutes a serious misapplication of the FA by the BCIE, and the Commission should recover the excess without delay.

Project monitoring

13.43. The above observations point to weaknesses in project supervision and monitoring. The technical assistance to the project paid insufficient attention to ensuring that the BCIE respected the terms of the FA, and that it established effective accounting and financial information systems for the project elements which are essential for the sustainability of this kind of credit programme. The technical assistance and the project management unit concentrated mainly on the process of identifying projects and bringing them through to loan award decisions.

13.44. Resources at the Delegation (located in Costa Rica) and at the Commission in Brussels for monitoring and supervision were limited. There has been an annual mission from Brussels to the BCIE during which the Commission has sought to resolve some of the problems identified. It was a recognition by the Commission that insufficient progress had been made by the end of 1995 that led to the negotiation of the rider to the FA in mid-1996. As part of this, a committee composed of representatives of the BCIE, project management, and the Delegation, has been established to improve decision-making for and control of the project.

13.45. Although a mid-term evaluation was carried out at the beginning of 1994, in accordance with the FA, no action was taken by project management in respect of one of the key findings, namely the inadequacy of information flows between the IFIs and the BCIE.

13.46. The FA provided 0,2 Mio ECU for the audit and evaluation of the project. Provision was also made in the management contract attached to it for the Commission to contract an external audit firm to carry out regular verifications of the accounting entries and reports, and to check that the management of the project was in conformity with the provisions of the FA and the management contract. No audit, however, took place until mid-1996, when the Commission was negotiating the rider to the FA.

Project results

13.47. At end-April 1996, 52 loans had been disbursed to 37 enterprises, for a total value of 22,3 Mio ECU. Of this, 12,2 Mio ECU concerned businesses in Honduras, 10,1 Mio ECU businesses in Nicaragua. Of the amount for Nicaragua, 40% (4 Mio ECU) had been awarded to businesses in a group controlled by the same family. Although it is recognized that there is a limited private business sector in Nicaragua, attention needs to be paid to avoiding excessive concentration of loans on the same business partners. The Commission has introduced a clause to this effect in the amendment to the FA.

13.48. The main objective of the FEPEX project was to stimulate the growth in exports and to increase the inflow of foreign exchange into the Nicaraguan and Honduranian economies. Assessing the extent to which this objective is achieved is made difficult by the lack of quantitative indicators provided in the FA, and the limited attention given to monitoring progress towards this objective. The only information available is from a questionnaire sent to the loan beneficiaries in which they were asked to report on their exports before and after the investment. The answers, however, were not checked, and the influence of other factors affecting export levels not taken into account. The value of the data from the questionnaire is therefore open to doubt. For example, the Court found that two companies had reported increased exports even though the investment funded by FEPEX had not yet been carried out.

13.49. Some secondary objectives, not mentioned explicitly in the FA, were considered by the Commission: encouraging European exports to the beneficiary countries, and promoting BCIE's private sector activities. Concerning the first, the limited evidence available is mixed. With regard to BCIE's involvement with the private sector, FEPEX is making a positive contribution(509). However, the continuity of BCIE's private sector activities is open to doubt since they are mainly financed by externally provided donor funds: the sustainability of this development necessitates the BCIE increasing the use of its own funds in this area.

Accounting for credit lines

13.50. The FEPEX project raises a general point concerning the accounting for such operations in the accounts of the Commission. Payments from the Commission to the fund are recorded as final payments in the budgetary accounts. These are payments into a loan fund, however, and according to the specific provisions of the FA, the ownership of the funds remains with the Commission until the end of the project. The BCIE is considered as the fiduciario, i.e. the trustee, managing the funds on behalf of the Commission under a management contract. As the funds are grants, at the end of the project they are to be transferred to the final beneficiaries which are Honduras and Nicaragua (although how this is to be done is not explained in the FA).

13.51. As the funds remain the property of the Commission during the life of the project, they should be incorporated in the balance sheet of the Commission, which is not the case. This is an observation which has much wider implications than the FEPEX project itself.

Conclusion

13.52. In 1990/91 the Court examined the implementation of the PAPIC project managed by the BCIE. Many of the same problems as those described above (lack of adequate accounting and financial information, difficulty in establishing the balance of available funds, weak financial monitoring by project management and technical assistance, non-respect by the BCIE of the terms of the FA) were identified, and pointed out in detail to the Commission. It is, therefore, disappointing to find that improvements have been so limited, despite the continuous efforts of the Commission to obtain changes from the BCIE.

13.53. The above findings show that:

(a) the Commission signed a FA for a significant volume of funds with a regional financial institution whose management weaknesses had already been noted in the past. Although the Commission included various conditions in the FA to try to ensure that these weaknesses were overcome, the BCIE failed to observe many of them and the technical assistance and the Commission did not take effective action to ensure compliance (paragraphs 13.38 to 13.42);

(b) the non-respect of conditions in the FA by the BCIE has resulted in the BCIE appropriating for itself more of the project funds than foreseen by the remuneration clauses of the FA, at the expense of both the intermediate financial institutions and the budget of the Union (paragraph 13.42);

(c) the inadequate information, including financial, provided by the BCIE to the Commission hindered its effective monitoring of the project (paragraph 13.42 (b) and (c));

(d) this notwithstanding, the monitoring and control by the technical assistance and the Commission was insufficient to ensure that the BCIE respected the provisions of the FA: in some respects, such as the provision for regular audit by an external firm, the Commission services did not implement what was foreseen (paragraphs 13.43 to 13.46);

(e) project results were limited (paragraphs 13.47 to 13.49).

13.54. The Commission should:

(a) have evaluated whether it should continue to fund projects through the BCIE. As an immediate step it should make clear to the BCIE that continued funding of projects through it depends on the bank respecting the commitments that it has undertaken, and improving its implementation performance;

(b) recover amounts unduly credited by BCIE to its own accounts (paragraph 13.42);

(c) while carrying out this evaluation, strengthen its monitoring of the various projects that it has financed with the BCIE to ensure that the new arrangements provided for in the amendments to the FA will lead to the improvements foreseen by the Commission (paragraphs 13.43 to 13.46);

(d) take appropriate steps to ensure that credit line projects such as FEPEX are properly accounted for in the Community's accounts (paragraphs 13.50 and 13.51).

13.55. The Court notes that in 1997 the Commission is to carry out a study of Central American financial institutions which will include an examination of possible alternatives to the BCIE for EU-financed projects in the region. This provides the opportunity for the fundamental review of its relations with the BCIE called for above.

BRIDGING LOANS

13.56. During the audit of the FEPEX project, it was observed that, on the basis of requests made by the Delegation in Costa Rica, a number of 'bridging loans` had been made by means of transfers of FEPEX funds to other Commission-financed projects in Central America. In January 1996, for example, the BCIE was requested to transfer a total of 1,5 Mio ECU (2 Mio USD) to 11 projects. At that time another 1,1 Mio ECU (1,5 Mio USD) was out on loan to various projects, and 6,1 Mio ECU (8 Mio USD) had been temporarily transferred from FEPEX to another Commission project managed by the BCIE, FOEXCA, so that the total on loan in this way was 8,7 Mio ECU (11,5 Mio USD) at that time.

13.57. Such a procedure is not provided for in the Commission's financial rules, the only description of it is set out in a Manual de Terreno prepared by the Technical Unit of the Latin America Directorate of DG IB, where it is provided for as an exceptional procedure to keep a project in funds. As described, the procedure may only be used where the Commission has approved the project's operational work plan. Sometimes delays associated with the internal procedures for processing payments within the Commission, together with delays in the banking system, mean that it is necessary to arrange temporary transfers to projects using funds already in the region(510).

13.58. The practice of bridging loans is one which has developed over the last ten years without any clear authorization. The Financial Controller was not asked for his opinion on it until the Court sent its observations to the Commission in September 1996. Decisions on individual bridging loans were made by the Delegation and Technical Unit concerned. According to the information supplied by the Commission, extensive use of bridging loans has been made by the projects in Central America, with occasional use in South America(511).

13.59. The manner in which this practice developed, and the way in which it has been used, are unsatisfactory. Firstly, proper rules and procedures which respect the Financial Regulation should have been established to ensure adequate authorization, accountability and control.

13.60. Secondly, the frequency with which the procedure was used in 1996 for projects in Central America is beyond what can be considered exceptional. The procedure has become a convenient tool for overcoming problems associated with the endemic slowness in Commission procedures.

13.61. Thirdly, insufficient control and monitoring of the procedure was found. The Delegation in Costa Rica was not able to provide auditors of the Court with an up-to-date statement of loans outstanding, repayments, etc. No monitoring procedures are provided for in the 'rules` contained in the Manuel de Terreno. It was only in April 1997 that the Commission provided the Court with this information. This showed, amongst other things, that many of the bridging loans remained outstanding for more than 6 months, and some for more than one year.

13.62. The Financial Controller in an internal note of 19 December 1996, when finally consulted on the practice, stated that in principle the practice of bridging loans should be avoided, but that, in exceptional circumstances it might be justified, if it avoided the project otherwise being forced to borrow funds from a bank. The note pointed out, however, that decisions to grant a bridging loan could only be taken by the Authorizing Officer after visa by the Financial Controller.

13.63. The major objection to the practice of bridging loans, however, is that it is a response to failure in the functioning of the normal procedures for financing projects. If the procedures used for, and the delays associated with, the approval of operational work plans and the making of payments are such that a significant number of projects would find themselves out of funds if a bridging loan is not made, then there is a need to change the procedures rather than find unsatisfactory ways around them.

Conclusion

13.64. The Commission should:

(a) give high priority to solving the underlying problem of slow internal procedures (paragraphs 13.57 and 13.63);

(b) in the meantime, make clear to project management and to Delegation and headquarters staff, that resort to bridging loans should be a truly exceptional procedure, and ensure that proper rules and procedures are put in place and applied which respect the Financial Regulation and which guarantee adequate authorization, accountability and control of transfers of funds (paragraphs 13.59 to 13.62).

REPLIES OF THE COMMISSION

IMPLEMENTATION OF THE BUDGET

Humanitarian aid (B7-21)

13.4. The Commission agrees that steps need to be taken to avoid excessive carryover of unused payment appropriations from the previous budget year.

It would nevertheless remind the Court why it is forced to carry over payment appropriations from one year to the next. The chronic insufficiency of the humanitarian aid budget means that once the year's appropriations have been used up, the Commission has to stretch its allocation by drawing on the reserve set aside for emergency aid. As this takes place at a late stage, not all the payment appropriations obtained in this way can be used and they therefore have to be carried over to cover contractual undertakings entered into on the strength of commitment appropriations obtained at the same time.

As regards prioritizing use of appropriations carried over against those from the emergency aid reserve, the Commission does not consider that the appropriations authorized for the current year refer to appropriations from Chapter B7-91. In Article 15 of the Council Decision of 31 October 1994, the emergency aid reserve is entered as a provisional appropriation. It is clear from the rules governing its use, as set out in the Interinstitutional Agreement of 29 October 1993, that the Commission should not send the budgetary authority a transfer proposal for a drawing on the reserve until it has exhausted the appropriations (both new and carried over) for the current year and looked at the scope for reallocation.

The Commission would also point to the progress it has achieved in cutting down carryovers of payment appropriations; carryovers from 1995 to the 1996 budget year were down to ECU 136.6 million, compared with ECU 241.7 million in 1993.

13.5. The Commission agrees with the Court of Auditors and the budgetary authority that carryovers should be kept to a minimum.

(a) It already makes extensive use, as suggested by the Court, of transfers from other budget lines under Heading 4. Indeed, it has gone well beyond the Council's recommendation that at least 10% of drawings on the reserve and ECU 15 million should come from redeployment within Heading 4. In 1996, it mobilized ECU 145 million from Heading 4 as against ECU 155 million from the reserve.

(b) It is up to the budgetary authority to increase appropriations for humanitarian aid. The volume of the reserve is fixed until 1999 and cannot be altered unless the Financial Perspectives are revised.

(c) The Commission takes care, whenever drawing on the reserve, to scrutinize the need for commitment appropriations independently of payment appropriations.

Nevertheless, such measures can only have a limited impact and the Commission may well have to carry over appropriations again on future occasions.

Financial cooperation with Asia and Latin America (B7-30 and B7-31)

13.6. The bunching of commitments in the last two months of 1996 was mainly due to the need to hold back commitments, so as to free the appropriations needed to meet the ECU 200 million MEDA negative reserve. The decision not to authorize this transfer of funds was only taken by the Budgetary Authority in mid-December 1996. As a substantial part of the appropriations available for Asia and Latin America projects was set aside to fund the MEDA negative reserve, they only became available in the last two weeks of the financial year. Indeed over ECU 117 million was set aside from appropriations normally available for covering the geographic areas. The projects were prepared, decided on by the Commission and could have been committed immediately had the Commission not needed to wait for the decision of the Budgetary Authority. Nevertheless, this established pipeline of proposals allowed a 100% execution rate of commitments before the year end.

South Africa (B7-32)

13.8 13.9. Some of the reasons for low payments are temporary: the depreciation of the South African rand, which lost more than 20% against the ECU between January and April 1996, resulted in ECU disbursements being significantly lower than expected to settle project expenditures incurred in rands.

But the main causes for the slowdown in payments are structural. The shift from NGO-managed projects, which were the standard practice in South Africa until 1994, to government-managed programmes which constitute the bulk of EPRD activities since then has resulted in a longer implementation cycle, and in the emergence of a number of administrative and legal bottlenecks. For instance:

- the signing of financing agreements with the South African Government has required several months in each case, delaying the start of implementation;

- throughout 1995 and 1996, the South African Government has refused the system of advance payments, and insisted that all project expenditures be settled on a reimbursement basis;

- disagreements over tendering rules and procedures have also hampered the implementation of several projects;

- the fiscal treatment of project partners has also given rise to difficulties.

The above obstacles to aid absorption are common to other donors' aid programmes in South Africa. They have been discussed in depth between the Commission and the South African Department of Finance during 1996, and a solution to most of them was agreed during the first EC/South Africa annual consultations on the EPRD held in March 1997. The agreed practices have been set out in the first 'Multiannual indicative` Programme signed with the Deputy Minister for Finance on 14 May 1997.

Cooperation with Mediterranean countries (B7-40 and B7-41)

13.13 13.16. The Court is correct in citing the provisions of Article 36(2) of the Financial Regulation ensuring that Commission Decisions constitute commitment of expenditures. However, the specific Commission Decisions about which the Court expressed concern were subject to the availability of appropriations. This condition, included in these Decisions, ensured that Commission authorizations for the funding of projects were tailored to the availability of appropriations in 1996 and future budgets. The approach selected is fully in agreement with Article 2 of the Financial Regulation. It seeks to match the funding covered by Commission Decisions to the use of commitment appropriations, in line with availability of appropriations and with the projections for the use of payment appropriations.

In doing so, the Commission did indeed build up a potential to absorb appropriations totalling ECU 596 million in the early months of the budget years 1997 and 1998. This planned, early utilization of the appropriations made available by the Budgetary Authority is a fundamental improvement sought by SEM 2000.

A provision stating that the execution of projects is subject to annual budget availability is in addition included in all corresponding Financing Agreements. Furthermore, the planned schedule of commitments relating to a given project is closely monitored and forms the basis for effectively planning the future use of appropriations. In doing so, the provisions of Article 5 (2) of the Financial Regulation are respected in both letter and spirit.

The Commission has followed the rules for multiannual actions and has remained within the concept of differentiated appropriations as provided for by the Financial Regulation. It has refined the procedure by ensuring that the conditions attached to the Commission Decisions are such that the principles of sound financial management are fully respected.

The Commission is, however, aware of the general issue raised by the Court and does not rule out a review of these rules as a whole when the Financial Regulation is next overhauled. In this connection it will take account of the guidelines set out in Opinion 4/97 of the Court regarding the seventh amendment of that Regulation.

13.17. The 3% provision in the Supplementary and Amending Budget known as STAP ('support technique et administratif pour les programmes`) is directly linked to the programmes and projects executed in the beneficiary countries. Therefore, the nature of the expenses is clearly operational. That is why the Budgetary Authority decided to include the necessary provisions in Article B7-410 of the Budget.

13.18. The Commission is aware of the need to increase the rate of disbursement of the MEDA programme. With this aim it has proposed to the Mediterranean partners a framework convention setting out the implementation procedures for activities financed by MEDA. The fact that the Council did not adopt the MEDA regulation until 23.07.96 and the MEDA programming guidelines until 06.12.96 has inevitably had a negative impact on the rate of disbursement to date. Effectively this left only 4 months in which ECU 372.6 million could be paid. In view of this, an execution rate of 71% (ECU 264.1 million) is the best that could be achieved under the circumstances.

13.19. The Commission considers that the manner in which Community funding for the Palestinian Authority has been carried out is not only efficient but also in line with the requirements of the Financial Regulation. The Commission has sought to maintain the right to audit projects funded by the Community as explained in its reply (point 11.50) to the Court's observation in its 1995 Annual Report.

INFORMATION TECHNOLOGY AND MANAGEMENT INFORMATION SYSTEMS

Development of MIS

13.22 13.32. The Court's observations are correct. The following points should nevertheless be taken into consideration, as they cast light on past circumstances to a large extent:

- when DG IB was created in October 1995, the information technology resources transferred to the new DG were minimal: only three officials (two B grades, one C grade). DG IB's IRM was only appointed in December 1996;

- during the course of 1996, Directorate E (Finances and Resources) was progressively put into place. This process was only completed in January 1997. Nevertheless, a number of corrective measures were taken, including the definition of rights of access and responsibilities for data entry and construction of a scaled-down version of the MIS.

With the prevailing staff constraints, it was impossible to devise a clear overall strategy earlier. In addition, the hardware was too old to allow such a heavy application as MIS to work properly. Considerable efforts are being made to upgrade the equipment: 150 PCs will be replaced in 1997 and a similar number in 1998, with the objective of completing the switch to Pentium processors by the end of 1998. In addition, DG IB will start migrating to the new Commission standard operating system (Windows NT) in 1997.

The contract for MIS, signed on 9 December 1992, was covered by two commitments on non-differentiated appropriations, one for support work and the other for analysis, both to be delivered by 31 December 1993. The Commission wrote to the contractor on 26 January 1993 asking for the work to be accelerated and confirming that the corresponding payments would be made prior to the end of 1993. Payments totalled 90% of the contract value; the remaining 10% (ECU 51 212) was allowed to lapse.

As the contractor had delivered the essentials and did not present an invoice for the final amount, the Commission never formally accepted the completion of the project. The 10% effectively withheld equalled the amount covered by the bank guarantee, which was allowed to lapse.

The Master Plan referred to in point 13.30 consists of departmental contributions analysed and compiled by DG I's IRM. As noted by the Court, DG IB was not organized until the end of 1996 in such a way that it could submit complete proposals in the field of information technology.

The Commission has taken the following steps in relation to the Court's recommendations:

(a) efforts have been made to strengthen the IRM Team, which now comprises one A grade official, two B grade officials, two C grade officials and two consultants, with the support of five external experts. However, the Commission recognizes that it is not yet up to the desired level.

(b) and (c) an expert has been recruited to carry out an information management strategic planning study, which will take about six months. Work started in May 1997. This study will produce an overview of DG IB's information technology needs, and examine how existing applications can meet these needs. In addition, three additional consultants have been contracted to document the existing MIS, stabilize it, and complete its financial aspects.

(d) the Commission has taken the Court's recommendation into consideration.

FONDO ESPECIAL DE PROMOCION DE LAS EXPORTACIONES DE HONDURAS Y NICARAGUA (FEPEX)

13.33 13.53. The Commission agrees to a large extent with the Court's observations, which are confirmed by the audits the Commission has carried out. The weaknesses found are largely due to the innovative nature of the project. The Commission is reviewing the shortcomings noted and putting measures into place to minimize their adverse effects.

At strategic level the task of establishing the Financing Agreement and related contracts and the responsibility for financial management of projects have been separated from the units responsible for policy matters and the technical follow-up of projects. In line with SEM 2000 recommendations, a Finance and Resources Directorate has been set up within DG IB. This Directorate has been operational since September 1996.

At the operational level, the Financing Agreement referred to by the Court has been revised and the amended version has been signed by both partners. The Commission is launching a study to consider possible ways of improving the efficiency of regional financial institutions. An extension of the Commission audit will help determine the amounts to be recovered or added to the Revolving Fund. The audit will also help BCIE ensure that there is full transparency and accountability in the use of the Revolving Fund, especially with regard to loan advances, grants provided and income received. In the meanwhile, the Commission has recognized the Revolving Fund as a debtor by issuing a notice of debt for an estimated amount of ECU 30 million. The actual amount may vary reflecting the interest accrued less grants provided.

Accounting for credit lines

13.50. The Commission acknowledges the pertinence of the Court's comment that payments to the fund from the Commission should not be recorded as final payments in the budgetary accounts because of (a) the BCIE's status as financial intermediary and (b) the very nature of this instrument as a loan fund. The central accounting department has promised to discuss with the authorizing department how best to present this instrument in the Commission's financial statements.

Conclusion

13.54. (a) Evaluation reports on FEPEX show continuous, though slow, improvement of existing weaknesses affecting its performance.

The Commission is envisaging possible alternatives for a more efficient administration of the project funds, with or without the BCIE. As the Court notes in point 13.55, the Commission intends to carry out a study of these alternatives in 1997.

The tendering process has been initiated and the final results should be available for next November. Should it be decided to replace the BCIE by another financial institution this can easily be done under the second rider to the Financing Agreement.

At the moment an external audit is being carried out to check the BCIE's application of the rules stipulated in the second rider. Depending on the results of the audit, the Commission will take all necessary measures to ensure that the BCIE presents both regular reports and financial statements on the situation of the project and also annual audited financial statements.

(b) The Commission agrees with the Court's recommendation.

The Commission will discuss with the BCIE the amounts to be recovered from the bank as a result of the lack of controls on outstanding balances and the inappropriate charging of administrative fees on investment returns.

(c) The new Financial Agreement requires the Delegation to be much more involved in following the project day to day, by creating a Committee composed of representatives from the Delegation, the BCIE and the Management Unit to carry out regular monitoring of the programme and its implementation.

As requested by the Court, the Commission will enter the debt in its balance sheet at 31 December 1997.

BRIDGING LOANS

13.56 13.64. The Commission has taken note of the Court's remarks on bridging loans and notes that the practice should be avoided, except in exceptional circumstances. It is agreed that decisions to grant a bridging loan should be taken by the Authorizing Officer, in agreement with the Financial Controller. The Authorizing Officer will examine the factors underlying the past need for bridging loans.

Regarding the Court's conclusion, the Commission would point out that:

(a) in the context of SEM 2000 it has taken steps to improve internal procedures;

(b) it has issued instructions to Delegations and Headquarters staff to ensure that bridging loans are a truly exceptional procedure.

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Table 13.2 - Budgetary implementation by area of expenditure

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Payments of 1996

(Mio ECU)

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Payments of 1996

(Mio ECU)

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>TABLE>

CHAPTER 14(512\*) Measures to benefit the countries of Central and Eastern Europe, the newly independent States (the former Soviet Union) and Mongolia

14.0. Contents Paragraph reference

Introduction 14.1 - 14.4

Budgetary implementation 14.5 - 14.34

Implementation of the PHARE programme 14.18 - 14.23

Implementation of the TACIS programme 14.24 - 14.25

Financial cooperation with the countries of the former Yugoslavia 14.26 - 14.31

Conclusion 14.32 - 14.34

Observations on operations carried out in the agricultural sector in the Central and East European countries and the newly independent States 14.35 - 14.96

The Commission's assistance strategies 14.40 - 14.52

Land-reform programmes 14.53 - 14.58

Restructuring and privatization programmes 14.59 - 14.65

Aid for the development of private farmers 14.66 - 14.73

Boosting investment in the agro-industrial sector 14.74 - 14.81

Lines of credit 14.82 - 14.88

Conclusion 14.89 - 14.96

INTRODUCTION

14.1. Cooperation between the European Union (EU), the Central and East European countries, the newly independent States (NIS) of the former Soviet Union and Mongolia aims to back the economic reform process and to support the creation of democratic institutions. In certain Central and East European countries (513), the EU's measures are an integral part of the pre-accession policy adopted at meetings of the European Council.

14.2. The main channels of Community aid are the PHARE programme(514) (B7-500) in the Central and East European countries (since 1989) and the TACIS programme(515) (B7-520) in the NIS and Mongolia (since 1990). Management of the PHARE programme, which comprises technical assistance operations and investment, has been increasingly decentralized. By contrast, the TACIS programme continues to be mainly a centrally managed technical assistance programme. In the nuclear safety sector, TACIS includes investment expenditure.

14.3. Table 14.1 shows the measures financed under title B7-5, 'Cooperation with countries of Central and Eastern Europe and the independent States of the former Soviet Union`, and humanitarian aid for these countries (B7-21). Further measures include food aid financed, in particular, by the European Agricultural Guidance and Guarantee Fund (EAGGF), counterpart funds generated by supply programmes and Commission loans to the Central and East European countries and to the NIS by way of macro-financial aid. Some of these countries also receive loans from the European Investment Bank (EIB) or from the European Bank for Reconstruction and Development (EBRD).

14.4. As the decentralized management of the PHARE programme and the operation of the TACIS system in the Ukraine have been the subject of Court special reports(516), this chapter analyses budgetary implementation in 1996 and provides the budgetary authority with an overall evaluation of PHARE and TACIS intervention in the agricultural sector.

BUDGETARY IMPLEMENTATION

14.5. Table 14.1 shows that, for the financial year 1996, the utilization rate for final appropriations under title B7-5(517) was 99,8% for commitments and 81,5% for payments. The most significant movements of appropriations for the financial year are indicated in Tables 14.2.1 and 14.2.2.

14.6. In the case of commitments, the PHARE and TACIS headings have been used at near-maximum rates since they were created. However, this does not mean that the programmes are implemented immediately, since contracts are very often concluded only several months after commitments have been entered in the accounts. Tables 14.3.1 to 14.3.4 give an overview of commitments still outstanding at the end of the financial years 1990 to 1996 (see paragraph 14.13).

14.7. As regards payment appropriations, the PHARE programme was implemented at the rate of 82,9%, while for the TACIS programme the rate was 92,4%. These implementation rates were obtained after net reductions in initial payment appropriations totalling 179,2 Mio ECU (518):

(a) PHARE (B7-500): 49,8 Mio ECU, i.e. 5,2% of initial appropriations;

(b) transfrontier cooperation (B7-502): 89,68 Mio ECU, i.e. 55,7% of initial appropriations;

(c) TACIS (B7-520): 26 Mio ECU, i.e. 6,1% of initial appropriations;

(d) protection of the environment, of nature and public health (B7-521): 19 Mio ECU, i.e. all initial appropriations.

14.8. The payment appropriations that were thus withdrawn partly supplemented those allocated to humanitarian aid under headings B7-214 (increased from 90 to 180 Mio ECU) and B7-215 (from 34 to 57,8 Mio ECU).

14.9. Payment appropriations under two budget headings were utilized at a low rate: 15% in the case of aid for the reconstruction of the former Yugoslavia (B7-54) (see paragraph 14.26) and 40% in the case of crossborder cooperation with the PHARE countries (B7-502). The year 1996 was the first financial year in which aid was used to rebuild the former Yugoslavia and the third financial year of cross-border cooperation.

14.10. In July 1996, the budgetary authority adopted supplementary and amending budget No 1 (519) which, for the PHARE and TACIS programmes, introduced a framework for covering the programmes' operating costs. This arrangement is essentially based on the 'mini-budget` concept. Thus, amounts taken from budgetary allocations in respect of programmes intended to provide technical support and to cover administrative expenditure to the mutual benefit of the Commission and its partner countries (520) may no longer exceed 2% of PHARE appropriations and 3,5% of TACIS appropriations. Accordingly, a global commitment of 15,6 Mio ECU was recorded on 31 December 1996 under appropriations for the PHARE programme. With regard to expenditure in support of the Commission departments' administration (programme supervision), maintaining this provisional commitment beyond 31 December 1996 is irregular under Article 36 of the Financial Regulation (521) and Article 54 of the detailed rules for implementing this Regulation (522). The fact is that, as an agreement or contract had not yet been concluded, there was no expenditure commitment to third persons on the above date. By contrast, no provisional commitments were recorded under TACIS appropriations in 1996.

14.11. An analysis of commitments not covered by contracts at the end of the financial year shows a rising trend in absolute terms for PHARE and TACIS, although their relative value has grown steadily weaker (see Table 14.4.1). This situation shows that, assuming no change in management resources, the Commission can cope only if the types of Community assistance in the PHARE and TACIS countries themselves change. The approach envisaged by the Commission, namely increasing the scale of PHARE projects in the future, is likely to improve the situation (see paragraph 14.38).

14.12. Since 1992, the value of the outstanding commitments has also steadily increased (see Table 14.4.2).

14.13. When a financing agreement signed as part of a programme expires (523), committed appropriations that have not given rise to contracts are cancelled and must be decommitted. In 1996, decommitments recorded under the PHARE programme amounted to only 4,2 Mio ECU, 3,1 Mio ECU of which concern closures of contracts concluded with the EBRD. In the case of the TACIS programme, decommitments amounted to 0,57 Mio ECU.

14.14. As regards the details of commitments outstanding at the end of the financial year 1996, about 100 of the 600 PHARE and TACIS operations under way that had commenced between 1990 and 1994 were examined. Just over 50 of the operations in respect of which a commitment had been made more than two years earlier showed a balance at the end of 1996 that should have been wholly or partly decommitted. The amounts thus kept in accounts with no justification totalled approximately 41 Mio ECU for the examined sample alone. These commitments, whose existence is no longer justified, artificially inflate the backlog that the Commission considers it must partly redirect towards new measures (COM(97) 112/8, 18.3.1997, p. 9). The Court's audit findings enable total commitments for the PHARE and TACIS programmes that no longer have any justification to be estimated at over 100 Mio ECU, given that the analysis concerned programmes, not current contracts.

14.15. The main reasons for the excessive quantities of outstanding commitments are the following:

(a) certain programmes, where the total appropriations had not been used up on contracts, were not cleared upon expiry;

(b) certain programmes, where the total appropriations had not been used up on contracts, were not cleared upon expiry;

(c) in the case of seven programmes, the use of interest earned on bank deposits resulted in the budgets being underused, even though the services for which provision had been made were implemented in their entirety.

14.16. Several programmes from 1990 to 1992 no longer had an official specifically designated by DG IA to monitor them, owing to the high turnover of staff at the Commission. Consequently, operations were neg-lected and closure was delayed.

14.17. At the beginning of 1997, DG IA's financial departments began to clear certain programmes. However, if this exercise is to produce results within a reasonable time, the geographical departments that manage the programmes should be made systematically responsible for clearance operations.

Implementation of the PHARE programme

14.18. Of the 1 029 Mio ECU committed under the PHARE programme in 1996 (B7-500), 155 Mio ECU (15%) concerned reconstruction work in the former Yugoslavia (Bosnia and the Former Yugoslav Republic of Macedonia (FYROM)). This aid is similar to the aid financed under Chapter B7-54, the commitment appropriations for which totalled 98 Mio ECU. Dividing operations up between two different chapters is detrimental to overall monitoring.

14.19. Within the framework of the PHARE programme, funds are advanced to the programme management units (PMUs) located in the beneficiary countries. From an accounting point of view, the Commission regards these advances as equivalent to final expenditure, which contravenes the provisions of Article 111 of the Financial Regulation and has the effect of increasing the consumption of payment appropriations. As the disbursed advances are not listed as such in the Commission's accounts, its departments in Brussels are not required to carry out the checks that would be needed in respect of such sizeable sums (524).

14.20. In February 1996 Bulgaria experienced a major banking crisis, as a result of which more than 12 credit institutions closed their doors. The funds deposited by the various PMUs with three of these insolvent establishments totalled approximately 9,1 Mio ECU in November 1996 and had still not been recovered in June 1997.

14.21. As, pursuant to the PHARE framework agreement signed with the Bulgarian Government, this latter is required to take all necessary measures to ensure that operations are properly concluded, and thus that the funds advanced are secure, the Commission should issue, at least as a precautionary measure, a recovery order (Article 28.2 of the Financial Regulation) to this effect for all of the frozen funds.

14.22. The Commission was obliged to withdraw from one programme the amounts it needed to make scheduled payments in respect of another programme whose funds had been affected by banking insolvencies. This practice is irregular from the point of view of the principle of the specific nature of appropriations, as it leads to a given operation being financed from two sources. Generally speaking, an advance thus made by one programme to another should be specifically recorded in the Commission's accounting records and submitted to the Financial Controller and the Commission's Accounting Officer for written authorization. This did not happen in this instance. Rather than resorting to on artifice in order to compensate for cash-flow losses, the Commission should have committed further appropriations in order to settle sums owed to contractors, pending the regularization of the operation following the (hypothetical) recovery of the amount mentioned in paragraph 14.21.

14.23. Pursuant to the provisions of Article 28 of the Financial Regulation, the Commission should also have issued a recovery order for this withdrawal so as to make it possible to monitor the file from an accounting perspective. According to the Commission, this one-off advance amounted to 899 198 ECU and involved the transport programme.

Implementation of the TACIS programme

14.24. The late adoption of the new TACIS Regulation on 25 June 1996 affected the mobilization of commitment appropriations (Table 14.1). As most of the appropriations were committed in December 1996, the rate at which contracts under the 1996 programme were concluded was very low (8,1%), even though delays in this area were already appreciable at the end of 1995 (525).

14.25. The Commission entrusted to subcontractors the purchase of spare parts intended for various nuclear power stations in the NIS. The contracts stipulate that interest earned by the subcontractors on the advances received shall either be refunded to the Commission at the end of the programme or added to the amounts available for purchasing spare parts. By 31 December 1996, the Commission had neither established a recovery order for the amounts it was owed (approximately 200 000 ECU) nor recorded the amounts to be credited to the programmes, i.e. approximately 1 435 000 ECU (see paragraph 14.27).

Financial cooperation with the countries of the former Yugoslavia

14.26. Specific reconstruction measures (B7-54) were very slow to get off the ground and more than 50% of the appropriations were committed at the last minute, in December 1996. Despite the payment of advances totalling 7,7 Mio ECU during the last quarter of 1996, the implementation rate for payment appropriations barely exceeded 15%. The first half of 1997 continues to give cause for concern in that only 1,3% of the 215 Mio ECU in payment appropriations allocated for reconstruction in the former Yugoslavia (526) had been implemented by 15 July 1997. In November 1996, the essential aid programme (B7-500: 'Equipment and supplies`) financed by PHARE and costing 125 Mio ECU was interrupted because of the risk of control being lost over distribution on the ground and because it did not offer sufficient incentive for refugees to return. The balance not used to purchase supplies (i.e. 42,5 Mio ECU) was allocated to reconstruction projects to be implemented in 1997.

14.27. Purchases of supplies intended for Bosnia were entrusted by the Commission to two subcontractors who were paid cash advances. These advances earned interest and the corresponding amounts totalled nearly 860 000 ECU on 31 December 1996. These sums, which were added to the programme's funds, were not listed in the Commission's accounts. These sums should not be exempt from budgetary control, for which reason they should be regarded as de facto reutilizations and, by analogy with the operations referred to in Article 27.2 of the Financial Regulation, should be recorded in suspense accounts that make it possible to monitor revenue and expenditure operations. The Commission should create a transparent procedure for listing and checking these operations.

14.28. As reconstruction aid could not be mobilized as planned in 1996, the Commission kept its humanitarian aid assistance at a high level in this region (187 Mio ECU as against 235 Mio ECU in 1995). Furthermore, it cited the continuation of this aid as a reason justifying a withdrawal of 42 Mio ECU from PHARE appropriations at the end of 1996.

14.29. At the beginning of 1996, the Commission opened an office in Sarajevo. One of the main tasks entrusted to this office was to monitor the programme of essential aid for the rebuilding of Bosnia (B7-500). As the appropriations under title A of the budget were insufficient to cover the operating costs of this office, the Commission withdrew 279 133,17 ECU for this purpose from the funds allocated to the essential aid programme. This operation calls for two observations.

14.30. The financing of the day-to-day expenditure of the Commission's office in Sarajevo from the programme's operational funds is inadmissible. The fact is that the detailed implementation of the programme was already being monitored in Sarajevo by branches of the two companies responsible for supplying equipment. In addition to these two teams, a third team from a surveillance office was responsible for supervising the delivery and instalment of the equipment. This being the situation, the Commission's office in Sarajevo was performing tasks that considerably exceeded the mere implementation of the essential aid programme.

14.31. Since January 1996, instead of creating imprest accounts, pursuant to the provisions of Article 54 of the Financial Regulation (527) and Articles 82 to 91 of the corresponding implementing provisions (528), the Commission has asked the two companies to which it entrusted the organization of purchasing supplies intended for Bosnia to pay directly to its Sarajevo office the funds it needs for operational purposes. Between January and June 1996, the de facto imprest account that was thus created functioned in an irregular manner as the expenditure implemented was not subject to prior authorization and regularization by the Financial Controller and the Commission's Accounting Officer.

Conclusion

14.32. Although the utilization rates for appropriations for commitment under the PHARE and TACIS programmes are high, delays in concluding contracts increased further in 1996, thereby reflecting the difficulties encountered by the Commission in converting programme decisions taken during the financial year into firm legal commitments. Furthermore, the commitments still outstanding at the end of the financial year were overestimated (see paragraphs 14.11 to 14.17).

14.33. Appropriations for payment remained under-used despite transfers made during the financial year to reduce the initial appropriations (see paragraphs 14.7 to 14.9). The procedures for preparing the budget should be re-examined by the Commission so as to establish a closer link between these procedures and actual operations effected in the various beneficiary countries.

14.34. As regards cash-flow management, and irrespective of the method of entering the payments in the accounts, the Commission's Accounting Officer should improve monitoring in respect of advances deposited in the beneficiary States (see paragraphs 14.19 to 14.23), of imprest accounts that may be concealed within operational programmes (see paragraphs 14.29 to 14.31) and of interest earned on advances paid to certain intermediaries (see paragraphs 14.25 to 14.27). In view of the flexibility for manoeuvre that it allows, the new procedure made possible by supplementary budget No 1/96 would require special attention from the Accounting Officer and the Financial Controller (see paragraph 14.10).

OBSERVATIONS ON OPERATIONS CARRIED OUT IN THE AGRICULTURAL SECTOR IN THE CENTRAL AND EAST EUROPEAN COUNTRIES AND THE NEWLY INDEPENDENT STATES

14.35. In the Central and East European countries and the NIS, agricultural production has fallen quite considerably since 1990 due to internal and external causes. Internal causes include low domestic demand, insufficient investment, increased factor costs and the structure of agricultural holdings. In addition to poor climatic conditions in 1992, 1993 and 1996, notable external causes are the loss of external markets and competition from imports of processed products (529).

14.36. Tables 14.5.1 and 14.5.2 provide some general indications of the importance and recent development of agriculture in the Central and East European countries and in the NIS.

14.37. However, in most of the Central and East European countries and the newly independent States, agriculture accounts for a significant part of economic activity. This is why the Court's audit was largely devoted to operations in the agricultural sector during audit visits to 10 Central and East European countries and the NIS from April 1995 to December 1996. Between 1990 and 1996, the PHARE and TACIS programmes mobilized 497 Mio ECU and 280 Mio ECU respectively in this sector, i.e. 7,5 and 10,1% of commitments under these programmes.

14.38. The audit observations were grouped according to types of Commission assistance so as to produce sectoral conclusions. This approach was possible because, in the case of PHARE, only programmes approved between 1990 and 1994 were examined. The fact is that PHARE and TACIS approaches were comparable until 1994 and PHARE operations were first carried out specifically with a view to preparing for accession only with effect from the 1995 programme that was implemented in 1996. From 1997 onwards, the reorientation of the PHARE programme will lead to greater differences with the TACIS programme. The 'response to demand` approach will be superseded by an accession-based approach; priority will be given to large-scale projects and more management will be decentralized to the candidate countries. The Commission estimates that 30% of PHARE assistance will go to the development of institutional capabilities and 70% to major infrastructure projects.

14.39. Tables 14.6.1 and 14.6.2 show commitments for agriculture and for land reform in the Central and East European countries between 1990 and 1996 and for the agricultural foodstuffs sector in the newly independent States from 1991 to 1996. It is surprising to note that, although the Commission was made responsible for coordinating aid provided by the G24 countries, it has no data on the volume of aid provided by the various donors for the industrial, agricultural or tertiary sectors. Thus, although the Commission knows that total aid from the G24 countries to the agricultural sector in the Central and East European countries amounted to 1 553 Mio ECU (half of which was in the form of grants and half in the form of loans) for the 1990-95 period, it does not know the percentages involved for each beneficiary country. Furthermore, it should be noted that although aid for the agricultural sector is vitally important for most of the population, it accounted for only 1,8% of total aid (86 234 Mio ECU) to these countries. The question arises as to how aid can be coordinated in advance when the amount subsequently disbursed is unknown (see Table 14.7).

The Commission's assistance strategies

14.40. The basic Regulations of the PHARE and TACIS programmes require the choice of measures to take account, inter alia, of the preferences of each beneficiary country. This explains the diversity of the approaches adopted by the Commission in the various countries.

14.41. The packages of appropriations allocated each year to individual beneficiary States depend on their capacity to absorb such funds, the quality of the proposed projects and, since 1995, their multiannual indicative programmes. As absorptive capacity is assessed on the basis of the implementation rate for previous projects, certain measures may be postponed where the Commission has previously adopted programmes that were ill-suited to the local context and where implementation was behindhand. Thus, owing to difficulties encountered when implementing the previous PHARE programmes, the agricultural sectors in Bulgaria (in 1993 and 1994) and in Albania (in 1995) were not granted new financing.

14.42. The PHARE programme's financing agreements are often vague and do not state clearly the objectives to be achieved. This phenomenon was also pointed out by the Court in its Special Report No 3/97 concerning the decentralized system for the implementation of the PHARE programme (530). An agricultural advice project in Albania thus received financing under the 1992 and 1993 programmes (the contracts concerned totalled 0,3 Mio ECU in April 1996) even though provision had not been made in the 1992 agreement and the 1993 agreement made no provision for a specific financing package.

14.43. When the Commission began to provide assistance in the NIS, it was unfamiliar with the local situation. Its first projects thus consisted of studies of the whole food chain (production, processing and distribution). These studies were not always welcomed by the beneficiaries, who were not yet aware of the need to improve their management methods and who expected concrete investment instead.

14.44. Since 1993, the Commission has oriented its programmes more towards measures that seek to alter management methods, in particular by implementing pilot projects within companies and local authorities. However, it has nevertheless encountered political obstacles in certain countries, such as Belarus and Turkmenistan. In order to increase cereal production in Turkmenistan, it financed, for example, an agronomic research project in 1995-96 (1,5 Mio ECU) without being able to tackle the real problems posed by the lack of economic reforms. This type of project is ill-suited to TACIS's objective of helping beneficiary States to implement the economic reforms needed to create a market economy.

14.45. In order to adapt the agricultural and agroindustrial sectors to the market economy, the Commission attempted to set up units to support the formulation of agricultural policies and strategies in Bulgaria, Romania and most of the NIS. Once these units had been set up within the various Ministries of Agriculture, their impact was limited because, at the time the first programmes were under way, the same Ministries were merely implementation agencies with no authority to propose new economic policies. From 1995 onwards, the Commission took greater account of the structural constraints, as is evidenced by a project currently under way in Uzbekistan (see paragraph 14.49).

14.46. In Kazakhstan (0,9 Mio ECU), the Western advisers' recommendations were generally welcomed but seldom followed up. In 1996, in Kyrgyzstan (1,3 Mio ECU), the Ministry of Agriculture was reluctant to follow foreign technical assistance advice as the formulation of national agricultural policy was considered far too sensitive a matter. In Turkmenistan, a team of economic analysts that was to formulate reform strategies could not be set up within the Ministry of Agriculture. This project (3,7 Mio ECU), which had been chosen by the Commission in 1993 and completed in March 1996 by Western technical assistants, had only limited effects, owing to the fact that the Ministry of Agriculture's role was essentially commercial and administrative.

14.47. In Ukraine, in 1995-96, a TACIS project (5,4 Mio ECU) which was supposed to help the authorities adapt their legislation in the agricultural and agro-industrial sector proved too ambitious and did not attach enough importance to the transfer of know-how. In agreement with the new political authorities, the project's priorities were re-established 20 months after it got off the ground (531).

14.48. In 1995, the Commission provided the Ministry of Agriculture in Belarus with short-term technical assistance (0,2 Mio ECU) to acquaint officials with the results of a pilot project that had shown the feasibility of restructuring the collective farms (see paragraph 14.61). Due to political opposition to the reforms, the provision of advice was discontinued.

14.49. By contrast, the advice unit set up in Uzbekistan by the Commission in 1995 (1,6 Mio ECU), which has also built on experience gained on the ground from other TACIS projects, has established sound contacts with the authorities concerned, thereby acquiring considerable credibility. The technical assistants proved to be flexible when implementing the programme agreed upon with the Commission to meet the national authorities' most pressing requests. They also endeavoured to form a local team by bringing together staff from bodies connected with the agricultural sector; this is supposed to take over from Western advisers in the medium term.

14.50. In Romania, the agricultural component (5 Mio ECU) of a 1991 PHARE programme included, in particular, the creation within the Ministry of Agriculture of a support unit to which the 1992 programme had allocated 0,3 Mio ECU. This unit, which was finally set up only in March 1993, was unable to fulfil its task. The fact is that the Ministry of Agriculture kept the unit at arm's length and did not provide it with the requisite human resources. Furthermore, it was unable to establish the desired degree of coordination with the other ministries concerned by privatizations. As the PHARE experts had not trained any counterparts capable of taking over the running of the unit, its long-term viability appeared to be in jeopardy in 1996.

14.51. In Bulgaria, the 1990 PHARE agriculture programme (16 Mio ECU) aimed to implement a sectoral development strategy and to promote the development of a private agricultural sector. Local structures did not make it possible to complete this programme (see paragraph 14.84). The same objective was included in the 1991 (25 Mio ECU) and 1992 (10 Mio ECU) programmes, to no more avail. Within the framework of these two programmes, a unit was created to assist the Ministry of Agriculture but coordination with the other ministries was inadequate. As in Romania, when the Court examined the operations in 1995, it found that most of the recommendations made by this unit had been ignored, owing to a lack of political will.

14.52. The agricultural support strategies financed by the Commission were not subject to overall evaluation in the Central and East European countries or in the NIS. Consequently, the reformulation envisaged by the Commission for its future measures is not based on a critical analysis of measures that have been implemented in the past. Similarly, the funds allocated to the agricultural sector do not appear to be determined on the basis of assistance provided by national authorities and other donors.

Land-reform programmes

14.53. Land reform is a prerequisite for the creation of a market economy in the agricultural sector. It requires the beneficiary countries to adapt their legislation and to create appropriate institutions.

14.54. In Romania, the 1991 programme in support of land reform (2,1 Mio ECU) essentially consisted of supplying equipment to the Ministry of Agriculture because the body responsible for the land register had not yet been created. The 1993 programme for setting up a rural land register (5 Mio ECU) was started only in 1996. In August 1995, the Commission had made the postponement of the deadline set in the financing agreement (December 1995) conditional upon the land register law being adopted. Although the law was adopted in October 1995, the Commission further delayed the start of operations and waited until February 1996 before approving the work programme that the Romanian partner had submitted in August 1995.

14.55. In Bulgaria, the Commission allocated 8,1 Mio ECU to land reform in 1991 and 1992. Accordingly, in 1993 it financed electronic measuring equipment (0,5 Mio ECU) that had still not been used three years later.

14.56. The Commission financed equipment for the land register in the Czech Republic in 1994 (1,7 Mio ECU under the 1992 programme) and in Slovakia in 1995 (1,7 Mio ECU under the 1993 programme). The 1994 programme also provided for the supply of other equipment worth 2,3 Mio ECU in the Czech Republic and 2,5 Mio ECU in Slovakia. In 1995, the Commission decided to deliver this equipment only after a land registry system had been adopted with a view to these countries joining the EU. However, the Commission did not grant technical assistance to contribute to the development of this system until 1996. At the end of 1996, the equipment concerned had not been delivered. The delay in providing technical assistance reflects the inadequate planning of the project from its inception.

14.57. In the absence of an appropriate institutional framework in Poland, by the end of 1996 the Commission had still not been able to provide significant support for land reform. A 1992 programme (5 Mio ECU) aimed to draw up modern maps of the country. Due to problems posed by foreigners flying over the territory concerned to take photographs, the project got off the ground only in 1995; by the end of 1996 only 60% of it had been implemented.

14.58. In the NIS, TACIS financed only limited land-reform pilot experiments in 1996, in particular in cooperation with the World Bank. These measures were undertaken in the absence of overall coordination. For example, the Commission undertook experimental measures in this area in Moldova without taking account of prior experience gained in other newly independent States and especially in the Central and East European countries.

Restructuring and privatization programmes

14.59. In order to meet the needs of a market economy, the sovkhozes (State farms) and kolkhozes (collective farms) (532) should be removed from the tutelage of the State. This reform requires profound legislative change.

14.60. In Romania, the Commission decided on a programme to privatize agriculture in 1991, before the government had adopted a strategy in this connection. As a result, the programme commenced only in February 1994.

14.61. In 1991, when the Soviet Union still existed, the Commission decided on seven State farm privatization projects worth a total of 6,4 Mio ECU. When these projects were implemented in 1993-95, they met the needs of the central authorities in Russia (0,3 Mio ECU) and of certain regional authorities in Ukraine (1 Mio ECU). They were looked upon with interest in Moldova (1 Mio ECU) and in Uzbekistan (1,6 Mio ECU) but met no demand in Belarus (1,5 Mio ECU) or Turkmenistan (1 Mio ECU), where reforms had not yet been seriously undertaken in the field of privatization in 1996.

14.62. After the break-up of the Soviet Union, a project implemented in western Russia in 1994 (2,2 Mio ECU) improved the management of farms which were still being run in the old way even though they had been officially privatized. The recommendations made prompted producers to respond to the needs of the market and had a broad impact on the region. The regional authorities also contributed to the success of the project and applied the same model to other collective farms.

14.63. In Kazakhstan, a project (2,1 Mio ECU) implemented in 1995-96 to promote the development of private agriculture developed original models for private agricultural holdings that were well suited to the region. The project sought pragmatic solutions to economic and social difficulties caused by restructuring. The technical assistance supplied took account of experience with previous TACIS projects, so the project can serve as a model for other regions with similar characteristics.

14.64. In Ukraine, few reforms had been undertaken by 1996 in the agricultural sector, to which TACIS had already allocated 41,5 Mio ECU. Pilot projects for the restructuring of former agricultural production systems nevertheless experienced a certain degree of success when implemented in regions that favoured the reforms and when they aroused the interest of farmers and regional authorities. However, these projects and the farmers concerned were still hampered in 1996 by the lack of an appropriate legal framework.

14.65. The restructuring of the State and collective farms requires certain workers to be retrained, a problem which can be tackled effectively within the framework of rural development programmes that affect all of the components of the regional economy. In Hungary, Slovakia and Romania, these programmes showed that success was conditional upon the participation of the authorities (533). Although a similar degree of involvement may occasionally be found at the regional level in certain NIS, there are difficulties at the national level due to a shortage of financial resources and a lack of political will.

Aid for the development of private farmers

14.66. The provision of agricultural advice is generally welcomed by farmers and regional authorities. Practical advice often makes it possible to win farmers' confidence, especially when the concrete feasibility of a project can be shown. This type of measure prompts farmers to rationalize production and to organize themselves more efficiently, as was the case in Ukraine, Moldova and Uzbekistan.

14.67. Experience gained from TACIS pilot projects often convinced beneficiaries of their utility; the 'Model farms in the Orekhovo-Zuzhevo district` project (1,7 Mio ECU) in Russia is a good example. However, in this case, the model holdings established can be reproduced only if farmers obtain access to credit. With the exception of new farming techniques that require no individual investment, farmers in the NIS and in certain Central and East European countries experience difficulty, due to a lack of financial resources, in acting on the advice they receive.

14.68. In the NIS, one of the few sources of credit for farmers is short-term advances, often in kind, provided by firms located upstream or downstream of the agricultural sector. In the absence of competition, farmers depend on these structures, which tend to abuse their monopoly position. The creation of cooperatives capable of resisting these monopolies goes some way to providing a solution, as shown by a TACIS project to promote sunflower production in Ukraine.

14.69. Furthermore, in the NIS the large-scale reproduction of pilot projects is hampered by bureaucracy and by the lack of a suitable legislative framework, which limits the development of holdings.

14.70. In Uzbekistan, a TACIS project to support private farmers that began in 1994 earmarked 0,4 Mio ECU for the purchase of equipment. The farmers formed small cooperatives to buy the equipment, which was well suited to local conditions and which gave them independence from the collective farms. This project was welcomed by the farmers and prompted them to organize themselves so as better to defend their interests against the collective farms and against an administration still wary of the private sector.

14.71. With regard to the TACIS programme, projects to provide advice are often too short (approximately two years) to enable the new structures (farmers' associations, cooperatives and centres offering farmers advice and services) to become permanent. A whole agricultural season is needed to gain farmers' confidence and to convince them to join cooperatives or farmers' associations, a step they are generally reluctant to take once they have left collective structures. Two years into the projects, the organizations that have been created are still too young to survive without external assistance and often have no clearly defined legal status.

14.72. Thus, in Moldova, one project (1,4 Mio ECU) aimed to create a federation of private farmers' associations in 1995. At the end of 1996, this federation still accounted for only 8% of Moldovan private farmers and its long-term viability was in doubt owing to a lack of support from grass-roots associations.

14.73. The requirement sometimes imposed by the Commission, namely that advisory centres for farmers should become financially independent, has never yet been fulfilled within the prescribed time. Considering the financial difficulties encountered by farmers, this requirement would seem premature. Moreover, it may be ill-conceived where these bodies are also responsible for public health and the protection of the environment.

Boosting investment in the agro-industrial sector

14.74. The development of agriculture also depends on the creation of a competitive and efficient agroindustrial sector. Programmes to support the privatization of this sector must be closely coordinated with the other economic reform guidelines defined by the authorities of the beneficiary countries.

14.75. In many countries, those responsible for the food industry primarily expected concrete investment. However, in order to attract investors, prior reorganization of agro-industrial complexes is required. Only a small number of projects concentrated in the distribution sector led to concrete investment.

14.76. In 1991, the Commission financed an audit of approximately half of the 400 agro-industrial companies in Bulgaria with a view to privatization (2,1 Mio ECU). In 1996, approximately 95% of these companies were still State-owned.

14.77. A TACIS project (1,6 Mio ECU) implemented between 1994 and 1996 in Russia aimed to improve animal feedingstuffs and concerned cereal suppliers, mills and breeders alike. It improved the profitability of the sector by meeting attendant needs. However, the local economic climate was still insufficiently attractive in 1996 to arouse the interest of foreign investors. The results of this project could, however, serve to improve breeding practices in other regions of the former Soviet Union.

14.78. Another project (1,6 Mio ECU) implemented in Moldova during the same period and designed to improve the way the pigmeat sector was run could not serve as a model because the assistance provided was oriented too specifically towards a processing company and did not take sufficient account of production and marketing.

14.79. A project implemented between 1994 and 1996 in Kazakhstan (1,2 Mio ECU) aimed to contribute to the production of agricultural machines suited to the needs of small private farms. It was also supposed to facilitate the transfer of technology, trade, investment and the creation of joint ventures between European businesses and the beneficiary. The Commission, however, was not sufficiently careful in its choice of beneficiary. Instead of a manufacturer of machines, an assembly and repair plant that lacked adequate technical facilities was chosen. The project did not attract any foreign investment and no joint venture was created. The fact is that the beneficiary's basic activity was of little interest to foreign investors.

14.80. In Uzbekistan, as part of a TACIS integrated development programme (1,8 Mio ECU), technical assistance gave priority from 1995 onwards to the search for potential investors in agro-industrial companies. Training in the management of processing companies that specialized in agricultural products was sidelined. At the end of 1996, no foreign investor had yet bought holdings in the companies concerned by the project and the usefulness of the component that aimed to develop agro-industrial companies had still not been determined.

14.81. Between 1992 and 1995 and within the framework of the Bangkok Agreement(534), the Commission financed groups of experts set up by the EBRD in five NIS: Russia (2,2 Mio ECU), Belarus (0,7 Mio ECU), Ukraine (1 Mio ECU), Kazakhstan (0,7 Mio ECU) and Uzbekistan (0,8 Mio ECU) to identify and prepare investment projects in the agro-industrial sector. None of these activities led to direct investment by the EBRD because experts were unable to identify projects that fulfilled the Bank's eligibility criteria.

Lines of credit

14.82. Within the context of PHARE, the Commission granted capital aid for redistribution in the form of appropriations. The opening of lines of credit requires appropriate legislation to be passed beforehand and the local economic climate to be taken into account. Coordination must also be sought with national measures in this area and with programmes to reform the banking sector. Furthermore, the bodies responsible for managing the appropriations generally require assistance.

14.83. In 1990, the PHARE programme allocated 30 Mio ECU to a line of credit for the development of private agriculture in Poland. At the time, the Commission had done very little analysis of the banking sector's ability to manage such an operation and had not studied the suitability of the legislation in force. The PHARE line of credit was in competition with two Polish programmes that offered more advantageous interest rates. This line of credit became attractive only in 1994, when the profitability of the agricultural sector improved. During the same period, the banks also became efficient enough to manage multiple small loans with high management costs.

14.84. In Bulgaria, the 1990 PHARE programme had opened a line of credit of 11 Mio ECU for private farmers. Faced with institutional obstacles at the national level, the Commission transformed the programme into an operation to supply inputs for agriculture. In 1991, it made provision once again for opening a line of credit (7 Mio ECU) for private farmers but did not pay close attention to the economic and legal situation. The funds were thus reoriented towards 33 new cooperatives which were made responsible for granting loans to their members. In 1996, these loans were still frozen as Bulgarian law, like that of many other countries, forbids any form of banking activity by companies, such as the cooperatives in question, that do not have a certain minimum capital.

14.85. In 1992, the Commission responded to a request by the authorities in Albania to open a line of credit financed by the PHARE programme's counterpart funds for supplies of agricultural inputs. The Albanian Bank for Rural Development, which was responsible for managing these funds, began to distribute loans in March 1993 but, in spite of the technical assistance that the Commission gave the bank as regards the management of transactions, the selection of beneficiaries was not very strict. By April 1996, 84,4% of borrowers had defaulted. Although the rate was already 34% by October 1994, the Commission became aware of the situation only in March 1995. It subsequently froze the line of credit and suspended all transfers to two other lines of credit for which 4,8 Mio ECU had been reserved in the meantime. As under Albanian legislation it is not possible to obtain real security for loans granted, these problems were to be expected.

14.86. In Albania, another project (3,5 Mio ECU) had provided for agricultural machinery to be sold on credit to private farmers. Due to the potential buyers' limited ability to make repayments, a study financed by PHARE advocated buying machines made in Central and East European countries, in particular, medium-powered tractors. In spite of this, the Commission concluded supply contracts with Western companies and 90% of the tractors supplied exceeded the recommended power. These tractors, which were delivered in 1993, turned out to be ill-suited to the small surface areas of Albanian holdings. Moreover, the investments proved unprofitable and in April 1996 the rate of debt recovery was less than 20%.

14.87. Unlike PHARE, the TACIS Regulations made no provision for establishing lines of credit. However, the Commission can provide technical assistance for managing lines of credit granted by other donors. By the end of 1996, such measures had been implemented only on a small scale, for example an agricultural advisory service in Kyrgyzstan.

14.88. In Russia, a TACIS project (1,5 Mio ECU) implemented between 1994 and 1996 aimed to help the banking sector offer its services to agricultural and agro-industrial companies. This project, which fitted in well with other TACIS activities in the agricultural sector, initially suffered from a lack of coordination with projects to support reform of the banking system. According to the specifications, the project, which was implemented in partnership with an agricultural bank, aimed to create a new bank for the same sector, which amounted to asking a partner to cooperate on the development of a competitor. The project was reorient-ated six months later towards providing support for the partner bank. However, because of a lack of available funds, the aim of meeting the needs of the agricultural sector in terms of medium-term appropriations, in particular by creating a rural guarantee fund, had still not been achieved in 1996.

Conclusion

14.89. The agricultural reform strategies chosen by the Commission to provide assistance in the PHARE and TACIS countries were not stated clearly enough (see paragraph 14.42). Thus, certain measures encountered opposition from the supervisory authorities in the beneficiary States (see paragraphs 14.46 to 14.61). The reticence of these authorities as regards the privatization process and the introduction of a market economy was not sufficiently taken into consideration when the programmes were adopted (see paragraphs 14.47 to 14.51). In such cases, Community financing produced, at best, limited results. Furthermore, the support provided by the Commission did not always take adequate account of the administrative organization of the beneficiary States and of the prevailing institutional and legislative frameworks in these countries. The Commission's sectoral strategies should be more clearly incorporated into those of the beneficiary States (see paragraph 14.52).

14.90. In the Central and East European countries, land reforms are essential for encouraging not only the creation of a market economy in the agricultural sector but also for promoting investment in agricultural holdings. Support in this sector must be considered a priority with a view to certain Central and East European countries joining the European Union. In terms of land reform, very few countries had made progress that could be considered satisfactory by the end of 1996 (see paragraphs 14.53 to 14.58).

14.91. In certain Central and East European countries that have applied for membership of the European Union, the production structures and legal and institutional frameworks are still incompatible with those of the Community's Member States (see paragraphs 14.50, 14.51, 14.54, 14.55 and 14.76). In these countries, focusing future PHARE assistance on pre-accession strategies seems premature, given that agricultural production is still far from meeting the most basic domestic needs. In countries where institutional reforms had been blocked, priority should preferably have been given to revitalizing the agricultural production sector. In this respect, Bulgaria provides a particularly striking illustration.

14.92. The rapid development of agricultural holdings is linked to the existence of systems that provide access to credit. This crucial aspect of agricultural development was too much neglected in the NIS (see paragraphs 14.68 to 14.87). In the Central and East European countries, several lines of credit that were created did not produce the desired effects immediately, either because systems were established at the wrong time or the Commission had not taken sufficient account of prevailing circumstances and the legislative framework (see paragraphs 14.83 to 14.86). In this area, cooperation should be sought with the banking sector and the Commission's aid must be increased. In many countries, closer coordination with EBRD aid needs to be envisaged.

14.93. Demonstration projects and projects to provide advice generally produced good results when they were accepted by beneficiaries rather than imposed upon them by the central authorities (see paragraphs 14.66 to 14.73). However, the incentive effects of these projects are difficult to assess as the Commission and the beneficiary authorities did not set up an ex post monitoring system.

14.94. Generally speaking, the restructuring projects showed that large holdings could be viable if they were reorganized effectively and freed from their old structures. However, the restructuring of certain large units, in particular the collective farms, is often a complex matter. Depending on the case concerned, it may be appropriate to promote small family holdings or cooperatives, either separately or at the same time (see paragraphs 14.59 to 14.65).

14.95. Support for agro-industry has seldom produced convincing results (see paragraphs 14.74 to 14.81). The amounts that have to be mobilized for agro-industrial conversion exceed the financial capacity of the PHARE and TACIS programmes. If the Commission wishes to pursue its assistance in this sector, it should seek partnerships more systematically with institutions such as the EIB or the EBRD that are able to mobilize significant amounts of capital. The restructuring projects that had the greatest impact concerned not only agro-industrial companies but also their suppliers and customers.

14.96. The TACIS Regulation specifies that the choice of measures is to be based, inter alia, on an assessment of their effectiveness in respect of the objectives of Community assistance. In the case of PHARE, since the financial year 1993 the budgetary authority has been careful to obtain qualitative analyses of the results of various sectoral programmes. By the end of 1996, no overall evaluation had been made of the various types of European Community assistance in the agricultural sectors of the PHARE and TACIS countries. These evaluations are necessary for the adoption by the Commission of future strategies (see paragraph 14.52).

REPLIES OF THE COMMISSION

BUDGETARY IMPLEMENTATION

14.10. Expenditure under supplementary and amending budget No 1/96 is described in the corresponding Remarks section. It is operational expenditure the aim of which is to improve implementation and monitoring of the programmes concerned. It cannot therefore be regarded as current administrative expenditure within the meaning of Article 36 of the Financial Regulation and the commitments are not provisional commitments within the meaning of Article 54 of the detailed implementing rules. Under the rules applying to differentiated appropriations the balance of the commitment will be cleared by payment appropriations in the 1997 budget and, if necessary, in subsequent years as well.

14.13 14.14. Throughout this year the Commission has been working on closure of programmes and contracts which have expired. As regards centralized programmes, 70 programmes and 559 contracts have been closed and a total of ECU 31.3 million decommitted (101 decommitments). A further 31 decommitments (ECU 17 million) are in the pipeline for decentralized programmes.

14.15 (c) The proposed new clause in Article 22(4)a of the Financial Regulation (part of the seventh revision, currently being discussed by Parliament and submitted to the Court of Auditors for approval) requires contractors to adopt more transparent bookkeeping practices, and in particular calls for recovery of interest accrued on moneys provided by the Commission.

14.16. Given the substantial increase in financial resources decided by the budgetary authority for the programmes managed by the Commission services concerned (PHARE, TACIS, former Yugoslavia, Turkey), available staff resources are inadequate and aggravated by high turnover. This can result in the involvement of the task manager for a certain project coming to an end prior to the completion of the project itself. However, this does not mean that the monitoring and supervision of the project is abandoned by the Commission. Up to now, the Commission has chosen to give greater priority to implementing ongoing programmes than to the formal closure of completed programmes. Since the beginning of 1997, the Commission has been making systematic efforts to bring to a financial completion those programmes that have closed, as indicated by the decommitments referred to in 14.13 - 14.14.

14.17. The Commission is taking steps to ensure that the officials responsible for managing the programmes follow the implementation of individual actions, including their closure, in a more systematic way. This is being done in close cooperation with the new financial services structure created in October 1996.

Implementation of the PHARE programme

14.18. The reason there are two chapters is that the former Yugoslavia's eligibility for the PHARE programme dates back to before the conflict, but Parliament subsequently created three new budget headings specifically for the purposes of reconstruction; this necessitated the drafting of a new basic Regulation which required the Commission to manage the programmes on separate legal bases. In order to make the applicable management rules clearer and more consistent, the budgetary authority decided that in the 1997 budget both operations, i.e. post-war reconstruction and rehabilitation work under PHARE, should be brought within a single chapter. The Commission is currently aligning the management rules for these programmes.

14.19. The Commission regards such payments as definitive. The accounting system used by the Commission for PHARE is linked to the requirements of the financial regulation for all Commission accounting. In the framework of the decentralized implementation system of the PHARE programme, for the final payments made by the PMUs, an internal system does exist which measures and records the final payments made by the PMUs (PHACSY). The Commission is conscious of the need to ensure that PMU balances are not excessive. The amount transferred to the PMUs in stage payments is verified in advance by the Commission to ensure that it corresponds as closely as possible to the actual payment obligations of the PMUs, on the basis of disbursement forecasts through work programmes.

14.20. The Bulgarian banking crisis has involved the putting into receivership and launching of bankruptcy procedures for a total of 15 banks. In consequence 11 programme bank accounts have been blocked in 3 banks involving a total of approximately ECU 9,6 million including accumulated interest. Since February 1996 the Commission services have systematically and repeatedly raised the issue of the security of PHARE funds in Bulgarian banks and taken steps to reduce the balances held by insisting on further payments only being made to four designated banks which are considered sufficiently secure.

14.21. The Commission has consistently insisted with the relevant Bulgarian authorities on the Government's responsibility under the PHARE framework agreement for possible losses of advanced funds. While all Bulgarian interlocutors in the past have expressed full agreement with this position, the unfolding economic and political crisis has delayed a final resolution. However, the caretaker Government approved a bill on 12 May 1997 now pending with the newly constituted National Assembly which eventually should ensure the full return of the funds. The Commission had to proceed with caution in order not to provoke a further destabilization of Bulgaria's banking sector. Given these circumstances the Court's observation that the Commission should have issued a recovery order at that time is not appropriate, though it will consider taking such action should it prove impossible to reach a negotiated solution.

14.22. The Commission believes the temporary withdrawal of amounts for the transport programme in Bulgaria offered a way of overcoming a short-term cash-flow problem in an exceptional crisis situation. It was necessary to allow the PMUs concerned to execute payments of invoices under signed contracts and thus avoid penalizing the contractors and eventually the contracting authorities for circumstances beyond their control. The commitment of further appropriations, as suggested by the Court of Auditors, would not have been a suitable response to that situation. It would have meant a fresh round of preliminary decision-making for the operations concerned, including consultation of the PHARE Committee and conclusion of a financing agreement with the Bulgarian government. However, the Financial Controller was consulted before the transfer.

14.23. The temporary transfer represented the best solution available in the circumstances. It has now been repaid to the programme which initially advanced the funds thereby ensuring that inter-programme cash transfer has been eliminated. It should also be recalled that the Commission made clear that no further temporary transfer would be approved, and it is continuing to seek a solution to the still outstanding problem of the blocked funds.

Implementation of the TACIS programme

14.25. As noted above in connection with point 14.15(c), the proposed revision of the Financial Regulation incorporates a suitable legal framework for dealing with interest generated by funds paid to contractors.

Financial cooperation with the countries of the former Yugoslavia

14.26. There are a number of reasons why the specific reconstruction measures financed under Chapter B7-54 were slow to get under way. In the first place, the legal basis for the corresponding budget headings was only adopted in August 1996. It was not possible to mobilize the bulk of the money until then, particularly since a considerable sum had been entered in the reserve. Again, elections were held in September, the new government was formed in November and only then was it possible for an agreement to be reached (in December) with that government. As the agreement was a prerequisite for commitment of the available funds, the Commission was unable to commit the balance from the 1996 budget until the end of the year.

The Commission was aware of the problems facing the PHARE Essential Aid Programme (EAP) and decided in November 1996 to reallocate some of it to specific projects designed to improve the monitoring and effectiveness of assistance.

14.27. The Commission refers to its reply to point 14.15(c).

14.30 14.31. The Court is failing to take account of the extreme circumstances prevailing at the time the Essential Aid Programme for Bosnia was initiated. Given the amounts involved, the importance of proper controls and the complex situation in the aftermath of the conflict, it was crucial for the Commission to maintain a visible, operational presence.

The original purpose of the Commission structure set up in January 1996 was purely to monitor the programme, so it was entirely reasonable to finance it from operational appropriations. The Commission could not have used appropriations from Part A of the Budget to finance the operating expenses of a representation as this was not in existence until the Commission's decision on 24 April 1996 to open an office in Sarajevo. An advance account was opened in accordance with Article 46(2) of the Financial Regulation on 1 June 1996. This was replaced by an imprest account on 1 March 1997. In accordance with the Financial Regulation, these accounts are funded entirely by Part A6 of the Budget and the two main items in the running costs (rent and wages) have been paid for in this way since June and November 1996 respectively. The Commission's checks on these accounts have not shown any anomalies. An advance account, rather than an imprest account, is usually created when a new Representation is being set up, since at the beginning the full complement of staff is not available. An advance account is, in other respects, administered like an imprest account.

Although the initial funding arrangements were necessary in order to ensure a presence in the region at the time the operations funded by the Commission in Bosnia were beginning, the Commission accepts that their control could have been improved upon. The Commission is ready to act on the findings of the Court as well as the results of the evaluation of the EAP programme which was launched in the summer of 1997.

Conclusion

14.32. As part of the proposed reorientation of the PHARE programme, adopted by the Commission on 19 March 1997, a number of measures are being taken which are intended to reduce the backlog of budgetary commitments remaining to be contracted, including:

- a reduction in the time-limit for letting contracts from 3 years to 2 years, following signature of Financing Agreements;

- automatic adjustments in programme allocations to reflect progress in implementation;

- closure of older programmes, with corresponding decommitment of resources from the Budget.

14.33. Underutilization of payment appropriations reflects the difficulties with contracting referred to above. This will be eased by the measures referred to in point 14.32 of the Commission's reply. Establishing a budget for payment appropriations necessarily reflects a balance between (a) the need to restrict the flow of payments in order to reflect more closely the pace of implementation on the ground and (b) the need to ensure a sufficient flow of resources to sustain the reform and pre-accession process in the beneficiary states. The Commission is taking the opportunity of the reorientation of PHARE to make adjustments to the budget for the programme, within overall budgetary and political constraints.

14.34. The Commission regards the method of accounting for payments as a matter of crucial importance. Sums paid out to contractors are final payments within the meaning of Article 51 of the Financial Regulation. Once the money has been paid out it no longer forms part of the funds handled by the institution's Accounting Officer. The Commission has incorporated in its latest proposals for revision of the Financial Regulation (seventh series) the provisions necessary to allow more transparent management of funds paid to contractors responsible for administering operations funded from the Community budget. It is also looking at ways of monitoring the use of the new procedure introduced by Supplementary and Amending Budget 1/96.

OBSERVATIONS ON OPERATIONS CARRIED OUT IN THE AGRICULTURAL SECTOR IN THE CENTRAL AND EAST EUROPEAN COUNTRIES AND THE NEWLY INDEPENDENT STATES

14.39. The format of the G-24 tables was agreed upon by the Commission and the donor countries as part of the reporting system which the national authorities follow in order to provide the Commission with material necessary for the updating of assistance tables. The purpose of these tables is to provide summary information on global assistance flows and not to provide detailed statistics on specific sectoral breakdowns At the operational level, for specific sectors, on the spot donor coordination is mainly done at the level of the authorities of each beneficiary country in cooperation with the local Commission staff.

The Commission's assistance strategies

14.41. In Bulgaria, given the lack of political will from 1992-96 to privatize or support effective private enterprise competition with State-owned enterprises, as independently reported by the OECD and the EBRD, the Commission did not agree further annual PHARE agricultural assistance until there was more concrete evidence of reform and private sector development. As far as Albania is concerned, the resources were targeted on other sectors appropriate to the overall reform strategy.

Since 1995, PHARE's multi-annual programming has enabled levels of annual PHARE assistance in individual sectors, such as agriculture, to be set, reflecting absorption capacity and other factors on a year by year basis. The important considerations under the multiannual approach are the overall priority and ceiling established for each of the key sectors over the period covered by the country's multi-annual indicative programme, as agreed with the country concerned and approved by Member States. Low or zero sectoral allocations, taking account of proven absorptive capacity, can be balanced by significantly higher allocations in previous or subsequent years.

14.42. The 1992 Financing Memorandum had as its overall objective to improve the country's capacity to feed itself. Extension services were not explicitly mentioned. However, as recognized by the Court in 14.67, 'extension` is in itself a key element contributing to the development and rationalization of local production capacities. It is in line with this approach that an ECU 70 000 pilot scheme to develop the extension services was contracted under the programme. This is a particularly small amount compared to the overall allocation which was ECU 15 million. The pilot scheme, which contributed to the overall aims of the 1992 programme, was to prepare the ground for a larger project to be funded in 1993.

The 1993 programme explicitly mentioned extension services under the component 'Support for private agriculture and programme management`. The funding for the extension contracts (ECU 1 031 163) originated from the ECU 2,1 million earmarked for that component.

14.45. The Court's observation does not reflect the fact that, as from 1995, in several Central and Eastern European countries Policy Advisory Units (PAUs) have been set up which are operating effectively and are fully integrated into the respective Ministries. This is the case in the Czech Republic, Slovenia and Slovakia.

In the NIS, projects have been gradually adjusted to reflect the decision-making structure.

14.46. In Kazakhstan and Kyrgyzstan the points raised by the Court are a matter for the national authorities. The unit in Turkmenistan was not set up as originally planned. The project was retargeted and used to finance some 30 well-conceived studies which can be used to plan future reforms.

14.50. The Commission recognizes the Romanian problems in previous years of providing adequate counterpart staff or integrating PHARE support units into the Ministry of Agriculture, and the relative shortage of any official capability for appropriate programming and policy development within the Ministry.

As a result of sustained efforts by the Commission at all levels over the last two years, progressively closer physical and organizational integration of the PHARE programme and policy support into the main Ministry structure has been achieved. The most recent step was the Minister's decision in March 1997 to establish a Minister's Advisers Group reporting to him, into which the PHARE-funded PAU (to which the Court refers) has been integrated.

14.51. The PHARE Policy Advisory Unit has been heavily used by Ministers and senior Ministry of Agriculture and Food Industry officials, albeit on tasks of an ad hoc nature rather than in systematic long-term reforms. However, the main success of the project has been in identifying and training Bulgarian counterparts in appreciation of market economic principles, and in undertaking systematic economic evaluation and recommendations. Officials trained under this project have made key contributions to the previous and current Governments' policy statement on economic reform and development to 2000 and have successfully established inter-ministerial links and contacts.

14.52. Since 1996 a system has been set up in the Commission for the PHARE programme to produce systematic annual assessment reports of all ongoing programmes. The reports are circulated to the PHARE Management Committee and are used as an essential input in assessing new programmes put forward for approval. Hence, recommendations and lessons learned have been fed back to the programmes and used for future ones where relevant and possible.

It is true that a comprehensive evaluation of the PHARE and TACIS programmes in the agricultural sector has not been carried out to date. However, a number of evaluation reports have been made on agricultural components in specific countries. For example, in Czech Republic and Slovakia an 'Agricultural Sectoral Appraisal` was carried out in the first months of 1997. In Hungary it was done in 1995. A total of 19 reports covering individual agricultural PHARE programmes were prepared prior to the establishment of the monitoring and assessment system which operates since 1996.

Performance of PHARE and TACIS agricultural programmes are discussed in the PHARE and TACIS interim evaluation reports that have been transmitted to the European Parliament.

The Commission also strengthened its attention to all stages of evaluation by setting up a new Evaluation Unit in 1996. This unit is within the DG IA Directorate for Financial and Human Resources, established in October 1996 in the context of the SEM 2000 initiative.

Finally, a comprehensive TACIS agricultural sector evaluation is foreseen in the 1997 workplan of the Evaluation Unit.

Land-reform programmes

14.54. To enable a land market to develop, important changes had to be made to the 1991 Romanian legislation. The changes were identified by experts financed from the 1991 PHARE assistance programme.

Confirmation from the Ministry of Agriculture PAO that it had completed all its adoption procedures was not received by the Commission until the end of November 1995.

14.55. Towards the end of 1993 and subsequently, a wide range of computerized surveying equipment became available which incorporated electronic measuring capabilities in addition to other surveying functions. The expected demand from Bulgarian land surveying companies to lease electronic distance meters did not materialize. The equipment remains the property of the Bulgarian agency which remains accountable for the value of the equipment supplied.

14.56. Although Czech and Slovak Republics started the implementation of the Land Register Programme very slowly, the support of Technical Assistance provided under the PHARE programme allowed projects to be running within an acceptable timetable and funds will be committed for both countries under the respective Financing Memoranda.

14.57. PHARE in Poland has not yet been able to modernize the land and buildings register because the institutional framework was not appropriate. However, this changed on 1 January 1997, when the Polish authorities, as part of their public administration reform programme (itself a PHARE project), established the Central Geodesy, Cartography and Land Register. This authority, which has been the subject of long-standing demand by PHARE, has been established along the lines of the Czech model.

Much still remains to be done regarding the legal framework as this is a highly political issue, especially in relation to the acquisition of land by foreigners. Indeed, the 1992 Land Info System programme encountered difficulties because of the Ministry of Defence's objections to aerial photography by foreign firms with the result that PHARE tender rules, permitting EU companies to tender, could not be applied. These difficulties were resolved in early 1995. The aerial photography campaign is progressing as planned and will be completed this year. In this respect, good weather conditions are the overall constraint, since it determines the quality of the pictures.

Restructuring and privatization programmes

14.60. The Commission agreed to support an agricultural privatisation sub-programme as part of the first substantial agricultural assistance programme (mainly supply of goods) developed in late 1990/early 1991 in response to the economic instabilities and policy uncertainties arising from the fall of President Ceausescu and the communist regime in Romania. At the time, there was no evidence to suggest that adoption of a central policy on privatization would be a low priority for Government.

As a result of sustained Commission exchanges with the Romanian government coalition in office until the end of 1996, commitment to effective privatization increased significantly. Major contracts for privatization of poultry and pig enterprises and training of management in market economy principles and operations were awarded in 1996. The results of these contracts enabled the new Government to make major privatization commitments in the overall reform policy and targets announced by the Prime Minister in February 1997.

Boosting investment in the agro-industrial sector

14.76. Although the 200 studies referred to were not directly used for privatization at the time they were undertaken, the assistance has contributed significantly to the policy decisions and privatization lists announced in 1997 by the interim and the new Government of Bulgaria. State-owned agro-industries already privatized or included in the first tranches of mass commercial privatization were included in the studies referred to above.

14.77. TACIS has in fact anticipated the Court's suggestion in the form of two projects (1995: support to the agro-industrial reform at oblast level; 1996: adapting beef and dairy farming to restructuring) from the Russia programme. Both projects are designed to multiply and disseminate the results of earlier operations.

The first of the two projects got under way at the beginning of 1997, and the second had reached the invitation-to-tender stage by June.

It is not up to the Commission alone to dictate priorities for the TACIS programme. These emerge from negotiations with the beneficiary country's authorities and therefore reflect their own economic and political strategy choices as well.

14.80. No conclusions can be reached about the value of the component for agro-industrial companies until we see the outcome of the negotiations with foreign investors which are still going on, particularly regarding the need for insurance to minimize the risk to which foreign investment is exposed.

Lines of credit

14.83. In the case of Poland, the agricultural credit line was indeed slow to start. The reasons for the slow start should not only be attributed to competition from other (subsidized) loans but mainly to the lack of interest and the highly inefficient banking system in Poland in the early days of the transition process. The project can now be considered a success, albeit with a long gestation period, since more than 1 000 farmer credits had been provided by the end of 1996, when the credit line was completed.

14.84. The final legal problems encountered in 1996 with the Agricultural Capital Fund Scheme in Bulgaria were resolved by the Government of Bulgaria following high level representations by the Commission. The first loans under the scheme were approved in February 1997. In June 1997, despite the economic uncertainties in Bulgaria, approximately 800 loans had been approved for a mixture of capital investment and short-term production financing.

14.85. In a joint effort with the PHARE PMU, the Commission monitored the credit lines developments. Specific technical assistance was mobilized to advise the RCA Credit Unit. In addition, the Commission decided at the end of 1994 to organize an in-depth assessment of the financial status of the RCA with particular emphasis on problem loans to assess the difficulties encountered and to prepare the remedial actions required. The mission was conducted in February 1995 with a first report in March 1995. Following this report, the Commission requested all the credit lines to be suspended until a Memorandum of Understanding detailing the new lending and monitoring procedures was signed.

14.86. Anticipating rapid progress with land privatization, the technical assistant suggested that the main requirement was for small-scale machinery. The Albanian authorities, however, realized that subdivision of large holdings would take longer than expected and argued for larger machines. A compromise was reached between the authorities and the experts and the tractors finally supplied were considered at the time to best suit the country's requirements.

14.88. The Court's comments on lack of coordination with projects to support reform of the banking system mainly apply to the project planning stage and reflect difficulties at the time of project identification in 1992. During the implementation stage the consultant did attempt to improve matters by contacting the Bank Training Institute in St Petersburg, which was involved in another project, but it unfortunately proved impossible to establish an effective link between the projects.

A feasibility study was carried out for an agricultural guarantee fund, but two prerequisites for such a scheme were lacking: participation by other local banks, and adequate technical assistance. The EBRD also declined a request to grant a credit line to Petroagroprombank; this could have tied in well with the guarantee fund, but the EBRD felt the beneficiary bank's own resources were inadequate for such an operation.

Conclusion

14.89. The Commission concurs with the Court's observation. Assistance can only have a full impact when it fits into the reform policies of the beneficiary country. In the cases cited by the Court, delays or reluctance on the part of the beneficiary country to fully embrace the reform process have usually been the root cause of the lack of progress.

14.90. Land rights, registration and market reform are all-important, particularly in the context of accession, and PHARE support has been provided for such activities. The rate of progress depends in large part on the reform process in the partner states.

14.91. In the case of Bulgaria the problem with food supply was primarily caused by the lack of market economic reform. Investing in the revitalization of agriculture might have the effect of postponing such reform.

14.92. In other cases, not cited by the Court, projects have produced good results. For example, in Hungary two large projects to develop rural credit have been very successful, taking full account of the legislation/banking framework - the Rural Credit Guarantee Fund and the Agricultural Credit Channels.

14.95. In particular cases, PHARE has been able to achieve synergy with other financial institutions where conditions were appropriate. For example, in Poland, PHARE has not funded the privatization of agro-industrial enterprises as a stand-alone project. PHARE funding in this respect was devoted to preparatory work for privatization of such enterprises, as part of its Enterprise Restructuring and Privatization programme. The programme was implemented in close consultation with the World Bank which was funding the capital needed for the subsequent restructuring or privatization. More recently PHARE cooperated with the EBRD, first through the Bad Debt Work Out project and more recently through the SRP programme.

14.96. It is true that a comprehensive evaluation of the PHARE and TACIS programmes in the agricultural sector has not been carried out to date. However, a total of 19 evaluation reports covering individual agricultural PHARE programmes were prepared prior to the establishment of the monitoring and assessment system which began its operations in 1996. For example, the evaluation in Hungary was done in 1995. In the Czech Republic and Slovakia an 'Agricultural Sectoral appraisal` was carried out in the first months of 1997.

Interim evaluations of the PHARE and TACIS programmes as a whole have been transmitted to the European Parliament and the management committees in which the Member States are represented. The PHARE interim evaluation is based on more than 80 evaluations and assessments which have been carried out to date. The TACIS interim evaluation is based on the monitoring reports which are regularly prepared concerning all major TACIS actions and projects. It is expected that both reports will indicate areas in which more focused evaluations could be carried out. This will be taken into account in the evaluation programme currently being implemented, under which a series of ex post and intermediate sectoral and country evaluations are being undertaken.

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B7-50 - Implementation of commitments by month

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B7-50 - Implementation of payments by month

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B7-52 - Implementation of commitments by month

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B7-54 - Implementation of commitments by month

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B7-54 - Implementation of payments by month

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Table 14.3.1 - Commitments outstanding under the PHARE programme (B7-500 and B7-502)

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Table 14.3.2 - Commitments outstanding under the TACIS programme (B7-520 and B7-521)

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Table 14.3.3 - Settlement of commitments under the PHARE programme (B7-500 and B7-502)

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Table 14.3.4 - Settlement of commitments under the TACIS programme (B7-520 and B7-521)

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PART VI Administrative expenditure

INTRODUCTION

VI.1. The personnel and administration expenditure of the European Communities is shown in the sections of the general budget concerning the European Parliament, the Council, the Commission (including the Office for Official Publications), the Court of Justice, the Court of Auditors, the Economic and Social Committee and the Committee of the Regions.

VI.2. The administrative expenditure for the financial year 1996 is set out by section in Table VI.1. Tables VI.2 and VI.3 detail the staff situation by institution and workplace.

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CHAPTER 15(535\*) The Commission

15.0. CONTENTS Paragraph reference

General subsidies (Title A-3 of the budget)

Introduction 15.1.1 - 15.1.5

Legal and regulatory situation 15.1.4

Management of subsidies by the Secretariat-General of the Commission 15.1.6 - 15.1.18

Compliance with criteria for granting subsidies 15.1.7 - 15.1.11

Repetitiveness of the subsidies 15.1.12

Evaluation of the use of subsidies 15.1.13 - 15.1.14

The implementation of audits 15.1.15 - 15.1.18

Administrative subsidies 15.1.19 - 15.1.22

Conclusion 15.1.23 - 15.1.24

Office for Official Publications of the European Communities (Article A-342 of the budget of the Commission and Annex II thereto)

Introduction 15.2.1

Financing the EUR-OP 15.2.2 - 15.2.14

Financial resources available to the EUR-OP 15.2.2 - 15.2.4

The presentation of the budget 15.2.5 - 15.2.6

Insufficient appropriations 15.2.7 - 15.2.9

Re-use of revenue 15.2.10 - 15.2.12

The presentation of the accounts 15.2.13 - 15.2.14

Financial management 15.2.15 - 15.2.21

Management of the liquid assets in the Revolving Fund 15.2.15 - 15.2.16

Banking operations 15.2.17 - 15.2.19

Collection of revenue 15.2.20 - 15.2.21

Production of the Official Journal 15.2.22 - 15.2.32

Printing the Official Journal 15.2.22 - 15.2.29

Other activities involving the Official Journal 15.2.30 - 15.2.32

The sale of publications 15.2.33 - 15.2.51

The price of the Official Journal 15.2.34 - 15.2.37

Distribution of other publications 15.2.38 - 15.2.43

Sales through agents 15.2.44 - 15.2.49

Marketing strategy tools 15.2.50 - 15.2.51

Conclusion 15.2.52 - 15.2.55

Decentralized Community bodies

Introduction 15.3.1 - 15.3.3

Rules of procedure 15.3.2 - 15.3.3

Presentation of the budget 15.3.4 - 15.3.7

Accounting systems/analytical accounts 15.3.8 - 15.3.12

The Financial Controller 15.3.13 - 15.3.15

Conclusion 15.3.16 - 15.3.17

Joint Sickness Insurance Scheme

Introduction 15.4.1 - 15.4.4

Scope of the audit 15.4.2 - 15.4.4

Organization and operation of the Scheme 15.4.5 - 15.4.15

Principles of organization and operation 15.4.5 - 15.4.7

Allocation of responsibilities within the Scheme 15.4.8 - 15.4.9

Composition and role of the Management Committee 15.4.10 - 15.4.11

Organization and role of the Central Office 15.4.12

Organization and operation of settlements offices 15.4.13 - 15.4.14

Supplementary cover for members' spouses in certain cases 15.4.15

Financial and accounting management 15.4.16 - 15.4.29

The Scheme's financial situation 15.4.16 - 15.4.24

Cost of operating the Scheme 15.4.25 - 15.4.29

Accounting and financial organization 15.4.30 - 15.4.57

Organization of the accounts 15.4.30 - 15.4.49

Internal control and financial control 15.4.50 - 15.4.57

Conclusion 15.4.58 - 15.4.65

General subsidies (Title A-3 of the budget)

INTRODUCTION

15.1.1. The observations set out in this Report cover subsidies under Title 3, Chapter A-30, of the budget (Community Subsidies). The Commission is the authorizing officer for these subsidies and their management is entrusted to its Secretariat-General.

15.1.2. The expenditure provided for in the 1995 budget for Chapter A-30 amounted to 16,1 Mio ECU. The audit concerned the following budget headings (amounts entered in the 1995 budget):

(a) A-304 'Subsidies to organizations advancing the idea of Europe`: 4 Mio ECU;

(b) A-306 'Town-twinning schemes in the European Community`: 3,5 Mio ECU.

15.1.3. For the financial year 1996, the appropriations allocated for this purpose amounted to 4,5 Mio ECU for 'subsidies to organizations advancing the idea of Europe` (Items A-3020 and A-3030) and to 7,5 Mio ECU for town-twinning schemes (Item A-3021).

Legal and regulatory situation

15.1.4. For the most part, the subsidies under Chapter A-30 represent the equivalent in terms of budget headings of the statements of principle and political resolutions of the European Parliament and the Council.

15.1.5. The Secretariat-General had laid down and formalized a number of rules for granting subsidies. The implementation of these rules and the results obtained were audited in the course of the financial year 1996 for the above items of expenditure via both an examination of files and an assessment of the results of the measures financed in this way.

MANAGEMENT OF SUBSIDIES BY THE SECRETARIAT-GENERAL OF THE COMMISSION

15.1.6. There were no major findings with regard to the management of Article A-306 (Aid for town-twinning schemes), as this type of subsidy involves the targeting of eligible expenditure and an objective evaluation of aid by the departments. The audit of a sample of Article A-304 subsidy files (organizations advancing the idea of Europe) calls for some comments on the shortcomings of the current system.

Compliance with the criteria for granting subsidies

15.1.7. As the Commission often has a hand in the budgetary authority's decisions with regard to the choice of the beneficiary bodies and the amounts to be granted, its room for manoeuvre or discretion meant that it had to apply strictly the criteria laid down for granting this type of subsidy(536).

15.1.8. However, the Court's findings cast doubts on the Commission's compliance with the rules for granting subsidies provided for in Article A-304. Thus, one association endowed with a significant subsidy (400 000 ECU in 1995) appears regularly in the Community budget, but the Court's examination of its utilization of these funds showed that they were administered primarily for internal purposes, without the measures that were carried out having any impact on European citizens.

15.1.9. A second organization was also included by the budgetary authority as from the financial year 1993, although its activities (environmental protection) fell 'explicitly under the responsibility of another Commission department` (537).

15.1.10. One association had been receiving a small subsidy of 5 000 ECU since 1987 to encourage its activities in favour of European integration. In 1994, it received a subsidy of 30 000 ECU, including 24 000 ECU to finance the launching of a weekly newsletter in French and, in 1995, it received a further 30 000 ECU for the same purpose despite the fact that 'all requests concerning study, translation and publication costs are not eligible` (538).

15.1.11. In another case, an association initially financed under Article A-307 (subsidies to higher education institutions) to the extent of ECU 25 000, received 30 000 ECU in 1993 and 1994 under Article A-304 (organizations advancing the idea of Europe) even though the criteria for granting subsidies under Article A-304 excluded 'expenditure for studies, expertise, translations or publications`. In addition, the supporting documents for the utilization of the first subsidy had not been produced as required specifically by the rules for granting the subsidies(539).

Repetitiveness of the subsidies

15.1.12. The same beneficiaries were met with over several successive financial years engaged in activities that remained identical and whose impact was not assessed. In particular, administrative subsidies, which take up a very large share of the appropriations under heading A-304, have, for several years, been allocated to a number of associations, movements and federations responsible for promoting projects with European aims.

Evaluation of the use of subsidies

15.1.13. In the absence of a suitable computer programme, the Secretariat-General only asked for supporting documents once a year - generally in July or August of the financial year following the one in which the subsidy was allocated. The three-month deadline provided for this purpose was thus not being complied with and some files were held up for several years, and could not be closed for want of more systematic reminders.

15.1.14. The financial and accounting documents produced by the bodies in receipt of subsidies seldom proved to be useable for audit and assessment purposes because the allocation of the subsidy was usually not separated from the accounts as a whole, in the absence of a satisfactory definition of the eligibility of the expenditure covered by the subsidy in question when the funds were allocated.

The implementation of audits

15.1.15. The Commission's audits, which were specifically required under the granting conditions, were formal in nature and inadequate for administrative subsidies, which require not only detailed verification of the supporting documents, but also periodic on-the-spot checks.

15.1.16. As a result, the assessment report produced for the Parliament in 1995 in respect of the financial year 1994 is superficial and does not include any form of assessment. Rather, it is a catalogue of subsidies allocated which does not enable the reader to measure 'the cost-effectiveness of the various activities financed`.

15.1.17. The lack of a centralized file of all the recipients of Community subsidies (necessary in order to avoid, in particular, double financing) makes it impossible at present, for any given body, for the Commission departments concerned to obtain a documented listing of all the aid received or being received by that body.

15.1.18. For example, a Commission audit concerning the utilization of subsidies under Article A-304 in 1993 and 1994 by a large organization showed that another subsidy of 200 000 ECU allocated in 1994 by DG X (Information, Communication, Culture and Audiovisual Media) had overlapped with the Article A-304 subsidy. In actual fact, some of the expenditure that should have been covered by the DG X subsidy was being met out of the administrative subsidy allocated to the organization in question.

ADMINISTRATIVE SUBSIDIES

15.1.19. The three associations that used up the most appropriations were audited on the spot, because, out of a total of 83 files, they alone represented more than a quarter of the appropriations granted (i.e. 775 000 ECU out of 2 842 500 ECU in 1995).

15.1.20. In these cases the audit was of administrative subsidies sometimes covering more than 80% of the expenditure under the budget of the association concerned. These subsidies enabled them to recruit and remunerate their employees, choose their premises, buy the computer and office equipment necessary for administration purposes and cover almost all of their administrative expenditure. Only some of the funds were directly allocated to activities or programmes corresponding to the purposes of the subsidy.

15.1.21. A share of the subsidy was used by these associations to constitute funds to cover legally required social obligations - redundancy pay in particular - in the event of the association being wound up.

15.1.22. Either there should be no participation in administrative expenditure at all or a suitable ceiling in relation to the total expenditure of the bodies concerned should be set when the subsidy is granted.

CONCLUSION

15.1.23. When the files are being appraised an attempt should be made at a better definition of the allocation of the subsidy in question and at a clear demarcation of the fields of expenditure and the range of activities that are eligible for Community financing:

(a) the rules and criteria for granting subsidies must be applied strictly on the basis of objective criteria. Exceptions to these rules and criteria should be justified in terms of the actual value of the programme or activity of the association in question for European integration;

(b) for the highest or most repetitive subsidies, the financing of administrative expenditure must be limited to a maximum rate (to be laid down). Furthermore, such expenditure should only be funded insofar as there is a direct link with the aim of the project or the activities of the beneficiary organization;

(c) where the subsidized expenditure is significant in terms of its kind or size, the accounts produced by the organizations concerned should be certified by independent auditors.

15.1.24. The Commission should also develop its machinery for both documentary and on-the-spot audits so as to make the beneficiary organizations aware of the need to manage the subsidies received with the necessary discipline.

Office for Official Publications of the European Communities (Article A-342 of the Commission budget and Annex II thereto)

INTRODUCTION

15.2.1. The task of the Office for Official Publications of the European Communities (EUR-OP) is to receive all Community documents that are for publication and print them under its own direct or indirect responsibility. It is also responsible for the sale and actual distribution of publications.

FINANCING THE EUR-OP

Financial resources available to the EUR-OP

15.2.2. Table 15.2.1 shows the financial resources corresponding to the EUR-OPs field of intervention. In the first place, this means its operational budget, which comes under Article A-342 of Commission's budget and is given in detail in an annex.

15.2.3. In order to help it cope with the expenditure involved in producing the Official Journal, a long-term revolving Fund was set up a long time ago even though such a device is not expressly provided for in the Financial Regulation (see Title XII of the Financial Regulation). All the institutions contribute to this Fund and it is managed by the EUR-OP.

15.2.4. The EUR-OP is also responsible for the technical supervision of the printing of various publications produced by the institutions. Its involvement (inter alia in the preparation of purchase orders and contracts) does not, in any way, release the institutions concerned from their responsibility as authorizing authorities for the expenditure in question.

The presentation of the budget

15.2.5. In contrast to the provisions of the Financial Regulation(540), the notes concerning the budget heading under which the total appropriations for the EUR-OP are entered no longer include an estimate of the cost of its services broken down by institution.

15.2.6. The entry in each institution's budget of pro forma appropriations was discontinued in 1990, but this was not followed by an amendment to the Decision setting up the EUR-OP.

Insufficient appropriations

15.2.7. The EUR-OP's operational appropriations are supposed to cover all its financial needs. The definitions of the tasks entrusted to the EUR-OP show which activities are to be covered by its own budget and which should be charged to the institutions.

15.2.8. Over the years, the volume of work entrusted to the EUR-OP by the institutions has grown without there being any corresponding increase in its operational budget. The institutions' budgets now bear the cost of work which ought, as was formerly the case, to be financed from the EUR-OP'S operating budget.

15.2.9. This development has had the following negative consequences:

(a) it is up to the EUR-OP alone to decide whether such expenditure should be charged to the institutions;

(b) the Decision setting up the EUR-OP is no longer being complied with where distribution work, for which there is no provision for subcontracting, is concerned;

(c) a form of indirect financing of work previously done by the EUR-OP has been created; and

(d) it has become almost impossible to assess its real running costs.

Re-use of revenue

15.2.10. The distribution of the Official Journal and the other publications produces income which may be re-used. The net proceeds of sales (a notion that has never been defined) must be paid over to the institutions.

15.2.11. The notes to Article 240 of the EUR-OP's budget ('postage and delivery charges`) show that a deduction is made from sales revenue as a flat-rate contribution towards the distribution of the publications that are sold (5,9 Mio ECU) and that the EUR-OP invoices the institutions for some of its services (5,7 Mio ECU).

15.2.12. The first case is a 'generous` interpretation of the concept of re-use. The Financial Regulation states that such sums must be recredited to the budget heading used to finance the initial expenditure. In the latter case, various EUR-OP regulations contain provisions opposed to such practices, in particular the principle of pro forma re-invoicing. This provides an illustration of the fact that the existing legal framework is no longer suited to the EUR-OP's financing needs.

The presentation of the accounts

15.2.13. For Article A-342 of the Commission's budget (Publications Office), the revenue and expenditure account relating to operations under the budget for the financial year 1996 shows the appropriations available as revenue for re-use (13,70 Mio ECU) and how they were used.

15.2.14. No detailed data on re-use at the EUR-OP is to be found in this revenue and expenditure account. This makes the accounts, which were undervalued by the same amount, less representative than they could be and contravenes the Financial Regulation, which requires the financial data to be presented in exactly the same way as the Commission's. This shortcoming had not been made good when the EUR-OP's Annual Report was drawn up.

FINANCIAL MANAGEMENT

Management of the liquid assets in the Revolving Fund

15.2.15. The payments carried out in 1996 amounted to 117 Mio ECU. An account, managed jointly with the Commission's accounts departments, was opened at a bank in Luxembourg. The balance of this account in the EUR-OP's favour varied greatly, ranging in general between 5 Mio and 10 Mio ECU. The interest earned (353 249,86 ECU) was duly paid over to the institutions.

15.2.16. The part of the accounts system (Jocomp) that was used for monitoring the Official Journal in respect of the bank account was unsuited to management needs. It was not possible to reconcile the balance displayed by this system with that appearing in the daily bank statement. The only monitoring of the current account that occurred was carried out outside the accounts. This implies an urgent need to review the banking side of the Jocomp accounting system. Overall, this system did not allow effective management.

Banking operations

15.2.17. For the purpose of collecting sales revenue, the EUR-OP opened at least one bank account in each Member State, in the interest of equal treatment. No invitation to tender was issued before the opening of the various bank accounts (collection of sales revenue and Revolving Fund).

15.2.18. The EUR-OP did not negotiate the conditions applying to its bank accounts and does not carry out any checks of the calculation of interest.

15.2.19. During a previous audit, the Court(541) had noted that a member of the accounts department had made fixed-term investments of the EUR-OP's liquid assets by telephone, without any formalities or checks. Since then, the procedure for investing funds has remained unchanged.

Collection of revenue

15.2.20. The contracts with the EUR-OP's agents for the distribution of the publications do not mention any rules concerning the means of payment. The invoice form, which is used for both agents and direct sales, states that payments must be carried out by bank transfer, credit card or cheque.

15.2.21. In 1996, payments by cheque amounted to approximately 5 Mio ECU, or 25% of all sales income. The procedures for collecting and cashing cheques must be re-examined in order to provide a suitable degree of security and control. The possibilities offered by other means of payment need to be examined (mainly in respect of relations with the sales agents) with a view to reducing the number of payments by cheque.

PRODUCTION OF THE OFFICIAL JOURNAL

Printing the Official Journal

15.2.22. The Official Journal (L, C and S series) and the budgetary documents are produced by external printers who work in close cooperation with the EUR-OP.

15.2.23. The EUR-OP has signed four printing contracts (shown in Table 15.2.2), and these represent approximately 50% (i.e. 60 Mio ECU out of 117 Mio ECU) of the Official Journal's 'external` production expenses. The data concerning the production of the Official Journal are set out in Table 15.2.3.

15.2.24. A competitive bidding procedure, in the form of four restricted invitations to tender, was launched in July 1993 (publication of the contract notice in the S Official Journal) and was completed in March 1994.

15.2.25. Table 15.2.4 shows the procedure for the awarding of the contracts. The four main contracts, for the daily edition of the Official Journal and the production of budgetary documents, were allocated to the previous contractors. In one case, the firm that had submitted the lowest tender (which had occasionally published the Official Journal) was rejected after a check of its technical capabilities. The tape containing the data to be set in type for the verification test was the same one that was used for the printing of the 'S` series of the Official Journal and was produced by a company controlled by the previous successful tenderer for the contract, which raises competition problems. This latter company was warded the contract at a cost that was 20% higher.

15.2.26. The competitive bidding procedure did not allow for the possibility of reducing offers in the event of the awarding of several contracts to the same firm.

15.2.27. Certain 'minimum` technical conditions laid down in the contract notice and required for admission to the competition limited participation de facto to the EUR-OP's usual contract holders. This was mainly true of the clause which required prior experience in 'daily press` printing, involving 'automatic synoptic typesetting in the nine Community languages on the basis of SGML files delivered by file transfer via the EUR-OP's computerized editorial system`.

15.2.28. Certain parts of the contract notice and the specifications were such as to allow only past contract holders to understand the quantity-related savings allowed by the contract. The average number of pages envisaged in the specifications was considerably lower than both the number printed at the time of the call for tenders and the level that could be forecast on the basis of past experience and the budget appropriations requested.

15.2.29. Finally, the required production deadlines, arising from the constraints of the distribution of the Official Journal, were such that the contracts were limited to firms situated near the EUR-OP's head office.

Other activities involving the Official Journal

15.2.30. For the production of the Official Journal, in particular the S series, the EUR-OP also uses other external firms. This subcontracting of data-processing activities is in contradiction of the Decision laying down the EUR-OP's role, which has not been adapted to modern realities.

15.2.31. These operations were carried out by two specialized firms, which, in 1996, received payments amounting to ECU 25 Mio, or 21% of the Official Journal's total 'external` production costs (117 Mio ECU).

15.2.32. In this case too, the contracts were awarded to firms that were already providing the same services, after only one legally valid tender had been submitted. There are financial links between these firms and the printers of the Official Journal. Overall, the volume of business entrusted to two industrial groups represents 68% of the 'external` production costs of the Official Journal.

THE SALE OF PUBLICATIONS

15.2.33. In 1996, revenue from the sale of publications amounted to ECU 23,3 Mio, to which 0,4 Mio ECU in bank interest should be added.

The price of the Official Journal

15.2.34. The Management Committee is responsible for establishing the sales price of the Official Journal (subscriptions and single issues). The same applies to most of the electronic products marketed by the EUR-OP.

15.2.35. In order to save money, and also for organizational reasons, the pricing policy tries to encourage subscriptions as opposed to the sale of individual issues. Table 15.2.5 shows the distribution conditions of the Official Journal, by type of subscription. In 1996, a joint subscription to the L and C series cost 635 ECU (or 0,0154 ECU per page). On the other hand, purchasing the same issues individually would have cost 8 819,50 ECU (0,214 ECU per page) - 14 times more expensive.

15.2.36. The method followed has produced very high prices for certain issues which, because of the subjects covered, could enjoy broader readerships. Table 15.2.6 shows some examples that were found in 1996. It must be stressed that the issues in question were printed individually, and therefore more cheaply than the daily edition.

15.2.37. The main step taken by the EUR-OP to cope with this problem (in 1994) was to accede to a request from the Commissioner responsible, to reduce the price of the edition containing the general budget by about 50%.

Distribution of other publications

15.2.38. The selling prices of other publications is set by the authorizing officers, on the basis of proposals from the EUR-OP.

15.2.39. For reasons concerning the qualitative image of its publications, the EUR-OP follows a pricing policy which results in prices that seem high in relation to the intrinsic cost of the publications. In general, the selling price put forward by the EUR-OP to the authorizing officers is about three to four times the external production cost. Such proposals are normally accepted.

15.2.40. A proportion of the print-run, varying between 60 and 90%, is not intended for sale and is distributed free of charge by the authorizing departments themselves.

15.2.41. The products marketed by the EUR-OP are intended for a specialized and limited readership. The existence of a double distribution network is well known and means that readers first try to obtain the publications free of charge. The publications in question are relatively expensive for those readers who are unaware of the double distribution network.

15.2.42. It is possible to obtain publications from the authors free of charge and then market them. There is no mention on EUR-OP publications distributed free of charge of the fact that they are available. For example, in 1990, one of the EUR-OP's official dealers asked for (but did not obtain) reimbursements for unsold publications that he had not ordered from the EUR-OP.

15.2.43. The EUR-OP should make the authorizing officers more aware of situations of this kind, propose alternative solutions and request verification of the strict application of the rules on free distribution, so as to reduce the risk of a disruption of the paying market and limit attempts at fraud.

Sales through agents

15.2.44. For the purpose of distribution of paper publications, the EUR-OP uses a network of 43 agents, 21 of which are situated in the Member States.

15.2.45. In 1993, the EUR-OP gave up the practice of leaving the goods on consignment with the agents in favour of a policy of 'sale or return`. The terms of payment granted (six months) make this system similar to leaving the goods on consignment.

15.2.46. The EUR-OP gives its agents a 25% discount on subscriptions and 60% on individual publications. In the latter case, if it were to apply a discount similar to that granted by other comparable international organizations (about 15% lower), its revenue would increase by approximately 0,7 Mio ECU.

15.2.47. In addition to this discount, there is also a second one of 2% for the promotion of the publications. An amount of approximately 1,1 Mio ECU was available for the financial year 1996, half of which came from previous years. Only 13% of the amount available and 25% of the income for the financial year was actually used (0,1 Mio ECU).

15.2.48. One of the EUR-OP's tasks is to promote sales. The Regulations provided for the charging of the corresponding expenditure to the EUR-OP's budget and a specific heading was created for this purpose. As the amounts deducted under the second discount were a part of net sales proceeds, they should have been transferred to the institutions.

15.2.49. The EUR-OP's monitoring of the use of liquid assets for the purpose of sales promotion is quite inadequate. Certain errors were discovered. The efficacy of its measures and the regularity of expenditure could not easily be assessed.

Marketing strategy tools

15.2.50. A sound editorial strategy and the sound allocation of resources require quick feedback to authors. The only regular and complete information provided by the EUR-OP is a statement of sales revenue per title.

15.2.51. Because of the administrative procedures and terms of payment granted, eight months at least elapse between the placing of the order and when the author is informed. The introduction of a DP tool aimed at improving the administration of orders and the notification of authors has been planned for some years, but it is not yet fully operational.

CONCLUSION

15.2.52. The Regulations governing the EUR-OP, in particular with regard to financing methods, are not being applied systematically and contain inconsistencies. They are no longer suited to current operating conditions, the broader scope of its activities and industrial and commercial character. None of the proposals being studied to adapt its budgetary status to its needs has yet come to fruition.

15.2.53. A body invested with an industrial and commercial role should be required to present a complete operating account and balance sheet that are representative of all its activities. Financial information is presented in a fragmentary way, which makes it impossible to appraise the real dimensions of the EUR-OP's economic activity - an essential aspect of any publication policy.

15.2.54. A substantial share of this activity is subcontracted, in compliance with only the formal aspects of competitive bidding procedures. No assessment could be made of their real effectiveness. The changes called for by the Court(542) have not been introduced.

15.2.55. Even if profitability cannot be an absolute requirement, in particular with regard to the publication of legal acts, a clearer distinction must be made between publications pertaining to the Communities' information policy and those for which a more efficient commercial policy should be introduced. Market conditions cannot be improved as long as there is still a significant volume of publications that are distributed free. This makes it impossible to review the EUR-OP's commercial strategy with regard to its policy on sales to the public, the discounts granted to its agents and the efficiency of its network.

Decentralized Community bodies

INTRODUCTION

15.3.1. The Decentralized Community bodies(543) (DCBs) are specifically audited by the Court with regard to each budgetary year. The aim of the relevant audit reports is to enable the budgetary authority to give discharge in respect of the implementation of the budget. Some general observations regarding the activity of these decentralized bodies are given below. More detailed comments are given in the annual audit reports that are sent to each DCB, the Commission and the budgetary authority.

Rules of procedure

15.3.2. Even though each agency was able to lay down its own rules, there are still some fields where the application of the general or individual Financial Regulations and the provisions of the body's internal regulations was found not to be complete. This may apply to the field of administrative organization (creation of an Advisory Committee on Procurement and Contracts (ACPC)), or that of budgetary implementation (presentation of supplementary and amending budgets, the entry of revenue in the accounts).

15.3.3. Moreover, the presentation of the accounts (the balance sheet and revenue and expenditure accounts) of the various agencies has not been standardized. Moreover, in certain cases, internal financial provisions have not yet been adopted.

PRESENTATION OF THE BUDGET

15.3.4. The DCBs received subsidies from the Commission. These subsidies, which are shown in part B of the Commission's budget, are presented as differentiated appropriations. At present, the available appropriations are entered in the agencies' budgets as appropriations that can be used on an annual basis.

15.3.5. However, certain agencies carry out their activities in Member or non-Member States on the basis of multi-annual programmes. For this reason, it would be desirable for the presentation of their budgets to be amended so as also to allow available resources to be used on the basis of programmes of activities that are to be implemented over several years.

15.3.6. In one particular case (the European Training Foundation in Turin), it was noted that an annual amount of about 200 Mio ECU that had been received from the Commission for the administration of programmes, mainly in Eastern European countries, had not been included in the budget of this agency as revenue.

15.3.7. The agencies continued to carry over a large share of their appropriations. The percentage of appropriations carried over was still high (between 22 and 45% of their budgets). This illustrates the advisability of making adequate budget estimates. Where necessary, a supplementary and amending budget should be drawn up.

ACCOUNTING SYSTEMS/ANALYTICAL ACCOUNTS

15.3.8. The agencies use two accounting systems. One records budget entries and the other records general accounts entries.

15.3.9. The system used for the budgetary accounts is not really accounting software but an application which allows ex post modifications. In certain agencies, a computer link with the general accounts system is not possible. Lastly, a potential shortage of appropriations cannot be detected by the system itself, which means that the agencies are liable to spend in excess of their available appropriations.

15.3.10. In its turn, the general accounts system used in almost all the agencies is, overall, limited and insufficient and cannot be integrated into the budgetary management.

15.3.11. Despite a joint effort on the part of the agencies to acquire software suited to their needs, no satisfactory solution has been found. Several years after the start of operations of most of these agencies, the systems in place still do not allow satisfactory monitoring of the various operations concerned.

15.3.12. Furthermore, the agencies should create more complex systems, including analytical accounts. In the interests of sound financial management, these must be such as to make it possible to compare the real cost of all the work or projects carried out.

THE FINANCIAL CONTROLLER

15.3.13. The uniform application of the Financial Regulation which is required of all the agencies, cannot be fully achieved if the Financial Controller is not present on the spot.

15.3.14. Where the agency's Financial Controller was the Commission's Financial Controller, the Court noted that he was not regularly present, which therefore did not allow effective management, in particular given the long delays in the regularization of imprest accounts (accounting for from 45% to 61% of the budgets) and certain cases where the ceilings on such accounts had been exceeded.

15.3.15. For certain agencies, the limited number of transactions and available manpower do not justify the continuous presence of a Financial Controller. One possible solution to such problems would be for the Commission to appoint Financial Controllers for given areas or even itinerant Financial Controllers.

CONCLUSION

15.3.16. There are still some operational problems in the DCBs. The most important ones concern the presentation of their budgets, their accounting systems and internal control.

15.3.17. In order to improve the management of the DCBs after their opening phase, they need to cooperate with the Commission, whilst still maintaining their independence. This is an unavoidable necessity, particularly given the significant development of these bodies in the years to come.

Joint Sickness Insurance Scheme

INTRODUCTION

15.4.1. The object of the Joint Sickness Insurance Scheme of the European Communities (JSIS) is to guarantee to persons covered by it the reimbursement of expenses incurred as a result of illness, accident or confinement and the payment of an allowance towards funeral expenses. The legal basis for it is contained in Article 72 of the Staff Regulations of officials of the European Communities; rules for the implementation of the provisions in question have been adopted by common agreement of all the Community institutions(544).

Scope of the audit

15.4.2. The enquiry concerned the sickness insurance Scheme for officials of the European Communities but did not include the special scheme which applies to the European Schools or the accident and occupational diseases scheme for European Community officials, which are subject to separate rules under Article 73 of the Staff Regulations.

15.4.3. The following aspects were considered in the course of the audit:

(a) the management of the JSIS and its accounting and financial organization;

(b) the revenue and expenditure of the Scheme that is directly associated with the direct payment of members' illness and confinement expenses. Since 1966 this revenue and expenditure has been recorded in an extra-budgetary account. The audit also covered the structural costs of the Scheme, which are charged to the institutions' budgets and do not appear in the JSIS accounts proper.

15.4.4. The audit concerned operations recorded during the period 1989-1995, after the last audit of the Scheme, which was in 1988. The results of that audit were included in the Annual Report on the 1988 financial year.

ORGANIZATION AND OPERATION OF THE SCHEME

Principles of organization and operation

15.4.5. The organization of the Scheme is specified in a set of rules adopted by common agreement between all the institutions. Only the institutions are empowered to make amendments that are general in scope.

15.4.6. A Management Committee, a Central Office, settlements offices and a Medical Council are responsible for the operation of the Scheme:

(a) the Management Committee is an interinstitutional body composed of 18 full members who represent the institutions and staff. Its role is: to ensure that the Rules are applied consistently; to examine the financial position; to make an annual report on the financial position and to make suggestions, proposals and recommendations to the institutions. It also delivers opinions in the cases mentioned in the Rules;

(b) the Central Office is attached to the Commission and is responsible for coordinating and monitoring the work of the settlements offices. It provides secretarial services for the Management Committee and carries out any statistical surveys or analyses that may be necessary in order to assist the Management Committee in the performance of its tasks;

(c) the settlements offices are essentially responsible for processing members' applications for reimbursement of medical expenses. They also maintain contact with the medical officer and deliver opinions as provided for in the Rules;

(d) the Medical Council assists the other bodies and is a purely consultative body.

15.4.7. The Commission also has certain exclusive powers, such as opening or closing down settlements offices, receiving contributions, authorizing and checking payments, keeping the accounts and investing the Scheme's surpluses.

Allocation of responsibilities within the Scheme

15.4.8. In its Annual report concerning the 1988 financial year the European Court of Auditors noted that the health insurance Scheme involved several bodies and administrative units and that their responsibilities and powers had been determined in such a way as to make the decision-taking process very unwieldy and long.

15.4.9. There has not so far been any progress in the direction indicated by the Court at the end of the last audit. The main features of the way in which powers are distributed within the Scheme are as follows:

(a) a decision-taking process which requires the joint agreement of all the institutions for even minor changes to the Rules. The length and unwieldiness of the revision procedure are unsuited to the Scheme's management requirements and cause the management bodies (Management Committee, Central Office and settlements offices) to exceed their powers by issuing rules of a general nature;

(b) a complex, even confused, overlapping of responsibilities between the institutions and the European Commission departments as regards the determination of members' entitlements, but also as regards the day-to-day management of the Scheme. For example, the European Parliament and the Council perform some or all of the functions for which the settlements office at the Commission would normally be responsible and provide it with human resources outside the rules laid down in the Staff Regulations;

(c) within the Commission, a poorly defined distribution of responsibilities between unit DG IX B5, which includes the Central Office and the settlements offices, and other departments, as regards decisions on such fundamental matters as the determination of rights of membership of the Scheme.

Composition and role of the Management Committee

15.4.10. Amongst other things, the Management Committee delivers opinions on appeals by members against decisions on reimbursement that have been taken by staff of the settlements offices. However, contrary to the Court's recommendations, the participation of the staff of the Central Office and the settlements offices in the work of the Management Committee has not been reviewed, so that they are obliged to deliver opinions concerning decisions which were originally theirs.

15.4.11. A considerable proportion of the time at Management Committee meetings is taken up with consideration of complaints submitted by Scheme members. Although such consideration is indeed desirable, the Court found that the substantial part played by discussion of individual cases was detrimental to the Committee's role as a general advisory body, concerned with the Scheme's financial position and its organization and operations.

Organization and role of the Central Office

15.4.12. The Central Office undertakes day-to-day management tasks which ought normally to be carried out by the settlements offices and, conversely, it does not carry out its statutory duties fully. The Central Office's role in providing impetus and coordination is weak, the monitoring of the settlements offices is generally poor, there is no management control and the analytical and statistical function is underdeveloped.

Organization and operation of settlements offices

15.4.13. Table 15.4.7 reveals disparities in activity and results between settlements offices which cannot be justified solely on the grounds of differences in size. The differences in productivity or the cost of processing an application are from one to three times as high, depending on the office in question. These disparities are evidence of excessive non-standardization of resources and operating conditions in the various offices and would suggest that management controls ought to be put in place at Central Office level, in order to achieve better distribution of resources and a certain amount of harmonization in the productivity of the various departments.

15.4.14. Although there has been some progress in harmonizing working methods within the offices, there were still some general weaknesses (absence of selective checks, disparities in the treatment of members' entitlements, defective monitoring of advances) and there is still too much divergence in conditions of reimbursement between the various locations.

Supplementary cover for members' spouses in certain cases

15.4.15. In accordance with the rules, the Scheme acts as a supplementary health insurance scheme for spouses who are gainfully employed and thus entitled to primary cover under another health scheme. This category represents barely 5% of total membership under the Scheme, but the management of it takes up substantial resources. Moreover, in certain cases, contrary to its own rules, the JSIS may act as the fund of first resort without checking the possibility of prior intervention by the national health scheme(545).

FINANCIAL AND ACCOUNTING MANAGEMENT

The Scheme's financial situation

15.4.16. In its previous report the Court mentioned the continuing deterioration in the Scheme's financial situation. This was evident in the operating deficits which began to accumulate during the 1985 financial year, to the point where, in 1989, it seemed that the total deficit would soon absorb the entire reserves.

15.4.17. Significant steps were taken in 1990 which made it possible to return the Scheme to financial equilibrium, which is still the case today.

15.4.18. The steps taken reduced the rate of increase of expenditure by half and produced a 34% increase in the volume of revenue during 1991. Thus, after an operating deficit of 275 Mio BEF in 1990 the Scheme showed an operating surplus of more than 400 Mio BEF in 1991. The level of the operating surpluses rose still higher in 1992 and 1993, when it reached 534 Mio BEF.

15.4.19. Even though the operating surplus has declined since 1994, the period 1991-95 was marked by a clear recovery in the Scheme's finances. This was evident in the level of its reserves, which reached 3 563 Mio BEF at the end of 1995 - the equivalent of a full year's expenditure (see Tables 15.4.8 and 15.4.9).

15.4.20. The level of the Scheme's accumulated surpluses at the end of 1995 is in line with the target set by the Management Committee in 1991(546) when it said that a 12-month 'reserve` was necessary, in view of the time needed to amend the Rules.

15.4.21. The normal function of contributions is not to provide funds for investment but to provide cover against health costs, as specified in Article 72 of the Staff Regulations. Article 27 of the Rules states: 'The financial objective of the Scheme shall be to ensure a balance on a periodic basis between expenditure and income resulting from the application of this Scheme`. Thus, a long-term surplus does not seem compatible with the spirit of these Rules.

Future developments

15.4.22. In the 1995 financial year the preclosure balance once again showed a surplus of 361 Mio BEF. However, the downward trend of the surpluses since 1994, with the demographic changes to which the Scheme is exposed, again raise the question of the Scheme's financial equilibrium in the medium term and the corrective action that might possibly be necessary.

15.4.23. With this in mind, the Central Office has for some years been trying to predict, on the basis of past trends, the probable date at which the Scheme will again be in deficit. It must be said, however, that these predictions are based on provisional, unreliable results and questionable assumptions as to future developments and have, so far, lacked relevance. More soundly-based projections(547) reveal the probability that a new operating deficit, net of interest, is imminent. However, it is obvious that changes in the rules or the widening of the European Union to include new Member States could completely upset the base data for the Scheme's financial equilibrium.

15.4.24. Taking into account the annual yield on the Scheme's investments and the accumulated surpluses, there is a risk of the reserves drying up only in the medium term. The level reached by the Scheme's reserves must not, however, be allowed to result in the indefinite postponement of the steps which must be taken in view of the imminent prospect of a new operating deficit.

Cost of operating the Scheme

15.4.25. Article 25 of the Rules merely states that 'transactions relating to the Scheme` must be recorded in separate, extra-budgetary accounts. Nowhere, however, is there a definition of the type of transaction that is to be monitored through non-budgetary accounts. Until now the institutions have borne out of their own budgets almost all the Scheme's equipment and management costs, whilst all the revenue, as well as the expenditure that is directly earmarked for the reimbursement of medical provision, is registered in a separate accounting system.

15.4.26. This breakdown has serious drawbacks: as they are dispersed among sections of each institution's budget and, in the case of the European Commission, among several directorates, there is a lack of information concerning the Scheme's equipment and operating costs. They have never yet been fully recorded.

15.4.27. In 1994 the Commission provisionally estimated the Scheme's total management cost for recorded staff numbers of 108 persons as around 230 Mio BEF. In a more recent study carried out by other departments of the Commission in March 1995, the own costs of the sickness insurance scheme were estimated at around 327 Mio BEF. This divergence demonstrates the current uncertainty as to the exact extent of the Scheme's operating costs.

15.4.28. The number of staff directly involved in the management of the Scheme (Central Office, settlements offices and sub-offices) was 130 persons at the beginning of 1996, for a total management cost of the order of 415 Mio BEF. This represents almost 12% of all the direct health care expenditure.

15.4.29. The dispersal of costs among the institutions and various departments of the Commission, the dilution of budgetary responsibilities and the resultant general lack of information have contributed substantially towards the current lack of control. Bringing the Scheme's costs back under control presupposes, firstly, that they can be clearly recognized and identified as the Scheme's own costs and, secondly, that there is one authority that is solely responsible for the management of them.

ACCOUNTING AND FINANCIAL ORGANIZATION

Organization of the accounts

Duration and closure of the financial year

Summary of the Court's previous observations

15.4.30. In its previous report, the Court noted that the accounts presented to the Management Committee each year were 'provisional, estimated multi-annual accounts for the previous three financial years`.

15.4.31. It pointed out that at least three years must pass before the final figures for a financial year can be obtained, in that, firstly, the Scheme's transactions are included in the accounts for the year in which the entitlements arose and, secondly, because in practice the expiry rules give members 18 months in which to submit standard applications for reimbursement and more than two and a half years in the case of special reimbursements.

15.4.32. The Commission, in its reply, maintained that the multi-annual nature of the accounts 'enables revenue and expenditure for any year to be compared exactly, giving an accurate picture of the financial situation of the Scheme`.

Analysis of the existing situation

15.4.33. The Scheme's accounting system is still accruals-based, which means that all the claims and debts that arise between 1 January and 31 December of a given year are charged to that year's budget, irrespective of the year in which they are actually recovered or paid. Such a system precludes the idea of an annual closure of the accounts.

15.4.34. Such a system is clearly not in accordance with the new financial provisions(548) (Articles 25, 26 and 26c), which adopted the principle of an annual closure. Its management is unwieldy and complex and has many disadvantages: the accounts are produced by reworking the provisional balance manually and are not always accurate; they are never final; the number of financial years and accounts does not improve their transparency; the system is not readily compatible with the mechanism for provisions.

15.4.35. In its replies to the Court's observations, the Commission's main argument in favour of retaining an accruals-based system was that it allowed the revenue and expenditure for a given year to be compared exactly, whereas a cash-based system would necessarily result in expenditure being booked on the basis of payment dates - a solution which may, in fact, result in delays in the discovery of any shortfalls that may exist.

15.4.36. In reality a cash-based system, with an annual closure of the accounts, is perfectly compatible with the retention of an accounting system based on established entitlements. All that is needed, in fact, is for provisions to be established at the year-end, so that the financial year then ending includes an allocation for payments that will not actually be made until subsequent years. This practice is followed by a number of health schemes in the Member States. The arguments put forward by the Commission cannot justify the retention of a system that does not comply with the financial rules if its advantages can be preserved as part of a cash-based system.

Accounts and calculation of provisions

15.4.37. The provisions established by the Scheme at the year-end are difficult to reconcile with an accruals-based system, in which the accounts are not closed at the year-end. The purpose of these provisions, in fact, is to relate to a year that has been closed the charges attributable to it. This principle is alien to a system which has no year-end closure. These are in the event only 'forecasts` of accounting entries during n+1.

15.4.38. For that reason the Scheme's accounts must be produced manually every year from the basic account data. This reworking is a source of error and does not provide a direct measurement of the precise extent to which the provisions have been used.

Overstatement of provisions

15.4.39. The limitations on the recording of provisions in the accounts under the accruals-based system have perhaps been factors limiting efforts to establish the provisions more accurately.

15.4.40. In its previous report, the Court had already noted that the establishment of provisions at the year-end had a considerable impact on the year's result and was not justified. It must now be reported that, far from having improved, the phenomenon has increased considerably in the recent period. Owing to the overstatement of provisions and the understatement of revenue, the forecast result for a year can vary considerably between the year when it first appears in the accounts and subsequent years.

15.4.41. Overall, the level of realization of provisions, which is analysed in Table 15.4.10, is unsatisfactory: over the period 1988-94 it was 89,6%, so that 615 Mio BEF was attributed to expense accounts during the period and remained unused. Furthermore, the extent to which the provisions are made has deteriorated since 1992 and reached a low of 80% in 1994.

15.4.42. In the view of the Scheme's managers, the introduction of a new computer system in 1994 partly explained the substantial overstatement in that year, in that the efficiency of the new system made it possible to speed up the rate of payments over the current year. They also thought that the data provided by the new system would improve the reliability of the provisions considerably.

Presentation of the accounts

The annual operating accounts

15.4.43. Due to the significant overstatement of provisions, the annual operating accounts do not provide a true view of the Scheme's financial situation. The surplus for 1994 was thus stated as 259 Mio BEF at the end of 1994, but was increased to 450 Mio BEF at the end of 1995. This being so, it is difficult to give an opinion on the validity of the surplus of 361 Mio BEF presented to the Management Committee in 1996 for the 1995 financial year.

The annual balance sheet and the Scheme's actual cash balance

15.4.44. The Court, in its previous report, asked for amounts to be presented more explicitly in the balance sheet in order to achieve a clearer and more comprehensible balance-sheet presentation. However, there has been no improvement in this area. The total cash balance included in the assets on the balance sheet at 31 December 1995 does not give a true view of the Scheme's cash assets.

15.4.45. Not only does the Scheme's balance sheet in fact include the Scheme's own financial transactions, it also includes the financial transactions of bodies that are not part of the Joint Scheme (European Schools, the European University Institute (EUI) in Florence and transactions in respect of supplementary cover for officials serving in Delegations in third countries). This situation means that the Scheme is 'harbouring` in its balance sheet transactions which do not concern it, firstly, because the management bodies are identical, and, secondly, because the surpluses of all the various health-insurance schemes are invested together, in order to obtain the most advantageous conditions.

15.4.46. In consequence, in the absence of any follow-up outside the accounts, it is now impossible to identify the proportions of invested cash and surpluses owned by the various schemes. It would be better to end this confusion by isolating the accounts for the Scheme's own transactions and assets from those of bodies that are not part of it.

Approval of the accounts

15.4.47. The Scheme's new financial provisions entered into force on 2 October 1995 were a significant advance on the previous position where there were no formal provisions setting out procedures for the approval of the accounts, as the Court pointed out in its previous report. Article 26c now provides that the Heads of Administration 'shall take note, within a period of two years following the submission of the annual operating account, that the official in charge of the Central Office has administered the Scheme properly`.

15.4.48. The wording adopted is, however, so vague that one wonders what the nature of the Heads of Administration's involvement is, since it cannot formally be equated with 'approval` or 'discharge`.

15.4.49. Moreover, such a procedure cannot be fully effective unless it is based on final accounts, which is not the case at the moment, given the accounting system used by the Scheme.

Internal control and financial control

Controls on the Scheme's revenue

Monitoring contributions

15.4.50. In its previous report the Court pointed out that neither the Commission nor the Scheme made any check as to the rate and accuracy of the contributions paid by the institutions each month. The Court also observed that the Rules did not contain any provisions relating to the authorization and control of the Scheme's revenue.

15.4.51. The new financial provisions which entered into force in 1995 closed this gap in the Rules, by making the Commission's Financial Controller responsible for ensuring that the contributions paid by the institutions tally with the revenue received under the same heading by the Scheme. However these new rules have, so far, gone unheeded. As of now, the Commission's Financial Controller does not perform any checks on the Scheme's revenue. The Central Office merely performs a plausibility check on the overall level of contributions paid by the institutions each month.

Monitoring the Scheme's investments

15.4.52. DG II took over DG XVIII's responsibilities and since 1982 has been responsible for the common management of the surpluses of the JSIS, of the sickness fund of the European Schools, of the EUI and of the supplementary cover in third countries. At the end of the year the Central Office allocates the interest on investments between the Joint Scheme and the other bodies.

15.4.53. The funds are allocated pro rata, on the basis of the previous year's operating surpluses. There is no accounting basis for this purely empirical method, which benefits the organizations whose surpluses are very high relative to the others. The method is the result of a lack of available information among the Scheme's managers regarding the exact allocation of assets between the JSIS and the other bodies.

Monitoring of advances

15.4.54. The Court highlighted in its previous report the weaknesses in the monitoring of advances that had been paid to members and had not been regularized. It observed that the Rules did not contain any provisions relating to the recovery of these claims or to when they might be considered to have lapsed as a result of time-barring.

15.4.55. Although the new financial provisions closed this loophole in the Rules, the clearance of old advances (going back to 1994 and earlier) was neglected by all the settlements offices, with the exception of the office at the Council of the European Union. Moreover when applications for recoveries from salaries are sent to the institutions they are not always put into effect. Finally, the Central Office has never so far asked the Financial Controller to agree to the balancing of accounts for advances which are definitively lost and which, in consequence, have been wrongly included in the accounts as assets down the years.

Controls on the Scheme's expenditure

15.4.56. Apart from the checks carried out within the Scheme by settlements offices and the Central Office, the Commission does not exercise any real control over the Scheme's expenditure, despite the obligations laid down by the Rules.

15.4.57. The role of the accounting officer at the Commission or the Council is confined to the actual management of payments and the charging of them to the accounts. The Commission's Financial Controller, who under the Rules is responsible for checking the payments made by settlements offices, merely approves the payment orders, without making any checks. The Council's Financial Controller no longer approves payment orders made out by the Council office.

CONCLUSION

15.4.58. The present distribution of responsibilities between the institutions and the management bodies is not satisfactory: the process of revising the Rules is lengthy and unsuitable, the increase in the number of bodies capable of taking decisions of an individual nature is a source of inequalities in treatment and the Commission's exclusive powers are not respected.

15.4.59. These findings call for clarification and redefinition of responsibilities, principally along the lines set out below:

(a) on the basis of Article 2 of the Staff Regulations, the Commission, or a body responsible for the common management of the Scheme, should be given power to amend the Rules;

(b) settlements offices should be given exclusive powers to take individual decisions of an administrative or financial nature, subject to control by the Central Office;

(c) the question of staff being made available should be settled under the Staff Regulations by seconding staff either to the Commission or the new management body and transferring the corresponding budgetary resources.

15.4.60. As regards the Scheme's management bodies, the composition of the Management Committee and its operating procedures should be reviewed; the allocation of duties between the Central Office and the settlements offices should be clarified, with reinforcement of the former's role of coordinator, initiator and management controller, so as to harmonize further the productivity and conditions of reimbursement within the settlements offices.

15.4.61. There has been a reversal of the Scheme's deficit since 1991. On the basis of current data, the demographic developments within the Scheme are expected to result in a new operating deficit fairly shortly. The high level of the Scheme's reserves must not lead to the indefinite postponement of the steps needed to preserve its equilibrium and harmonize the level of services.

15.4.62. The Scheme's management costs are, at present, borne almost entirely by the institutions' budgets and not by the Scheme's own budget. They are difficult to identify. The way to control them is to include all the costs in the Scheme's extra-budgetary accounts and to designate a single authority to be responsible for the management of its transactions. This could be either the Commission or a new management body representing all the institutions, to which the powers, resources and facilities of the Scheme would be transferred.

15.4.63. The organization of the Scheme's accounts on an accruals basis is not in accordance with the new financial provisions. It is cumbersome and complicated to manage and has many disadvantages: the accounts are produced by reworking the general provisional balance manually and are not always accurate; they are never final; the number of financial years and accounts does not facilitate transparency; it is difficult to reconcile this system with the provisions mechanism. The systematic overstatement of provisions puts the reliability of the accounts at risk. The balance sheet presentation does not give a true and fair view of the Scheme's own cash resources. The procedures for approving the accounts are not adequately defined.

15.4.64. Without calling into question the principle of basing accounts on established entitlements, the adoption of a cash-based system would simplify management of the Scheme and would significantly improve the presentation and transparency of the accounts. The provisions should be calculated much more strictly and the Scheme's own assets should be identified.

15.4.65. The Scheme's internal controls must be reinforced (monitoring of advances, selective audits) and extended to include management controls. Despite the new financial provisions, the financial control to which the Scheme is currently subjected by the Commission is purely formal, for both contributions and expenditure. There should, at least, be sample checks or periodic audits. The creation of a management body could also make the exercise of financial control closer and more effective.

REPLIES OF THE COMMISSION

General subsidies (Title A-3 of the budget)

MANAGEMENT OF SUBSIDIES BY THE SECRETARIAT-GENERAL OF THE COMMMISSION

15.1.6. For the most part, the Secretariat-General acknowledges the shortcomings in the system identified by the Court. The policy on subsidies and the way they are managed are being reviewed throughout the Commission following an in-depth study carried out by the Commission's Inspectorate-General in 1997.

Compliance with the criteria for granting subsidies

15.1.8. The association in question was entered by the budgetary authority for an operating subsidy. In 1996, the subsidy was cut by ECU 145 000. The 1997 subsidy was suspended until July following a Commission check. ECU 100 000 has now been released, though specific conditions have been set concerning management of the association in the future.

15.1.10. From 1998 onwards, a subsidy will be given to this association only for specific activities which are covered by the rules.

Repetitiveness of the subsidies

15.1.12. The Court is referring to associations receiving operating subsidies which are entered by the budgetary authority. The impact of their activities is assessed in the course of regular contacts between the association and the relevant Commission department, in the light of which the Commission may change the amount of support it gives. (see reply to paragraph 15.1.8 above).

Evaluation of the use of subsidies

15.1.13. A suitable computer program has now been installed. The Court referred to some files which could not be closed: these are very few in number.

15.1.14. The accounting systems of some of the small associations given subsidies are not very sophisticated. The letter sent out when the subsidy is granted specifies what expenditure is covered if this is not clear from the description of the purpose. In the case of larger subsidies charged to the headings in question, the practice of defining eligible expenditure in the award letter should be standard by the end of 1997. The Commission is studying the possibility of introducing a system to limit the period of time over which a subsidy can be granted.

The implementation of audits

15.1.15 15.1.16. In view of the nature and purpose of the subsidies in question, and the fact that many of them are relatively small, an assessment procedure of the sort used for major Community projects would be inappropriate for the simple reason that it would not be cost-effective. The associations' activities are monitored by the relevant operational departments, which communicate with the other departments concerned (see reply to paragraph 15.1.12). The Commission acknowledges that it needs to increase the number of on-the-spot checks but can only do so to the extent that human resources allow.

15.1.17 15.1.18. The Commission is acutely aware of this problem. In the light of the IG's inspection, new structures and procedures are being devised to tackle it. With the Sincom 2 system currently under development, it should be possible, on the basis of information from the general 'payees ledger`, to identify all current and potential (e.g. by virtue of a commitment) recipients.

ADMINISTRATIVE SUBSIDIES

15.1.19 15.1.22. Administrative subsidies are granted on the basis of the remarks in the budget, drafted by the budgetary authority. The Commission takes note of the Court's recommendations.

CONCLUSION

15.1.23. (a) The Commission endeavours to apply the rules and criteria for granting subsidies in this extremely diverse area.

(b) and (c) The Commission agrees with the Court.

Office for Official Publications of the European Communities (Article A-342 of the budget of the Commission and Annex II thereto)

FINANCING THE EUR-OP

The presentation of the budget

15.2.5 15.2.6. The Commission and the Publications Office have taken steps to ensure that this information will be given in future, starting with the preliminary draft budget for 1998.

Insufficient appropriations

15.2.8. It is true that the Office's volume of work has grown faster than its resources.

15.2.9 (a) The Office's Management Committee is composed of representatives of the institutions who regularly ask the Director to give an account of the management of the Office.

(d) The Commission acknowledges that the total cost of the institutions' publishing activities is hard to calculate (though the cost of running the Publications Office is not). It will examine the potential effectiveness of the measures proposed by the Court in paragraph 15.2.53.

Re-use of revenue

15.2.11 15.2.12. It was the budgetary authority's decision to make subscribers pay towards the cost of delivering their publications.

The Publications Office's Management Committee has always taken the view that the price of a subscription covers both publication and delivery costs, and acts accordingly.

Services reimbursed by the institutions concern publications sent out free of charge for which the Publications Office advances payment on the institutions' behalf but does not have its own appropriation for this.

In this respect, the regulatory framework does need to be updated: when the basic instruments governing the Office were drafted, it was thought that as a rule a charge would be made for publications, and the economies of scale generated by centralization in the Office of free distribution of the institutions' publications were not taken into consideration (see also paragraph 15.2.52).

The presentation of the accounts

15.2.13 15.2.14. In the revenue and expenditure account, re-use by the Publications Office is included in the overall re-use figure for the Commission. It has never been shown as a separate item. However, details of reuse by the Publications Office can be obtained from the accounting departments.

The Commission will ensure that, in future revenue and expenditure accounts, reuse figures are presented in exactly the same way as the Commission's.

FINANCIAL MANAGEMENT

Management of the liquid assets in the Revolving Fund

15.2.16. In view of the shortcomings of the present Jocomp system, the Publications Office plans to develop a new version. Work is being done to discover the source of the discrepancy between the bank statement balance and the balance arrived at using the accounting system. This will inevitably be a long and involved process owing to the sheer number of transactions to be checked.

The monitoring done outside the accounts makes it possible to keep track of transactions involving this account.

Banking operations

15.2.17. Most of the accounts were opened in the 1980s. A bank was sought which had branches in every Member State. Since the last enlargement, the Publications Office has been using the banks the Commission selected for itself.

15.2.18. The Publications Office will take whatever action is required to ensure the checks are carried out.

15.2.19. In order to relieve the Publications Office of responsibility for the management of investment accounts, the Commission has opened an account covering the funds previously managed by the Office and those managed by the financial departments within the Commission specializing in these matters.

Collection of revenue

15.2.20 15.2.21. The Publications Office has already taken a number of measures in response to the Court's criticisms. Furthermore, it will encourage its sales offices to avoid payment by cheque wherever possible and will continue its efforts to eliminate the risks identified by the Court.

However, habits differ from one Member States to the next, making it difficult to impose a single means of payment.

PRODUCTION OF THE OFFICIAL JOURNAL

Printing the Official Journal

15.2.25. The Publications Office checked that the contents of the magnetic tape were identical to the contents of the tape used by the contractor for publication of that day's Official Journal. The firm submitting the tender could produce no more than around a quarter of the required output in the time it had itself allocated. The Publications Office is bound by very tight publication deadlines and could not award the contract to a firm which would have been unable to meet them.

15.2.26. The Publications Office's printing contracts give the contractor no guarantee as to the volume or work to be provided. To ask for the offer to be reduced if a number of contracts are awarded to the same firm would seem to invite uncertainty.

15.2.27. These 'minimum` technical conditions are indispensable if the required output is to be achieved. They are an indication of the complexity of producing a daily edition of the Official Journal in three series and eleven languages. The approach has the advantage of allowing texts with different layouts and in different formats to be reused at no extra cost. This practice saves large amounts of money and is increasingly widespread amongst modern publishers operating in similar environments to the Publications Office.

15.2.28. The specifications contained the figures that were available at the time of drafting. From the drafting of the technical specifications to the signing of the contract, the procedure takes an estimated 18 to 24 months. Furthermore, the number of pages is beyond the control of the Publications Office: the size of the L and C series is determined by the institutions, and the size of the S series depends on the contract notices issued by the contracting authorities.

Two new language versions were added after the most recent enlargement. This alone has pushed up the number of pages by over 20%. The Commission would point out that there was no attempt to conceal the fact that the S series Journals were rapidly increasing in volume; any subscriber and hence any potential tenderer could easily have checked. The expansion was quicker than expected when the specifications were drawn up and, for the next call for tenders, the Publications Office will endeavour to update the figures immediately prior to publication of the call.

THE SALE OF PUBLICATIONS

The price of the Official Journal

15.2.35 15.2.37. The Court's description of current practice is correct. All distributors give preference to subscriptions over single copies.

The Publications Office merely implements the pricing policies adopted by authorizing officers or the Management Committee. They have the power to make decisions, including the decision not to apply the general rules in certain cases.

The reason given for reducing the price of the budget edition was to increase budgetary openness by making the most important instrument in the field more affordable.

Distribution of other publications

15.2.39. The Publications Office's prices are based on the cost price, multiplied by a mark-up factor.

The cost price the Office uses as a base is fairly high because it has to publish in a number of different languages, one of the constants in Community publications. Fixed production costs are the same for all versions, irrespective of the size of the print run. Naturally, this has an effect on the average cost price for all versions.

The mark-up factor used by the Publications Office is in the lower part of the average range applied by the publishing industry. Unlike the Community institutions, other publishers include in the price the 'intellectual` cost of producing their material. Consequently, Community publications are sold for less than comparable publications on the market.

15.2.40. The Publications Office confirms the Court's analysis. It will try to draw this problem to the institutions' attention.

Sales through agents

15.2.45. From 1 January 1998, agents will have only 90 days to make payments on individual publications. This is already the rule for subscriptions.

15.2.46. The 25% discount given by the Publications Office on subscriptions is entirely in line with standard practice.

The discount on individual publications is higher than normal but the Publications Office feels this is warranted; special incentives need to be offered to compensate for the problems associated with Community publications (e.g. the large number of titles, the different language versions and the small readership).

15.2.47 15.2.49. The Publications Office takes note of the Court's comments and will suggest that the Management Committee put a stop to the decentralization of promotional activities and hence to the special 2% discount for agents.

Marketing strategy tools

15.2.50 15.2.51. The Publications Office is committed to developing tools which will provide it with the information it needs.

However, it is no simple matter to design a computer system that can cope with the complexity and diversity of the Office's output.

CONCLUSION

15.2.52. The Commission will ask the Management Committee of the Publications Office to submit proposals aimed at tailoring its regulatory framework to the functions it now performs.

15.2.53. The Publications Office will take account of this remark when producing its Annual Management Report for 1997.

15.2.54. The Publications Office will take whatever measures it can to open up the contract for Official Journal to the widest group of competitors possible without disregarding the constraints of production or the rules on public procurement.

15.2.55. The Publications Office agrees with the Court's findings and will once again draw the institutions' attention to the need for a more healthy balance between the free distribution and sales of any given publication.

Decentralized Community bodies

INTRODUCTION

Rules of procedure

15.3.2. The Commission would point out that its responsibilities regarding the agencies are clearly defined by the regulations establishing them. They are by definition independent of the Commission as regards day-to-day administration and budget management. However, the Commission is urging the agencies which have not yet done so to implement the Financial Regulations and their rules of procedure in full by the end of 1997.

15.3.3. The Commission is calling on the agencies to work, in close cooperation with it, towards harmonizing the presentation of their accounts for 1997 in the interests of greater clarity.

PRESENTATION OF THE BUDGET

15.3.5. The European Environment Agency is the only agency whose internal rules provide for multi-annual programmes and allow use of the relevant appropriations to be spread over a number of years. The Commission is suggesting that the other agencies consider amending their financial regulations so that appropriations for expenditure on operations can be entered in their budgets as differentiated appropriations.

15.3.6. The Court is correct: the funds which the European Training Foundation received from the Commission for running the PHARE and TACIS programmes (Tempus and VET) do not appear in the agency's budget as revenue. The amounts in question were treated as revenue and expenditure outside the budget since these programmes are administered by the Foundation on the Commission's behalf in accordance with special agreements made with the Commission. The Commission and the Foundation will together examine possible ways of incorporating this revenue into the general accounts while at the same time respecting the special nature of the funds, managed on the Commission's behalf.

15.3.7. The rather large carryovers are a result of the delays in budget implementation, due in turn to the agencies' early teething troubles. However, the Commission agrees with the Court that, after the running-in period, the budget forecasts should start to become more reliable and the proportion of appropriations carried over should diminish considerably as more experience is acquired and the situation stabilizes. A number of agencies are trying or have tried to achieve this and are making increasing use of supplementary and amending budgets to tailor their budgets to their requirements.

ACCOUNTING SYSTEMS/ANALYTICAL ACCOUNTS

15.3.9 15.3.11. With the exception of Cedefop, the systems used by the agencies for budget accounts are not really accounting programs. A number of agencies are fully aware of the importance of having an efficient system for budget accounts by the end of 1997. Some of the agencies' systems already detect shortages of appropriations.

Most of the agencies issued a call for tenders for integrated accounting software in December 1995. The results were unsatisfactory and the procedure was cancelled.

The agencies then turned to the solution developed by the Commission (Sincom 2), which, initially at least, seemed to fulfil their requirements and be readily adjustable. Various coordination meetings were held for the Commission departments and the agencies. The larger agencies, in particular, feel that developing a customized version of Sincom 2 would provide a satisfactory solution. However, Sincom 2 proved unsuitable for the smaller agencies with correspondingly small computer departments. Consequently, a number of them, led by Cedefop, decided to custom-design their own integrated software.

The Commission has been urging the agencies to press ahead with work on developing their own system or adapting Sincom 2 so that they have integrated accounting software for 1998.

15.3.12. The Medicines Evaluation Agency started work in 1997 on developing a system for analytical accounts. The Commission is calling on the other agencies to do likewise in order to improve and extend their range of financial management tools.

THE FINANCIAL CONTROLLER

15.3.14. The Financial Controller is of the view that the introduction of customized versions of the Commission's new accounting system (Sincom 2) will be an important step towards rationalization of the agencies' auditing procedures. The development and installation of an electronic approval system will offset some of the drawbacks caused by the fact that the Financial Controller is not on site and will also limit use of the imprest accounts.

Subject to availability of resources, financial control intends to send more of its officials out to work with the agencies. In a further bid to bring financial control closer to the agencies, the Turin agency and the Translation Centre in Luxembourg are now to be audited respectively by the Financial Control units in Ispra and Luxembourg.

Other ways of decentralizing Financial Control are cur-rently being examined.

Joint Sickness Insurance Scheme

ORGANIZATION AND OPERATION OF THE SCHEME

Allocation of responsibilities within the Scheme

15.4.9. (a) The length of the decision-making procedure depends on the scope of the proposed changes to the Scheme:

- long-term changes to the basic rules require more extensive consultation;

- short-term amendments are made by changing the way the rules are interpreted.

In response to the Court's comments, the Commission intends to propose an increase in the number of limited-scope measures that can be adopted using one of the quicker decision-making procedures, e.g. by changing the way the rules are interpreted. This solution has been applied, for example, using Article 8 of the rules (adoption of equality coefficients).

(b) When the Council sub-office takes a management decision, it ensures that it is consistent with the Central Office's procedures. The Parliament sub-office deals only with advances. For staff from other institutions assigned to settlements offices, the institutions in question either second the staff in accordance with the Staff Regulations or request the budgetary authority for a transfer from one institution's establishment plans to the other's.

(c) As soon as the new PAIE system is installed in late 1998 and there is integrated management of staff data between PAIE and Assmal (a sickness insurance program), the settlement offices, under Central Office supervision, will be responsible for determining members' entitlements for the Commission.

Composition and role of the Management Committee

15.4.10. In response to the Court's remarks, the Commission will propose that members of the Management Committee from the Central Office or the settlements offices should not be allowed to vote at its meetings.

15.4.11. The Commission agrees with the Court and, to give the Management Committee time to discuss general matters, it will propose the establishment of more specialized subcommittees, which will lighten the Management Committee's agenda and provide back-up on technical matters.

Organization and role of the Central Office

15.4.12. In order to perform its functions within the Scheme, the Central Office needs in-depth knowledge of the tasks carried out by the settlements offices.

On the subject of its monitoring of the settlements offices, during the setting up of the Assmal system, the Central Office has had temporarily to concentrate on the new techniques for gathering and validating data at the expense of its monitoring function. The transition period is now over and the Office will reorder its priorities as recommended by the Court.

Organization and operation of settlements offices

15.4.13. The comments on the level of activity and the resources used need to be qualified. Different settlements offices have widely differing tasks and the diversity of the groups they serve means that their workloads vary. Most of the people dealt with by Karlsruhe are retired and their files are more complex. The Commission will examine the Court's figures for Ispra and take action to redress the situation if necessary.

The Court's figures on productivity reflect the extent to which the different offices use Assmal and how generally computerized they are. However, the Commission will ensure that resources are more evenly distributed between offices.

15.4.14. Some of the points raised by the Court have been dealt with. The new Assmal system enables offices to target their monitoring more effectively and implement measures taken by the Central Office to ensure greater harmonization of reimbursement practice between settlements offices.

Supplementary cover for members' spouses in certain cases

15.4.15. The task of administering entitlements and payments for the supplementary cover system is a complex one. The rules governing sickness insurance in the various Member States have to be taken into account, particularly when the Scheme acts as fund of first resort.

FINANCIAL AND ACCOUNTING MANAGEMENT

The Scheme's financial situation

15.4.21. In the Commission's view, the current situation is compatible with the spirit of the rules. Under Article 27, the objective of the Scheme is to ensure a balance on a periodic basis and Article 29 states that accumulated surpluses are to be used first and foremost to cover any deficits which may arise.

Future developments

15.4.22 15.4.24. In accordance with Article 29, the current reserve is the first line of defence against the possibility of a deficit arising in the future. This is particularly relevant given the current unfavourable demographic trends and the accompanying prospect of higher expenditure. The Commission monitors the balance carefully and will consider amending the rules if necessary.

Cost of operating the Scheme

15.4.26 15.4.27. Analytical accounts must be introduced if equipment and operating costs are to be properly detailed on a systematic and regular basis. A reform on this scale would have to cover more than just the allocation of resources to the Scheme. In response to the Court's comments, the Commission will reassess and rationalize the Scheme's operating costs.

15.4.29. In keeping with the goal of rationalising expenditure, the Commission intends to review Article 20 of the rules on sickness insurance for officials.

ACCOUNTING AND FINANCIAL ORGANIZATION

Organization of the accounts

Duration and closure of the financial year

Analysis of the existing situation

15.4.33 15.4.36. In the interests of efficiency and clear accounting, i.e. in order to comply with standard accounting principles, the Commission will adopt the 'management system` when the 1997 accounts are closed.

Accounts and calculation of provisions

15.4.37 15.4.38. It will be possible, using the new management system, to calculate in the revenue and expenditure account the utilization rate of the provisions entered in the balance sheets for previous years. The system will also obviate the need for the figures to be processed a second time manually.

Overstatement of provisions

15.4.39 15.4.42. The Assmal computer system enables 80% of the payments covered by the provisions to be made by April of the following year. This should make it possible to assess more accurately the right level for provisions in the management system.

Presentation of the accounts

The annual operating accounts

15.4.40 15.4.43. In order to balance the system, the provisions must be calculated relative to entitlements arising in the current year but not entered in the accounts for that year. But, even if the management system is used to forecast provisions, the utilization rate for the provisions may vary.

Between 1988 and 1994, provisions expressed as a proportion of the Scheme's total annual expenditure remained steady at around 34%, but the rate of utilization of the provisions fluctuated between 80% and 103%.

However, the Commission does feel that more reliable statistical assessment techniques need to be developed.

The annual balance sheet and the Scheme's actual cash balance

15.4.44 15.4.46. The only transactions in the Scheme's balance sheet that do not concern it relate to the joint investment of the surpluses and available funds from all the various individual schemes. The Commission, acting on a proposal from its accounting officer, will improve the clarity of the balance sheet and calculate the surpluses and amounts of available funds for each separate scheme.

Approval of the accounts

15.4.48. The introduction of the management system, which will produce final accounts, will give more importance to the role of the heads of administration.

Internal control and financial control

Controls on the Scheme's revenue

Monitoring contributions

15.4.50 15.4.51. In view of the new rules, which entered into force on 2 October 1995, Financial Control is prepared to carry out periodic audits.

Monitoring the Scheme's investments

15.4.53. Once it has been established what the breakdown of available funds and surpluses is between the Joint Scheme and the other schemes (European Schools, EUI in Florence and supplementary cover for officials in non-member countries), it will be possible to allocate interest on a pro rata basis reflecting the surplus of each individual scheme.

Monitoring of advances

15.4.55. Clearance of old advances (pre-1994) is now under way. In June 1997, 62% of advances had been recovered. The clearance procedure has now been completed for advances granted in 1994 and has been started for advances granted after 1 January 1995.

CONCLUSION

15.4.58. The Commission intends to make more use of the room for manoeuvre offered by the rules to extend the range of limited-scope decision, thereby streamlining the decision-making procedure for amendments to the rules.

15.4.59. With regard to individual decisions, delegation of the appointing authority's powers is a matter for each individual institution to decide on autonomously (Article 2 of the Staff Regulations). The Commission is trying to follow the approach suggested by the Court.

For staff from other institutions assigned to the Commission's settlements office, the institutions intend, in line with the Court's recommendation, either to second staff in accordance with the Staff Regulations or to ask the budgetary authority for a transfer from one institution's establishment plan to the other's.

15.4.60. In order to allow the Management Committee more time to consider general matters, the Commission will suggest that greater use be made of technical sub-committees for the preparation of dossiers. In addition, members of the Management Committee from the Central Office or the settlements offices will not be entitled to vote at its meetings.

The Commission agrees with the Court that the tasks of the Central Office and those of the settlements offices must be clearly demarcated. The distinction will be clear after Assmal is past its transitional phase. Once the new technique for gathering and validating data has been properly established, the Central Office will be in a better position to monitor the settlements offices and harmonize payment procedures.

15.4.61. The Commission monitors the Scheme's financial situation carefully and will consider amending the rules if necessary. In line with Article 29 of the rules the current reserve is a first line of defence against the increases in spending forecast on the basis of demographic trends.

15.4.62. The institutions have always been very clear as to the interpretation of Article 25 of the rules, concerning 'transactions relating to the Scheme`. The Commission will endeavour to rationalize operating costs, primarily through Article 20. It is of the opinion that it would be better to control expenditure by means of a separate analytical approach rather than by including costs in the extra-budgetary accounts under the current system, which must cover only receipts and expenditure on reimbursements for health care.

15.4.63. The Commission will adopt the 'management system` for 1997. It will endeavour to improve the accuracy of the provisions in the balance sheet. The use of Assmal data is the first step in this process.

Even with a 'management system`, the utilization rate for provisions will be affected by factors beyond the institutions' control.

Furthermore, the Commission will make the balance sheet clearer, particularly with regard to the Scheme's own funds.

The production of final accounts using the management system will give more importance to the role of the heads of administration.

15.4.65. Financial control of revenue is done automatically by the institutions and other bodies' financial controllers since most of the Scheme's revenue corresponds to expenditure by an institution or other body and this expenditure is controlled on a regular basis.

With regard to the Scheme's expenditure, Financial Control will work to develop sample checks and periodic audits. Changes to the rules will also be considered to enable financial controllers from other institutions and bodies to become involved.

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Table 15.4.8 - JSIS - Balance sheet as of 31 December

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CHAPTER 16 Court of Auditors

The external auditor's certificate as to the regularity and fairness of the revenue and expenditure account and the financial balance sheet as at 31 December 1995

and

his report on the internal control system and the soundness of the financial management of the Court of Auditors

were published in OJ C 326, 28.10.1997.

CHAPTER 17(549\*) The Economic and Social Committee and the Committee of the Regions

17.0 CONTENTS Paragraph reference

General 17.1 - 17.5

Rules governing the reimbursement of air-travel expenses 17.6 - 17.10

Audit of expenditure 17.11 - 17.19

Travel and meeting allowances 17.16 - 17.19

Conclusion 17.20 - 17.21

GENERAL

17.1. The Economic and Social Committee (ESC) and the Committee of the Regions (COR) each consists of 222 members. Most of the administration of these two Committees has been entrusted to a common organizational structure. The meetings of the ESC and COR are organized on the basis of plenary sessions and numerous section and study group meetings (ESC) and committee and subcommittee meetings (COR) inside the Union (in most cases in Brussels). Some members and delegations participate from time to time in meetings outside the Union. The members, alternates and experts who attend these meetings are reimbursed their travel expenses (air fares, train fares or expenses incurred when travelling by car).

17.2. They also receive the following two allowances:

(a) a meeting allowance (day of the meeting);

(b) a travel allowance.

17.3. The former is a fixed sum covering the cost of accommodation, meals, etc. The second is also a lump sum but it depends on the average travelling time between the place of departure and the place of the meeting, based on a distance of over 100 km.

17.4. The appropriations available in 1996 for this expenditure amounted to 8,8 Mio ECU for the ESC and 5,3 Mio ECU for the COR (Articles A-250 and B-250 of the ESC/COR section of the budget, i.e. a total of 14,1 Mio ECU).

17.5. In its decision giving discharge in respect of the implementation of the budget for the financial year 1994 (550), the European Parliament asked for an external audit of the travel expenses of the members of the COR. The Court took note of this resolution of the European Parliament and included an examination of the travel expenses of the members of the COR and the ESC in its annual work programme.

RULES GOVERNING THE REIMBURSEMENT OF AIR-TRAVEL EXPENSES

17.6. The rules concerning the refunding of the travel expenses of members of the ESC and the COR are set out in various documents(551). In September 1994 the ESC's Bureau decided to abolish repayment in cash, which resulted in the generalization of repayment by cheque. It also drew up new rules on 21 November 1995, to be effective from 1 January 1996, with a view to improving the existing legislation, which dates back to 1986 (ESC Regulation No 55/86), making provision for the reimbursement of air-travel expenses on production of the ticket (option A). The first amendment (effective 1 January 1996) introduced the possibility of reimbursing the members' travel expenses at a fixed rate (option B) calculated on the basis of the distance in kilometres between the place of residence and the place of the meeting. The second stipulated that as from 1 October 1996 boarding cards should be provided as proof that the journey had actually been made and should be attached to applications for reimbursement.

17.7. After its creation in 1994, the COR adopted on 24 July 1994 the old rules applicable to the members of the ESC, which date back to 1986 (option A only). These rules were amended on 19 September 1996.

17.8. In the case of the ESC, the amount of the daily meeting allowance is 5 700 BEF. The daily travel allowance is variable and ranges, according to the distance, from 4 450 BEF to 8 900 BEF. For the COR the daily meeting allowance amounts to 206 ECU, whilst the daily travel allowance varies, according to the distance, between 86 ECU and 222 ECU.

17.9. The regulation concerning reimbursement (Articles 2.1(c) (ESC) and 2.C (COR))(552) does not specify whether the ticket should be submitted during the journey or afterwards. The Financial Regulation of the European Union does not authorize payment until after the journey has been completed. The ESC and COR have adopted the practice of making most payments before the return journey.

17.10. The specific rules at the ESC and COR lay down that, in the case of air travel, the reimbursement shall be made on production of tickets in the class immediately below first class. The audit results revealed that the majority of members had submitted business class tickets for reimbursement. The reimbursement may only be made on production of the ticket actually used for the journey and on the basis of a written statement attesting to the amount of the expenditure.

AUDIT OF EXPENDITURE

17.11. In 1995 an investigation by the Financial Controller revealed that some ESC members and alternates had asked for reimbursement of the cost of air tickets other than the ones they had actually used. The Court's examination of tickets (1 000) over a period of two months showed that 60% of the tickets on which information concerning the use made of them had been obtained (875) from the airlines had given rise to unwarranted payments by means of the presentation of tickets other than those actually used.

17.12. Moreover, the Court estimated the value of tickets in respect of which unwarranted reimbursements had been made at 0,4 Mio ECU, or 52% of reimbursements of travel by air paid for during these two months (0,8 Mio ECU). Total reimbursements for air-travel expenses of the ESC members for 1995 were 4,4 Mio ECU.

17.13. On the basis of an inquiry covering three months of 1996, the Court observed that the number of tickets in respect of which unwarranted reimbursements had been made continued to be very high at the ESC (69%). Of the 94 members and alternates whose files were examined, 41 had submitted airline tickets that did not conform to the rules.

17.14. In the case of the COR this figure was 3%. Of 208 members and alternates whose files were examined, 21 had submitted airline tickets that did not conform to the rules.

17.15. The Court estimated that the value of tickets paid for without justification amounted to 0,3 Mio ECU for the ESC and 0,01 Mio ECU for the COR. The inquiry covered a total of 0,8 Mio ECU, of which 0,4 Mio ECU was accounted for by the ESC and 0,4 Mio ECU by the COR. Total reimbursements of air tickets for members of the ESC amounted to 5,3 Mio ECU in 1996 and 1,8 Mio ECU for the COR.

Travel and meeting allowances

17.16. The Court also examined the travel and meeting allowances of members of the ESC and COR.

17.17. The members complete a statement in which they request both the reimbursement of their travel expenses and the payment of the two allowances. The general rule is that they may (ESC) and must (COR) also sign the meeting attendance list.

17.18. The common organizational structure (COS) scrutinizes the statements and photocopies the tickets. According to the rules at present in force, members may not receive both the allowance to cover days of travelling and the attendance at meetings allowance in respect of one and the same day. In several cases, however, the Court observed that this rule was not being complied with.

17.19. An examination of the attendance list revealed in turn that:

(a) the Rules of Procedure did not lay down that the members should sign the attendance lists;

(b) at the ESC there are no such lists for certain meetings whereas they are available for plenary sessions. At the COR the lists relating to the plenary sessions and other meetings are in general duly completed;

(c) in some cases the ESC and COR members do not sign the attendance lists. The lists do not always tally with the attendance details of the minutes of the meetings or with the reimbursements;

(d) in some cases, ESC and COR members were paid, although, according to the tickets submitted, they had not attended the meetings (plenary sessions only).

CONCLUSION

17.20. The number of air tickets and the amount of undue payments in respect of the reimbursement of air fares to ESC members are both high (see paragraphs 17.11 to 17.15) for 1995 and 1996. The Court considers that a detailed examination of all reimbursements is indispensable.

17.21. According to the analyses made for 1995 and 1996 expenditure, the following points should be taken into consideration:

(a) the need strictly to monitor expenditure relating to air fares and meeting costs. Improved management and the use of informatics tools are required for this task;

(b) given the gravity of the findings made by both the Financial Controller and the Court, all appropriate steps to correct the situation should be taken forthwith and in particular as regards cases of undue reimbursements;

(c) at an internal level, conclusions should be drawn from the wrong use of the appropriations concerned in the light of the Financial Regulation and the Staff Regulations of officials.

REPLIES OF THE ECONOMIC AND SOCIAL COMMITTEE, THE COMMITTEE OF THE REGIONS

17.4. It is not standard practice to aggregate the appropriations in budget lines A-250 and B-250 which cover the resources needed to fund the activities of two independent bodies, particularly when their respective working methods are not identical.

17.8. It should be pointed out that ESC members' allowances, which are solely designed to cover subsistence and travel expenses, are set by the Council (Article 194 of the Treaty). The last adjustment came into force on 1 July 1995. Moreover ESC members do not receive any remuneration for their services.

17.9 The practice of paying out members' allowances in Brussels, i.e. before they embark on their return journey is prompted by two considerations:

- if a person proves that he has travelled to Brussels from his place of origin, he/she will presumably also return home;

- if allowances were not paid until after the round trip had been completed, members would have to advance the cost of the ticket out of their own pockets. This would be a heavy financial burden on them, given the protracted refund procedure. This cannot really be countenanced since members are not paid for their activity on behalf of the Committee.

- later reimbursement would substantially increase the administrative work involved (for both the secretariat and the members concerned).

In addition the COR rules on payment of expenses stipulate that claimants must complete and sign the relevant claim forms at the meeting. Claim forms submitted after meetings are processed at the end of the month.

17.11. In this paragraph the Court of Auditors based its comments on the findings of an internal ESC enquiry carried out in May 1996. The following measures were taken as a result of the enquiry.

1. urgent measures were introduced in the last quarter of 1996; e.g. in future, members must produce boarding cards;

2. a three-man group was set up (in September 1996) to assess the findings of the internal enquiry and to table proposals in the light of this assessment. The group submitted its final report on 29 May 1997.

17.13. The check method used by the Court is based on the findings of the investigation carried out by the ESC in 1995.

Consequently the results of the Court's investigation give a picture of the overall situation which requires qualification: these figures do not permit precise conclusions in respect of all tickets.

In this context it should be pointed out that 41 members (out of 94 whose claims were checked) submitted tickets which did not coincide with their actual travel arrangements. This constitutes 18% of the overall ESC membership.

In addition the check carried out by the Court in early 1997 covered early 1996.

At that point in time, the initial measures taken by the ESC in the wake of the internal investigation (May 1996) had not yet been put in train. A further Court check in November 1996 showed that the new measures had had a significant impact (there were only four irregularities out of 125 tickets checked).

17.14. In more than one third of these cases the plane tickets used were in line with the declaration made at the meeting. Some discrepancies arose because of changes in itinerary, airline or mode of transport during the return journey.

17.15. As in para. 17.12, the Court refers to 'wrongly refunded tickets`. It should however be pointed out that the amounts refunded for the disputed tickets cannot be considered as completely unjustified. Since these members were present at the meeting, they obviously used some means of transport to get there.

17.18. The rule referred to is designed to prevent an aggregation of travel allowances where a member undertakes two trips, one after the other, in the same week.

Allowances for meetings and allowances for travel time have two different objectives: the daily allowance for a meeting day covers all expenses at the meeting venue, while the travel time allowance is designed to cover travel related expenses, irrespective of the travel arrangements and without reference to the actual date on which travel took place.

The Committees concede that the wording of this rule could give rise to misunderstandings. It will be amended the next time the allowances are reviewed.

17.19 (a) When the Rules of Procedure are next revised, the ESC will stipulate that members are required to sign an attendance list.

The COR is making it obligatory for members to sign attendance lists for all meetings. The relevant requirement is to be incorporated in the Bureau's instructions on the procedures for implementing the rules of procedure.

The Bureau's rules on the operation of commissions, adopted on 19 April 1995 made it compulsory for members attending commissions to sign an attendance register.

(b) ESC members are already required to sign an attendance register for plenary sessions.

At section and study group meetings, which are on a smaller scale, the secretariat draws up an attendance list which appears in the summary minutes of the meeting.

In addition the claim forms submitted by members at meetings constitute supporting documents for payments.

Nevertheless on 25 July 1997 the ESC secretary-general gave instructions that in future, members would be required to sign attendance registers not only for plenary sessions, but also for other meetings (section, study groups).

(c) In some cases ESC and COR members did in fact forget to sign attendance lists. However the meeting minutes and the members' claim forms proved that they had attended the meeting.

(d) In general, members of both Committees use tickets which can be changed: therefore instead of leaving the meeting venue on the day indicated on the ticket (a copy of which is attached to the claim form), they can change their ticket and leave the following day.

Moreover, their claim form, the meeting minutes and in future, the attendance list can be used to prove that they attended the meeting.

17.20. The ESC recognizes that the situation revealed by the internal check in 1995 and confirmed by the Court's investigation is regrettable and requires immediate corrective action.

Against this background, the authorizing officers have decided to take steps to recover all unauthorized payments.

Moreover, it is clear that the measures already taken have had a significant impact. A spot check carried out by the Court on claims submitted in November 1996 revealed only four tickets with irregularities requiring more detailed investigation.

17.21 (a) Since the internal investigation, the following measures have been taken or are in the pipeline (at both the ESC and the COR):

1. Boarding cards have to be produced.

2. Tickets submitted are stamped 'refunded`

3. Spot checks are carried out with the airlines on tickets submitted for refund.

4. Members are required to sign attendance lists.

In addition the computer equipment used to process ESC and COR members expenses claims will be substantially upgraded and this will make for more efficient administration.

An imprest accounts system for calculating and paying members' expenses and allowances is under examination and should be operational in the near future.

Finally, the Committees propose in the short term to clarify the rules on members' allowances, in the light of experience in the other institutions.

(b) The authorizing officers in the two Committees have decided to recover all unwarranted payments.

(c) In addition to the measures listed under (a), the Committees have decided to hold an internal enquiry into their operation of their administrative organization.

PART VII Financial instruments and banking activities

CHAPTER 18(553\*) Financial instruments and banking activities

18.0. CONTENTS Paragraph reference

The financial instruments 18.1 - 18.6

Audit of interventions in the form of subsidized loans to those regions of Italy which have suffered from earthquake damage 18.7 - 18.24

Introduction 18.7 - 18.10

The system of control 18.11 - 18.12

Industrial estates 18.13 - 18.16

Public buildings 18.17 - 18.24

The project's progress 18.17 - 18.20

Causes of delays 18.21

Eligibility and quality 18.22

Monitoring 18.23 - 18.24

The Guarantee Fund for External Activities 18.25 - 18.39

The Fund's objectives 18.25 - 18.28

How the Fund works 18.29 - 18.30

Utilization in 1996 18.31 - 18.32

The situation at the end of the financial year 1996 18.33 - 18.36

Financial management 18.37 - 18.39

The European Investment Fund 18.40 - 18.47

The Fund's objectives and how it works 18.40

Legal status 18.41 - 18.42

Financial repercussions for the EU 18.43 - 18.44

The Court's audit 18.45

Findings 18.46 - 18.47

Conclusion 18.48 - 18.52

THE FINANCIAL INSTRUMENTS

18.1. In addition to non-repayable aid financed from the budget, the European Union possesses a wide range of financial instruments which are either of an extra-budgetary character (e.g. loans financed by borrowings), or of a hybrid character, i.e. having a potential link to the budget (e.g. possible payments by virtue of guarantees given or possible reimbursements of participations taken up), or a combination of budgetary and extra-budgetary measures (e.g. interest subsidies on loans). Tables 18.1 to 18.4 give an overview of the financial instruments for all Community activities, both those linked to the general budget of the European Union and those coming under the ECSC and the EDFs.

18.2. The EU's borrowing and lending operations are presented in Table 18.1. Loans may be financed either by borrowing on the financial markets, in which case they are managed outside the budget, or from budgetary appropriations.

18.3. Loans, whether granted by the European Union and/or granted by the EIB, may be accompanied, as part of certain support measures, by interest subsidies. These subsidies are set out in Table 18.2.

18.4. In addition, the EU is also authorized, within the framework of its external activities, to guarantee its own borrowings and certain loan operations by third parties (see Table 18.3). In order to facilitate management of defaulting debtors in non-member States, a Guarantee Fund for External Activities was set up in 1994 (see paragraphs 18.25 to 18.39). All guarantees are recorded in the statement of items not included in the balance sheet and appear in the budget as a 'p.m.` (token entry).

18.5. Finally, the EU can take up direct shareholdings in common interest bodies such as the European Bank for Reconstruction and Development (EBRD) or the European Investment Fund (EIF), or else it may acquire shares in special operations such as joint ventures. A summary of the EU's participations as at 31 December 1996 is set out in Table 18.4.

18.6. As at 31 December 1996, loans to Member States accounted for 73% (1995: 77%) of the total of outstanding loans and loans to non-member States accounted for 27% (1995: 23%). Overall, financial activities in the form of loans (14 484 Mio ECU), borrowings (12 655 Mio ECU), capital participations (272 Mio ECU) and guarantees (11 877 Mio ECU) came to a total of 39 287 Mio ECU at the end of 1996, representing a decrease of 7 651 Mio ECU, or 16%, compared with the situation at the end of the previous year.

AUDIT OF INTERVENTIONS IN THE FORM OF SUBSIDIZED LOANS TO THOSE REGIONS OF ITALY WHICH HAVE SUFFERED EARTHQUAKE DAMAGE

Introduction

18.7. On 23 November 1980, an earthquake devastated an area of approximately 20 000 km2 in the Campania and Basilicata regions of southern Italy. The Council considered that this situation called for rapid and effective remedial action. It therefore authorized the Commission to incur borrowings in order to finance the reconstruction of the economic and social infrastructures in those areas affected by the earthquake (554), by enlarging the field of application of the 1978 Decision on the New Community Instrument (NCI)(555). The principal of the loans was not to exceed the equivalent of 1 000 Mio ECU, after deduction of those operations which could be carried out for the same purpose by the EIB using its own resources. Both types of loan would benefit from an interest subsidy of 3% for a maximum of 12 years. The European Investment Bank would be appointed to manage these loans under a mandate from and on behalf of the Commission.

18.8. Loans totalling 965,7 Mio ECU were granted during the period 1981-1988 (see Table 18.5). Interest subsidies charged to the Community budget were spread out over the period 1982 to 1999; at the end of this period they will total 239,7 Mio ECU (see Table 18.6).

18.9. The Italian authorities estimated the cost of the damage at 13 596 Mio ECU. Community intervention in the form of loans at subsidized interest rates represents 7,1% of this amount. Table 18.7 contains a summary of those projects which have been financed. The allocation of the loans was formalized in an agreement, concluded in March 1981, between the Commission, the EIB and the Italian Ministry of the Treasury, according to which the loans would be disbursed by the Ministry of the Treasury which would also act as a conduit for the repayments.

18.10. The Court has repeatedly(556) expressed its concern about these interventions, particularly in respect of their effectiveness and the question of monitoring them. The Commission's replies were, in most cases, very general and optimistic in tone. In general, the Commission confirmed that follow-up and monitoring procedures were in place and were being applied, but that its departments were studying ways of enhancing the transparency of the controls(557). In the case of the public buildings project, the Commission said that the problem of delays was not attributable to the quality of the management(558). In respect of the industrial estates project, which has created far fewer jobs than planned, the Commission has twice said(559) that an improvement in the situation was imminent. Nevertheless, the Court has been unable to find any evidence of real improvement. For this reason, once the last sub-project of this measure (public buildings) had been closed, it examined certain problems which had already been pointed out by the Court but had not been dealt with by the Commission.

The system of control

18.11. The national control framework applying to the interventions for reconstruction after the earthquake was affected by serious deficiencies which were noted by a Committee of Inquiry of the Italian Parliament(560) and by the Italian National Audit Institution (Corte dei Conti)(561). The EIB considers that it has no responsibility for controls(562). The Commission has not carried out any independent visit to check the implementation of these interventions, in spite of the responsibility that devolves on it from Article 205 of the Treaty to ensure appropriate controls with a view to protecting the Community interest.

18.12. The Court did not have any opportunity to carry out the necessary inspections until November 1992(563). In practice, however, it is impossible to carry out comprehensive inspections on a project so long after the events. Moreover, the contracts concluded between the EIB and the beneficiaries did indeed contain provision for a method of accounting which allowed identification of work carried out on the basis of Community financing. However, this provision was not always observed, particularly by the office responsible for the construction of roads. In fact, the latter submitted three different calculations for work financed by the Community. In such circumstances, it is impossible to ascertain whether the funds and, by extension, the interest subsidies made available were used correctly.

Industrial estates

18.13. One of the most important projects involved the creation of infrastructures for 20 areas of industrial development (of which 15 were being financed through subsidized loans granted under special intervention measures) in order to encourage industrial enterprises to set up operations there which would create jobs. The object was to seek to compensate for the job losses caused by the earthquake while at the same time countering the risk of depopulation in these regions, which have long been economically depressed. Community financing consisted of 149,2 Mio ECU of loans, representing 15,4% of the total of special loans, and 38,4 Mio ECU of interest subsidies, plus 116,1 Mio ECU of ERDF aid and 65 Mio ECU of national aid.

18.14. Since 1991, the Court has carried out regular monitoring(564) of companies moving to these estates and of the creation of jobs, as these are the decisive factors reflecting the success of the intervention, and because the trend was towards a deteriorating situation, notwithstanding that the Commission has said that it 'expects an improvement in the course of the coming years`(565).

18.15. In fact, the number of companies and jobs has fallen. One significant reason was the absence, discovered by the Court in 1994(566), of a procedure for the allocation of sites which were still vacant, and for the reallocation of sites which had become available again following closures due to company liquidations.

18.16. In May 1996, the Italian Ministry of Industry introduced arrangements to reallocate vacant sites(567) but in December 1996 a new law came into force(568) which provided for the transfer of administrative authority for the industrial estates to the regions, so that the process of reallocation had to begin again at this level. In the meantime, the situation is continuing to deteriorate. Table 18.8 shows developments from 1994 to 1996.

Public buildings

The project's progress

18.17. Another project involved the repair of public buildings. Of the 85 interventions proposed by the Ministry of Public Works, the Bank selected 65 which it considered eligible according to the terms of the Council's Decision, of which 35 involved repair work and 30 involved the construction of new buildings. Total costs were estimated at 112 500 Mio ITL (88 Mio ECU). According to the preliminary schedule, work was to commence in 1983 and be completed in 1985.

18.18. As early as 1984, the year after the contract was concluded, the planned construction of four new Carabinieri barracks planned for Campania was no longer a matter of urgency because, in the meantime, the Carabinieri had found alternative solutions. These four sub-projects were therefore cancelled in 1985. Subsequently, four more were cancelled in 1989 and another one in 1991.

18.19. The implementation of the remaining 56 sub-projects suffered considerable delays. Table 18.9 shows the situation regarding delays as at 31 December 1996. For the 47 buildings completed, the delays range from one to eleven years, with an average of four and a half years. If the nine incomplete sub-projects are included, the average delay increases to five years at present, and will rise even further.

18.20. The estimated cost of the revised project was 102 000 Mio ITL (76,4 Mio ECU). According to the last statement drawn up by the EIB at the end of 1996, the actual expenditure amounted to 105 200 Mio ITL (78,8 Mio ECU), of which 91 400 Mio ITL (68,5 Mio ECU) was for the sub-projects completed and 13 800 Mio ITL (10,3 Mio ECU) was for the nine sub-projects which were still to be completed. The funds made available have thus been used up and future work will be financed by national public funds. The additional amount needed has been estimated at 18 000 Mio ITL (13,5 Mio ECU), meaning that the initial budget (which nevertheless already included a provision of 17 900 Mio ITL, i.e. 13,4 Mio ECU, for price increases) has now been exceeded by 21%.

Causes of delays

18.21. In general, the project was held up at national and regional levels by design, planning and coordination faults, by legal, administrative and budgetary prob-lems(569), by a high number of bankruptcies of construction companies and by the introduction of new anti-earthquake standards.

Eligibility and quality

18.22. In approximately 30% of the cases inspected on the spot (five sub-projects out of 17), there was no direct connection between the buildings and the departments concerned on the consequences of the earthquake. In some cases the work concerned rather the restoration of historic monuments that had been but little affected by the earthquake and moreover, in these same cases, there was no question of rehousing a public service which had been rendered homeless by the earthquake. In addition, a large number of buildings completed and in use are suffering from construction problems, particularly leaks and cracks in the walls.

Monitoring

18.23. Under the terms of the agreement concluded with the Commission and the Republic of Italy, the EIB is required to ensure monitoring of the implementation of the projects, carrying out such checks as it deems necessary, including visits and inspections, all of which is to be without prejudice to monitoring by the Commission. However, the EIB has encountered many problems of information and coordination at the level of the Regional Office of Public Works in Naples, which made the monitoring of this project particularly laborious. Information on the progress of the work had to be requested repeatedly and, once received, subsequently had to be verified because it proved to be contradictory. The Court encountered the same difficulties during its enquiries.

18.24. The progress reports, which are drawn up by the EIB, instance the problems encountered and the delays incurred. Eight reports have been drawn up on the unsatisfactory development of this project and sent to the Commission. The Commission, however, has not taken any steps whatsoever to approach the Italian authorities in order to remedy the situation. Discussions to this end only took place at the level of the EIB's local representative and produced no results. It would, however, appear obvious that problems on this scale should be dealt with at a higher level and that the Commission should have fulfilled its role as guardian of the Community interest to ensure the action taken was more effective.

THE GUARANTEE FUND FOR EXTERNAL ACTIVITIES

The Fund's objectives

18.25. As the Commission is responsible for ensuring the servicing of the debt and the repayment of the borrowings which it has incurred itself or which have been incurred under guarantees given by financial institutions on behalf of the Community, particularly by the EIB, loans granted to non-member States are the subject of a budgetary guarantee so as to cover any possible default by the beneficiaries of the primary loans. Before the creation of the Guarantee Fund a token entry (p.m.) was inserted in the budget whenever there was a risk of future expenditure connected with a guarantee charged to the Community budget. The risk borne by the Community budget had become significant by the beginning of the 1990s due to the increase in the number of guarantees granted to a growing number of non-member States for more and more substantial amounts.

18.26. There was, at that time, a very great probability of the implementation of the budget being seriously disrupted, should a call have been made upon the Guarantee Fund for a large amount; in fact, there was no way in which funds could have been generated to cover the budgetary expenditure resulting from a default and a call on the Guarantee Fund other than recourse to existing items in the budget or to a supplementary and amending budget.

18.27. In its Annual Report on the financial year 1991(570), the Court of Auditors asked the Commission 'to examine the possibility of creating a special "loan guarantee" reserve (similar to the EAGGF monetary reserve), financed from own resources and which would not be called upon except in cases of real need or if the default was in excess of the predetermined level of the threshold`. A guarantee reserve allows a more flexible procedural treatment at budgetary level while removing the problem of the availability of funds at the end of the year.

18.28. Once the Edinburgh Council had decided in December 1992 on its creation, the Guarantee Fund for External Activities was established on 31 October 1994 by Council Regulation (EC, Euratom) No 2728/94(571). The Fund's mechanisms act as a buffer, thus facilitating the budgetary procedure. It is thus intended to reimburse lenders in the event of a default by the beneficiary of a loan granted or guaranteed by the Community to, or in, a non-member State. The Guarantee Fund is brought into play if the beneficiary is still in default three months after the due date; it then takes over from the Community Treasury which, up to this point, was responsible for the servicing of the loan. Pursuant to Article 6 of the Fund's Regulation, the Commission has entrusted the EIB with its financial management under the terms of an agreement signed by the Community and the EIB in November 1994.

How the Fund works

18.29. The Council has fixed a target amount for the Fund of 10% of the Community's total outstanding capital liabilities arising from all lending and guarantee operations for the benefit of third countries, plus interest due and not yet paid. Until it reaches this amount, the Fund is endowed by:

- payments from the general budget corresponding to a percentage of the capital value of the operations decided on and committed as from 1 January 1993;

- interest yielded by investing the Fund's resources;

- recoveries of arrears from defaulting debtors.

18.30. The Guarantee Fund's mechanisms impose a de facto limit on the amount that can be granted in loans and loan guarantees to non-member States. This limit is equal to the ratio between, on the one hand, the guarantee reserve (budget item B0-230) and, on the other, the rate of provisioning of the Fund. The guarantee reserve was set at 326 Mio ECU for 1996 and at 329 Mio ECU for 1997, while the rate of provisioning is currently 15%. This would be equivalent to approximately 2 200 Mio ECU in the case of loans guaranteed to the extent of 100%.

Utilization in 1996

18.31. During the financial year 1996, the Guarantee Fund, the resources of which amounted to 300,85 Mio ECU on 1 January 1996, was endowed with two payments totalling 235,39 Mio ECU. The Fund intervened in respect of guarantees totalling 52,54 Mio ECU, including 0,45 Mio ECU of interest on arrears (in 1995, the corresponding figures were 303,07 Mio ECU, including 6,08 Mio ECU of interest on arrears). A total of 55,72 Mio ECU, including 9,71 Mio ECU of interest on arrears, was recovered from defaulting debtors (in 1995, these two figures were 35,63 and 1,39 Mio ECU respectively).

18.32. Total defaults had reached 288,81 Mio ECU on 31 December 1996 (including 19,98 Mio ECU of interest on arrears) and broke down as follows:

- a total of 224,95 Mio ECU (including 10,85 Mio ECU of interest on arrears) in connection with a loan of 1 250 Mio ECU to finance food aid granted in December 1991 to the republics of the former Soviet Union;

- 63,86 Mio ECU (including 9,13 Mio ECU of interest on arrears) concerning loans for an authorized total of 760 Mio ECU granted by the EIB under a Community guarantee to the countries of the former Yugoslavia.

Table 18.10 supplies details of the total cumulative operations since the creation of the Fund as well as the defaults situation, by country, as at 31 December 1996.

The situation at the end of the financial year 1996

18.33. Table 18.11 charts the main vicissitudes of the Guarantee Fund since its launch. On 31 December 1996 total Fund resources came to 557,52 Mio ECU, whilst the total outstanding for loans and loan guarantees to non-member States, plus interest due but not yet paid, amounted to 6 521 Mio ECU. The ratio between the Fund's resources and the sum outstanding as defined in the Regulation is therefore 8,5% compared with 5,1% on 31 December 1995. At the end of the financial year 1996, defaults on payments which had been outstanding for less than three months totalled 5,7 Mio ECU, but, when included, this figure is, relatively, so small that it does not alter the ratio of 8,5%.

18.34. The year 1996 saw a slowdown in the Fund's interventions compared with 1995 (52,54 Mio ECU in 1996 as against 303,07 Mio ECU in 1995). This may be explained by the fact that the Fund was created at the end of 1994 and the first calls on the Fund were made in 1995 and, in accordance with the Fund's Regulation, covered defaults which had occurred since 1 January 1993. This catching-up effect only affected the Fund during 1995, and the calls made on it in 1996 only concerned defaults of three months.

18.35. The opposite effect was the case with recoveries from defaulting debtors. These, in fact, reached 55,72 Mio ECU in 1996, compared with 35,63 Mio ECU in 1995. These repayments, which came mainly from two countries, included not only the capital and normal interest, to the value of 46,00 Mio ECU, but also 7,29 Mio ECU in interest on arrears accrued after the three months between the default and the call on the Guarantee Fund.

18.36. Although defaults may still occur in the future, the Fund, which initially had no capital of its own, has, to date, fulfilled its purpose, although large calls were made upon it at first, due to the necessity of catching up on defaults which had occurred previously. Experience shows that it is on the way to achieving its target amount.

Financial management

18.37. The annex to the agreement concluded between the Commission and the EIB relating to the management of the Guarantee Fund stipulates that, for such time as the invested capital does not exceed 300 Mio ECU, the Fund shall be considered an investment fund investing only in short-term instruments with a maturity not exceeding one year. This was the case in 1995. Once the Fund has exceeded the ceiling of 300 Mio ECU, the Commission may decide, in agreement with the EIB, to alter its investment principles. This is precisely what happened in 1996 when the Fund easily exceeded the level of 300 Mio ECU in the course of the first quarter. The Commission therefore decided, at the EIB's proposal, to invest part of the capital in securities.

18.38. In 1996 the Fund's revenue was 18,2 Mio ECU. The reduction to 0,05% in the rate of commission charged by the EIB, agreed during the financial year 1995, was the subject of an amendment to the agreement that was signed in September 1996. The management commission paid to the EIB for 1996 thus totalled 0,2 Mio ECU. The net result for 1996 was, therefore, 18,0 Mio ECU.

18.39. The Court conducted its audit of the Fund for the financial year ending 31 December 1996 by firstly examining its administration by the Commission and then by examining the financial management by the EIB. After concluding these examinations, the Court has no particular comments to make.

THE EUROPEAN INVESTMENT FUND

The Fund's objectives and how it works

18.40. The Fund (EIF) was created on 14 June 1994 in response to the wishes expressed by the Edinburgh European Council in December 1992 and was designed to offer additional financial capacity to support the development of trans-European networks (TENs) and small and medium-sized enterprises (SMEs). Its role is to furnish guarantees to lenders and to hold participations, thereby covering risks which the banking and industrial sectors are not able to accept.

Legal status

18.41. The EIF is a financial institution of hybrid legal status. It brings together bodies which are subject to Community law (the EU, on the one hand, represented by the Commission and, on the other, the EIB) and financial institutions regulated by private law. As a result, and as Article 40 of the Fund's statute stipulates, disputes between the Fund and the beneficiaries of its interventions are settled by the relevant national courts, whereas disputes concerning the measures adopted by the Fund's structures fall within the jurisdiction of the Court of Justice of the European Communities.

18.42. Pursuant to Article 41 of the Fund's statute, the provisions relating to the privileges and immunities of the European Communities are applicable to the Fund, to the members of its various structures and to its staff. The Fund moved into offices in the EIB's building in Luxembourg which it was still occupying on 31 December 1996.

Financial repercussions for the EU

18.43. The EU has subscribed 30% of the authorized capital of the EIF, i.e. 600 Mio ECU of the 2 000 Mio ECU. The remainder of the EIF's capital has been subscribed by the EIB (40%), and by 76 banking institutions (19%). It follows that 11% of the authorized capital has not yet been subscribed. Table 18.12 shows the Fund's main movements and its situation since its creation.

18.44. In accordance with the EIF's statute, 20% of the subscribed capital has been paid up, which represents, for the EU, 120 Mio ECU to be paid between 1994 and 1997 in annual instalments of 30 Mio ECU. The EU had already paid 90 Mio ECU as at 31 December 1996. On that same date total guarantees outstanding came to 1 423 Mio ECU, i.e. 80% of the subscribed capital and four times the paid-up capital. For the EU, the amount exposed to maximum risk is, therefore, 480 Mio ECU (1 423 x 600/0,89 x 2 000), with the result that the EU could be required to make an additional payment of approximately 360 Mio ECU (480 P120).

The Court's audit

18.45. The Court has still not obtained satisfactory access to information essential to its audit, which mainly covers the following aspects:

- The audit of the risks borne by the general budget. The EIF's operations entail risks, by their very nature, and the guarantees that the Fund has provided may be invoked in the event of default by a beneficiary. The risks of non-recovery of the loans guaranteed must be evaluated in the most precise manner possible, all the more so since contributions from the general budget may be necessary should the EIF's own funds be insufficient, within the limits indicated in paragraph 18.44. This evaluation requires detailed study of the files.

- An audit of the value of the EU's shareholding in the EIF, which is entered in the EU's balance sheet. The Court, as part of its audit of this balance sheet, needs to assess the real economic value of this participation, particularly those aspects that might require the creation of a provision.

- An audit of the management of the EIF, regarding both its operating costs and its liquidity.

- An audit of the EIF's efficacy, firstly in terms of the operations themselves and, secondly, in terms of the degree to which these operations complement, and are consistent with, the Community's other financial and budgetary instruments(572).

The documents supplied to the Court are certainly interesting but do not correspond to what it asked for. They contain analyses and assessments by the Fund's staff. As long as the Court is not in a position to check the contents of these documents against the constituent items or make its own observations and analyses, the mere fact of making these documents available will not be enough to guarantee independent external control.

Findings

18.46. In spite of a significant increase in the total value of guarantees as at 31 December 1996 (1 423 Mio ECU) compared with 31 December 1995 (632 Mio ECU), they had still only reached 27% of the Fund's potential, which corresponds to three times the subscribed capital, i.e. 5 358 Mio ECU. Under these conditions, revenue from investments far exceeds commission received on loan guarantee operations (12,6 Mio ECU and 5,6 Mio ECU respectively for the financial year 1996).

18.47. Of the 21 loan guarantee operations authorized in 1996, totalling 833 Mio ECU, loans granted by the EIB accounted for 498 Mio ECU. Of the 31 loan guarantee operations authorized since the creation of the Fund for a total of 1 465 Mio ECU, 19 involved the EIB and accounted for 999 Mio ECU, i.e. 68% of the total.

CONCLUSION

18.48. The total volume of the EU's financial operations in the form of loans, borrowings, guarantees and shareholdings was 39 287 Mio ECU at the end of the financial year 1996, which represents a decrease of approximately 7 651 Mio ECU, or 16%, compared with the end of the previous financial year (see paragraphs 18.1 to 18.6).

18.49. The industrial estates and public buildings projects represent almost 25% of Community interventions in the form of loans to those areas of southern Italy which were affected by the earthquake of November 1980 (965,7 Mio ECU of loans granted, together with approximately 240 Mio ECU of interest subsidies). The implementation of these projects did not satisfy the criteria of rapidity and effectiveness advocated in the Council Decision(573). The Commission has not carried out any independent control and monitoring measures and has not undertaken any corrective action.

18.50. Generally speaking, the experience of the subsidized loans granted to Italy after the earthquake of November 1980 clearly demonstrates the need for much more rigorous planning, monitoring and control in respect of this type of intervention. In future, when the Commission entrusts the management of funds granted, subsidized or guaranteed by the EU to the EIB or any other management body, the selection criteria for the projects or activities which are to benefit will have to be defined very clearly in terms of the relevant European objectives, and more binding provisions will have to be put in place in respect of monitoring and evaluation of progress by the body entrusted by the EU with the management of the funds. As part of its responsibilities for the implementation of the budget of the EU and in order to demonstrate clearly its resolve not to repeat its performance in the matter of its loans to Italy, the Commission will itself have to take control of monitoring in order to ensure progress is made on the projects or financial activities and to control the performance of the managing body. Provision should in any case be made for corrective measures to be taken by the managing body when borrowers do not respect their obligations and by the Commission when the performance of the managing body is unsatisfactory.

18.51. As far as the Guarantee Fund is concerned, developments in 1996 confirm that the Fund is nearing achievement of its target amount of 10% of total outstanding capital liabilities from lending operations plus accrued interest. The audit of the Fund conducted by the Court as part of its annual reporting has not given rise to any other comments (see paragraphs 18.36 and 18.39).

18.52. As the Court did not obtain access to all the necessary documents, in spite of the requests made by the Parliament and the Council, it is still not in a position to carry out an audit of the European Investment Fund and is, therefore, not able to submit an opinion to the discharge authority (see paragraph 18.45).

REPLIES OF THE COMMISSION

AUDIT OF INTERVENTIONS IN THE FORM OF SUBSIDIZED LOANS TO THOSE REGIONS OF ITALY WHICH HAVE SUFFERED EARTHQUAKE DAMAGE

Introduction

18.7 18.10. The Court underlines that the building of industrial zones has led to less job creation than was initially foreseen. This is correct but it should be borne in mind that the main objective of the EIB/NCI loans was to finance the creation of the basic infrastructure and to help restore the means of production in the earthquake-stricken regions. The Commission has stressed in the past that the provision of infrastructure for industrial zones cannot by itself create employment. However, it facilitates investment and job creation by entrepreneurs.

The system of control

18.11. The Commission's responsibility and the Community interest are safeguarded by a number of procedures within both the Commission and the EIB. Eligibility and conformity with Community policy and, more specifically, with the relevant Council decision are guaranteed by the Commission through the 'Article 21 procedure`. Article 21 of the Bank's statute requires an opinion of the Commission on each project financed by the Bank. A positive opinion is given by the Commission only if the project is eligible and in conformity with Community regulations and policy. Projects are also scrutinized by the Bank's Board of Directors in which the Commission is represented. The legal, economic, operational and technical services of the Bank assure ex ante and ex post monitoring of the projects financed.

18.12. Since the start of the reconstruction works in 1981, extensive restructuring of the agency in question occurred, with major personnel changes and the introduction of a new set of accounting principles and practices, rendering the reconciliation of the different sources of finance for their various investment programmes impracticable. However, no additional project costs nor any extra cost to the Community budget were incurred as a result of this.

Industrial estates

18.14 18.16. The physical completion of the project has been essentially in line with initial plans, thus achieving the project's objective, i.e. the creation of the fundamental infrastructure. There is a general consensus that the creation of industrial zones was a good idea, not only because of job creation in a rural area but also with a view to stopping the exodus of inhabitants.

The lack of job creation, which was a secondary criterion and is criticized by the Court, is mainly due to a number of problems on national or regional level:

- the planning and execution were entrusted to a special commissioner whose activity was conditioned by political decisions;

- inadequate selection of firms to occupy the industrial zones; lots of firms that have gone into receivership or have never started production;

- legal obstacles to the reallocation by the Italian authorities of sites in industrial zones having become available, in spite of sufficient demands;

- lack of access roads to zones in mountain areas.

Finally, it should be taken into account that the construction of the industrial zones has led to the indirect creation of employment, even if the exact number of jobs created indirectly cannot be measured exactly.

Public buildings

Eligibility and quality

18.22. The Commission and the EIB have adhered carefully to the selection criteria as defined by the relevant Council decision and the Agreement between the Commission, EIB and Italian Ministry of the Treasury, which stipulates that the loans are destined to finance 'investment for the reconstruction of means of production and the reconstruction of economic and social infrastructures in the Campania and Basilicata regions [...] which are defined by national laws...`.

Monitoring

18.24. The Commission and the Bank have coordinated their policy with regard to the interventions under consideration. However, neither the Bank nor the Commission can presume to usurp the role of the national and regional authorities.

THE EUROPEAN INVESTMENT FUND

Financial repercussions for the EU

18.43. Between the inaugural EIF meeting in 1994 and 10 June 1997, 19 financial institutions had joined the 58 founding shareholders. Thus, new shareholders are still being recruited and real progress has been made since the Fund was set up.

At 1 September 1997, ECU 201 million of the authorized capital had not been subscribed. The Fund is now launching a new initiative to recruit shareholders amid hopes that the initial hesitation shown by some commercial banks, particularly private banks in the United Kingdom and Germany, will give way to a more favourable reaction now that the Fund is developing its role on the markets. The Fund's strategy is to attract and strengthen the presence of institutions that are specialized in the financing of projects. It is also considering the possibility of encouraging participation by institutional investors (insurance companies and pension funds), to improve the balance in its membership.

The decision to participate in the EIF's capital is not a purely financial one. It may also be taken with an eye to the possibility of making an active contribution to the Fund's strategic development, ease of access to the Fund's management in developing ideas on specific business opportunities, entry to a 'club` exchanging ideas and experience, etc.

The Court's audit

18.45. The Commission has provided the Court with the following documents:

(i) documents automatically available to all other shareholders (Annual Report and accounts, information letters and notes to shareholders, etc.);

(ii) documents specifically connected with the verification of revenues and costs arising from the Community shareholding (calls for capital, payment of dividends, etc.);

(iii) the Fund's guarantee policy guidelines, Treasury guidelines, and other policy guidelines determined from time to time by the Supervisory Board;

(iv) Quarterly reports to the Supervisory Board (including reports on the Treasury) and other periodic progress reports (including the business plan and overall risk review);

(v) minutes of Supervisory Board meetings dealing with issues listed in (i) to (iv) above and minutes of the general meetings.

The Commission has always been prepared to give further clarification on the documents transmitted and has emphasized its willingness to do so already at the first transmission of documents. Should the Court feel that it requires further information, the Commission will examine any such request carefully, together with the EIF.

Findings

18.46. While it is true that the EIF has not yet used up its full guarantee capacity of three times the amount of its subscribed capital of ECU 1 786 million, this cannot prudently be expected after two and a half years of operation. It is only logical that a financial institution of this kind has to build up its activities prudently in order to establish trust and to ensure the quality of its operations.

In terms of subscribed and paid-in capital (ECU 267,9 million by year-end 1996), the outstanding guarantee volume of ECU 1 423 million is fully satisfactory (gearing of 1 to 5). The EIF has made real progress in developing its operations and is increasing its portfolio at a steady rate. The attainment of 27% of the maximum permitted guarantee volume can be considered creditable in a period of two and a half years.

Commission income on guarantees is increasing steadily as a proportion of total income, from 17% in 1994 to 24% in 1995 and 31% in 1996. When it is borne in mind that the income from investing the paid-in capital increased substantially each year as new tranches were received, the progression in the percentage of guarantee commission is all the more satisfactory.

CONCLUSION

18.50. The Commission does not agree with the Court's conclusions. Community loans and interest subsidies financed nearly all of the planned investments in accordance with the prescribed objectives.

The problems raised by the Court regarding delays were caused by shortcomings at national, regional or local level. The Commission does not see why such findings should be a reason to call into question the whole existing management system, which, it believes, operates satisfactorily, given the special circumstances.

Nevertheless, the Commission is prepared in future to examine, on a case-by-case basis, the best way of managing and scrutinizing similar Community operations, while respecting the roles and tasks conferred on itself and the EIB.

18.52. With regard to the EIF, the Commission has always underlined the need to ensure that the Court has the necessary information at its disposal to exercise its function. Given the size of the Community contribution to the Fund's capital (30%) and the potential impact on the budget (in the event of financial difficulties, the EIF can ask its shareholders to pay unpaid tranches of the capital), the Court is justified in carrying out an audit of the management of this Community share. In this respect it will be given access to the abovementioned documents which the Commission receives as a shareholder. The Commission has already sent the Court a large number of internal administrative documents.

Since February 1995, when a high-level meeting was held between the parties concerned, a dialogue has developed to work out an agreement between the Court and the Commission for a satisfactory solution as regards the underlying problem. This dialogue is continuing.

The Commission does not deny that the share of the EIF's capital held by private banks is a matter requiring a great deal of attention from the Court. It would also point out that the right of shareholders does not give access to all types of information relating to firms. However, it is willing to pursue discussions with the Court in order to come to an appropriate arrangement, while bearing in mind the special situation of the EIF and the fact that the Community's subscription to its capital amounts only to a minority share of 30%.

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ANNEX I Reports and opinions adopted by the Court of Auditors during the last five years

The Court of Auditors is required by the terms of the Treaties to produce an annual report. It is also required, by the Treaties and other regulations, to produce annual reports on certain Community bodies and activities. The Treaties further give the Court the power to submit observations on specific questions and to deliver opinions at the request of one of the institutions. The reports and opinions adopted by the Court during the last five years are listed below.

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VOLUME II STATEMENTS OF ASSURANCE

TABLE OF CONTENTS

Page

Part I Statement of assurance concerning activities financed from the general budget

Chapter 19 Statement of assurance and supporting information 5

Chapter 20 Analysis of EAGGF-Guarantee and fisheries expenditure 21

Chapter 21 Analysis of Structural Fund expenditure 31

Part II Statement of assurance concerning the activities of the sixth and seventh European Development Funds

Chapter 22 Statement of assurance and supporting information concerning the activities of the sixth and seventh European Development Funds 39

Annex II (\*) Financial information on the general budget, the balance sheet of the European Union and the European Development Funds

(\*) The diagrams are all in this Annex.

THE INSTITUTIONS' REPLIES

Page

Part I Statement of assurance concerning activities financed from the general budget

Chapter 19 Statement of assurance and supporting information 16

Chapter 20 Analysis of EAGGF-Guarantee and fisheries expenditure 29

Chapter 21 Analysis of Structural Funds expenditure 36

Part II Statement of assurance concerning the activities of the sixth and seventh European Development Funds

Chapter 22 Statement of assurance and supporting information concerning the activities of the sixth and seventh European Development Funds 50

PART I Statement of assurance concerning activities financed from the general budget

CHAPTER 19(574\*) Statement of assurance and supporting information

19.0. CONTENTS Paragraph reference

Statement of assurance

Information supporting the statement of assurance 19.1 - 19.40

Introduction 19.1

Scope of the audit 19.2 - 19.5

Reliability of the accounts 19.6 - 19.25

Understatement of amounts owed by Member States 19.6 - 19.7

Overstatement of claims on Member States related to the clearance of the EAGGF-Guarantee accounts 19.8

Understatement of cash account balances 19.9 - 19.11

Overstatement of commitments still to be settled 19.12 - 19.18

Understatement of commitments recorded in the budgetary accounts 19.19

Understatement of commitments related to the Structural Funds 19.20

Omission of off-balance sheet commitments related to multi-annual obligations for PHARE and TACIS operations 19.21

Failure to quantify commitments in respect of pension rights 19.22

Understatement of budgetary payments consisting of advances and payments on account 19.23 - 19.25

The legality and regularity of the underlying transactions 19.26 - 19.36

Errors affecting the legality and regularity of commitment transactions 19.26

Limitations on the audit work relating to payments 19.27

Errors affecting the legality and regularity of the transactions underlying payments 19.28 - 19.36

Accounting standards, policies and procedures 19.37 - 19.40

Accounting standards and policies 19.37 - 19.39

Accounting procedures 19.40

Statement of assurance concerning activities financed from the general budget for the financial year ended 31 December 1996

I. The Court has examined the consolidated accounts of the European Community for the financial year ended 31 December 1996. These accounts include the balance sheet as at 31 December 1996, the revenue and expenditure account for the financial year ended on the same date and the notes in annex, and were drawn up under the Commission's responsibility in accordance with the provisions of the Financial Regulations. They are summarized in Volume IV of the documents submitted by the Commission to the discharge authorities, and to the Court of Auditors on 30 April 1997(575). Pursuant to the Treaties(576), the Court of Auditors is required to provide the European Parliament and the Council with a statement of assurance as to the reliability of the accounts and the legality and regularity of the underlying transactions.

II. The Court carried out the audit in accordance with generally accepted international auditing standards, to the extent that these apply in the Community context. The audit of revenue was based on the amounts to be recovered and the amounts actually paid to the Community. The audit of expenditure was based on expenditure committed and the payments made. The audit comprised an appropriate range of audit procedures designed to examine, on a test basis, evidence relating both to the amounts and disclosures in the consolidated accounts and to the regularity and legality of the transactions underlying the accounts. It also included an assessment of the accounting principles used and significant estimates made by management, as well as the overall presentation of the accounts. The Court obtained through the audit a sufficient basis for the opinion expressed below.

\* \* \*

Reliability of the accounts

III. The total amount of debtors representing amounts owed by Member States to the Community institutions, and disclosed in the consolidated balance sheet as 1 981,6 Mio ECU, is not accurately reflected in the accounts:

(a) One of the main components of the debtors' figure is understated owing to problems of completeness and valuation. This concerns the separate accounts operated by Member States under Community legislation for recording entitlements to customs duties and agricultural levies which are either unsecured or are contested. The total recorded in the balance sheet was 1 064,2 Mio ECU.

(see paragraphs 19.6 19.7)

(b) The debtors relating to the clearance of accounts of EAGGF-Guarantee expenditure are overstated by 264,1 Mio ECU, because certain repayments made by the Member States during 1996 were not taken into account.

(see paragraph 19.8)

IV. Bank account assets of the Communities, recorded in the balance sheet as 11 696,7 Mio ECU, are not accurately reflected in the accounts:

(a) Replenishments of bank accounts in certain third countries to a value of several hundred million ECU are recorded as expenditure instead of being recorded as an asset in the balance sheet.

(see paragraph 19.9)

(b) Community assets of at least 25,9 Mio ECU, the management of which has been entrusted to third parties, do not appear in the cash accounts in the balance sheet.

(see paragraph 19.10)

(c) The Commission has not performed reconciliations (39,3 Mio ECU) between the general ledger and the confirmations from the banks relating to the imprest accounts of the Mediterranean protocols.

(see paragraph 19.11)

V. The value of commitments still to be settled (47 489,2 Mio ECU) is understated by a net amount of at least 715 Mio ECU. This figure is made up of both overstatements and understatements:

(a) The total value of commitments from differentiated appropriations still to be settled at the end of 1996 is overstated by at least 587 Mio ECU because it includes commitments that were no longer required to meet future payments. In addition, no information was provided by the Commission to demonstrate that a further 466 Mio ECU of outstanding commitments were required to meet future payments.

(see paragraphs 19.12 19.18)

(b) The value of certain other commitments still to be settled at the end of 1996, as well as the value of the commitments of the year, are understated by some 1 302 Mio ECU due to the practice of the Commission of committing in the accounts less than the full amount actually committed in the fields of cooperation and fisheries. Furthermore, these amounts are not disclosed in the schedule of off-balance sheet commitments.

(see paragraph 19.19)

VI. The multi-annual obligations disclosed as off-balance sheet commitments (91 134,5 Mio ECU) are inaccurately stated:

(a) The accuracy of the amount (88 500 Mio ECU) shown for multi-annual obligations for Structural Funds as off-balance sheet commitments is doubtful because the underlying calculations were found to contain numerous errors.

(see paragraph 19.20)

(b) Multi-annual obligations of some 4 200 Mio ECU for PHARE and TACIS operations have been omitted from the off-balance sheet commitments.

(see paragraph 19.21)

(c) The obligations of the Communities in respect of pension rights acquired by its personnel are mentioned in the off-balance sheet commitments, but have not been quantified.

(see paragraph 19.22)

VII. The total value of advances or payments on account registered during the year as budgetary payments which were not definitive at the end of the year is understated by a net amount of some 19 000 Mio ECU.

(see paragraphs 19.23 19.25)

Legality and regularity of the underlying transactions

VIII. The substantive legality and regularity of commitments is affected by the errors described at V (b) above, because the amounts actually committed breached the limits of the commitment appropriations fixed by the budgetary authorities.

(see paragraph 19.26)

IX. The most probable estimate of the rate of substantive errors concerning the transactions underlying payments is about 5,4% of the total recorded budgetary payments of the order of 77 000 Mio ECU.

(see paragraph 19.30)

X. The audit again showed a high incidence of formal errors affecting payments. In these cases there were failures to comply with the applicable regulations and other conditions.

(see paragraphs 19.33 19.36)

XI. In a number of cases, estimated to represent 4,3 % of Community payments, it was impossible for the Court to obtain sufficient evidence to reach a firm opinion as to the correct use of Community funds.

(see paragraph 19.27)

XII. - Except for the effects of the matters summarized in paragraphs III-VII above, the Court is of the opinion that the accounts for the financial year 1996 reflect reliably the Union's revenue and expenditure for the year and financial situation at the end of the year. - The Court is of the opinion that the transactions underlying the revenue entered in the accounts for the financial year, taken as a whole, are legal and regular, within the limits specified in paragraphs 19.4 and 19.5. - Except for the effect of the matters discussed in paragraph VIII above, the Court is of the opinion that the commitment transactions for the financial year are, taken as a whole, legal and regular. - Because of the effect of the matters described in paragraphs IX-XI above the Court declines to provide positive global assurance as to the legality and regularity of the transactions underlying the payments for the financial year.

16 October 1997

B. Friedmann

President

European Court of Auditors 12, rue Alcide De Gasperi, L-1615 Luxembourg

INFORMATION SUPPORTING THE STATEMENT OF ASSURANCE

Introduction

19.1. This third statement of assurance (referred to throughout this report as the DAS)(577) concerns the reliability of the accounts of the European Community and the legality and regularity of the underlying transactions for the financial year 1996.

Scope of the audit

19.2. Transactions in certain areas audited by the Court are subject to further verification by other authorities, in particular during the clearance of the EAGGF-Guarantee accounts.

19.3. The DAS itself contains no conclusions as to the degree of compliance with the principles of sound financial management. This is something which the Court continues to assess and report separately as part of its other work.

19.4. Certain cases of deliberate irregularity to the detriment of the Community finances including, for example, the failure to declare dutiable imports cannot, by their very nature, be detected by the usual auditing procedures. The Court is not therefore in a position to give any assurance concerning the absence of cases of this type. However, as part of its financial audit of own resources, during 1996 the Court carried out a specific audit of the procedures for the establishment and recovery of customs duties and agricultural levies in cases of fraud and irregularity. The results of this audit are described in Chapter 1 of this annual report.

19.5. Because of the macroeconomic nature of the statistical data on which the GNP and VAT own resources (accounting for about 80 % of Community revenue) are based, the Court concentrated on assessing the adequacy of the procedures applied for compiling these data and guaranteeing their reliability. For the other principal element of own resources, customs duties and agricultural levies (accounting for about 17 % of Community revenue), it was not possible to provide an assurance that all taxable imports have actually been declared and have generated the corresponding revenue. Accordingly, the Court's audit focused on assessing the adequacy of procedures applied for ensuring that the Community's entitlement to customs duties and agricultural levies is properly established as soon as the conditions provided for by the customs regulations concerning entry into the accounts of the entitlement and notification to the debtor have been met.

Reliability of the accounts

Understatement of amounts owed by Member States (paragraph III(a) of the statement of assurance)

19.6. The consolidated balance sheet (Item III (a)) shows total debtors of 1 981,6 Mio ECU, representing the amounts due to the Community institutions by Member States as at 31 December 1996. Of this total, 1 064,2 Mio ECU(578) comprises entitlements to customs duties and agricultural levies established by Member States which they have entered into separate (revenue) accounts. Article 6.2(b) of Council Regulation (EEC) No 1552/89 of 29 May 1989(579) sets out the criteria under which Member States use the separate accounts. The Member States are responsible for keeping the separate accounts and report on them to the Commission once a quarter.

19.7. Taken as a whole, the Court found that the separate accounts are still affected by significant errors which have a material impact on the completeness of the total debtors' figure disclosed in the consolidated balance sheet. In particular, the Court found that insufficient procedures were in place to ensure that all entitlements to customs duties and agricultural levies that are established and which are either unsecured or are contested are properly brought to account in the separate accounts at an appropriate valuation. The Court is not able to quantify the extent to which the separate accounts and hence the total debtors' figure may be understated, but considers that the amount of the understatement in the separate accounts is likely to be material.

Overstatement of claims on Member States related to the clearance of the EAGGF-Guarantee accounts (paragraph III(b) of the statement of assurance)

19.8. The Commission chose to follow up on one Court observation by replacing the forward estimates of debts related to the clearance of the accounts drawn up in 1995 with recovery orders. Nevertheless, on the basis of the data calculated at the end of 1995, the total debt thus shown on the assets side of the balance sheet at 31 December 1996 (792,2 Mio ECU)(580) is overstated by 264,1 Mio ECU, since the revenue actually collected in the form of negative expenditure that had been declared in the October 1996 statements of each Member State concerned had not been taken into account.

Understatement of cash account balances (paragraph IV of the Statement of Assurance)

19.9. Within the field of cooperation with Latin American, Asian and Central and Eastern European countries, projects are covered by financing agreements with authorities in the beneficiary countries. It is the established practice of the Commission to charge to the budget appropriations transfers made to replenish bank accounts opened by project management within the beneficiary countries. Local project costs are subsequently paid from these bank accounts. This money remains the Commission's property until it is properly paid out for the approved purposes. In view of this the Court considers that the Commission's practice is consistent neither with normal accounting practice nor with the relevant provisions of the Financial Regulation which apply to actions covered by financing agreements. The financing agreements stipulate more and more often that the balances on the bank accounts involved remain the property of the Community. Furthermore, paragraph 7 of Article 111 of the Financial Regulation states that 'payments made in the currency of the recipient State shall be subject to a clearance procedure before they are finally booked to the budget appropriations. Clearance shall consist of an examination by the Commission to establish that validation, authorization and payment have been properly effected, in accordance with this Financial Regulation`. All this implies that amounts replenished but not yet cleared should be reflected in the Commission's balance sheet. The Court is not in a position to estimate the outstanding amounts concerned, but it is likely that they are of the order of several hundred million ecus. The fact that the Commission does not share the Court's interpretation of the relevant articles of the Financial Regulation suggests that there is a need to clarify its Title IX, which specifically relates to external aid, in the context of a general revision of this Regulation.

19.10. In connection with the MEDIA programmes (heading B3-2010), at the end of the financial year 1996 the Commission transferred 25,9 Mio ECU to a bank account opened by a services company providing technical assistance in implementing these programmes. Moreover, this account is designed to receive interest paid by the bank, as well as repayments from recipients to whom loans have been granted. Although these funds remain Community property, they are not shown in the balance sheet's cash accounts. Furthermore, and as a result of the foregoing, Community follow-up and control procedures are not applied with regard to the utilization of these funds and such utilization is subject only to the prior approval of DG X officials, who, de facto and in breach of the procedures stipulated in the Financial Regulation, are performing the duties of both authorizing officer and accounting officer, in contravention of the same provisions of the above Regulation.

19.11. At the request of the Court, the Commission sent out questionnaires and reminders for the purpose of reconciling the bank account balances with data confirmed by the banks themselves. To date, in respect of the bank accounts for aid to Mediterranean countries, five out of a total of seven banks have replied, but no reconciliations have been carried out by the Commission. In the absence of such reconciliations and in view of the materiality of these differences, the accuracy of the related balance sheet figures (39,3 Mio ECU) cannot be confirmed.

Overstatement of 'commitments still to be settled` (paragraph V(a) of the statement of assurance)

19.12. At the end of 1996, some 60 000 commitments against differentiated appropriations totalling 47 911,7 Mio ECU remained to be settled, 422,5 Mio ECU of which were covered by payment appropriations carried over from 1996 to 1997.

19.13. The Court audited a sample of 173 outstanding commitments amounting to 982 Mio ECU that had been selected from pre-1995 outstanding commitments to which no payments had been charged for two successive financial years. The population thus sampled contains 8 518 balances amounting to 6 212 Mio ECU; 2 060 of these balances, totalling 944 Mio ECU, went back to before 1992 and no payments had been charged to them for the last three financial years.

19.14. The findings of the Court's audits, with which the Commission authorizing departments were directly associated, lead it to conclude that the Commission was unable to provide evidence that some 17,0 % of the sums relating to these outstanding commitments, totalling 1 053 Mio ECU, still related to an obligation to make further payments; the Court is also of the opinion that at least 9,4 % of the amounts of these outstanding commitments, i.e. some 587 Mio ECU, no longer related to an obligation to make payments.

19.15. Moreover, operations that have been blocked for legal reasons, and which therefore probably no longer relate to actual obligations, but which the Commission is unable to cancel are estimated by the Court to amount to approximately 14 % of the commitments, or a total of some 864 Mio ECU.

19.16. The time limits for implementing commitments were often exceeded, sometimes by several years. Of the commitments remaining to be settled at the end of 1996, some 9 000 concerned cases where the settlement deadlines had expired.

19.17. Separate work carried out by the Court in a specific field corroborated these findings. For example, a selective audit in the field of TACIS and PHARE programmes, which focused on around 100 of the 600 operations committed between 1990 and 1994, makes it possible to estimate that the sum of the commitments outstanding under these programmes that were no longer justified at the end of 1996 is of the order of some a hundred Mio ECU (see Volume I, paragraphs 14.12 14.15).

19.18. Although there were some clear improvements in certain fields, the situation regarding outstanding commitments thus leaves little room for satisfaction otherwise. Measures should be taken by the authorizing officers and the budget and financial control departments in order to ensure that outstanding commitments reflect the Community's real obligations in a reliable manner in future. To this end, the Commission should, in addition to putting the situation in order by cancelling all commitments that no longer relate to formal legal obligations, include an estimate in its financial statements of the volume of those of its outstanding commitments that are unlikely to result in a payment in subsequent financial years. The payment appropriations to be entered under forthcoming budgets could thus be better estimated.

Understatement of commitments recorded in the budgetary accounts (paragraph V(b) of the statement of assurance)

19.19. In certain areas covered by differentiated appropriations the Commission has adopted inconsistent practices as a result of which some effective obligations are not reflected as commitments in the budgetary accounts. This situation results from the fact that the commission decided to enter into obligations which were not covered by the commitment appropriations in the budget. As a result the commitments remaining to be settled at the end of 1996 (581), as well as the total amount of the commitments of the financial year 1996, are understated by 1 302 Mio ECU. This includes:

(a) 685 Mio ECU for financing decisions in respect of Cooperation with Mediterranean countries and India (see Volume 1, paragraphs 13.11 13.16), and

(b) 617 Mio ECU relating to international fisheries' agreements (see Volume 1, paragraphs 9.18 9.19).

These multi-annual obligations were not even disclosed in the schedule of off-balance sheet commitments which form part of the accounts (582).

Understatement of commitments related to the Structural Funds (paragraph VI(a) of the statement of assurance)

19.20. At 31 December 1996, the Commission showed a sum of 88 513,9 Mio ECU for off-balance sheet commitments made relating to Structural Funds (aid planned for and not committed for the 1994-99 period at 1996 prices), including an amount of 8 476,8 Mio ECU for Community initiatives. These sums represent the difference between the Structural Fund spending scheduled for the 1994-99 planning period and the accumulated commitments for the 1994-96 period recorded in Sincom. As was the case for the preceding year, these commitments include commitments relating to previous planning periods which should have been omitted from this calculation. The result is that the amounts recorded under off-balance sheet commitments are understated. The data on which the amounts entered under the off-balance sheet commitments for the Structural Funds are based, and which were made available to the Court for the purpose of the audit, also call for further observations, the most important being the lack of reconciliation between the figures used by the central accounting departments and those used by the authorizing departments. The overall impact of the anomalies detected in the amount entered under the off-balance sheet commitments is an understatement of at least 2 000 Mio ECU.

Omission of off-balance sheet commitments related to multiannual obligations for PHARE and TACIS operations (paragraph VI(b) of the statement of assurance)

19.21. The obligations laid down in the multiannual indicative programmes in the context of the PHARE and TACIS programmes, and not yet reflected as commitments in the budgetary accounts, have not been disclosed in the schedule of off-balance sheet commitments which form part of the accounts (583). The amounts concerned are about 2 900 Mio ECU for PHARE and 1 300 Mio ECU for TACIS at 31 December 1996. In the case of PHARE the agreed programmes are signed by the Commission and third countries concerned. In such cases, it could even be argued that these obligations should be recorded as commitments in the budgetary accounts, because differentiated appropriations are designed to cover multi-annual obligations of this kind.

Failure to quantify commitments in respect of pension rights (paragraph VI(c) of the statement of assurance)

19.22. In 1996, the Commission provided for the first time an overview of the operation of the Communities' pension scheme in the explanatory notes to the off-balance sheet commitments. It did not, however, provide any figures. The 1996 presentation is, nevertheless, an improvement on that for the financial year 1995, when a mere token entry was entered under the off-balance sheet commitments. The Commission has undertaken to carry out an actuarial assessment during 1997 that will take account of all the necessary factors with a view to determining and incorporating, in accordance with international accounting standards, the amount that should be shown in the financial statements.

Understatement of budgetary payments consisting of advances and payments on account (paragraph VII of the statement of assurance)

19.23. Since 1995, in response to requests made by the Court and the European Parliament, the Commission has made a distinction in its accounting system between the year's payments in the form of advances/payments on account and those comprising definitive payments. This should enable the Commission to draw up a statement of non-definitive payments in its revenue and expenditure account at the end of the financial year(584).

19.24. By using the identification parameters in the Sincom accounting system, the Court calculated that the non-definitive payments made for the financial year 1996 amounted to 19 068 Mio ECU. The figure of 1 736 Mio ECU published by the Commission in the 1996 revenue and expenditure account(585) was thus understated by some 17 000 Mio ECU owing to design errors in the computation systems and computer programs used by the Commission to produce this figure (notably the exclusion from non-definitive payments at the end of the financial year of advances/payments on account not yet charged to commitments already settled).

19.25. Furthermore, the result arrived at by the Court is affected by the fact that, in spite of the instructions issued in this regard by the accounting officer's and Financial Controller's departments, the authorizing officers did not always clearly identify the amounts that were not definitive. Transactions totalling at least 2 000 Mio ECU, mainly in the fields of external policies and structural measures, are not identified in the accounts as being part payments that are not definitive, the result being that the total for these has been understated by the same amount.

The legality and regularity of the underlying transactions

Errors affecting the legality and regularity of commitment transactions

Substantive(586) legality and regularity errors concerning commitments (paragraph VIII of the Statement of Assurance)

19.26. The cases where obligations effectively entered into by the Commission breached the limits of the commitment appropriations fixed by the budgetary authorities are identified in paragraph 19.19.

Limitations on the audit work relating to payments (paragraph XI of the statement of assurance)

19.27. In a number of cases in the sample of payments - estimated to represent some 4,3 % of the Community budget in 1996 - it was impossible for the Court to obtain sufficient evidence to reach a firm opinion as to the correct use of Community funds. The main causes of the lack of assurance on individual transactions are:

(a) in the area of public storage of agricultural produce, problems in reconciling monthly declared figures with the underlying supporting documents and general weaknesses in stock-taking procedures, leading to uncertainty as to the amount chargeable to the Community budget;

(b) unforeseeable legal or physical circumstances in Member States which resulted in the Court not having access to the documents essential for its audit.

Errors affecting the legality and regularity of the transactions underlying payments

Substantive legality and regularity errors concerning payments (paragraph IX of the statement of assurance)

19.28. As the Court made clear in paragraph 1.32 of its 1994 DAS report(587), its audit has to cover all stages in the management of Community funds, starting with the Commission's central accountancy and ending with final recipients in the Member States and elsewhere. The Court's audit for the purposes of the Statement of Assurance is aimed at establishing whether the rate of error detected in its sample of transactions verified down to the level of final recipients is low enough to enable it to provide a positive global assurance that the accounts are reliable and the underlying transactions legal and regular. On the basis of extrapolations of its sample results, it provides estimates of the rates of substantive error detected in order to support its conclusions. These estimates should be regarded as indications of orders of magnitude, associated with upper and lower limits at a level of 95 % confidence, rather than as precise measurements.

19.29. The total unextrapolated value of substantive errors relating to payments - also taking into account errors occurring outside the sample - is 273 Mio ECU. These errors do not necessarily result from an intent to defraud the Communities. They may also not lead to recovery of the wrongly paid amounts. In the cases concerning the EAGGF-Guarantee, the Court's findings should be taken into account by the Commission when it clears the annual accounts. In the cases concerning the Structural Funds, where there is no comparable clearance procedure, the specific error detected may be corrected in the accounts of current programmes. Where there is evidence that the beneficiary has not acted in good faith, it is up to the national authorities to recover the amounts concerned and reimburse the Community budget. Because it is an extrapolation of the sample results, the Court's estimate of the most likely volume of substantive errors cannot of course serve to identify specific amounts to be recovered.

19.30. The overall rate of substantive errors - quantifiable errors directly affecting the amount of the transactions underlying Community funds disbursed - is estimated to be in the range of 3,5 to 8,3 % of total payments: the most likely estimate is 5,4 % of total payments. The error rate for the EAGGF-Guarantee remains, as for the past two years, below the average for the budget as a whole. The Court notes the steps taken to improve financial management in this area. Similar improvements should be made in respect of the Structural Funds, to provide adequate assurance on the proper use of resources so as to reduce the error rate, which still remains higher than the average for the budget as a whole. The Commission decisions to improve the application of Articles 23 and 24 of the Structural Funds Regulation (EEC) No 2082/93(588) are moves in the right direction.

19.31. The estimated level of error in the transactions underlying the payments for the financial year 1996 is so high that the Court declines to provide positive global assurance as to the legality and regularity of the transactions concerned.

19.32. The majority of the substantive errors affected the eligibility of operations financed by the Community budget. Other substantive errors concerned the reality or the accuracy of the expenditure presented for such financing, the accuracy of the calculation of the amount of the Community contribution, and the existence or quality of the supporting documents on which the payments were based. In terms of impact on the amounts financed, the errors occurred in most cases in Member States (90 %), mainly at beneficiary level (60 %) and also at the level of local (20 %) and central (10 %) authorities responsible for managing the operations. See paragraphs 20.9 20.10 for further analysis of those errors found in the field of the EAGGF-Guarantee and paragraphs 21.16 21.17 for further analysis of those errors found in the area of the Structural Funds. In the case of the Structural Funds, the estimated value of the errors does not necessarily affect the payments made by the Commission in the form of advances. However, as the underlying transactions were financed with EU funds there is a risk that the general budget will be permanently affected by such errors if they are not detected and corrected.

Formal legality and regularity errors concerning payments (paragraph X of the statement of assurance)

19.33. Many formal errors - errors without any directly quantifiable effect on the amounts of the transactions underlying the Community funds disbursed - were found in the main fields of Community expenditure (EAGGF-Guarantee and Structural Funds - see paragraphs 20.11 20.12 and 21.18 21.19 respectively for further analysis), as well as in other fields, such as development cooperation with the countries of the Mediterranean, Latin America, Asia and Central and Eastern Europe and administrative expenditure. The incidence of formal errors was most marked in the field of the Structural Funds.

19.34. These formal errors comprise, for the most part (70 %), cases where the regulatory conditions laid down concerning the subsequent implementation of the measure financed were not complied with and, to a lesser extent (20 %), cases where the management or control procedures stipulated in the Community Regulations were not applied. Taken as a whole, these errors originate mostly at Member State level (80 %), and mainly at the level of central (35 %) and local (25 %) bodies responsible for managing the operations.

19.35. The formal errors that arose at Community institution level (20 %) are mainly cases where the management and control procedures were not complied with.

19.36. The formal errors that arose at Member State level are characterized by the following:

(a) The majority of the many formal errors concern the failure of the recipients or bodies implementing the measures to meet their obligations, particularly as regards keeping separate accounts for measures financed from the Community budget or maintaining the quality of the documents supporting expenditure declarations.

(b) The other formal errors relate principally to shortcomings in the establishment and implementation of regulatory controls, which are the responsibility of the relevant authorities in the Member States.

Accounting standards, policies and procedures

Accounting standards and policies

19.37. In previous reports, and in particular in its DAS reports for 1994 and 1995(589), the Court underlined the need for the adoption of accounting policies to ensure completeness and consistency in the information presented in the consolidated accounts (including consistent treatment by different institutions), and to improve their informative value. In its DAS report for 1995, the Court referred to an external study carried out for the Commission on appropriate accounting standards for the Community's accounts whose results had not yet been made available to it. Having now had an opportunity to review the study, the Court notes that it identified areas in the balance sheet accounts where greater consistency in the accounting treatment is needed. These findings confirm those of the Court itself regarding the accounts of recent years, including those of 1996. The Commission is currently drawing up a manual for the consolidation of its accounts which aims to deal with the problems identified.

19.38. In the Court's view, there remains a need for a clear statement of the accounting principles and policies applicable to the accounts of the European Community. This statement might, for example, indicate the fundamental basis of the revenue and expenditure account (for instance, a cash basis or an accruals basis), define the principles applicable to the valuation of balance sheet items (notably, providing for the depreciation of fixed assets) and define a framework for appropriate reconciliation between these two accounts. In preparing this statement of accounting principles the Commission should consider the Directives applicable to enterprises within the Community, and the standards promulgated by the international bodies setting accounting standards, particularly those applicable to the accounts of public sector bodies.

19.39. The establishment of comprehensive accounting policies is not an end in itself. It is the means of providing the basic framework for financial reporting from which the Commission should be able to produce a set of financial statements which are responsive to the needs of their users, the budgetary authorities. In particular, the Commission should be able to provide the budgetary authorities with financial statements which are not only concise and easy to understand, but also enhance the transparency of the Commission's operations, and provide a clearer indication of the Commission's financial position as at 31 December 1997.

Accounting procedures

19.40. Much of the information presented in the balance sheet and in the off-balance sheet commitments is based on information which is not processed by the basic accounting system, but which is provided to the accountant of the Commission on an ad hoc basis. The Court's observations in the context of the DAS, particularly on items such as fixed assets and off-balance sheet commitments, show that these procedures too often fail to ensure that complete and accurate information is included in the accounts. The Commission should ensure that clearly defined accounting procedures are laid down in these areas, the application of which will result in the provision by authorizing officers in operational directorates-general of the information required for incorporation in the accounts.

REPLIES OF THE COMMISSION

INFORMATION SUPPORTING THE STATEMENT OF ASSURANCE

Reliability of the accounts

Understatement of amounts owed by Member States (paragraph III(a) of the statement of assurance)

19.7. The Commission feels that following their introduction in 1990, the B accounts were kept in a manner which improved significantly once the initial problems had been solved. Appropriate rules were introduced to make management more transparent. As these accounts are kept at local level, there are sometimes odd errors, mostly of a formal nature. However, these anomalies cannot lead to the general conclusion that the accounts are not reliable.

The Commission agrees with the Court that the separate account cannot include all Community entitlements. Moreover, it feels that, to some extent, this account overestimates the actual entitlements of the EU because some amounts have been entered in it for a long time although there is no hope of recovering them in reality.

In order to resolve this problem, the Commission, on 3 July 1997, presented a proposal for the amendment of Regulation No 1552/89 with a view to strengthening the procedure for writing off unrecovered debts within a very specific time limit.

Overstatement of claims on Member States related to the clearance of the EAGGF-Guarantee accounts (paragraph III(b) of the statement of assurance)

19.8. It is true that, following an error, total entitlement was overstated by 264,1 Mio ECU at 31 December 1996. However, as soon as the error had been discovered, the Commission cancelled the recovery orders in question.

The Accounting Officer's department is establishing a monitoring system to prevent this error from being repeated.

Understatement of cash account balances (paragraph IV of the statement of assurance)

19.9. Article 111(7) of the Financial Regulation applies under the financial protocols which involve a paying agent. Cash advances to the accounts of the financial institution as referred to in Article 111(7) of the Financial Regulation appear in the balance sheet until they are cleared by being charged to the budget.

However, when aid is granted unilaterally and not covered by a financial protocol, the procedure in Article 111(7) does not apply and the budget is implemented in accordance with Articles 40 to 53 of the Financial Regulation as provided in Article 105(1) of the Financial Regulation.

The Commission also feels that a clearer wording of the Financial Regulation would avoid the differing interpretations noted here. It will endeavour to secure such clarification when the Financial Regulation as a whole is recast. In this connection, it will take into account the comments made by the Court in Opinion 4/97 relating to the seventh series of amendments to the Financial Regulation.

19.10. In 1996, the Commission (DG X) signed a contract with an intermediary organization (MEDIA programme assistance, PMA, specialist in financial management). A bank account was opened requiring two signatures:

- Holder: MEDIA assistance SC;

- Signatures : every transfer order must be initialled by the Commission (DG X) and signed by the contractor. This means that the holder cannot carry out any transaction on this account without the signature of a Commission representative (DG X);

- Bank interest: must be transferred each quarter to the Commission's bank account;

- The advance written approval of the Commission (DG X) is required for opening, transferring, closing and any change in the operation of the account. The owner undertakes not to invoke any right to this account in the event of cancellation or at the end of the contract.

The case referred to by the Court comes under the general problem of payments made by financial intermediaries, of the technical assistance bureaux type, which then distribute the funds to the financial beneficiaries. The Accounting Officer's department would like to come together with authorizing departments and the Court of Auditors to analyse ways of dealing with these transactions in terms of the utilization of budgetary appropriations and of the presentation in the balance sheet of the funds held by financial intermediaries. This analysis should be taken into account in the identification of the general accounting principles applicable to the Union's financial statements which the Commission is undertaking as a preliminary to the publication of the consolidated financial statements for 1997.

19.11. Details on the reconciliation of the balances with figures in the general account were given to the Accounting Officer in mid-July 1997.

The Commission is considering what measures should be taken so that, in due course, the Accounting Officer will be in possession of the information required to ensure that the amounts entered in the accounts are reliable and that any differences and anomalies are corrected.

Overstatement of 'commitments still to be settled` (paragraph V(a) of statement of assurance)

19.12 19.14. The Commission is aware of the problem of commitments outstanding and of the need for more systematic monitoring. The instructions given to the Accounting Officer in recent years reflect the Court's concern.

19.15. As stated in 19.12-19.14, the Commission agrees with the Court that when commitments do not tally with actual obligations they should be cancelled. Nevertheless, it is not always possible to do this quickly.

As pointed out by the Court, when commitments are blocked because judicial proceedings are in progress, the Commission must wait for the judicial authority's decision before cancelling the commitment.

In some cases, cancellation is not possible until the programme or project has been cancelled, and then only with the beneficiary's agreement.

A number of commitments were cancelled by the Commission on its own initiative at the beginning of the following year or after the Court's inquiry.

19.17. At the beginning of this year, a procedure was put in place to close programmes which had expired. Expired programmes and contracts were identified and an audit programme and a plan to recover unused bank balances were prepared. At the end of June 1997, 78 expired centralized programmes had been closed, 1586 expired centralized contracts had been analysed (of which 937 were closed) and 148 commitments were cancelled (partially and finally) representing 34 172 059 ECU. Twenty-one final audits of decentralized programmes were launched and recovery orders were issued for over 2 Mio ECU. The commitments relating to the expired programmes will be cancelled after the final audits.

This work can only be done with existing human resources. Concentrating more on this activity could therefore be detrimental to the performance of other tasks (for example, longer payment times).

19.18. In response to internal instructions and the Court's inquiry, most of the departments involved have been closely monitoring outstanding commitments in 1997 and have cancelled commitments and closed programmes as necessary. Some authorizing departments have even prepared a special programme for clearance and systematic monitoring. The Commission will ensure that that this work continues as part of the routine activities of the units in question.

The Commission will examine the Court's suggestion that the accounts should contain estimates of payments which will probably not be made.

Understatement of commitments recorded in the budgetary accounts (paragraph V (b) of the statement of assurance)

19.19. In its reply to paragraphs 13.11-13.16 and 9.18-9.19 of the Court of Auditor's Annual Report for 1996, the Commission outlined the reasons why it considers these transactions regular.

It is prepared to provide information on these two cases in a note to the balance sheet.

The Commission is nevertheless aware of the general problem raised by the Court. It may review all the relevant provisions in the forthcoming recasting of the Financial Regulation referred to at paragraph 19.9.

Understatement of commitments related to the Structural Funds (paragraph VI(a) of the statement of assurance)

19.20. The Commission is currently comparing the programming figures by objective and by Member States with the DGs responsible for the Structural Funds with a view to making the necessary corrections. The various tables have been sent to them for checking and comments.

Omission of off-balance sheet commitments related to multiannual obligations for PHARE and TACIS operations (paragraph VI(b) of the statement of assurance)

19.21. The MIPs (multiannual indicative programmes) are not legally binding on either the Commission or the partner country and thus should not be regarded as budgetary commitments. The financial information which the programmes contain is intended merely as a guide. The purpose of the MIPs is to serve as a basis for detailed planning and scheduled discussions between the Commission and the partner country. These discussions result in the annual national operational programmes which lead to budgetary commitments.

Since the programmes are also agreed with the beneficiary country and thus imply a political commitment, the Commission will examine how these details should be shown, if appropriate, in the off-balance sheet information.

Failure to quantify commitments in respect of pension rights (paragraph VI(c) of the statement of assurance)

19.22. The Commission confirms its intention to show an estimate of the overall financial obligation for pensions in the financial statements at 31 december 1997.

However, the final results of the actuarial study will not be available until the end of 1998.

Understatement of budgetary payments consisting of advances and payments on account (paragraph VII of the statement of assurance)

19.23 19.24. It is true that Table 15 of the revenue and expenditure account and financial balance sheet contains errors. These errors are due to the definition of data in the extraction programmes which are used for the production of the information. The programmes will be reviewed and corrected.

The legality and regularity of the underlying transactions

Errors affecting the legality and regularity of commitment transactions

Substantive legality and regularity errors concerning commitments (paragraph VIII of the Statement of Assurance)

19.26. As stated at 19.19, the Commission considers that these decisions are regular.

Limitations on the audit work relating to payments (paragraph XI of the statement of assurance)

19.27. Like the Court, the Commission was also unable to form a clear idea in a number of the cases mentioned. This was because some of the Court's sectoral letters to Member States informing them of the cases examined were sent too late for the Member States to have a reasonable length of time to reply. In these cases, the Commission has only the information provided by the Court and does not have the viewpoint of the beneficiary Member State, which it needs in order to adopt its position or to decide whether an on-the-spot inquiry is necessary. The Commission regrets that the overall results arrived at by the Court are based on a number of cases on which the Commission has been unable to express a fully informed opinion.

(a) With regard to the problem specifically mentioned by the Court, the following comments can be made:

Article 3(3) of Regulation (EC) No 1663/95 requires certifying bodies to report on the statements of intervention operations and on whether the financial interests of the Community are protected. In the light of the results of the certification procedure for 1996, the Commission has circulated Member States' certifying bodies with a guideline for the audit of intervention storage in 1997, is pursuing improvements in the management of intervention stocks with several paying agencies and has initiated an exercise paying particular attention to year-end stocktaking procedures.

The introduction of accreditation criteria for paying agencies and the recent adoption of Regulation (EC) No 2148/96 (Evaluating and monitoring public intervention stocks) should ensure the early introduction of improvements in the management and control of intervention stocks.

Errors affecting the legality and regularity of the transactions underlying payments

19.28 19.36. The Commission takes note of the overall results of the DAS. It agrees with the Court that the number of errors is still too high. It believes that because of the degree of uncertainty inherent in any statistical method and because it will be some years before the DAS audit has acquired sufficient maturity to determine clear trends in rates of error, the Court's findings must be interpreted with caution.

The general rate of error found by the Court covers very different situations, namely 90 % of the transactions carried out in the Member States and 10 % of transactions falling under the Commission's exclusive responsibility.

For the EAGGF-Guarantee, where fund management structures are relatively simple, the Commission has been able to rapidly implement reforms which already seem to be bearing fruit. Indeed, the Court acknowledges these improvements (see Introduction p. 0.35).

The situation with regard to the Structural Funds is more complex. The many levels of intervention (Community, central government, region, district, contractor, etc.), numerous procedures and the complexity of the structures lend themselves to a higher rate of errors. However, this is not necessarily a sign of less efficient management. The financial implications of such errors for the Community budget are generally neither certain nor easy to assess.

In spite of these difficulties, the Commission is equipping itself with the necessary means to improve management. On 23 April 1997, for instance, it adopted a document on the eligibility rules for the Structural Funds. On 15 October 1997 it also approved a regulation laying down specific rules for the Member States with regard to monitoring the Structural Funds (see paragraph 21.6). These measures should produce the necessary improvements in the near future.

Lastly, it would be interesting to use the rate of error found by the Court as a way of establishing the level of performance of Community management in relation to that of other administrations. Unfortunately, the lack of an audit similar to the DAS in the Member States and the special features of the Structural Funds, which have a unique comanagement system, do not allow a real comparison to be made.

19.32. The Commission notes and endorses the Court's remark that in the case of the Structural Funds, the estimated value of errors categorized by the Court as substantive errors concerning payments does not necessarily affect the payments made by the Commission in the form of advances. The Commission continues to consider that errors of this kind should be categorized separately from the generality of substantive errors. However, the Commission regards these errors with proper seriousness and it corrects or requires the correction of all errors coming to its notice.

The Commission notes with interest the cases raised by the Court in the area of EAGGF-Guarantee. In the majority of cases, the Court's findings match the Commission's own and appropriate corrective measures will be taken in the framework of the clearance of accounts procedure. Thus it is reasonable to assume that no significant loss to the Community budget will remain.

However, the Commission points out that the risk of errors resulting from human error is difficult to eliminate entirely unless every single transaction was checked. For these obvious cost/efficiency reasons, such an approach is not possible.

Accounting standards, policies and procedures

Accounting standards and policies

19.37 19.39. As the Court proposes, the Commission feels that the accounting principles which govern the preparation of the accounts of the European Union should be formalized. The Commission will establish its accounting policy bearing in mind the specific character of what constitutes a public institution and will be guided by the principles contained in the fourth and seventh directives and international standards where these are transposable to the public sector and the practices applied by international organizations. On this point the Commission's Accounting Officer would like to thank the Court for the documentation provided. The Commission's aim is to reach an agreement with the Court on the reference standards and how they impact on the structure and the presentation of the financial statements as a preliminary to the production of the revenue and expenditure account and the consolidated balance sheet for 1997.

Accounting procedures

19.40. The Commission, with the help of an outside consultant, has prepared a consolidation manual. The other institutions will be asked to approve the manual before it is applied to the consolidated balance sheet of the European Union. This manual will enable the Commission to determine the scope of the consolidation of the accounts both in the Commission and for all the institutions and to present information in a standardized form in accordance with generally accepted accounting practices.

CHAPTER 20(590\*) Analysis EAGGF-Guarantee and fisheries expenditure

20.0. CONTENTS Paragraph reference

Introductory information 20.1

Accreditation of paying agencies and the certification of accounts 20.2 - 20.5

Reliability of the accounts 20.6 - 20.7

Analysis of the Court's audit findings on the legality and regularity of the transactions underlying payments 20.8 - 20.12

Substantive errors 20.9 - 20.10

Formal errors 20.11 - 20.12

Areas of limited assurance 20.13

Identification of an area of particular risk 20.14

General conclusions 20.15 - 20.17

INTRODUCTORY INFORMATION

20.1. EAGGF-Guarantee and fisheries expenditure represented in 1996 some 51,3 % by value of total budgetary payments (about 39 430 Mio ECU) and includes the entire expenditure of subsection B1 - EAGGF-Guarantee (39 081 Mio ECU), title B2-5 - Other agricultural operations (81 Mio ECU), title B2-9 - Fisheries and the sea (17 Mio ECU) and chapter B7-80 - International fisheries agreements (251 Mio ECU). The expenditure for subsection B1 - EAGGF-Guarantee - accounts for 99 % of total expenditure in this field and is exclusively managed by the paying agencies in Member States. 1996 was the first year of application of new rules for the paying agencies and for the clearance of accounts procedure. These rules were introduced by Council Regulation (EC) No 1287/95 of 22 May 1995(591) (amending Council Regulation (EEC) No 729/70(592)) and the related implementation rules were established by Commission Regulation (EC) No 1663/95 of 7 July 1995(593).

ACCREDITATION OF PAYING AGENCIES AND THE CERTIFICATION OF ACCOUNTS

20.2. In its DAS for the financial year 1995(594) the Court indicated the importance of the new procedures for a more effective monitoring of EAGGF-Guarantee expenditure. The certification of accounts, and related accounts clearance decision of the Commission, concern the 'integrality, exactitude and veracity` of the accounts and form the basis for certain financial corrections. The complementary assessment of compliance with EU regulations both at the level of the paying agencies and the final beneficiaries, essential for the evaluation of the legality and regularity of the underlying transactions, will continue to be undertaken by the Commission at a later stage, and further financial corrections may be made in respect of expenditure incurred up to 24 months prior to notification of such corrections.

20.3. The key elements of the new procedures are the formal accreditation of paying agencies by the Member States and the certification of the annual accounts by a certifying body. The annual accounts of expenditure charged to EAGGF-Guarantee, as well as the certificates and reports of the certifying body, must be sent to the Commission by 10 February of the following year. By 31 March the Commission is required to communicate to the Member States the results of its verifications of the information supplied as well as any proposed amendments. The accounts clearance decision shall be taken by 30 April of the same year and determines the amounts recognized as chargeable to EAGGF-Guarantee.

20.4. Despite these requirements, for 1996 the Commission only adopted a partial decision on 5 May 1997(595). At the statutory deadline no definitive accounts clearance decision could be taken:

(a) for those Member States whose certified accounts had not yet been delivered (United Kingdom and Greece);

(b) and for those paying agencies for which the evaluation made by the Commission of the certification report or a subsequent visit to the agency revealed, either that the audit work was not sufficient or that there were particular problems which needed clarification (this concerns all paying agencies in France and Portugal, three central and one regional paying agencies in Spain, the German Länder of Rheinland-Pfalz and Sachsen and three out of four Italian paying agencies).

20.5. The Commission's decision of 5 May 1997 covered therefore only 12 936,6 Mio ECU or some 33 % of the total EAGGF-Guarantee expenditure. For the other paying agencies that account for some 67 % of the total expenditure declared, the definitive clearance of accounts decision on the recognized expenditure for 1996 was taken on 31 July 1997(596). Table 20.1 indicates the amounts covered by each of the clearance decisions, including the amounts of the financial corrections.

RELIABILITY OF THE ACCOUNTS

20.6. The Court has considered the implications of the operation of the new system in the DAS context. Satisfactory implementation of the system should improve the reliability of the accounts. In addition the audit procedures required of the certifying bodies might contribute to a better judgment on the operation of the controls over legality and regularity, but there is as yet insufficient information about this aspect of the new procedures. For 1996 the system has achieved a certain measure of progress, but much remains to be done. Certifying bodies in a number of Member States issued audit opinions qualified to some degree in respect of one or more of the paying agencies.

20.7. For example, the Court notes that the paying agencies of the United Kingdom presented the final accounts only on the 22 May 1997 to the certifying body, which issued a qualified opinion. Reconciliation problems had persisted between the records of the operational systems within the paying agencies managing the different schemes and the accounting records. Furthermore, accounting records for some of the paying agencies had not been reconciled with those of the coordinating body, responsible for the monthly declarations to the Commission. These declarations continue to be submitted on the basis of advances to the paying agencies rather than the actual payments made by them to beneficiaries, contrary to Regulation (EC) No 296/96(597). It is doubtful whether these problems will be completely resolved before the 1998 financial year. Difficulties with certification were also experienced in a number of other Member States and are currently under investigation by the Court.

ANALYSIS OF THE COURT'S AUDIT FINDINGS ON THE LEGALITY AND REGULARITY OF THE TRANSACTIONS UNDERLYING PAYMENTS

20.8. Since agricultural guarantee expenditure still accounted in 1996 for more than half of total payments from the general budget, more than half of the transactions tested in the Court's sample were in this area. The Court considers that, in conjunction with other relevant information in its Annual Report, including particularly its assessment of the area aid payments scheme for arable crops (see points 3.1 to 3.79), it has sufficient information to draw certain broad conclusions relating to EAGGF-Guarantee expenditure as a whole.

Substantive errors

20.9. One in ten of the EAGGF-Guarantee transactions contained in the 1996 sample audited were affected by substantive errors. However, most errors had a relatively small impact on the amounts paid and the rate of most likely error, in terms of the effect on total EAGGF-Guarantee expenditure, is estimated for 1996, as in the two previous years, to be lower than the rate for the general budget as a whole (see point 19.30). All errors detected in the Court's sample originated in the Member States; in terms of impact on the amounts paid about 70 % occurred at the level of administrative bodies and about 30 % at the level of final beneficiaries.

20.10. The main error types detected by the Court which account for the vast majority of substantive errors are:

(a) errors relating to the eligibility of the expenditure. These errors concern mainly:

(i) differences between actual and declared quantitative data (land surfaces, products or livestock). A significant number of errors (however, with relatively small impact on the amounts paid out) were noted in area aid schemes where the final beneficiaries claimed for areas greater than those actually sown;

(ii) payments in respect of produce or beneficiaries not fulfilling eligibility requirements;

(iii) transactions effected outside the eligibility period;

(b) errors in calculating the amount of Community support. These errors concern mainly:

(i) application of incorrect rates (aid rates, exchange rates, coefficients, etc.), incorrect calculation methods, and EU contributions to the financing of total costs exceeding maximum limits. Errors of this kind had little impact on the amounts paid out;

(ii) failure to apply overall reductions in the aid rates required by the regulations. This type of error occurred essentially in Spain where the national authorities did not apply the required penalties of 137 Mio ECU in relation to the overshoots of the base area qualifying for per hectare aid for arable crops. On 3 September 1997 the Commission, in application of Council Regulation (EC) No 1422/97 of 22 July 1997(598), adopted Regulation (EC) No 1716/97(599) which retroactively exempted Spain from the application of these penalties in respect of the 1995/96 campaign;

(c) absence or unreliability of essential evidence required to justify payments, such as proof of arrival of goods at final destination in the field of export refunds.

Formal errors

20.11. The incidence of formal errors in the context of EAGGF-Guarantee expenditure is significant although it is estimated to be less than the incidence of formal errors elsewhere in the budget. The majority of the errors occurred at the level of the paying agencies although in some cases delay in the promulgation of regulations was a contributory factor.

20.12. The most significant types of formal errors relate to:

(a) failure to comply with regulatory conditions stipulated for carrying out the measure financed by the Community budget:

(i) non-compliance with regulatory deadlines for payments to beneficiaries or for transfer of premium rights;

(ii) incomplete supporting documents (mainly in the context of export refunds);

(iii) non-compliance with other Community rules (maintenance of registers, incomplete contracts, incorrect declarations supporting compliance with minimal yield requirements, etc.);

(b) inadequate implementation and execution of regulatory management and control procedures to be performed by the paying agencies, mainly concerning on-the-spot checks at the level of the final beneficiaries for the area aid schemes.

AREAS OF LIMITED ASSURANCE

20.13. As explained in paragraph 19.27, in certain areas the responsible authorities were unable to provide sufficient evidence which would allow the Court to obtain assurance as to the correct use of Community funds. This particularly affects the following areas:

(a) in the area of public storage in Italy, Ireland and the United Kingdom deficiencies such as inadequate physical checks on quantities were noted by Court auditors and by the certifying bodies. The Court also takes note of the fact that certifying bodies have limited the scope of their audit opinions in respect of public storage in Spain and Portugal;

(b) in the area of the storage of sugar, in Denmark changes in stock measurement methods led to uncertainty as to the amount chargeable for the financial year, while in Sweden storage claims were affected by the incorrect treatment of surpluses and shortages;

(c) in the area of ewe and goat premiums in Greece, weaknesses in the control system were noted and the actual livestock situation could not be verified in the absence of a reliable register.

IDENTIFICATION OF AN AREA OF PARTICULAR RISK

20.14. Council Regulation(600) (EC) No 2466/96 delayed until January 1997 the entry into force of the second stage of the integrated administrative and control system (IACS) which included the establishment of an alphanumeric system for the identification of agricultural parcels eligible for support under area aid schemes. Reliable cross-checks of agricultural parcels were in place in very few Member States for campaign 1995/96 (see also points 3.1 to 3.79). In respect of the livestock schemes, delays in the development of computer systems in most of the Member States reduced the effectiveness of checks on the eligibility of the aid claims (see points 4.18, 4.45 and 4.82). The Court therefore notes that, for those Member States who had not completed the implementation of the IACS system for campaign 1995/96, the absence or inadequacy of such checks prolonged the risk that parcels were declared more than once or that ineligible claims for livestock remained undetected.

GENERAL CONCLUSIONS

20.15. Control measures for EAGGF-Guarantee expenditure, which is characterized by a highly decentralized management, have been systematically tightened over the last few years, and clear responsibilities defined both for the Commission and for the paying agencies. Nevertheless, the Court's audit shows that the implementation of these control procedures, which are intended to detect and correct errors in declarations by beneficiaries prior to actual payment of the aid has proved inadequate in certain cases. It is essential that the paying agencies concerned implement and execute all the control procedures effectively.

20.16. The Commission should continue to press for the implementation each year in all Member States of the first stage of the new clearance of accounts procedure within the time schedule established by regulation. The audit carried out by the certifying bodies is a key element in the Commission's monitoring of the performance of the paying agencies, including the full functioning of their internal audit services and other internal control systems. It is important that the Commission succeeds in its aim of accelerating the implementation of the second stage of the clearance of accounts procedure which includes the assessment, by its own services, of compliance with Community regulations, given that it can no longer make corrections in respect of transactions which occurred more than two years previously.

20.17. These improvements in a posteriori audit arrangements must be accompanied by the completion of the installation of effective management controls in all the agricultural markets concerned. The IACS in respect of arable crops and livestock premiums must operate effectively throughout the EU, and the land holding registers in respect of other crops (vines, olive oil) must be completed with the minimum further delay (See also points 3.1 to 3.79). Successful completion of these steps will represent important progress in reducing the remaining errors and removing the areas of uncertainty which still affected agricultural guarantee expenditure in 1996.

REPLIES OF THE COMMISSION

ACCREDITATION OF PAYING AGENCIES AND THE CERTIFICATION OF ACCOUNTS

20.4 20.5. On 31 July 1997, the Commission was able to clear the accounts of all the paying agencies, the Member States having forwarded the necessary information, and having undertaken the required additional audit work. It is hoped that with the experience of the first year of the new certification procedure, the Member States will take effective steps to submit their accounts and certificates within the stipulated deadlines.

RELIABILITY OF THE ACCOUNTS

20.6 20.7. The first implementation of the certification procedure has been encouraging given that 1996 was the first year, and is expected to continue to improve and to give increasing assurance that the Member States' control systems are operating effectively. The Commission will actively pursue this. In previous years, the accounts prepared by Member States' paying agencies were not audited prior to their submission to the Commission. The new certification procedure, which is intended to be based on an audit of accounts to international standards prior to their submission, has given improved credibility to paying agencies accounts for 1996.

In this first year, the rigour of the certification procedure has also placed paying agencies under a new and explicit financial discipline requiring, in many cases, changes to existing arrangements. Many of these changes were achieved by the close of the certification procedure; some will require a longer time scale for their resolution. Although certain audit opinions were qualified, none justified the exclusion of the accounts from the clearance decision. The Commission has already established some financial corrections for 1996. The investigations carried out under the compliance phase of the clearance of accounts procedure may result in further financial corrections.

The United Kingdom had particular difficulties in the preparation of accounts for 1996 which, arising from the implementation of a new computerized accounts system, were unrelated to the new certification procedure. The Commission is monitoring closely the situation with particular regard to compliance with the accreditation criteria laid down in Commission Regulation (EC) No 1663/95. As of 16 October 1997, the United Kingdom paying agencies will submit monthly declarations of expenditure based on actual expenditure.

ANALYSIS OF THE COURT'S AUDIT FINDINGS ON THE LEGALITY AND REGULARITY OF THE TRANSACTIONS UNDERLYING PAYMENTS

Substantive errors and formal errors

20.9 20.12. The Commission agrees that, as the Member States are responsible for executing payments charged to the Guarantee Fund, the errors detected occur in the Member States. A certain amount of error in the amounts claimed and paid has to be accepted, as the cost of exhaustively checking 100% of all aid claims would exceed the benefits. Much reliance is therefore placed in the EU instruments on the dissuasive effect of sanctions when incorrect claims are discovered, and of recoveries of irregular claims with penalties. The Commission continues, through the two stages of clearance of the accounts procedure, to ensure that the Member States implement effective control procedures, and that they apply the stipulated sanctions when irregularities are detected. The results of the Court's 1996 DAS audit in the Guarantee Section give some comfort that the Commission's efforts are bearing their fruit.

20.10. (b) ii. It is true that Spain had not applied the penalties in respect of the overshoots of the base area. However, by Regulation (EC) No 1422/97, the Council had provided for retroactive exemption from these penalties in respect of the 1995/96 marketing year in the event of exceptional weather conditions, which excluded any financial impact on the Community budget. Consequently, no penalties were to be applied to these regions. The clearance departments will ensure correct application of the exemption.

Areas of limited assurance

20.13. Checks of the clearance of the paying agencies' accounts made by the certification bodies were based on an analysis of a sample of public warehouses.

Checks of the compliance phase of the clearance of accounts of the EAGGF-Guarantee Section immediately revealed errors with respect to public storage and sheep premiums. In addition, a systematic programme of checks is being carried out on the position with regard to stock inventories in all Member States at the beginning of the 1996 financial year and at the end of the 1997 financial year.

IDENTIFICATION OF AN AREA OF PARTICULAR RISK

20.14. The Commission is monitoring very closely the full and effective introduction of the integrated control system. Those Member States which were unable to introduce all elements of the system in 1996 or 1997 were required to increase the proportion of claims checked on the spot.

GENERAL CONCLUSIONS

20.15. With the modification of Council Regulation (EEC) No 729/70, and the adoption of Commission Regulation (EC) No 1663/95, the Commission obtained an important reform in the financial management of EAGGF funds by Member States' paying agencies. In 1996 the Commission has worked closely with Member States in order to strengthen financial controls and to make explicit the responsibilities of paying agencies and certifying bodies. Inevitably, as improvements (e.g. the reliability of pre-payment controls; internal control procedures; and internal audit function) were introduced throughout the course of 1996, the situation at the close of the year was, overall, much better than at its opening. Thus, there has been substantial progress. The exceptions, in both the payment systems and the integrated control systems, will be closely monitored by the Commission, and appropriate financial consequences drawn for non-compliance in the clearance of accounts decisions.

20.16. The Commission has insisted that Member States submit the annual accounts of their paying agencies by the regulatory deadline of 10 February, in writing and in meetings convened to discuss the certification procedure with Member States. For 1997, the Commission will announce to Member States a measure based on budgetary discipline which will involve the retention of advances and which will be triggered where a paying agency fails to submit its accounts by the regulatory deadline.

20.17. The Commission is actively engaged in assisting the Member States concerned to introduce land holding registers, through aerial surveys and field identification systems. Those Member States which fail to meet the deadlines set for the implementation of these registers risk refusal of financing of part of the payments executed in the absence of effective management controls.

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CHAPTER 21(601\*) Analysis Structural Fund expenditure

21.0. CONTENTS Paragraph reference

Accounts of the Structural Funds 21.1 - 21.6

Systems governing Structural Fund operations 21.7 - 21.15

Overall assessment in the context of the DAS 21.7

Expenditure systems and the risks of error 21.8 - 21.14

Control in Member States 21.8 - 21.9

Availability of information on expenditure 21.10 - 21.11

Closure procedures 21.12

Definition of eligibility 21.13

Impact of national legislation 21.14

Size of advance payments 21.15

Results of the 1996 DAS Audit 21.16 - 21.19

Remedial action 21.20 - 21.22

ACCOUNTS OF THE STRUCTURAL FUNDS

21.1. The Structural Funds and other structural instruments account for around 24 426 Mio ECU or some 31,8 % by value of total budgetary payments. During 1996 commitments made totalled 28 672 Mio ECU of which 16 345 Mio ECU remained open at the end of the year. Further details of budgetary amounts involved in the main Structural Funds can be found in Volume I, paragraphs 6.2-6.3, 7.6-7.14 and 8.1-8.5.

21.2. Structural Fund interventions mainly consist of operational programmes approved by the Commission on the basis of proposals from Member States and lasting for up to 6 years. These amounts are committed in annual tranches over the programming period in accordance with the relevant programming documents. The operations are co-financed, generally by public authorities in the Member States.

21.3. At the beginning of an operational programme, the Commission's first payment takes the form of an unconditional advance representing a specified percentage (generally 50 %) of the first tranche. Subsequent advances are then made when the Member States declare to the Commission that a given proportion of the previous advance(s) has actually been disbursed in line with the Community objectives and rules. There is no regulatory requirement that these declarations should show details of expenditure. At the end of the programming period a final settlement is made by the Commission of any outstanding balance following examination of an implementation report and the final declaration of expenditure provided by the Member State which is required to contain details of expenditure. The intermediate annual tranches are also closed through the payment of a final balance. The Commission decides on the closure of annual tranches on the basis of a review of annual progress reports prepared and submitted by Member States. These progress reports have no fixed format and content and do not, except for the Social Fund, generally contain details of expenditure. The Commission is therefore not able to identify and exclude ineligible expenditure on the basis of these reports.

21.4. Until 1995 the Commission's accounts made no distinction between the Structural Fund disbursements which represented advance payments and those which took the form of final settlements. Table 15 of the revenue and expenditure account, which should now provide such information, is not reliable, as the Commission recognizes in its reply to paragraphs 19.23 to 19.25. Moreover, because the commitments are divided into annual tranches their closure in the accounts does not imply either the closure of a programme or the establishment of definitive expenditure - the latter being limited, except for Social Fund programmes, to the accounting closure of the commitment covering the final tranche. Furthermore the closure in the accounts of commitments related to annual tranches is artificial and misleading because the Commission in certain areas (particularly EAGGF-Guidance) allocates payments relating to later tranches to commitments for earlier tranches (thereby closing them before paying the final balance) and/or fails to adjust commitments after reprogramming (see DAS report 1995, Volume I, paragraphs 3.34 to 3.35). Finally, the annual accounts contain no information on the different programme periods or tranches, and thus do not show the degree of execution of the successive programmes. No accounts are published of closed programmes or programme tranches.

21.5. There is thus no direct relationship between the operations at the level of the beneficiaries and the disbursements of the Commission, most of which are in the form of advances. Only when final settlements are made is there a clear and definitive link between the declared expenditure and total Commission disbursements.

21.6. The Court has sought to obtain a representative view of the expenditure presented as underlying the declarations. It has used random sampling methods to audit payments to final recipients. The errors found thus relate primarily to the transactions at the level of the intermediate administrative bodies or the final recipients; they do not imply that the Commission's advance payments are necessarily incorrect, because Member States in many cases declare more than the minimum required to justify the advances. Nevertheless there were a number of examples encountered in the course of the audit where it was clear that the amount of eligible expenditure supporting an expenditure declaration was insufficient to justify the payment made by the Commission at the time it was paid. In some cases correct declarations would have resulted in the postponement of Commission payments until later, but in others, where final settlements were concerned, the errors have a direct effect on the amounts of the Commission's payments.

SYSTEMS GOVERNING STRUCTURAL FUND OPERATIONS

Overall assessment in the context of the DAS

21.7. In its successive Annual Reports, and in its 1994 and 1995 DAS reports, the Court has drawn attention to deficiencies in the way in which Structural Fund operations are planned, managed and accounted for (see the chapters in Volume I dealing with the regional Development Fund, paragraphs 6.9 to 6.42 in particular, Social Fund, paragraphs 7.35 to 7.57 and EAGGF- Guidance, paragraphs 8.6 to 8.69). Objectives have not been set in a way which enables progress to be measured, there has been insufficient clarity in prescribing which expenditures can be eligible for Community assistance, reliable accounting systems have not been put in place and there have not been sufficient controls to ensure that expenditure declarations reflect only eligible expenditure. The Commission is taking important steps in the context of its SEM 2000 initiative to address these problems: new rules on eligibility have been agreed with the Member States, and the Commission has just adopted a Regulation aimed at improving the accounting and control framework.

Expenditure systems and the risks of error

Control in Member States

21.8. The high incidence of substantive errors of eligibility within the 1996 DAS sample of payments - errors which occurred in most Member States - confirms that the administrative and control systems currently in place do not ensure that all Community co-financed expenditure is eligible and that Community rules and regulations are applied. The main responsibility for proper financial management and control rests with Member States. Nevertheless, the Commission, in the exercise of its responsibility for the execution of the EU budget, should ensure that these establish adequate systems and controls which are consistently applied. If this is not achieved then the European taxpayer does not have reasonable assurance that Community funds are properly used.

21.9. In two significant areas of EAGGF-Guidance expenditure Community legislation requires that physical inspections be carried out for a predetermined percentage of recipients. The Court's audit work shows examples of the required action not being documented or not even being performed at all (see Volume I, paragraphs 8.44 to 8.45 and 8.65).

Availability of information on expenditure

21.10. Effective control and monitoring systems require sufficient detailed information on how funds are being used, but the Court has often found that such information is not available in the context of the Structural Funds at regional, national and Community levels. An obligation to provide such information would induce both final recipients and preparers of declarations to assess carefully the type of expenditure for which Community financing is being sought and its conformity with the rules and regulations.

21.11. Adequate information on expenditure would make it possible to identify a number of errors, such as ineligible expenditure, lack of co-financing, the presentation of budgeted or expected rather than actual expenditure, and multiple funding of the same project. Furthermore the information would provide the basis for the Commission and the Court to undertake effective risk oriented examinations of expenditure declared.

Closure procedures

21.12. As noted in paragraph 21.3 above expenditure in Structural Fund programmes remains non-definitive until the operational programmes are closed, at which time appropriate verification of all declared expenditure should occur. However, the first results of the Court's detailed audit work in this area in relation to the Regional Development Fund (see conclusion in Volume I, paragraph 6.39) indicate that the verification procedures in Member States in many of the cases examined could not be relied on to identify and exclude ineligible items from previously declared expenditure. There is thus a serious risk that the type of errors found in underlying transactions identified from declarations supporting advances will remain undetected in the definitive expenditure when programmes are closed, unless there is a substantial improvement in control procedures, in particular in Member States.

Definition of eligibility

21.13. The imprecise definition of eligibility criteria has on occasion led to differing interpretations by Member States. This imprecision, in conjunction with the absence of effective control and verification procedures, has led to the submission of ineligible expenditure by certain beneficiaries. Examples of this are given in relation to the Regional Development Fund (Volume I, paragraphs 6.45 and 6.46) and Social Fund field (Volume I, paragraphs 7.39 to 7.41 and 7.47). A further risk of error has resulted from the incorrect or inappropriate communication of eligibility criteria within Member States as illustrated within the Regional Development Fund (Volume I, paragraph 6.65).

Impact of national legislation

21.14. Activities which are co-financed by the Member States are often managed and accounted for on the basis of pre-existing national arrangements. These arrangements sometimes conflict with the relevant European legislation, resulting in beneficiaries presenting expenditure for reimbursement which under European legislation may be ineligible. Some operational programmes are also affected by charges and commissions imposed by national law which should be excluded from Community financing.

Size of advance payments

21.15. In general, payments of initial advances represent some 50 % of total expenditure for a particular annual tranche. The programming document which fixes the size of each tranche can overestimate a Member State's capacity to absorb expenditure quickly at the start of a programme thus resulting in larger advances than necessary. The size of such advance payments represents not only an inefficient use of Community funds from a treasury standpoint but can also lead to non-compliance with Community legislation defining time limits for transfer of funds from Member States to recipients. This is illustrated by the Court's findings in the Social Fund field (Volume I, paragraphs 7.13 and 7.14). If it becomes apparent that a Member State is not in a position to implement a programme according to the planned time scale, then the remaining amounts may be reprogrammed to subsequent years so accelerating the payment of the first advance in respect of the next tranche.

RESULTS OF THE 1996 DAS AUDIT

21.16. The rate of substantive error found in the Structural Funds budgetary area is, as in the last two years, estimated to be higher than that for the general budget as a whole (see paragraph 19.30). Over nine tenths by value of the substantive errors found in the Structural Funds audit area originated in Member States, of which some two thirds were at the level of the final recipients of Community funds, with almost all of the remainder occurring at local level.

21.17. The majority of substantive errors found fell into the following categories:

(a) expenditure not meeting the required eligibility criteria relating to the nature of the action financed, the type of costs claimed or the eligible period;

(b) expenditure claimed which had not been disbursed at the time of the declaration.

21.18. There was a very high incidence of formal errors involving breaches of the regulatory and control framework applicable to Structural Funds expenditure. Over four fifths of these errors originated in Member States: they were split roughly equally between central, local and final beneficiary levels.

21.19. Nearly two thirds of these formal errors concerned breaches of the following regulatory conditions stipulated for the subsequent implementation of the measure financed by the Community budget:

(a) national and final beneficiary accounting systems which do not provide for separate identification of expenditure of Community funds;

(b) a lack of complete or adequate data on underlying transactions.

REMEDIAL ACTION

21.20. An important first step towards ensuring adequate control of Structural Funds expenditure and therefore reducing the risk of loss to the Community or other error, is the provision of complete detailed information on the expenditure being financed. The Court notes that the Commission has launched studies in this direction in the context of SEM 2000. Such information could also be used for more efficient management of the programmes, more efficient and effective verification of the actions and better evaluation of progress towards Community objectives.

21.21. The Commission should maintain pressure on the Member States to establish effective administrative and control systems which enforce compliance with Community criteria. Such systems should include procedures for adequate and accurate communication of Community requirements, provide for adequate appraisal of requests for Community funding, and specify the arrangements for sufficient analysis and verification of the expenditure. The systems should also provide for regular effective monitoring of projects in qualitative and quantitative terms.

21.22. The action under way in the context of the SEM 2000 programme should result in some improvement in the management and control of the Structural Fund programmes during the second half of the current programme period. However, these changes do not address all the problems associated with the operation of the Structural Funds which have been identified in the successive reports of the Court and the Commission. For the next programming period running forward from the year 2000, the basic Regulations need to be reconsidered. While respecting the principle of subsidiarity in terms of the choice by the responsible administrations in the Member State of the detailed actions to be co-financed, the Regulations need to provide for:

(a) unambiguous definitions of eligible expenditure at the level of the Regulations;

(b) clear and comprehensive reporting and accounting arrangements;

(c) the proper discharge by the authorities in the Member States of their responsibilities for the control and certification of expenditure;

(d) the imposition of financial corrections where authorities use Structural Funds financing other than in accordance with the Regulations.

REPLIES OF THE COMMISSION

ACCOUNTS OF THE STRUCTURAL FUNDS

21.3. Member States' declarations of expenditure contain, in general, the same level of detail as the financial tables attached to the programming documents and to the Commission co-financing decisions.

In June 1995 the Commission drew up and sent to the Member States an annual report schema which also provides the basis for final reports. However, this is not and should not be a rigid framework imposed on the Member States: given the widely differing content of each programme, it is for the national authorities to furnish the information provided for in the schema, but the layout of the presentation is for them to decide.

It is not the purpose of these reports to allow the Commission to identify ineligible expenditure. This would not be practicable given the size of the programmes and of the sums involved. The Commission seeks to identify ineligible expenditure in other ways, for example by on-the-spot checks. However, the Commission emphasizes that the primary responsibility for ensuring that ineligible expenditure is not presented to the Commission for co-financing lies with the various authorities concerned in the Member States.

21.4. In its reply to paragraphs 3.34 and 3.35 of the DAS Report 1995, the Commission explained its position in relation to the Court's claim that it 'fails to adjust commitments after reprogramming`. Where reprogramming produces a situation where an existing financial commitment is now greater than the corresponding sum in the financial plan of the programme, the Commission, instead of decommitting the difference, makes an adjustment in the next commitment by offsetting the surplus. The Commission takes the view that this practice, which avoids unnecessary financial transactions, is fully justified.

As far as EAGGF-Guidance is concerned, according to current practice, each payment is posted to the oldest commitment still existing for the programme in question in order to reduce the number of accounting operations. Otherwise, the general system of accounts would become cumbersome: Community management of operational programmes could easily triple (decommitments, additional commitments as a result of these decommitments, recovery as a result of the decommitments, payments against new commitments, etc.). In a context of simplification of administrative procedures, this would not appear to make optimal use of staff.

Moreover, due to frequent modifications of financing plans, the running total for all commitments is corrected when the next instalment is committed and, therefore, the individual commitments no longer correspond to the annual instalments of the latest version of the programme. There can be no logical rule for posting successive payments to the annual commitment of instalments, as these commitments no longer relate to the annual instalments.

21.6. Member State final declarations of expenditure may, to the extent that the expenditure declared contains unidentified ineligible items, result in the Commission's paying too much. When such cases are discovered, the Commission makes or requires the necessary correction. The Member States are responsible for ensuring that their declarations do not include ineligible expenditure; the Commission is responsible for ensuring, within the limits of the resources available to it, that the Member States have put in place, and correctly apply, financial management, control and audit systems which tend to prevent such errors. The Commission adopted on 15 October 1997 a Regulation establishing detailed arrangements for the financial control by Member States of operations co-financed by the Structural Funds.

SYSTEMS GOVERNING STRUCTURAL FUND OPERATIONS

Control in Member States

21.8. Most of the errors categorized by the Court as 'substantive` have, for reasons which the Commission explained in its reply to paragraph 3.133 of the 1995 DAS, no adverse effect on the Community budget or accounts and require the Commission to make no financial recovery. The Commission continues to consider that errors of this kind should be categorized separately from the generality of substantive errors. However, the Commission regards these errors with proper seriousness and it corrects or requires the correction of all errors coming to its notice.

The Commission Regulation mentioned above aims inter alia at improving the accounting and control framework for management of Structural Fund operations in the Member States.

21.9. The Commission will take account of the Court's remark in planning its on-the-spot control activity in this area and in its regular consultations with the Member States about control activity.

Availability of information on expenditure

21.10 21.11. In the context of the Commission's SEM 2000 initiative, steps are being taken to address the problem of information on how funds are being used, by means of a set of minimum requirements for implementation reports. In the same context, the new Commission Regulation mentioned above includes specific provisions about the detailed information to be made available at the appropriate management level in the Member States. However, given the size of the programmes and of the amounts concerned, it would not be appropriate to require detailed information to be forwarded to the Commission on a systematic basis. The Commission requests and receives detailed information when it is needed, e.g. for the planning of an on-the-spot check.

Closure procedures

21.12. The Commission agrees about the importance of ensuring that programmes are closed on a correct financial basis. With a view to improving the quality of Member States' expenditure declarations at closure, the Commission Regulation includes a specific requirement for Member States to present, at the time of programme closure, a statement providing an independent conclusion as to the validity of the request for the final payment and the legality and regularity of the transactions underlying the final declaration of expenditure. This requirement should have the effect of encouraging sound financial management and control throughout the life of the programme.

The Commission also carries out on-the-spot checks during the programme implementation period, ensures that any problems reported by national or Community controls have been satisfactorily settled before the closure of the programmes and makes ex-post checks on a sample basis. All this helps to ensure the legality and regularity of the Community payments, including the final payment.

Definition of eligibility

21.13. The Commission formally adopted on 23 April 1997, after lengthy discussions with the Member States in the framework of the partnership, some 30 pages of detailed eligibility rules (see point 21.7 of the Court's comments).The Commission comments, in its replies to the passages mentioned, on the specific examples of ineligible expenditure advanced by the Court.

Impact of national legislation

21.14. The Commission takes appropriate steps to ensure that such problems are satisfactorily settled.

Size of advance payments

21.15. The size of the Commission advances is governed by Article 21 of Regulation (EEC) No 4253/88. Modification of the financial plan requires a specific Commission decision, and the Commission examines whether the allocation of the unspent amounts to the subsequent years is reasonable, with a view to ensuring that the Member State does not receive an unduly high advance.

The reprogramming system provided for by the rules does not necessarily accelerate the payment of the first advance in respect of the next tranche.

In the context of the ESF, the Commission has already adjusted the payment of certain advances in 1996 and undertakes to continue its efforts to extend the practice. It would, however, recall that, thanks to the annual closure of the ESF accounts, compensation is systematically made after the remaining amounts have been reprogrammed to take account of the position with regard to expenditure actually incurred.

RESULTS OF THE 1996 DAS AUDIT

21.16 17. The Commission notes that over 90% by value of the substantive errors found in the area of the Structural Funds originated in the Member States. Faced with this situation, the Commission corrects or requires the correction of all errors which it identifies or are brought to its attention, usually by requesting the Member Sate concerned to present a corrected declaration of expenditure; and it seeks to ensure that effective financial management and control systems are in place in the Member States and are correctly applied.

21.19. The new Commission Regulation includes provisions specifying the requirements for a sufficient audit trail. It is also already clear that the expenditure of Community funds must be separately identified and it is up to the Member State to ensure this.

REMEDIAL ACTION

21.20 21.22. The basic responsibility for ensuring proper financial control of the operations co-financed by the Structural Funds lies and must continue to lie with the Member States. The Commission's general responsibility is to ensure, within the limits of the human and other resources available to it, that the Member States establish, and correctly apply, financial management, audit and control systems capable of ensuring that proper control. The Commission corrects or ensures the correction of all irregularities which it discovers or are drawn to its attention. The Commission adopted on 15 October 1997 a Regulation establishing detailed arrangements for the financial control by Member States of operations co-financed by the Structural Funds, together with guidelines for its departments on the circumstances in which it would be appropriate, in applying Article 24 of Regulation (EEC) No 4253/88, to make a net correction in the amount of the Community co-financing. The Commission notes the Court's remark that the changes in hand do not address all the problems associated with the operation of the Structural Funds. The Commission intends to review fundamentally the existing Council Regulations and to make proposals for amendments designed to improve financial management and control in the next programming period. It will take the Court's suggestions in this respect into account.

PART II Statement of assurance concerning the activities of the sixth and seventh European Development Funds

CHAPTER 22(602\*) Statement of assurance and supporting information concerning the sixth and seventh European Development Funds

22.0. CONTENTS Paragraph reference

Statement of assurance relating to the activities of the sixth and seventh European Development Funds for the financial year ending 31 December 1996 I - XI

Reliability of the accounts III - IV

Legality and regularity of the underlying transactions V - XI

Information supporting the statement of assurance 22.1 - 22.31

Introduction 22.1

Scope of the audit 22.2 - 22.6

Detailed observations on the accounts 22.7 - 22.19

Detailed observations on legality and regularity of underlying transactions 22.20 - 22.31

Other observations 22.32 - 22.51

Comments on other information disclosed 22.32 - 22.36

Management of the Stabex bank accounts 22.37 - 22.43

Conditions of work programme and direct labour contracts 22.44 - 22.45

Operations managed by the EIB 22.46

ACP bank accounts for Stabex transfers 22.47 - 22.48

Contract conditions on variation of prices in works contracts 22.49 - 22.51

Statement of assurance relating to the activities of the sixth and seventh European Development Funds for the financial year ending 31 December 1996

I. The Court has examined the accounts of the sixth and seventh EDFs for the financial year ended 31 December 1996. These accounts include the balance sheets as at 31 December 1996, the revenue and expenditure accounts for the financial year ended on the same date and the notes in annex, as presented in Chapters VIII, X and XI of a Communication from the Commission to the Court of Auditors, the Parliament and the Council under reference SEC(97) 938 final of 27 May 1997. The Court of Auditors provides the European Parliament and the Council with a statement of assurance as to the reliability of the accounts and the legality and regularity of the underlying transactions.

II. The Court carried out the audit in accordance with generally accepted international auditing standards, to the extent that these apply in the EDF context. The audit of revenue was based on the amounts of the contributions receivable and actually paid to the EDF. The audit of expenditure was based on expenditure committed and the payments made. The audit comprised an appropriate range of audit procedures, designed to examine, on a test basis, evidence relating both to the amounts and disclosures in the accounts and to the regularity and legality of the transactions underlying the accounts. It also included an assessment of the accounting principles used and significant estimates made by management, as well as the overall presentation of the accounts. The Court obtained through the audit a sufficient basis for the opinion expressed below.

Reliability of the accounts

III. The amount disclosed as advances on contracts (for works, services and supplies) is underestimated by at least 336,8 Mio ECU. Moreover, advances are shown as final payments in the financial statements (see paragraphs 22.7-22.8).

IV. Despite improvements introduced by the Commission, the accounts are still affected to a significant extent by the following accounting methods or practices:

(a) the notes disclosing the amount of commitments unlikely to be used (34,9 Mio ECU to be decommitted plus 530 Mio ECU unlikely to be used) understates their total value by, according to the Court's estimate, some 145,3 Mio ECU (see paragraphs 22.12-22.13);

(b) 78,23 Mio ECU have been paid out of the seventh EDF as advances for the eighth EDF and are not disclosed as debtors on the balance sheet of the seventh EDF, but are included in the receipts and expenditure account of the year. Corresponding commitments (totalling 101,5 Mio ECU) for both Stabex and the Centre for the Development of Industry (CDI) are included in the management accounts without being disclosed separately in the balance sheet (see paragraph 22.11);

(c) the 19,6 Mio ECU shown as advances for scholarships and technical assistance include expenditure under verification amounting to 14,7 Mio ECU (see paragraphs 22.16, 22.17);

(d) the treasury accounts include 3,7 Mio ECU of doubtful accounts and 89,5 Mio ECU of Government bonds and associated interest which are not specifically mentioned in the financial statements (see paragraph 22.15);

(e) certain generally accepted accounting principles have not been applied (see paragraphs 22.9, 22.10, 22.18, 22.19).

Legality and regularity of the underlying transactions

V. The commitments were not affected by substantive errors of legality and regularity, but the audit showed a high incidence of formal errors (see paragraph 22.21).

VI. Of the 101,5 Mio ECU of commitments mentioned under paragraph IV b), 76,2 Mio ECU, related to Stabex, were made as advances for the eighth EDF using funds of the seventh EDF, following a decision by the ACP-EU Council. As the eighth EDF was not yet ratified, these commitments were effected with appropriations that were not available at the time (see paragraph 22.20).

VII. Of the 78,23 Mio ECU of payments mentioned under paragraph IV b), 68,6 Mio ECU related to Stabex were made for which, because of the same reasons mentioned in paragraph VI, no sufficient legal basis exists either.

VIII. Other than the transactions mentioned in paragraph VII which are of an exceptional nature, the errors found in the sample amount to 8,3 Mio ECU:

(a) support for structural adjustment, to the amount of 8 Mio ECU was paid, although no evaluation of the conditionality had taken place;

(b) errors in the calculation of amounts paid to contractors totalled 0,3 Mio ECU.

On the basis of these results, the most likely amount of substantive legality/regularity errors affecting the year's payments was 21,2 Mio ECU (2,0 % of the payments) (see paragraph 22.28).

IX. Although there was an improvement as compared with 1995, the audit again showed a high incidence of formal errors affecting payments. In these cases there were failures to comply with the applicable regulations and other conditions (see paragraph 22.29).

X. Based on the results of the sample, the Court is unable to reach a firm opinion as to the correct use of an estimated 4,5 % of the payment transactions mainly due to material obstacles to the audit beyond the influence of the Commission. Moreover, for those related to structural adjustment, because of the weak organization of payments files, the Court was unable to assure itself that all relevant documents were available and taken into consideration at the moment of the authorization of the payments (see paragraph 22.25).

XI. - Except for the effects of the matters summarized in paragraphs III and IV above, the Court is of the opinion that the accounts for the financial year 1996 reflect reliably the EDF's revenue and expenditure for the year and financial situation at the end of the year. - The Court is of the opinion that, except for the effects of the matters discussed in paragraphs V and VI, the commitment transactions for the financial year are, taken as a whole, legal and regular. - As regards payment transactions, the Court is of the opinion that, with the exception of the effects of the matters described in paragraphs VII to X above, the transactions underlying the payments for the financial year are, taken as a whole, legal and regular.

16 October 1997

B. Friedmann

President

European Court of Auditors 12, rue Alcide De Gasperi, L-1615 Luxembourg

INFORMATION SUPPORTING THE STATEMENT OF ASSURANCE

Introduction

22.1. The Treaty establishing the European Community entrusted the Court of Auditors with the task of auditing transactions carried out under the European Development Funds. The Court of Auditors is required to provide the European Parliament and the Council with a statement of assurance as to the reliability of the accounts and the legality and regularity of the underlying transactions. This information in support of the statement of assurance sets out the overall results of the work performed under that mandate for operations under the sixth and seventh EDFs for the financial year 1996.

Scope of the audit

22.2. The DAS itself contains no conclusions as to the degree of compliance with the principles of sound financial management. This is something which the Court continues to assess separately as part of its other work, in particular in the context of its annual and other special reports.

22.3. Certain cases of deliberate irregularity to the detriment of the Community finances cannot, by their very nature, be detected by the usual auditing procedures implemented in accordance with generally accepted auditing standards. The Court is not therefore in a position to give any assurance concerning the absence of cases of this type.

22.4. The audit of 1996 expenditure was based on a statistical sample of 63 commitments (Commission decisions) and 247 payments. The transactions pertaining to the two current EDFs were grouped together for the purpose of the audit and each Fund was treated as part of the same population.

22.5. The commitments and payments examined in the context of the sampling procedures accounted for 45 % and 32 % respectively of total commitments and payments for the year. In the fields of Stabex and structural adjustment, the size of the transactions examined was such that most of the movements in that year were examined(603).

22.6. At the year-end, to ascertain the appropriations available for re-use, it is necessary to deduct from the capital of each EDF both the final payments disbursed since the start of the Fund and the commitments of appropriations that are awaiting settlement. Table 1 shows the amounts that were expected to be available for re-use at the end of the 1996 financial year and thus also provides a summary overview of the progress of the sixth and Seventh EDF'(604).

Detailed observations on the accounts

Advances on contracts (paragraph III of statement of assurance)

22.7. Many contracts provide for the payment of advances before the commencement of works, deliveries of supplies or the provision of services. These advances are different from payments on account that are made on the basis of progress reports during implementation. In the accounts, the Commission does not distinguish between advances and final payments, which results in a forced presentation of the use of the appropriations that is not pointed out in the financial statements.

22.8. In the 1996 accounts, the Commission presents for the first time a schedule indicating the extent of such advances(605). The schedule in the financial statements showing payments of advances is incomplete due to a computer error. The difference between the figures as analysed by the Court (604,41 Mio ECU) and the financial statements (267,61 Mio ECU) amounts to 336,8 Mio ECU.

Accounting principles, methods and practices (paragraph IV (e) of statement of assurance)

22.9. The generally accepted accounting principle of gross accounting (not netting off) has not been applied:

(a) cash at bank and an overdraft have been netted off in the accounts(606);

(b) expenditure to be regularized includes both receipts and income to be regularized, as well as expenses (see paragraph 22.18).

22.10. No provision has been made for the following:

(a) 2,8 Mio ECU for bank balances with the Central Bank of Zaire (see paragraph 22.15 (a));

(b) the unrealized loss of 0,9 Mio ECU on the market value of Government bonds included in the Stabex treasury account (see paragraph 22.15 (b));

(c) an amount due of 0,1 Mio ECU for Germany's 1994 contributions that is still outstanding(607) as a result of the exchange rates applied when the contributions were actually paid, and which is unlikely to be recovered.

Balance sheet

Expenses incurred in advance for the eighth EDF (paragraph IV (b) of statement of assurance)

22.11. The audit of the appropriations showed that remainders of the seventh EDF were used to finance operations that would not otherwise have been executed as the eighth EDF has not yet been ratified. Such a situation has never arisen before. More specifically, 78,23 Mio ECU paid out of the seventh EDF as advances for the eighth EDF are not disclosed as debtors on the balance sheet of the seventh EDF, but are included in the revenue and expenditure account of the year. Corresponding commitments (totalling 101,5 Mio ECU) for both Stabex and the Centre for the Development of Industry (CDI) are included in the management accounts without being disclosed separately in the balance sheet and concern:

(a) for Stabex the Seventh EDF covered the application years 1990 to 1994. For the application year 1995, the Commission, basing itself on a decision by the ACP-EU Council(608), used unaffected reserves of the seventh EDF, totalling 76,2 Mio ECU to make commitments and to make payments;

(b) for the Centre for the Development of Industry (CDI), which had used its 60,0 Mio ECU envelope foreseen in the Financial Protocol annexed to the Lomé fourth Convention, the same method was used, amounting to 25,3 Mio ECU(609);

Valuation of the Funds at the end of the financial year (sleeping commitments) (paragraph IV (a) of statement of assurance

22.12. In Annex 3.1 to the 1996 financial statements, the Commission presents an analysis of the commitments for which there have been no movements in the accounts for over 18 months. Of these, the Commission has identified total commitments of 34,9 Mio ECU which need to be cancelled (14,8 Mio ECU for the sixth EDF and 20,1 Mio for the seventh EDF). The audit work performed indicates that the Commission's analysis understates the amount of the appropriations that are unnecessarily tied up. A total of 180,2 Mio ECU should be decommitted rather than the 34,9 Mio ECU disclosed in the accounts.

22.13. The same Annex 3.1 also indicates that of the 5 096 Mio ECU outstanding commitments, an estimated 530 Mio ECU are unlikely to be paid out. This amount represents the contingency reserves made when the commitments are drawn up. By means of decommitments the fund balances of 2 207,9 Mio ECU available for re-use (Table 1) should be increased by 180,2 Mio ECU, and a further 530 Mio ECU should be taken into account for commitments that are unlikely to be paid out.

22.14. It should be noted that included in the commitments to be paid are Stabex transfers of 103,8 Mio ECU, due to Sudan under the seventh EDF. A political decision is required before these monies can be paid over to Sudan.

EDF Cash position (paragraph IV (d) of statement of assurance)

22.15. The balance of 402,49 Mio ECU in the EDF bank accounts includes:

(a) 2,8 Mio ECU for bank balances with the Central Bank of Zaire, which are unlikely to be recovered, and which should be disclosed as doubtful accounts on the balance sheet(610). The EDF authorizing and accounting officers should make provisions to write this amount off;

(b) 89,55 Mio ECU of Government bonds (including interest purchased of 1,53 Mio ECU) as part of the Stabex treasury balance of 106,06 Mio ECU. Furthermore, no provision has been made for an unrealized loss of 0,92 Mio ECU on the market value of these bonds as at 31 December 1996.

Advances for scholarships and technical assistance (paragraph IV (c) of statement of assurance)

22.16. Details of the advances paid for scholarships and technical assistance, amounting to 19,6 Mio ECU are disclosed in the financial statements(611), and broken down into three groups:

(a) 4,3 Mio ECU managed directly by 44 Delegations in the ACPs, of which only 0,5 Mio ECU was confirmed to the Court by 26 delegations. For 18 advances totalling 0,3 Mio ECU, no accounting movements had been recorded since 1993, and it is likely that these have been used up. In another case, advances of 1,5 Mio ECU were paid since January 1993, although no expenditure was reported by the delegation;

(b) 9,1 Mio ECU of advances to AEC for technical assistance, overstated by 5 Mio ECU for expenses made locally by AEC but not reported at all to the Commission in 1996;

(c) 6,2 Mio ECU paid to agencies in the Member States for scholarships was overstated by some 5,2 Mio ECU, which amount had not yet been recorded as expenditure in 1996 by the Commission. In one case, the last accounting entry was made in 1992, but no steps have been taken to recover the outstanding advance (of 78 939 ECU).

22.17. The lack of follow-up on these advances and late accounting of expenditure has already been commented upon by the Court(612). The Court notes with satisfaction that the advances have been reduced from 29 Mio ECU to 19,6 Mio in the year to 31 December 1996. However, efforts should be continued to ensure that the accounts are up to date. The asset balance of 19,6 Mio ECU of advances recorded by the Commission cannot be considered to be available for re-use, and the capital of the fund is overstated by some 14,7 Mio ECU.

Expenditure to be regularized (paragraph IV (e) of statement of assurance)

22.18. Payments made locally in the ACPs are initially to be recorded by the Accounting Officer in a transitory account for expenditure to be regularized, before being attributed to a project and cleared as final expenditure after controls made by the Authorizing Officer and the Financial Controller. At the end of 1996, the amount of 33,8 Mio ECU of expenditure to be regularized actually comprised 3,3 Mio ECU of receipts and income to be regularized and 37,2 Mio ECU of expenses to be regularized, which represents 10,0 % of total local payments in 1996.

22.19. Included in the amounts to be regularized are:

(a) differences between the year end bank balances on the ACP bank accounts and the balances recorded in the accounting records, this difference being local payments for which the Commission had not received information at the accounts closure date, and which are explained by bank reconciliations. A total of 4,03 Mio ECU thus recorded at the year end on five bank accounts could not be explained by the Commission, as bank reconciliations had not been prepared and procedures for recording local payments as described in paragraph 22.18 were not followed;

(b) 1,1 Mio ECU of operations carried out between 1988 and 1993, on which problems were identified in 1994. Three years later, these have still not been resolved and the payments remain outstanding to be regularized.

Detailed observations on legality and regularity of underlying transactions

Decisions (primary commitments)

Substantive legality/regularity errors (paragraph VI of statement of assurance)

22.20. Commitments related to Stabex, totalling 76,2 Mio ECU, were made as advances for the eighth EDF using funds of the seventh EDF on the basis of Decision No 2/96 of 28 June, 1996 by the ACP-EU Council. As the EDF is based upon an international treaty that cannot enter into force before its ratification, the governments of Member States and ACP countries cannot decide upon an anticipated start of the Fund, because the ratification has to be given by the legislative power and not by the executive power (see also paragraph 22.27).

Formal legality/regularity errors (paragraph V of statement of assurance)

22.21. In total 13 out of 63 commitments (20,6 %) in the sample were affected by some kind of formal errors.

22.22. Commitments for two structural adjustment programmes(613) were increased by 3,8 Mio ECU and 4,8 Mio ECU, on the basis of Articles 292 and 311 of the fourth Lomé Convention and Article 62 of the Financial Regulation. However, the procedures laid down in Article 292(1) of the Convention limit additional financing to the traditional types of programme and project. These additional commitments should not, thus, have been authorized following this procedure.

22.23. An increasing proportion of structural adjustment measures is financed by subsidies drawn from the national indicative programmes(614). Nine commitments(615) amounting to 84,2 Mio ECU were financed by drawing on the national indicative programmes and resulted in the 10 % limit being exceeded. No information was supplied to the EDF Committee concerning the percentage by which the indicative ceiling of 10 % had been exceeded and the reasons therefore.

22.24. For the transactions managed under mandate, it was noted that:

(a) the ceiling of 3 % interest rate on risk capital loans(616) was not always strictly adhered to; in cases of on-lending in form of equity participations, higher remuneration was not excluded because the remuneration equals 50 % of any dividends;

(b) Article 233.4(b) requires that any financial benefit accruing to the intermediary from the on-lending transaction shall be used for development purposes (after taking into account administrative costs, exchange and financial risks, and the cost of technical assistance). This condition was not included in the finance contracts relating to three commitments;

(c) for one commitment for interest rate subsidies the stipulation of Article 235 (b) of the Lomé Convention whereby the interest rate borne by the borrower shall be neither less than 3 nor more than 6 % was not fully adhered to, as the possibility of an interest rate higher than 6 % was not excluded in the finance contract.

Payments

Non opinions (paragraph X of statement of assurance)

22.25. In a number of cases estimated to represent 4,5 % of payment transactions, it is not possible to judge on the legality and regularity of the underlying transactions, mainly due to material obstacles to the audit beyond the influence of the Commission.

22.26. Supporting documents were found to be missing for a further five local payments totalling 0,1 Mio ECU, regularized during 1996.

Substantive legality/regularity errors (paragraph VII and VIII of statement of assurance)

22.27. As mentioned in paragraph 22.20 above, a number of payments have been made on behalf of the eighth EDF, using funds of the seventh EDF following decisions by the ACP-EU Council. As the eighth EDF was not yet ratified, the related underlying payments, totalling 68,6 Mio ECU, were made with credits that were not available at the time of payment.

22.28. The most likely amount of substantive legality/regularity errors - quantifiable errors directly affecting the amounts of the transactions underlying EDF funds disbursed - affecting the year's payments is 21,2 Mio ECU (2,0 % of the payments):

(a) the non-eligibility of payments (no evaluation of the conditionality related to structural adjustment; ineligible supplies for a project);

(b) the calculation of the amounts paid to contractors (reimbursement of advances; 16 cases where the prescribed retention of 10 % had not taken place);

(c) an amount paid in local currency exceeded the amount committed in that currency.

Formal legality/regularity errors (paragraph IX of statement of assurance)

22.29. Of the payments, 10,9 % was affected by formal errors - errors without any directly quantifiable effect on the amounts of the transactions underlying the EDF funds disbursed - especially in the area of Structural Adjustment and operations managed by the EIB.

22.30. For structural adjustment two payments, totalling 12,7 Mio ECU were contrary to Article 250.3 of the Lomé Convention transferred to accounts outside the EU(617) (USA). Two others were made without the necessary Memorandum of understanding on the use of counterpart funds being concluded(618). As regarding conditionality it was noted that either payments were made when conditions were not all fulfilled or conditionality was changed and/or annulled without informing the EDF Committee.

22.31. For the payments of grants the types of errors included the following: the prescribed tendering procedure was not followed, the necessary bank guarantees were not always provided, payments were made on bank accounts other than those stipulated in the contract.

OTHER OBSERVATIONS

Comments on other information disclosed

22.32. Apart from the balance sheets, revenue and expenditure accounts and annexes thereto examined in the context of the 1996 DAS, other information presented by the Commission in the financial statements has also been reviewed. The primary objective of this review was to confirm the consistency of the other information with the audited financial statements.

22.33. The payments for structural adjustment support and Stabex are in the first instance made into intermediary bank accounts in Europe. For structural adjustment support, according to Article 250.3 of the Lomé Convention, the funds remitted to the beneficiary authorities are to be considered as advances of funds until the authorities in question submit justification for their use. The Commission does not follow this provision in the Convention.

22.34. For both instruments (Stabex and Structural Adjustment), local currency counterpart funds are constituted. For the seventh EDF, the Commission has provided details of the payments made, of ecu amounts on deposit on European bank accounts and of the counterpart funds constituted, used and remaining to be used(619):

(a) of the structural adjustment support payments to date of 1 308,3 Mio ECU, 76,1 Mio ECU remains on European bank accounts; local currency counterpart funds remaining to be used total 152,3 Mio ECU. However, the delegations confirmed to the Court the amounts of 74,3 Mio ECU and 107,4 Mio ECU respectively;

(b) of the 1 610,6 Mio ECU paid for Stabex transfers from the seventh EDF (including payments on account for the eighth EDF), 575 Mio ECU remains on European bank accounts; unused local currency counterpart funds total 222,7 Mio ECU. The delegations confirmed to the Court the amounts of 744,4 Mio ECU and 116,7 Mio ECU respectively.

22.35. The figures presented on the special iniative for Africa (rehabilitation)(620) include both EDF funds and budget funds. The total commitments amount to 783,0 Mio ECU of which 592,7 Mio ECU are funded from EDF resources and payments total 227,0 Mio ECU of which 152,6 Mio ECU from EDF.

22.36. Finally, the overall authorizations for risk capital, totalling 30,0 Mio ECU of which 5,0 Mio ECU for the sixth and 25,0 Mio ECU for the seventh EDF, are not disclosed at all(621).

Management of the Stabex bank accounts

22.37. Following a restricted invitation to tender in June 1994, the Stabex bank account was opened in October 1994 for an initial period of one year. The terms and conditions were established by an exchange of letters between the Accounting Officer (DG XIX) and the bank concerned. The account was subsequently renewed, each time for a period of one year, without any changes to these terms and conditions.

22.38. The interest offered on the account was one of the critera used for assessing the terms offered by the banks invited to tender. However, the costs of the services offered were not considered at all, and were not mentioned in the terms and conditions for the account. In the absence of any agreement, the successful bank applied costs in accordance with its general terms and conditions. As these account charges were not shown separately, but were deducted from the interest paid to the Commission, the latter was not in a position to judge how much it was actually paying for the account services.

22.39. The Stabex account comprises several bank accounts for capital and interest, and a portfolio of Government bonds, managed as a whole in order to maximize the return on the accounts, given the prudent investment policy of the Commission and the liquidity requirement of the EDF. Details of all underlying transactions, bank statements and an overall summary of the Stabex account are provided by the bank. Only one account is maintained in the EDF accounting records, representing the overall Stabex account(622). Accounting entries are recorded on the basis of the overall summary of the Stabex account, which gives details of interest earned, payments, and transfers between the various accounts.

22.40. The total Stabex interest earned during the year (15,7 Mio ECU per the accounts) comprises 2,7 Mio ECU interest on the deposits made in the year, 13,8 Mio ECU of interest earned on bonds and 0,9 Mio ECU of capital losses.

22.41. The underlying documentation for the Stabex account was found to be incomplete - no bank statements had been kept for two of the bank accounts, and an incomplete set only was available for the other two accounts; the instructions to the bank and confirmations of transactions from the bank were also incomplete. A complete set of bank statements and confirmations of operations are the minimum basic documents required as justification for accounting movements recorded for bank accounts, and it is absolutely imperative that there are controls to ensure that these have all been received and kept. In the absence of supporting documentation, it is not possible to verify what checks had been carried out by the Accounting Officer to ascertain that his instructions were followed, that all income due to the EDF had been received, and that the Community assets were safeguarded.

22.42. Within the Accounting Officer unit, no standard procedures have been established as concerns recording of bank operations, recovery of bank charges not due, filing and archiving of bank statements and preparation of bank reconciliations. During the course of the 1996 DAS audit, the lack of consistent and proper reconciling procedures between bank statements and the accounting records (see paragraph 22.19) were noted. For a number of bank accounts operations were incorrectly recorded and follow-up of operations for which no information was available was weak.

22.43. These weaknesses have already been drawn to the attention of the Accounting Officer in previous years, but the situation remains unsatisfactory. Standard procedures need to be established and applied in the Accounting Officer unit.

Conditions of work programme and direct labour contracts

22.44. Of 30 work programme and direct labour payments examined in the context of the 1996 DAS, the contract conditions of 22 related contracts totalling 41,2 Mio ECU, showed a number of weaknesses:

(a) in eight contracts, there was no mention of conditions concerning the administrator of imprest accounts, the accountant or the modalities for the recovery of the advance. Responsibilities were not clear as regards payments made from the advance and the accountability of beneficiaries for the use of funds received;

(b) on 10 contracts, no procedures were specified for local procurement, and on a further 12 contracts the local procurement conditions applicable were different to those allowed per instructions from the central services. The impact of the differing procurement procedures on the costs eventually borne by the EDF cannot be quantified.

22.45. Application of management instructions should be controlled, and all derogations should be specifically approved.

Operations managed by the EIB

22.46. For the operations managed by the EIB, although the calculations for the interest rate subsidies were checked for the operations in the sample and no errors were noted, the Commission itself still does not check if the elements for the calculation and the calculation mode for amounts paid are in accordance with the Financial Regulation(623) and Article 235 of the Convention.

ACP bank accounts for Stabex transfers

22.47. Stabex transfers are initially paid from the EDF bank accounts onto intermediary, interest bearing bank accounts in Europe in the name of the ACP State concerned, but for which both the Commission and the ACP State are joint signatories. These monies can only be released when conditions concerning their use have been met(624).

22.48. However, the Court came across a case where, pending the agreement on the use of the Stabex transfers, the monies from the intermediary bank account were used to purchase shares in an investment fund. The Commission should remind its Officials and the ACP States concerned that such transactions are in conflict with the Lomé Convention.

Contract conditions on variation of prices in works contracts

22.49. Changes in the prices of works contractors' costs, such as labour and materials' costs, occurring during contract execution, may give rise to additional payments, referred to as 'variation of prices`. The rules governing the calculation of price variation are detailed in the special tender conditions. Two systems are commonly used: either utilization of published price indices or price variation based on prices effectively paid to suppliers. Both systems imply however that the 'basic rates`, i.e. the cost prices effective at the time of tender opening, are stated correctly, which must be checked during the evaluation of the offers submitted.

22.50. The Courts' examination of payments for works contracts revealed one case, where the amount of price variation paid was conform to contract conditions, but yet was economically unjustified, since the stated tender rate was manifestly understated (Uganda, Kampala City Roads, bitumen).

22.51. Although the legality/regularity of this payment cannot be contested, the Court draws attention to the fact that the thorough checking of basic cost rates during tender evaluation is essentil, if contractually correct but economically unjustified payments of price variation are to be avoided.

REPLIES OF THE COMMISSION

Detailed observations on the accounts

Advances on contracts

22.7. In the EDF accounts for 1996, the Commission does distinguish between final payments and advances, making it possible to monitor clearance of the advances.

The financial statements show advances as expenditure on projects, which is what they are. The Financial Regulation does not require that advances and payments on account be presented separately.

However, the Commission acknowledges the benefits of giving a figure for advances in an annex to the financial statements and did so for the first time in the financial statements for 1996 (Annex 3.4, page 167).

In June 1995 the accounting system was improved so that reliable figures on advances paid could be produced at the end of the year: the amount of each advance was recorded, together with the currency in which it was paid. However, it was not possible with the resources available to publish details (currency and amount after conversion) of the backlog of advances recorded before June 1995, in time for closure of the 1996 accounts. The Commission confirms the Court's figures. The differences between those and the figures in the Annexes to the financial statements stem from an error in the computer program, which was corrected in 1997.

Accounting principles, methods and practices

22.9 (a) The balance sheet gives a single figure for the balance on all bank accounts. The Commission takes the view that, by giving a net figure for the hundreds of accounts in question (all of which are open to inspection), it is helping to make the balance sheet clearer and more readily understandable.

22.9 (b) The accounts for local payments cannot be finalized until all the supporting documents accompanying the bank statements have been checked by the authorizing officer and the financial controller to ensure that the payments are charged to the correct heading.

A bank statement may include expenditure and income with no supporting documents. As all such transactions should be cleared in the course of the following year, there is no justification for separating them out and duplicating outstanding items.

22.10 (a) When the final accounts were being drawn up, it was hoped that the Zairean Government might pay the outstanding amount. This now seems unlikely in the light of recent events and the Commission will take the necessary action.

22.10 (b) It is true to say that, for some investments, the realizable value is not the same as the purchase price. However, losses are always offset by interest received. At the end of the year, the Commission makes no provision for losses, interest receivable or profit on realization, but merely records the situation at 31 December.

22.10 (c) The Commission has received no reply to its request to the German authorities and must therefore record the amount under profit and loss.

Balance sheet

Expenses incurred in advance for the eight EDFs

22.11. To be prudent, the Commission entered the amounts paid prior to ratification of the eighth EDF as expenditure under the seventh EDF.

Thus they are not presented separately from the other expenditure included on the balance sheet and the financial statements.

As soon as the ratification procedure is complete, the Commission will ensure that the amounts are charged to the eighth EDF.

Valuation of the Funds at the end of the financial year (sleeping commitments)

22.12. The accounts show the Commission's legal commitments concerning implementation of the EDF. Commitments are entered in the accounts when the Commission takes the relevant funding decision. Financing agreements or exchanges of letters replacing such agreements constitute contracts which are legally binding on the Commission and the ACP recipient alike. Changes to these contracts can be made only if both parties agree. Hence a project can only be closed if the national authorizing officer agrees and confirms that implementation of the project is complete. To reduce the amount allocated to a project in mid-implementation requires a decision to be taken by the Commission at the request of the national authorizing officer.

The amount which the Commission shows can be decommitted (34,9 Mio ECU at the end of 1996) relates to projects in respect of which both parties have agreed to start the closure procedure.

The 145,3 Mio ECU difference between the Court's figures and the financial statements can accounted for by four differences in approach:

- a differing assessment concerning the resumption of cooperation with certain ACP States and the re-starting of certain projects (26 Mio ECU). The main countries concerned are Equatorial Guinea (four commitments for 6,1 Mio ECU), Gambia (five commitments for 4,2 Mio ECU) following the resumption of cooperation in 1997, and Togo (Sysmin commitment worth 15,7 Mio ECU). Technical studies were launched in early 1997 with a view to redefining the Sysmin project with Togo;

- a difference of opinion concerning the decommitment of appropriations for projects on which objections have been made (19,4 Mio ECU): the Commission feels it is more sensible to cancel outstanding commitments when all such objections have been dealt with;

- a difference in the criteria applied to the cancellation of commitments to EIB operations (10,9 Mio ECU: the Commission is not empowered to close a project unless the EIB requests it, and the Bank thinks that the projects concerned should continue;

- a difference of opinion on the criteria for decommitting projects without accounting movements (89,1 Mio ECU). The Commission will examine which of these commitments can be cancelled. In 1997 it already closed some of the projects, releasing 19,6 Mio ECU in the process.

22.13. The 530 Mio ECU shown in Annex 3.1 (page 163) to the financial statements account for 6,3 % of initial commitments. The Commission will conduct a more detailed study of the situation.

EDF cash position

22.15. See replies to paragraph 22.10.

Advances for scholarships and technical assistance

22.16. The Commission has started work on clearing the advances for scholarships (delegations and Member States' management bodies) and technical assistance (AEC). This has proved successful and advances shrank by 32 % from 1995 to 1996.

(i) The 4,3 Mio ECU covers not only expenditure on projects but also amounts available for future expenditure.

In 1996 the Commission worked on clearing the biggest advances (Member States' management bodies and AEC) when resources allowed. Advances for delegations will be dealt with separately in 1997.

(ii) From 1995 to 1996, the AEC advance at the closure of the accounts shrank by 40 %. It amounted to approximately four months' expenditure by the AEC, which seems entirely reasonable.

In view of the time taken by the AEC to gather together and check the supporting documents for local expenditure (in the ACP States) and the date of closure of the EDF accounts (end-January 1997) it was materially impossible to charge certain items of expenditure made by the AEC in 1996. The expenditure in question, which was charged during the first half of 1997, was equivalent to two and a half months of AEC expenditure.

Advances paid to the AEC which had not been cleared when the accounts were closed are presented as assets on the balance sheet in accordance with standard accounting practice.

(iii) From 1995 to 1996 there was a 40 % reduction in advances paid to Member States' management bodies. The Commission will continue the process of clearing advances.

Advances paid to the Member States' management bodies which had not been cleared when the accounts were closed are presented as assets on the balance sheet in accordance with standard accounting practice.

22.17. Given that the EDF accounts are closed at the end of January, it is not materially possible to charge all expenditure made by the management bodies in the course of the year. Advances which are not cleared are therefore presented as assets until the management bodies submit their statements of expenditure. The Commission is willing to add a footnote to the financial statements to the effect that the advances may represent expenditure already incurred against the year in question.

Expenditure to be regularized

22.18. Local payments still to be regularized when the 1996 accounts were closed amounted to 37,2 Mio ECU, or 2,8 % of total EDF payments, which seems entirely reasonable.

22.19 (i) The anomalies pointed out by the Court have been corrected and reconciliations prepared. Instructions on these procedures are to be revised and tightened up this year.

(ii) The Commission has identified the transactions in question and will take appropriate action in the course of the year.

Detailed observations on legality and regularity of underlying transactions

Decisions (primary commitments)

Substantive legality/regularity errors

22.20. The Commission's decision concerning the commitments was taken in accordance with the rules laid down in Decision No 2/96 of the ACP-EC Council of Ministers of 28 June 1996, which forms the legal basis for the Commission decision.

With regard to the legality of the decision of the Joint Council, Article 366(2) of the Lomé Convention authorizes the Council of Ministers to adopt transitional measures where necessary. This Article was applied by analogy to adopt transitional measures for the switch from the fourth Lomé Convention to the revised fourth Convention and could be applied in a similar way to cover the transition from the first to the second financial protocol (which form an integral part of the Convention). It is regrettable that the decisions in question do not refer explicitly to Article 366(2).

The Commission would draw attention to the practical implications for the STABEX transfers if the implementation of the ACP-EC Council of Minister's Decision had been blocked: compensation for export receipts would not have been paid for at least seven countries (Dominica, Senegal, St Lucia, St Vincent and the Grenadines, Togo and Zimbabwe), causing a breakdown of the system for stabilizing their fragile economies (see reply to paragraph 22.11 above).

Formal legality/regularity errors

22.22. With regard to the decisions to increase funding for the structural adjustment programmes, Article 292(1) of the fourth Lomé Convention was correctly applied to the programmes in question. It is in no way restricted to 'traditional` projects and programmes (it merely refers to 'projects and programmes` covered by the Financing Agreement). This is very clear for programmes funded by the national indicative programme.

Where there was no other procedure expressly provided for, the Commission used the same procedure, by analogy, for programmes funded exclusively by the structural adjustment facility. Furthermore, for future reference, Article 25.3(a) of the Internal Agreement for the eighth EDF explicitly provides that the procedure set out in Article 292 of the Convention should also be used for structural adjustment programmes.

22.23. The 10 % limit was exceeded when funding from the national indicative programme was used for the nine countries, but this was done in accordance with the rules laid down by the Internal Agreement. The Commission was always under the impression that the EDF Committee was automatically informed when the financing proposals were submitted. However, in response to the Court's comments, instructions have been issued with a view to ensuring than, from 1997 onwards, financing proposals submitted for approval to the EDF Committee, will explicitly mention cases where the 10 % limit is exceeded.

22.24 (i) Referring to Article 234, the Court notes that, in the case of equity investment, 50 % of the dividends collected by the financial intermediary must be paid to the EIB, which can sometimes push the rate collected by the Bank above the 3 % mark.

If the company in which the EIB borrower has acquired a holding is declared bankrupt or ceases trading, the borrower is no longer required to pay back the relevant part of the EIB loan, which means that the EU Member States carry all the risk attached to transactions of this type. It is only fair, then, that the Member States should receive a share of any profits, particularly in view of the exchange risks they cover.

(ii) Referring to Article 233, the Court remarks that the financing contracts do not stipulate that any profit accruing to the intermediary must be used for development, after administrative costs, exchange and financial risks, and the cost of technical assistance are taken into account.

As a rule, the intermediaries for the loans in question are ACP states or development banks. Any surpluses are made over to the developing country's treasury, or are used by the financial intermediary for standard loans. Thus the spirit of the Article is observed. It should be pointed out that the excess is set by the EIB at a level which enables the intermediary to cover costs. In ACP States whose currencies are depreciating rapidly, the exchange risk often cuts quite deeply into the intermediaries' margins.

(iii) In order to meet the pressing demands of certain clients, the Bank agreed to a number of open-rate, single currency loans. In combination with Article 235(b) limiting the interest rate for loans entered into at the reference, i.e. the ecu, rate, the rules for determining interest rate subsidies on the day the financing contract is signed, make it impossible to fix a ceiling for the interest rate in the contract.

Payments

Substantive legality/regularity errors

22.27. See reply to paragraph 22.20.

22.28 (i) In one case, the decision to release the second structural adjustment tranche was taken on the basis of two assessments as to whether or not the relevant criteria had been met. One assessment was carried out by an accountancy firm in January 1996, the other by the Commission in June of the same year.

In the other case the Financing Agreement (FA) should indeed have been concluded before launching the tender. The nature of the supplies and objectives of the FA had been respected but adapted to the actual needs confirmed by the national authorizing official within the budget of the FA.

(ii) The Commission takes the view that each tranche of a technical assistance contract is approved by the contracting authority as it pays the invoices relating to the work done. To withhold the guarantee while accepting the work for a particular tranche would send contradictory signals. It would be hard for a contracting authority to keep back part of the guarantee for unsatisfactory performance of the contract after accepting the work as it was done.

Therefore, the Commission agrees to allow the ACP authorities to negotiate special conditions taking precedence over the general conditions or authorizes 100 % of the value of the work done. In three cases the general conditions laid down by Decision No 3/90 do not apply, in four cases, involving (27 720,60 ECU) the special conditions take precedence over the general ones and in a further nine cases, involving (48 217,23 ECU) 100% of the value of the work done was authorized.

The Commission agrees with the Court on one case in which an advance of 6 700 ECU should have been recovered on payment of the first instalment rather than subsequent ones.

3) Since the programme in question was a work programme, it was denominated in the local currency The amount paid was ecu denominated, pushing the local currency amount for the work programme above the limit. However, the excess will be recovered either from the following work programme or when the advance is repaid.

Formal legality/regularity errors

22.30 (a) The Commission acknowledges that it did not fully comply with Article 250(3) of the Lomé Convention in transferring structural adjustment funds for two ACP States to their accounts at banks based in New York. However, this was done with the agreement of both parties to the financing agreement and in the interests of sound financial management; strict application of Article 250(3) would have seriously compromised the transparency and effectiveness of the two governments' currency and reserve policies.

(b) One case concerns the disbursement of structural adjustment counterpart funds in accordance with the 'Memorandum of understanding` between the Commission and the government in question. The memorandum had been extended by tacit agreement between the two parties.

(c) In one case, the release of funds for a single tranche structural adjustment programme was delayed until the government in question and the International Monetary Fund (IMF) could reach an agreement on the second year of the enhanced structural adjustment facility. In other words, the funds were released only when the conditions laid down in the programme had been met. It is clear from the timing of the decisions taken by the Commission and the IMF that there were no irregularities in the disbursement procedure. Furthermore, the Commission decision was made in parallel with the IMF decision and was consistent with it: the Commission was able to delay disbursement of the tranche until the IMF had officially taken its decision. Notwithstanding this, the Commission was never in any doubt as to the outcome of the decision.

(d) In one case, the changes made when the 1994 financing agreement was amended do not affect all the conditions attached to the programme, but only those concerning tax, proof-of-import procedures and the rules governing the setting-up of counterpart funds (reflecting the radical changes made to the exchange system in the country in question). Since the changes were of a purely technical nature (as they related to that particular country), it was not necessary to involve the EDF Committee.

(e) In another case, the conditions for release laid down in the financing conditions were met before the decision was taken to release the first tranche of structural adjustment funding; the Commission checked that this was the case in June 1996.

(f) In y t another case, the additional tranche of structural-adjustment support, which had been increased under the financing agreement between the Commission and the national government, was used specifically to support the health-care budget and the reforms made to the health-care sector. In view of the special nature of this additional tranche, the assessment of whether the release criteria had been met was restricted to the government's health-care commitments. Macroeconomic considerations and factors relating to fields other than health care were examined in the course of the normal implementation of the programme.

22.31 (a) In one case the accelerated tendering procedure should have been followed in accordance with the financing agreement. Due to a misunderstanding of the Contracting Authority about the tendering procedure, a restricted tender was launched followed by a direct agreement. However, when taking the amount into consideration, a restricted invitation to tender should already have been foreseen in the financing agreement.

(b) The Commission acknowledges that in two cases advances were paid without a bank guarantee. In the first case the administrative and financial departments viewed the payment, made six months after implementation of the contract had begun, as the first payment for services rendered rather than an advance.

(c) In two cases where funds were paid into bank accounts other than those specified in the contracts, the payment order, which had been drawn up and signed by the national authorizing officer and the Head of Delegation, indicated the account into which the money was paid. Thus the parties to the work programme officially agreed, in writing, to the change of account. In the second case, the new account had been confirmed by revised work programme No 5.

OTHER OBSERVATIONS

Comments on other information disclosed

22.33. The Commission takes the view that Stabex and structural adjustment payments are presented in accordance with the legislation governing such matters. There is nothing in the Lomé Convention which requires the EDF accounts to show whether funds belonging to ACP States are used for structural adjustment or for Stabex after they have been transferred.

The Commission has already provided detailed explanations on this matter in the special supplementary DAS report for 1994 (paragraphs 3.40 to 3.42). However, it would stress that, with regard to balance-of-payments support:

- the payment of the funds to the recipient countries represents 'final use`;

- the transfers are final;

- funds paid into ecu-denominated accounts in Europe and counterpart funds are the property of the recipient country.

However, in the interests of openness, the Commission's financial statements include tables showing the use of funds paid into accounts in Europe and counterpart funds (pages 78 to 97 of the 1996 financial statements). It is not required to do so.

22.34. The reasons for the difference between the figures are as follows:

- not all delegations had replied when the accounts were closed;

- there may be additional transactions as the Commission's enquiries relate to November and the Court's to April/May of the following year, and the dates of the bank statements are not necessarily the same;

- the Court may have used a different rate to the one valid on 31 December, used by the Commission to calculate the value of the ecu-denominated counterpart funds.

22.35. The Commission did indeed present a combined figure for funds from the EDF and the general budget in its comments on the financial statements. It will endeavour to show these two sources of funding separately in future financial statements.

22.36. In future, the Commission will provide this information in the financial statements.

Management of the Stabex bank accounts

22.37 22.38. In the past, the situation concerning the interest to be credited to the Stabex allocation for the sixth and seventh EDFs was not clear.

Until the special account was opened, the interest to be attributed to Stabex was calculated according to a formula, but because the balance in the Commission's account was kept at a very low level, there was not as much actual interest as the calculations would suggest. Hence, the Stabex account was opened to solve this problem. It is true that the bank applied its general terms and conditions to this account.

As soon as the Commission can be certain that the Stabex contributions will be paid and expenditure for the eighth EDF is programmed, a new call for tenders will be launched with a view to renewing the terms of the contract. Particular attention will be paid to banking charges and the successful tenderer will be required to provide clearer information concerning transactions.

22.39 22.41. With regard to the monitoring of accounts, the Commission assures the Court that the necessary documentation is kept on its premises. It is true that, for reasons connected with the German regulations, the bank in question preferred to transfer the bulk of its funds to accounts in Luxembourg.

22.42. Reconciliation procedures were not completely standardized, which accounts for the errors concerning five banks (amongst the hundred or so used by the department in question). The errors were corrected immediately. In order to resolve this problem and comply with the Court's recommendation, the Commission intends to standardize working methods, introducing better procedures and tighter supervision of all files dealt with by the unit.

Conditions of work programme and direct labour contracts

22.44 and 22.45. The Commission pays particular attention to the management of direct labour contracts (work programmes), which are used in an increasingly broad range of areas as recipients become more involved in aid management (e.g. through micro-projects, decentralized cooperation and health-care projects). Guidance is given in the compendium of instructions and a practical guide is now ready and will be distributed in the fourth quarter of 1997.

Direct labour contracts performed by the ACP country are not covered by the general regulations (Council Decision No 3/90). However, as the Commission has to approve the contracts, it requires that certain ACP rules be adhered to. The application of these rules should be examined on a case-by-case basis. Brussels grants exemption from the rules when the draft work programme is approved.

It is common practice for the arrangements concerning financial and administrative management to be explained in the first work programme and not repeated in subsequent ones.

Operations managed by the EIB

22.46. The Commission provided a detailed explanation on this matter in the special supplementary DAS report for 1995 (paragraph 3.69). However, it would point out once again that:

- under the Lomé Convention (Article 1(2) of the Financial Protocol attached to the fourth Convention), responsibility for managing interest rate subsidies and venture capital is attributed to the EIB. This is confirmed by Article 10(2) of the Internal Agreement, which states that '... risk capital and interest rate subsidies financed from the Fund's resources shall be administered by the Bank on behalf of the Community...`;

- the EIB acts as the authorized agent of the Community not of the Commission;

- the EIB is responsible for assessing the interest rate subsidies to be granted to the borrower, in accordance with the Convention, the Internal Agreement and the Financial Regulation. These instruments do not require the Commission to check the Bank's calculations, the accuracy of which is ensured by the internal and external checks arranged by the Bank itself.

ACP bank accounts for Stabex transfers

22.47 22.48. The Commission takes note of the Court's comments and will issue a reminder to the relevant departments.

Contract conditions on variation of prices in works contracts

22.49 22-51. While it is not possible to check the basic rates applied by the tenderer in his tender, the Commission agrees that, should the price revision clause in a contract not rely on published price indices because these do not exist, it is necessary, in order to guarantee fair competition, that the Administration establish at the time of tendering a list of basic prices applicable to the contract, so that there is an agreed, realistic basis for any price revision which may take place later on.

>TABLE>

ANNEX II Financial information on the general budget, the balance sheet of the European Union and the European Development Funds

Preliminary notes

1. Sources of financial data

The financial data contained in this Annex have been drawn from the revenue and expenditure accounts and the balance sheets of assets and liabilities of the European Communities(625) and of the European Development Funds and from other financial records provided by the Commission. The geographical distribution is in accordance with the indices of the country codes in the Sincom system.

2. Monetary unit

All the financial data are presented in millions of ECU (Mio ECU), rounded to one decimal place. They always represent the rounding-off of each exact value and not the sum of the rounded-off figures.

3. Nomenclature

For each financial year the Court uses the budgetary nomenclature corresponding to that financial year for the presentation of the historical data. In 1988 there was a significant change in the nomenclature compared with previous financial years: as from that financial year costs incurred in the collection of own resources are no longer shown as expenditure but as negative revenue. In 1991 the nomenclature for expenditure was considerably changed with the regrouping of Commission appropriations into subsections in order to align the budgetary nomenclature of the headings used to encompass the 'multiannual financial perspective`. This should be borne in mind when comparing the various financial years.

4. Abbreviations and symbols

EC European Community(ies)

ECSC European Coal and Steel Community

EEC European Economic Community

EAEC or Euratom European Atomic Energy Community

EFTA European Free Trade Association

GNP Gross national product

VAT Value added tax

ATS Austrian schilling

BEF Belgian franc

DEM German mark

DKK Danish krone

ESP Spanish peseta

FIM Finnish markka

FRF French franc

GBP Pound sterling

GRD Greek drachma

IEP Irish pound

ITL Italian lira

LUF Luxembourg franc

NLG Dutch guilder

PTE Portuguese escudo

SEK Swedish krona

u.a. Unit of account (until 1977)

EUA European unit of account (from 1978 to 1980)

ECU European currency unit (as from 1 January 1981)

Mio ECU Million European currency units

DA Differentiated appropriations

NDA Non-differentiated appropriations

CA Commitment appropriations

PA Payment appropriations

AFC Appropriations for commitment

AFP Appropriations for payment

B Belgium

DK Denmark

D Germany

EL Greece

E Spain

F France

IRL Ireland

I Italy

L Luxembourg

NL Netherlands

A Austria

P Portugal

FIN Finland

S Sweden

UK United Kingdom

EUR 15 Total of the 15 Member States of the European Community

CEEC Central and East European Countries

ex-GDR The former German Democratic Republic

NIS Newly Independent States (ex-Soviet Union)

EDF European Development Fund

FYROM Former Yugoslav Republic of Macedonia

ACP African, Caribbean and Pacific States signatories to the Lomé Convention

OCTs Overseas countries and territories

FOD French overseas departments

RRP Rehabilitation and revival plan

Stabex Stabilization of export earnings

Sysmin System of stabilization of export earnings from mining products

FR Financial Regulation of 21 December 1977 (see also the foreword on page 2)

OJ Official Journal of the European Communities

S Budgetary section

Ss Budgetary subsection

T Budgetary title

Ch Budgetary chapter

0,0 Data between zero and 0,05

- Lack of data

% Percentage

D Diagram referred to within other diagrams (e.g. D IX)

SUMMARY

Part One: General budget and balance sheet

1. Background information on the general budget

2. General budget and balance sheet for the financial year 1996 and budgetary implementation during the financial year 1996

D I General budget 1996 - estimated revenue

D II General budget 1996 - estimated expenditure - appropriations for payment

D III General budget 1996 - appropriations for commitment

D IV Estimated and actual revenue in 1996

D V Estimated and actual own resources in 1996, by Member State

D VI Actual own resources in 1996

D VII Appropriations for commitment available in 1996 and their utilization, by sector and by institution

D VIII Appropriations for payment available in 1996 and their utilisation, by sector and by institution

D IX Financial perspective: breakdown of appropriations for commitment available from the 1996 budget and implementation; total appropriations for payment available from the 1996 budget and implementation

D X Payments made in 1996, by sector

D XI Payments made in 1996, in each Member State

D XII EAGGF-Guarantee - payments made in 1996, in each market

D XIII EAGGF-Guarantee - payments made in 1996, by market and in each Member State

D XIV The Structural Funds: commitments entered into and payments made in 1996, in each Member State

D XV Structural aid - commitments entered into and payments made in 1996, by Member State and in each objective

D XVI Aid to the countries of Central and Eastern Europe and to the Newly Independent States of the former Soviet Union: PHARE and TACIS programmes

D XVII The consolidated revenue and expenditure account and the balance calculated for the 1996 financial year

D XVIII Summary of the consolidated balance sheet of the European Union as at 31 December 1996

3. Historical data in respect of the implementation of the general budget (1992-96)

D XIX Actual own resources in 1996, by Member State (1992-96)

D XX Evolution and utilization of appropriations for payment for the period 1992 to 1996, by sector

D XXI Utilization rates of appropriations for payment from 1992 to 1996, by sector

D XXII Annual payments during the period 1992 to 1996, by sector and by institution

Part Two: The European Development Funds (EDF)

1. Basic information on the European Development Funds (EDFs) (position as at 31 December 1996)

D XXIII The sixth EDF - allocation, financing and distribution of aid, overall utilization

D XXIV The seventh EDF - allocation, financing and distribution of aid, overall utilization

D XXV The sixth and seventh EDFs - utilization of aid by economic sector (position as at 31 December 1996)

D XXVI The seven EDFs - evolution of annual payments (1960-96)

Part One: General budget and balance sheet

1. Background information on the general budget

1.1. Origin of the general budget

The general budget was created by the Merger Treaty(626) (Article 20). It replaced, on 1 January 1968, the three separate EC budgets which existed before that date: the ECSC administrative budget, the EEC budget and the Euratom operating budget. The Euratom research and investment budget was incorporated into the general budget as from 1971 by the Treaty of Luxembourg(627) (Article 10).

1.2. Legal basis

The general budget is governed by the financial provisions of the Treaties of Paris(628) (Article 78 ECSC) and Rome(629)(630) (Articles 199 to 209 EEC and Articles 171 to 183 Euratom) and by the Financial Regulations(631).

1.3. Main budgetary principles laid down in the Treaties and the Financial Regulation

All items of Community revenue and expenditure are to be included in a single budget (unity). Revenue is to be used without distinction to finance all expenditure and, like the expenditure, is to be entered in full in the budget and subsequently in the accounts without any adjustment of one item against another (universality). The appropriations are specialized according to their nature or intended use (speciality). The budget is authorized for one financial year only (annuality). Budgetary revenue and expenditure must balance (equilibrium). There are some exceptions to these general principles.

1.4. Content and structure of the general budget

The budget consist of a 'General statement of revenue` and a 'Statement of revenue and expenditure`, which itself is subdivided into five sections: (I) Parliament; (II) Council (annexed: Economic and Social Committee); (III) Commission (632); (IV) Court of Justice; (V) Court of Auditors; (VI) Economic and Social Committee and Committee of the Regions. Within each section(633) , items of revenue and expenditure are classified under budget headings (titles, chapters, articles and, where applicable, items) according to their type or the use to which they are to be applied.

1.5. Monetary unit of the general budget

The budget is established and implemented in ECU. The ECU is a unit based on a basket of national currencies. Following the revision of September 1989, the basket of currencies is made up as follows: 1 ECU = 3,301 BEF + 0,6242 DEM + 0,1976 DKK + 6,885 ESP + 1,332 FRF + 0,08784 GBP + 1,440 GRD + 0,008552 IEP + 151,8 ITL + 0,130 LUF + 0,2198 NLG + 1,393 PTE.

The rates of conversion at 31 December 1996 between the ECU and the national currencies were as follows: 1 ECU = 13,6965 ATS = 40,1021 BEF = 1,94653 DEM = 7,44655 DKK = 164,167 ESP = 5,81640 FIM = 6,56193 FRF = 0,737273 GBP = 309,502 GRD = 0,745342 IEP = 1 913,72 ITL = 40,1021 LUF = 2,18472 NLG = 195,968 PTE = 8,6280 SEK.

1.6. Financing of the general budget (budgetary revenue)

The general budget is mainly financed from the Communities' own resources: agricultural levies, sugar and isoglucose levies; customs duties; VAT-based own resources and GNP-based own resources; for more detailed information see the legislation in force(634).

Besides own resources, there are other, marginal items of revenue (see Diagram IV).

1.7. Types of budget appropriations

To cover estimated expenditure, the following types of budget appropriations are distinguished in the general budget:

(a) differentiated appropriations (DA) are used to finance multiannual activities in certain sectors. They comprise commitment appropriations and payment appropriations:

- commitment appropriations (CA) make it possible to enter into legal obligations during the financial year for activities whose implementation extends over several financial years;

- payment appropriations (PA) make it possible to cover expenditure arising from commitments entered into during the financial year and/or preceding financial years.

(b) non-differentiated appropriations (NDA) make it possible to ensure, during the financial year, the commitment and payment of expenditure relating to annual activities.

It is thus important to establish the following two totals for the same financial year:

(a) the total of appropriations for commitment (AFC)(635) = non-differentiated appropriations (NDA) + commitment appropriations (CA) (636);

(b) the total of appropriations for payment (AFP) (637) = non-differentiated appropriations (NDA) + payment appropriations (PA) (638).

Revenue raised in the budget is intended to cover the total appropriations for payment. Commitment appropriations do not need to be covered by revenue.

The following simplified presentation (with illustrative amounts) shows the impact of these types of appropriations in each budget year.

(see presentation, Annual Report 1995)

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1.8. Implementation of the general budget

1.8.1. Responsibility for implementation

The Commission implements the budget on its own responsibility in accordance with the Financial Regulation and within the limits of the appropriations allotted; it also confers upon the other institutions the requisite powers for the implementation of the sections of the budget relating to them(639). The Financial Regulation lays down the implementation procedures and, in particular, the responsibilities of the authorizing officers, accounting officers, administrators of advance funds and Financial Controllers of the institutions(640). In certain specific areas (EAGGF-Guarantee, mainly the Structural Funds) the management of Community funds is shared with the Member States.

1.8.2. Implementation of revenue

The estimated revenue is entered in the budget subject to change by amending and supplementary budgets.

The budgetary implementation of revenue consists of establishing the entitlements and recovering the revenue due to the Communities (own resources and other revenue); it is governed by certain special provisions(641). The actual revenue of a financial year is defined as the total of sums collected against entitlements established during the current financial year and sums collected against entitlements still to be recovered from previous financial years.

1.8.3. Implementation of expenditure

The estimated expenditure is entered in the budget. The budgetary implementation of expenditure, i.e. the evolution and utilisation of appropriations, may be summarized as follows:

(a) appropriations for commitment:

- evolution of appropriations: the appropriations for commitment allocated in the initial budget can undergo certain modifications until the final appropriations for commitment are obtained: final appropriations for commitment = initial budget (NDA and CA) + amending and supplementary budgets + supplementary receipts(642) + transfers (643) + commitment appropriations carried over from the preceding financial year(644) + non-automatic carryovers(645) from the preceding financial year /uncommitted NDA) + released commitment appropriations from preceding financial years which have been made available again(646) + repayments of advances giving rise to reutilisation(647);

- utilization of appropriations: the final appropriations for commitment are available in the financial year for use in the form of commitments entered into (appropriations for commitment utilized = amount of commitments entered into);

- carryovers of appropriations from one financial year to the next financial year: non-differentiated appropriations belonging to the financial year which have not been committed may be carried over non-automatically to the next financial year after approval by the budgetary authority (648). Non-utilized commitment appropriations of the financial year may be carried over by the Commission to the following financial year (649). In the case of expenditure on behalf of third parties, carryovers may be repeated;

- cancellation of appropriations: the balance is cancelled.

(b) appropriations for payment:

- evolution of appropriations: appropriations for payment may also undergo modifications before leading to the final appropriations for payment: final appropriations for payment = initial budget (NDA and PA) + amending and supplementary budgets + supplementary receipts (650) + transfers (651) + appropriations carried over from the previous financial year in the form of automatic carryovers(652) or non-automatic carry-overs(653) + repayments of advances giving rise to reutilisation (654);

- utilization of appropriations: the appropriations for payment are available in the financial year for use as payments (utilized appropriations for payment = amount of payments made from the appropriations of the financial year);

- carryovers of appropriations from one financial year to the next financial year: non-utilized appropriations of the financial year may be carried over to the next financial year in the form of automatic(655) or non-automatic(656) carryovers. In the case of expenditure on behalf of third parties, carryovers may be repeated;

- cancellation of appropriations: the balance is cancelled.

With regard to actual expenditure, a distinction is made between:

- actual expenditure during a financial year = total payments during the financial year = payments against appropriations for payment of the financial year plus payments against appropriations for payment carried over from the preceding financial year;

- actual expenditure charged to a financial year = expenditure charged to the consolidated revenue and expenditure account (see paragraph 1.8.4) = payments against appropriations for payment of the financial year plus appropriations for payment of the financial year carried over to the following financial year.

1.8.4. The consolidated revenue and expenditure account and the balance of the financial year

After the closure of each financial year the consolidated revenue and expenditure account is drawn up. The balance of the year, which is to be entered in the budget of the next financial year on the occasion of an amending budget, is determined therein(657) (see Diagram XVII).

1.9. Presentation of the accounts

The accounts for a given financial year are forwarded not later than 1 May of the following financial year to Parliament, the Council and the Court of Auditors; these accounts comprise a revenue and expenditure account and a balance sheet, together with an analysis of the financial management(658).

1.10. External audit

Since 1977 the external audit of the general budget has been carried out by the Court of Auditors of the European Communities(659).The Court of Auditors examines the accounts of all revenue and expenditure of the general budget. It must provide the European Parliament and the Council with a statement of assurance as to the reliability of the accounts and the legality and regularity of the underlying transactions. It also considers whether revenue has been received and expenditure incurred in a lawful and regular manner, and whether the financial management has been sound. The audits may be carried out before the closure of the financial year in question and are performed on the basis of records and, where necessary, on the spot in the institutions of the Communities and in the Member States. The Court of Auditors draws up an annual report for each financial year and may also, at any time, submit its observations on specific questions and deliver opinions at the request of one of the institutions of the Communities.

1.11. Discharge and follow-up

As from 1977 the following provisions are applicable(660): Parliament, on the recommendation of the Council, gives, before 30 April of the second year following the financial year in question, discharge to the Commission on the implementation of the budget. To this end the Council and Parliament in turn examine the accounts presented by the Commission and the annual report of the Court of Auditors. The institutions must take appropriate action on the comments appearing in the decisions giving discharge and report on the measures taken(661).

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PART TWO: THE EUROPEAN DEVELOPMENT FUNDS (EDFs)

1. Basic information on the European Development Funds (EDFs) (position as at 31 December 1996)

1.1. The first five EDFs

Basic information and detailed financial information on the first three EDFs was most recently given in the annual report of the Court of Auditors concerning the 1980 financial year. Information on the fourth EDF was given in the annual report concerning the 1986 financial year and information on the fifth EDF in the annual report concerning the 1990 financial year. Only a few minor sums transferred to the sixth EDF still remain to be paid under the fourth EDF. A summary of the payments made under the first four EDFs is given in Diagram XXVI.

1.2. The sixth and seventh EDFs

1.2.1. Legal provisions

(a) Legal basis in respect of ACP States:

- sixth EDF: third ACP-EEC Convention, signed in Lomé on 8 December 1984 (Lomé III);

- seventh EDF: fourth ACP-EEC Convention, signed in Lomé on 15 December 1989 (Lomé IV).

(b) Legal basis in respect of the OCTs:

- sixth EDF: Council Decision 86/283/EEC of 30 June 1986;

- seventh EDF : Council Decision 91/482/EEC of 25 July 1991.

(c) Establishment of the EDFs:

- sixth EDF: internal agreement of 19 February 1985;

- seventh EDF: internal agreement of 16 July 1990.

(d) Financial Regulations:

- sixth EDF: Financial Regulation 86/548/EEC of 11 November 1986;

- seventh EDF: Financial Regulation 91/491/EEC of 29 July 1991.

1.2.2. Allocations, financing, distribution and type of aid

The EDF allocation after amendments(662) by the Council are as follows:

- sixth EDF: 7 919,7 Mio ECU;

- seventh EDF : 11 816,3 Mio ECU.

The EDFs are financed by the Member States of the European Communities in proportions laid down in the internal agreements (see also Diagrams XXIII and XXIV).

The above-mentioned internal agreements provide for distribution of the allocations of the EDFs between the ACP States and the OCTs and between grants, special loans, risk capital, Stabex(663) and Sysmin(664).

Part of the allocation in the form of grants is reserved for exceptional aid, support operations for structural adjustment and for interest rate subsidies on loans granted by the European Investment Bank. The rest of the allocation in the form of grants and the allocation in the form of special loans is distributed among the recipient countries, with the exception of funds for the regional projects, administrative costs and a contingency reserve. The amounts thus allocated to the recipient countries, called indicative programmes in the case of ACP States, are used to finance the projects adopted.

1.2.3. Monetary unit

EDF allocations are denominated in ECUs; for the purpose of converting the monetary units previously applied into ECUs, it has been agreed that 1 u.a. = 1 EUA = 1 ECU.

1.2.4. Date of entry into force

- sixth EDF: 1 May 1986;

- seventh EDF: 1 September 1991.

1.2.5. Financial implementation

The Commission draws up a timetable of requests for contributions which, in principle, are to be paid quarterly by the Member States of the European Communities. The use of the EDF resources is shown in the accounts in three stages: (I) financing decision; (II) signing of contracts against funds allocated to national authorizing officers; (III) authorization of payments to contractors.

1.2.6. External audit

The Court of Auditors is responsible for the external audit of the EDFs (in accordance with the Treaty).

1.2.7. Authority giving discharge

The European Parliament gives discharge for the financial management of the EDFs, on the recommendation of the Council (in accordance with the internal agreements).

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(1\*)(\*) The Commission's replies are on page 37.

(2)Net traditional own resources (13 583,6 Mio ECU) + collection costs (1 509,3 Mio ECU) = gross traditional own resources (15 092,9 Mio ECU).

(3)VAT own resource (36 535 Mio ECU) = VAT own resources for the financial year (35 676,8 Mio ECU) + balances and adjustments from previous financial years (858,2 Mio ECU).

(4)GNP resource (21 058 Mio ECU) = GNP resource for the financial year (21 085 Mio ECU) + balances and adjustments from previous financial years ( P27 Mio ECU).

(5)OJ C 330, 15.12.1992, paragraphs 1.37-1.54.

(6)OJ C 309, 16.11.1993, paragraphs 1.105-1.128.

(7)OJ C 327, 24.11.1994, paragraphs 1.3-1.38.

(8)OJ C 303, 14.11.1995, paragraphs 1.4-1.89.

(9)OJ C 340, 12.11.1996, paragraphs 1.5-1.63.

(10)Article 218(1) of Council Regulation (EEC) No 2913/92 of 12 October 1992, establishing the Community Customs Code (OJ L 302, 19.10.1992, p.1).

(11)Article 218(3) of Regulation (EEC) No 2913/92.

(12)Belgium, Greece, Spain, Ireland, Italy, the Netherlands and the United Kingdom.

(13)Article 256 of Commission Regulation (EEC) No 2454/93 of 2 July 1993 laying down provisions for the implementation of Regulation (EEC) No 2913/92 (OJ L 253, 11.10.1993, p. 1); Article 258 of Regulation (EEC) No 2913/1992.

(14)Reply from HM Customs and Excise of 3 June 1992 to the Court's audit findings of 13.3.1992 collected during a mission from 13 to 20.1.1992.

(15)Reply from HM Customs and Excise of 25 October 1996 to the Court's audit findings of 18.8.1996 collected during a mission from 29.4.1996 to 10.5.1996.

(16)'Period entry` means that one customs declaration lodged at the end of a given period summarizes all import goods released for free circulation during that given period. Articles 218 and 219 of Council Regulation (EEC) No 2913/92.

(17)Council Regulation (EEC/Euratom) No 1552/89 of 29 May 1989 (OJ L 155, 7.6.1989, p.1).

(18)Article 17(2) of Regulation (EEC, Euratom) No 1552/89.

(19)Article 166 of Regulation (EEC) No 2913/92.

(20)Article 801 and Annex 108 of Regulation (EEC) No 2454/93.

(21)Germany, Greece, Spain, Ireland, Italy and United Kingdom.

(22)Article 840 of Regulation (EEC) No 2454/93.

(23)Article 176 of Regulation (EEC) No 2913/92. Articles 805 and 808 of Regulation (EEC) No 2454/93.

(24)Article 168(4) of Regulation (EEC) No 2913/92 and Article 804 of Regulation (EEC) No 2454/93.

(25)Hamburg, Bremen, Bremerhaven, Piraeus, Thessaloniki, Trieste, Cadiz and Tilbury.

(26)Article 50 of Regulation (EEC) No 2913/92.

(27)Article 176(2) of Regulation (EEC) No 2913/92.

(28)Article 176(1) of Regulation (EEC) No 2913/92.

(29)Articles 807 and 808 of Regulation (EEC) No 2454/93.

(30)Article 170(1) of Regulation (EEC) No 2913/92.

(31)Article 313(3), (a) and (b) of Regulation (EEC) No 2454/93.

(32)Article 313(3), (b), second paragraph, and Article 447 of Regulation (EEC) No 2454/93.

(33)Article 168, (2) and (4) of Regulation (EEC) No 2913/92. Article 804 of Regulation (EEC) No 2454/93.

(34)Article 447 of Regulation (EEC) No 2454/93.

(35)OJ C 340, 12.11.1996, paragraphs 1.17 to 1.38.

(36)Belgium, Germany, Spain, France, Ireland, Italy, the Netherlands, Portugal.

(37)This figure includes the value of authorizations delivered in Luxembourg.

(38)Article 552 of Regulation (EEC) No 2454/93.

(39)Generally 300 000 ECU or 150 000 ECU in the case of products listed at annex 75 of Regulation (EEC) No 2454/93.

(40)Article 648 of Regulation (EEC) No 2454/93.

(41)Article 558 of Regulation (EEC) No 2454/93.

(42)Article 559(1) of Regulation (EEC) No 2454/93.

(43)Article 596(1) of Regulation (EEC) No 2454/93.

(44)Article 597(1) of Regulation (EEC) No 2454/93.

(45)Aggregation means that all import goods placed under the inward processing regime during a given period (one month or one quarter) are considered to be placed under this regime at the end of that given period.

(46)Article 566(2) of Regulation (EEC) No 2454/93 and Article 119 of Regulation (EEC) No 2913/92.

(47)Article 569(3) of Regulation (EEC) No 2454/93.

(48)Article 561(1) of Regulation (EEC) No 2454/93.

(49)The judgment of the Court of Justice in case 103/96 confirms this interpretation.

(50)Belgium, Denmark, Germany, Greece, Spain, France, Italy and the United Kingdom.

(51)Council Regulation (EEC) No 1468/81 of 19 May 1981 concerning mutual assistance between the administrative authorities of the Member States and cooperation between the latter and the Commission with a view to ensuring the proper application of customs and agricultural regulations. (OJ L 144, 2.6.1991, amended by Council Regulation (EEC) No 945/87 of 30 March 1987 (OJ L 90, 2.4.1987).

(52)Court of Auditors - Annual report concerning the financial year 1994, paragraphs 1.12 to 1.44 (OJ C 303, 14.11.1995).

(53)Article 221(3) of Council Regulation (EEC) No 2913/92.

(54)OJ C 303, 14.11.1995, p. 31.

(55)OJ C 260, 5.10.1995, p. 8.

(56)Commission Document XXI/1144/95.

(57)Council Decision of 28 May 1996 concerning the ex post facto recovery of customs debts (OJ C 170, 14.6.1996, p. 1).

(58)Article 9 of Council Regulation (EC) No 3281/94 of 19 December 1994 (OJ L 348, 31.12.1994, p. 1).

(59)Community mission carried out in Israel from 22 May to 6 June 1995.

(60)Article 26 of Protocol No 1 of the Lomé Convention allows the exporting State a maximum of six months to inform the importing State of the results of ex post facto checks. Council and Commission Decision of 25 February 1991 concerning the fourth ACP-EEC Convention (OJ L 229, 17.8.1991).

(61)By virtue of Article 25 of Protocol No 1 of the Lomé Convention, the ACP States communicate to the Commission the impressions of the stamps used; the Commission then communicates them to the Member States. Council and Commission Decision of 25 February 1991 concerning the fourth ACP-EEC Convention (OJ L 229, 17.8.1991).

(62)Article 147 of Regulation (EEC) No 2454/93.

(63)Commission Regulation (EEC) No 3798/90 of 21 December 1990 instituting a provisional anti-dumping duty on imports of espadrilles originating in the People's Republic of China (OJ L 365, 28.12.1990). Council Regulation (EEC) No 1812/91 of 24 June 1991 instituting a definitive anti-dumping duty on imports of espadrilles originating in the People's Republic of China and covering the definitive collection of the provisional duty (OJ L 166, 28.6.1991).

(64)Article 6 of Commission Regulation (EEC) No 1495/80 of 11 June 1980 implementing certain provisions of Articles 1, 3 and 8 of Council Regulation (EEC) No 1224/80 on the valuation of goods for customs purposes, OJ L 154, 21.6.1980, p. 14.

(65)Article 248 of Regulation (EEC) No 2454/93.

(66)MA Communication 105/93 S2 (95) of 27 July 1995.

(67)Eurostat, external trade statistics.

(68)OJ L 90, 2.4.1987.

(69)Commission Regulation (EEC) No 4062/88 of 23 December 1988 instituting a provisional anti-dumping duty on imports of video cassettes and tapes for video cassettes originating in the Republic of Korea and Hong Kong (OJ L 356, 24.12.1988). Council Regulation (EEC) No 1768/89 of 19 June 1989 instituting a definitive anti-dumping duty on imports of video cassettes originating in the Republic of Korea and Hong Kong, concerning the definitive collection of the provisional duty and closure of the anti-dumping proceedings concerning the imports of tapes for video cassettes originating in the Republic of Korea (OJ L 174, 22.6.1989). Commission Regulation (EEC) No 1034/91 of 23 April 1991 instituting a provisional anti-dumping duty on imports of video tapes and cassettes originating in the People's Republic of China (OJ L 106, 26.4.1991). Council Regulation (EEC) No 3091/91 of 21 October 1991 instituting a definitive anti-dumping duty on imports of video tapes and cassettes originating in the People's Republic of China and concerning definitive collection of the provisional duty (OJ L 293, 24.10.1991).

(70)Belgium, Spain, France and Italy.

(71)Article 243(2)(a) of Regulation (EEC) No 2913/92.

(72)UCLAF letter 2087 of 23.4.1996 to the Subdirector General de Inspección, Departamiento de Aduanas e Impuestos Speciales.

(73)OJ L 312, 23.12.1995, p. 1.

(74)These are, specifically, Council Regulation (EEC, Euratom) No 1553/89 of 29 May 1989 (OJ L 155, 7.6.1989) in the case of the VAT resource and Council Directive 89/130/EEC, Euratom of 13 February 1989 (OJ L 49, 21.2.1989) for the GNP resource.

(75)Council Regulation (EEC, Euratom) No 1552/89 of 29 May 1989 (OJ L 155, 7.6.1989).

(76)Article 33 of Council Financial Regulation of 21 December 1977 (OJ L 356, 31.12.1977) and subsequent amendments.

(77)Council Directive No 77/388/EEC of 17 May 1977 (OJ L 145, 13.6.1977) and subsequent amendments.

(78)The Court of Auditors' Annual Report concerning the financial year 1988, paragraphs 4.16 to 4.31; Court of Auditors' Annual Report concerning the financial year 1989, paragraphs 1.74 to 1.80; Court of Auditors' Annual Report concerning the financial year 1991, paragraphs 1.99 to 1.102; Court of Auditors' Annual Report concerning the financial year 1995, paragraphs 1.69 to 1.71.

(79)Discharge resolutions for the 1988 financial year, paragraphs 15 ff. (OJ L 174, 7.7.1990); for the 1989 financial year, paragraphs 13 ff. (OJ L 146, 11.6.1991); for the 1991 financial year, paragraphs 28 ff. (OJ L 155, 26.6.1993).

(80)Article 9 of Council Regulation (EEC, Euratom) No 1553/89.

(81)Article 6 of Council Directive 89/130/EEC, Euratom, of 13 February 1989 (OJ L 49, 21.2.1989).

(82)Improving the procedures for recovering the VAT own resource and determining the criteria for charging arrears interest, Document SEC(91) 1985 final of 31 October 1991.

(83)With regard to the VAT resource, see Article 9 of Regulation (EEC, Euratom) No 1553/89. With regard to the GNP resource, see Article 6 of Directive 89/130/EEC, Euratom.

(84)OJ L 175, 13.7.1996, p. 3.

(85)OJ L 155, 7.6.1989, p. 1.

(86)See the Commission's replies in the Court of Auditors' Annual Report for 1988 (OJ C 31, pp. 265-266).

(87\*)(\*) The Commission's replies are on page 59.

(88)OJ L 22, 29.1.1996.

(89)Council Decision 94/729/CE of 31 October 1994 (OJ L 293, 12.11.1994).

(90)Council Decision 94/729/CE of 31 October 1994 (OJ L 293, 12.11.1994).

(91)Commission Regulation (EC) No 296/96 of 16 February 1996 (OJ L 39, 17.2.1996).

(92)COM(91) 379 final of 18.10.1991.

(93\*)(\*) The Commission's replies are on page 91.

(94)OJ C 313, 12.12.1990, paragraph 4.3.58 and following.

(95)Internal document INF 22/92, paragraph 5.3 and following. (Not published, but available to the public from the Secretariat General of the Court. The report was also sent to the European Parliament.) (96)'Development and future of common agricultural policy`. CMO(91) 258 of 22 July 1991, point 1, first indent, p. 3.

(97)Council Regulation (EEC) No 1765/92 of 30 June 1992. (OJ L 181, 1.7.1992, p. 12). Council Regulation (EEC) No 1766/92 of 30 June 1992. (OJ L 181, 1.7.1992, p. 21).

(98)'Evaluation des incidences financières de la décision sur la réforme de la PAC au cours des exercices budgétaires 1993-1997`, Doc. DG VI/405/91 rev.1 of 8.7.1992.

(99)The Council used to fix two types of institutional prices: (a) intervention price: the intervention agencies must, at certain periods of the year, buy in cereals they are offered that have requisite quality characteristics; the cereals are bought in at the intervention price concerned; (b) target price: this served only as a guide for the market price and was abolished as from 1995/96 marketing year; the introduction of a fixed import levy instead of a variable one rendered the target price irrelevant; The real guarantee was and is provided by the intervention price.

(100)Commission Regulation (EEC) No 2836/93 of 18 October 1993 (OJ L 260, 19.10.1993, p. 3).

(101)The set-aside requirement had four options: rotational, non-rotational, flexible and guaranteed. If rotational was taken it could not return to the same area for at least five years. The other options required the farmers to set aside a higher percentage of their arable land.

(102)Equalizing is the method of reducing the difference of yields between regions in order to level out big differences in regional yields.

(103)Commission Regulation (EEC) No 1113/93 of 6 May 1993 (OJ L 113, 7.5.1993, p. 14).

(104)Council Regulation (EC) No 231/94 of 21 January 1994 (OJ L 30, 3.2.1994, p. 2).

(105)'Agricultural Council 13-17/1993, document of 4 January 1994, reference 4056, restrained.

(106)OJ L 88, 3.4.1990, p. 1.

(107)Study reference 38540006, November 1994.

(108)'Development and future of common agricultural policy`, CMO(91) 258 of 22 July 1991, point 1, first indent, p. 3.

(109)'Agricultural policies, market and trade in OECD countries - Monitoring and evaluation 1996`, p. 39, OECD 1996.

(110)OJ L 355, 5.12.1992, p. 1.

(111)Article 10 of Regulation (EEC) No 3508/92.

(112)Article 14 of Regulation (EEC) No 729/70 of 21 April 1970 (OJ L 94, 28.4.1970, p. 13).

(113)Article 10(3) of Regulation (EEC) No 1765/92 and Article 4(1) of Commission Regulation (EEC) No 3887/92 of 23 December 1992 (OJ L 391, 31.12.1992, p. 36).

(114)Regulation (EEC) No 3508/92.

(115)According to Article 17(1) of Regulation (EEC) No3887/92.

(116)Council Regulation (EEC) No 1765/92 of 30 June 1992 (OJ L 181, 1.7.1992, p. 12).

(117)Article 6 of Regulation (EEC) No 3887/92.

(118)Council Regulation (EEC) No 762/89 of 20 March 1989 (OJ L 80, 23.3.1989, p. 76).

(119)The intervention agency ONIC in France have offices at regional level. Staff of these offices organize field inspection. Normally each regional office of ONIC is responsible for three departments.

(120)Article 6(7) of Regulation (EEC) No 3887/92.

(121)The topofil is a French device. The topofil is used by pulling out a cotton thread along the distance to be measured. A counting device on the topofil will tell you how much thread was pulled out, telling the length of the measured field.

(122)This working paper of the Commission is undated, but has the file No VI/8388/94-EN rev. 4 and it was sent to the Court by DG VI on 5 June 1996.

(123)Article 4(1) of Commission Regulation No 2780/92 of 24 September 1992 (OJ L 281, 25.9.1992, p. 5) reads: '... an area of cereals must be fully sown in line with locally recognized standards and maintained until at least the beginning of flowering in normal growth conditions`. Checks, therefore, should be made while plant cover can be verified. Article 6(1) of Regulation 3887/92 etc. states on-the-spot checks should be performed in such a way that effective verification can take place.

(124)Council Regulation (EEC) No 1765/92 of 30 June 1992 (OJ L 181, 1.7.1992, p. 12).

(125)Commission Regulation (EEC) No 2293/92 of 31 July 1992 (OJ L 221, 6.8.1992, p. 19) and Commission Regulation (EEC) No 762/94 of 6 April 1994 (OJ L 90, 7.4.1994, p. 8).

(126)Articles 2(1) and 3(4) of Commission Regulation (EC) No 762/94.

(127)Article 12 of Regulation (EEC) No 3887/92.

(128)'Estimation statistique des erreurs de mesure des superficies parcellaires agricoles sur images satellites`, Document I.94.105 (Avrain and others) Joint Research Centre, April 1994.

(129)Point 2.2.13 of the Commission document of 4 July 1996, 'The use of remote sensing for the administration of area aid in the EU`.

(130)DG VI/G.4 'La mise en place du système intégré de gestion et de contrôle (SIGC) dans les 12 États membres`, September 1993.

(131)Commission report (CMO(96) 174 final of 29 April 1996).

(132)OJ C 65, 2.3.1994.

(133)OJ C 327, 24.11.1994.

(134)Council Regulation (EEC) No 2075/92 of 30 June 1992, OJ L 215, 30.7.1992, p. 70.

(135)Document No 4712/95 of 13.2.1995 of the European Council.

(136)Discharge resolution for financial year 1992, document No 95/220/EC of 5.4.1995, OJ L 141.

(137)CMO(96) 554 final of 18.12.1996. According to Council Regulation (EEC) No 2075/92 this report was due on 1 April 1996 but was delivered only on 15 January 1997.

(138)CMO(96) 554, p. 15.

(139)CMO(96) 554, p. 20.

(140)CMO(96) 554, p. 25.

(141)Special Report 8/93, paragraph 7.15.

(142)OJ C 327, 24.11.1994.

(143)Document No 4712/95 of 13.12 1995 of the European Council. Document 95/221/EC of 5.4.1995, OJ L 141, 24.6.1995.

(144)Document number CMO(94) 117 of 11.5.1994.

(145)Increasing of alcohol content by adding beet sugar or concentrated grape must before fermentation.

(146)See 'Wine in the European Community`, European documentation periodical 1/1988, Office for Official Publications of the European Communities, Luxembourg, 1988.

(147)Commission, 'OCM viti-vinicole, évaluation et défis pour l'avenir`, 14.4.1993.

(148)Doc. reference, p. 16 of CAP working notes 1995.

(149)OJ L 166, 5.7.1996, p. 14.

(150)OJ L 84, 27.3.1987.

(151)OJ L 208, 31.7.1986, p. 1.

(152)OJ L 62, 5.3.1987, p. 10.

(153)OJ L 148, 30.6.1995, p. 37.

(154)OJ L 202, 14.7.1989, p. 32.

(155)CMO(95) 368, 19.7.1995.

(156\*)(\*) The Commission's replies are on page 118.

(157)OJ L 148, 28.6.1968, p. 24.

(158)The general upward trend in beefmeat production is characterized by a series of peaks and troughs approximately four to five years apart. The market prices follow a trend inverse to that of production.

(159)Document from Meat Outlook Group, Commission, DG VI.

(160)The intervention price decline is fixed by Council Regulation (EEC) No 2068/92 of 30 June 1992 (OJ L 215, 30.7.1992, p. 58). The intervention limits together with the premium rates were set by Council Regulation (EEC) No 2066/92 of 30 June 1992 (OJ L 215, 30.7.1992, p. 49) modifying Council Regulation (EEC) No 805/68 of 27 June 1968 (OJ L 148, 28.6.1968, p. 24). The intervention limits were fixed as follows: 750 000 tonnes in 1993, 650 000 tonnes in 1994, 550 000 tonnes in 1995, 400 000 tonnes in 1996 and 350 000 tonnes in 1997.

(161)The premium amounts are those in operation from 1995 onwards. In order to enable comparisons to be made, the amounts in force before the abolition of the agricultural conversion factor have been multiplied by the coefficient (1,207509) set by Commission Regulation (EC) No 2417/95 of 13 October 1995 (OJ L 248, 14.10.1995, p. 39). The amount of the special premium was 72,45 ECU in 1993, 90,56 in 1994 and 108,68 in 1995.

(162)84,53 ECU in 1993, 114,71 ECU in 1994 and 144,9 ECU in 1995.

(163)Common term used for cattle, sheep and goats for which premiums have been requested and for the number of milk cows necessary to produce the reference quantity. It is defined as follows in Annex 1 of Council Regulation (EEC) No 2328/91 of 15 July 1991, concerning the improvement in the effectiveness of agricultural structures (OJ L 218, 6.8.1991, p. 1): the bulls, cows and other cattle over 2 years count for 1 LU; the cattle from 6 months to 2 years count for 0,6 LU and sheep and goats for 0,15 LU each.

(164)The number of suckler cows for which the premium is paid is limited to the individual producer's quota. The special premium, on the other hand, is paid in respect of all animals considered eligible in the producer's claim. It is only at the end of the year that the total number of eligible animals is calculated for the region under consideration (usually a Member State). If this total exceeds the regional ceiling by, for example, 5%, the amount of the special premium will be reduced by 5% for all the producers in this region through a reduction in the balance payable. The premiums are, in fact, paid in two instalments, an advance of a maximum of 60% and a balance.

(165)Council Regulation (EEC) No 3508/92 of 27 November 1992 (OJ L 355, 5.12.1992, p. 1).

(166)Council Directive 92/102/EEC of 27 November 1992 (OJ L 355, 5.12.1992, p. 32).

(167)Council Regulation (EC) No 2466/96 of 17 December 1996 (OJ L 335, 24.12.1996, p. 1).

(168)See paragraph 3.66 of the Court's annual report concerning the financial year 1991 (OJ C 330, 15.12.1992).

(169)140 Mio ECU in 1993, 107 Mio ECU in 1994, 70 Mio ECU in 1995 and in 1996.

(170)Feed costs represent between 18% (Ireland) and 66% (Spain) of total inputs (Source: Farm Accountancy Data Network (FADN), 1994).

(171)Special Reports No 4/91 on the operation of the Common Market Organization in the sugar and isoglucose market (OJ C 290, 7.11.1991, p. 1) and No 4/93 on the implementation of the quota system intended to control milk production (OJ C 12, 15.1.1994, p. 1).

(172)Council Regulation (EC) No 1884/94 of 27 July 1994 (OJ L 197, 30.7.1994, p. 27).

(173)Council Regulation (EC) No 2222/96 of 18 November 1996 (OJ L 296, 21.11.1996, p. 50).

(174)See Commission report to the Council concerning the application of individual ceilings for producers in respect of the ewe and suckler cow annual premium schemes (COM(96) 430 final of 9 September 1996).

(175)Council Regulation (EEC) No 1357/80 of 5 June 1980 (OJ L 140, 5.6.1980, p. 1).

(176)See the Commission's reports on certain aspects of the beef and sheep meat sectors included in Annex II of the Commission's proposals concerning the fixing of prices for agricultural produce and certain related measures (1996-97), volume 1, preamble (COM(96) 44 final of 14 February 1996).

(177)Council Regulation (EC) No 2222/96 of 18 November 1996 (OJ L 296, 21.11.1996, p. 50).

(178)See paragraphs 3.61 to 3.63 of the Court's annual report concerning the financial year 1991 (OJ C 330, 15.12.1992).

(179)Less-favoured areas are defined at Article 3 of Council Directive 75/268/CEE of 28 April 1975 on mountain and hill farming in certain less-favoured areas (OJ L 128, 19.5.1975, p. 1). In those areas various schemes are aimed at offsetting the effects of natural handicaps and ensuring a fair standard of living for farmers in order to maintain a viable agricultural community.

(180)Council Regulation (EC) No 1588/96 of 30 July 1996 (OJ L 206, 16.8.1996, p 23).

(181)Scenario: producer has a reference quantity of milk corresponding to 19 dairy cows, 7 suckler cows, 11 male beef cattle aged under 24 months and 23 hectares forage. Option 1: claims on all animals, receives: 7×144,9 ECU + 11×108,7 ECU = 2 210 ECU. Stocking density = (19×1 + 7×1 + 11×0,6) / 23 = 1,42 LU/h > 1,4: no extensification supplement payable. Option 2: strategic claim: 7×144,9 ECU + 10×108,7 ECU = 2 101 ECU. Stocking density = (19×1 + 7×1 + 10×0,6) / 23 = 1,39 LU/h

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