The illegal trade that costs the taxpayer £2.8bn a year

The principality of Andorra is better known for its Pyrenean landscapes than its links to the tobacco trade. Locked between France and Spain, it is only two and a half times the size of Washington, DC, and has a population of 68,000. But judging by the number of cigarettes for sale there, its inhabitants must have smoke coming out of their ears.

There are warehouses full of cigarettes for sale in Andorra. But most are not bound for the domestic market. They are likely to be smuggled abroad, including to Britain, as part of an illicit trade that costs the British Government £2.8bn in lost tax revenue each year.

Organised gangs and petty criminals are profiting from the trade in around 17 billion cigarettes that find their way into the UK.

Three years ago, MPs, concerned by the scale of smuggling and allegations that tobacco companies - despite their public condemnation - were aware of it, started an investigation. Company bosses, including Conservative MP Kenneth Clarke, who holds an executive post with British American Tobacco (BAT), were called before the House of Commons Health Select Committee to give evidence.

The committee's report, published in June 2000, called for a government inquiry into allegations that cigarette manufacturers had "deliberately stimulated" the smuggling market. The MPs urged Stephen Byers, then Secretary of State for Trade and Industry, to investigate allegations that BAT may have profited from bootlegging.

Mr Byers launched an inquiry and DTI officials raided BAT's offices. Since then nothing has been heard of the action and officials go quiet when it is mentioned, saying merely: "It is ongoing."

When the report was published the committee's Labour chairman, David Hinchliffe, told ministers to sever links with cigarette companies to avoid being "manipulated". He said: "The tobacco industry has run rings round the Government in recent years. There has been manipulation of the political process."

Now the committee, frustrated by the inquiry's lack of progress, is considering recalling BAT officials to appear again. But it is not for lack of evidence that the inquiry is taking so long. The DTI has access to hundreds of internal BAT documents that emerged because of legal action by smokers in the United States.

One internal BAT document, dated 1992, outlines the company's awareness of smuggling in Andorra. The memo, marked "secret" and entitled "Andorra Contract Manufacture Proposals", mentions that "one option" open to BAT's Spanish subsidiary is to permit smuggling through Andorra. It also indicates that small-scale smugglers could be satisfied "to stay competitive".

BAT, has consistently denied any involvement in smuggling and says it does not condone the practice and has never profited from it. It has signed a memorandum of understanding with British Customs to help combat smuggling by agreeing to work with the authorities to "identify, prevent and deter counterfeit product".

But it is not the only cigarette manufacturer to have faced allegations that it is not an ignorant victim when it comes to contraband.

Imperial Tobacco was strongly criticised by MPs on the House of Commons Public Accounts Committee earlier this year for failing to co-operate with Customs in the war against smuggling.

The committee found that its brands accounted for half of the cigarettes imported illegally into Britain - £1.4bn a year in lost tax revenue.