They've got the Chancellor fuming

Today the High Court decides whether Sten Bertelsen and BJ Cunningham can continue to sell their tax-free cigarettes in Britain. If so, Kenneth Clarke's next Budget just might go up in smoke.

On the wall of Sten Bertelsen's unprepossessing office, in an unprepossessing by-way of south- east London, is a mock-up of an advertisement for a brand of cut-price cigarette called Chancellor's.

"What a great name for a tab," chortles Sten as he lifts the advert down from its hook and brandishes it about proudly. "We bought the trademark from Gallaher's - they didn't know it was us, basically, otherwise they'd have never let us near it. It's a great name because you can use this ad."

The mock-up shows a picture of Kenneth Clarke looking gloomy - particularly gloomy - above the legend: "Chancellor's: He's fuming about our prices."

Quite funny, as it happens. But more to the point, the ad is an accurate prediction of Mr Clarke's reaction should things go Sten and his partner BJ Cunningham's way in the High Court this morning. If a judicial review to be delivered there decides in their favour against Her Majesty's Customs and Excise and Imperial Tobacco - who have allied in an attempt to stop Sten and BJ trading in cigarettes bought, at lower duty, in Luxembourg - a couple of billion pounds could disappear from the Chancellor's coffers overnight, the British tobacco industry would be thrown into turmoil and we will have taken a huge step towards a homogeneous European super state. Not a bad morning's work for a couple of lads in pinstripes who smoke too much.

"It's a fairly simple thing," says Sten, lighting up his fifth cigarette of the hour. "If we win, British smokers will be able to get their tabs for a pound less than they do at the moment, British drinkers will be able to get cheap booze and the Government's Budget will be buggered. If we lose, we go out of business."

The cheap cigarette story began for the pair when they met at Exeter University in the early Eighties. In 1991, when BJ was importing second- hand cars from California and Sten - whose father is the Scandinavian fashion magnate Peder Bertelsen and whose wife is the socialite PR Susannah Constantine - was working in corporate finance on Wall Street. BJ had an idea. It was an idea that they reckoned would enable them to break into the enormously lucrative, and enormously old-fashioned, British tobacco market and make them huge amounts of money. In November 1991, trading as the Enlightened Tobacco Company, they launched Death Cigarettes: "Smoking does not make you sexy, stylish or sophisticated," ran the warning on the side of the box. "It kills you. We are not selling a pack of lies, we are selling a pack of cigarettes."

Though swathed in libertarian jargon - "in a free society it is your privilege to decide whether to smoke or not" - and though displaying a candour not generally associated with the tobacco industry - "choose Death for an honest smoke" - Death was chosen as a brand name for more prosaic reasons: it would generate incalculable quantities of publicity.

"If you wanted to enter the tobacco market with our brand called Premier," says Sten, "it would cost you millions in advertising. We just couldn't finance that. With Death the media could do that work for us. For free."

At first, BJ sold the brand out of his car boot outside pubs. But in 1993, the pair went public, got a stock exchange listing, acquired significant funding and a board of directors that included Nigel Anderson, former managing director of Gallaher's. Enobled by a pounds 1.2m budget, they began to market Death as a conventional brand, in tobacconists' and newsagents'. And they immediately discovered that there were vested interests that would try to prevent them from succeeding.

"Pretty soon the major wholesalers dropped us," said Sten. "Death was a double-edged name. Sure it got us publicity, but it also prevented us from getting distribution because the big companies didn't enjoy the joke. You see Camel, or whoever, were saying: 'Hey, I'm a moustachioed coolster hanging around the jungle killing alligators.' We were saying: 'Use this product and you're going to die.' So you can understand why the big brands didn't like us up there on the shelves next to them."

Forced out of the game, and facing imminent bankruptcy, the pair needed another method of distribution. Their attention was drawn to the European legislation that allows cross-border shopping - the rules enabling Brits to hire Transit vans and return from day-trips across the Channel burdened with beer and fags bought at French prices. It seemed to the pair that if they could somehow exploit the personal import law and offer Death at European prices, they wouldn't need tobacconists. But Article 8 of the relevant legislation says that imports have to be bought by the person who is going to consume them in the foreign country and be transported by them back home. They had an answer to that. Their contention was based in Roman Law: that which can be done by you can be done by an agent on your behalf. So they set up a scheme whereby they offered to purchase Death cigarettes in Luxembourg on behalf of smokers and then courier them on: tabs on the doorstep within seven days of ordering.

"At first, nobody could believe we were for real," said BJ. "We ran ads saying Death at pounds 1.60 for 20 and people couldn't handle it. So we decided to offer name brands - Marlboro, Camel, Benson's - at pounds 1.99, as a loss leader, and then when people became used to the scheme, and could see it worked, we could sell them Death - and the other brands we have planned, like Chancellor's or Premier - at even cheaper prices."

Within a month of placing advertisements in the newspapers, the pair, now trading as Tobacco Direct, had 50,000 clients, on whose behalf they were buying thousands of cigarettes a day from a very pleased retailer in Luxembourg. Turnover is projected at pounds 10m a year.

"Smokers are sick and tired of ever-increasing tax on tobacco and we're offering a tremendous discount, so of course it's a successful scheme," said BJ. "Also, we are exploiting the true spirit of Europe. Europe is like a Magic Eye picture, a mad, incomprehensible haze of legislation. But if you focus hard, you see freedom of movement of goods and people, something that will liberate all consumers."

As they do about Death, so the pair talk about Europe in elevated terms of freedom and choice, but their primary motive remains more fundamental: profit.

"Of course," said Sten. "Where there is a gap between the levels of tax between two countries there is an opportunity to turn a profit. It's called arbitrage."

Or smuggling. Not surprisingly, HM Customs and Excise soon took an interest in the pair's trade and started impounding the goods at Dover. In turn, they took the Excise to court and, more surprisingly, won an injunction preventing such impounding. The Excise then asked for a judicial review to clarify the law. What the tax collectors feared was this: if Tobacco Direct could set a precedent, everyone else would jump on board the trade, so while waiting judgment they allowed Sten and BJ to continue trading while seizing the goods of anyone else trying the same thing. At this point Imperial Tobacco, alarmed that its business would be assaulted by foreign tobacco giants flooding Britain with cheap cigarettes, asked to be involved in the action.

You could see the protagonists' point. An affidavit from an independent economist to the judge states that, if made legal, personal importation through agencies would account for 90 per cent of the retail cigarette market within five years. This would have a hugely debilitating effect on the Government, which accrues pounds 7.5bn a year from tobacco taxes. The only way, then, to stop the trade would be to harmonise duties in line with other European Union countries, one of the principal planks of European integration. Rather like monetary policy being dictated by the barrow boys in braces in the City dealing rooms, the cause of European integration is thus being advanced much more significantly by two maverick lads in pinstripe suits in a shabby office in Lewisham than it is by anyone in Parliament. And if Sten and BJ win their case, there is not a great deal Michael Portillo or Teresa Gorman can do about it. Except have a draw on a cheap cigarette.

"It is inevitable that harmonisation would have to happen, should Tobacco Direct win," says Karen Williams, campaigns manager of ASH (Action on Smoking and Health). "We have always been in favour of high taxation on cigarettes because high prices are one of the best ways of stopping people - children especially - from smoking. So we would be perfectly happy to see harmonisation of taxes throughout Europe, providing it was harmonisation upwards to British levels. We know that would take time.

"We are sitting on tenterhooks waiting for this judgment because if it goes in Tobacco Direct's favour, it could strike a devastating blow to the Government's commitment to reducing smoking."

Not that BJ and Sten, lighting up another Death, concern themselves with that.

"There is a window of opportunity caused by different duty levels here," said BJ. "If we win this case - and we are very confident we will - that window will inevitably, eventually, be closed. But we reckon that since politicians always lag behind businessmen, we've got three or four years to exploit.''

You could almost light up off his smile.