EU taxation of smoking tobacco products

The EU Legislation as regards the structure and rates of excise duty applied on manufactured tobacco stipulates that the Council, acting on the basis of a report and, where appropriate, a proposal from the Commission, shall every four years re-examine the structure and minimum excise rates of tobacco products at EU level. In its review of the EU tobacco excise structure and minimum rates, the Commission is obliged to take account of the functioning of the internal market, the real value of duty rates and the wider Treaty objectives (i.e. employment and public health). The Commission has announced that in the first half of 2008 it will publish a report and proposal to amend the current EU legislation.

On the 30th March 2007, the Commission published a Consultation paper on the structure and rates of excise duty applied on cigarettes and other manufactured tobacco products as part of its tobacco excise review process.

The text hereafter summarizes ESTA's submission including annexes in response to the Commission's Consultation paper:

Executive Summary

  • Fine-cut tobacco should be taxed at a lower level than cigarettes given the different characteristics between both product categories and their consumers.
  • A tax differential has been endorsed for many years by EU Member States. The Commission has stated that it considers a two-third ratio between the EU minimum excise levels of fine-cut tobacco and those of cigarettes reasonable.
  • On the basis of the different product characteristics between fine-cut tobacco (a semi-finished product) and cigarettes (ready-made product), specific taxation is based on a per-kilogram basis for fine-cut tobacco, while on a per stick basis for cigarettes. Nonetheless, if an appropriate comparison between both product categories should be made for excise tax purposes, this should continue to be based on a conversion factor of 1 gram of fine-cut tobacco equaling 1 hand-made cigarette - as generally acknowledged by legislators in the fine-cut tobacco core markets.
  • On the basis of the tobacco excise review criteria, ESTA considers that there are no reasons to increase the EU minimum rates for fine-cut tobacco above the proposed two-thirds ratio compared to cigarettes.
  • This would -based on the current minimum rates for cigarettes - result in minimum rates for fine-cut tobacco of 38% of the retail selling price (from 36%), or -to be introduced gradually - € 43,- per kilogram (from €32,-). In the frame of the current review, the minimum specific rate should not be raised above €36,- per kilogram, already reflecting double inflation.
  • It will be indispensable that appropriate transitional periods are granted to those Member States that would be affected as a result of a possible increase of the EU minimum rates on fine-cut tobacco.
  • The current minimum rates on pipe tobacco should be freezed in order to help safeguard the existence of this declining niche market. In this respect, ESTA acknowledges the importance of agreeing on a revised definition for pipe tobacco that would as much as possible help in preventing the misuse of pipe tobacco.
  • With regard to structure, Member States should remain free to choose ad-valorem (based on the retail selling price), specific (on a per kilogram basis) or mixed excise (a mix of ad-valorem and specific) on fine-cut tobacco and pipe tobacco - as laid down in the current EU legislation.

Tax Bearing Capacity

The various tobacco product categories carry different levels of taxation, reflecting fiscal and economic developments in the Member States and the tax bearing capacity of the different product categories.

Fine-cut tobacco
Fine-cut tobacco has a lower tax bearing capacity than factory made cigarettes for the following reasons:

  • Fine-cut tobacco is a semi-finished product, sold by weight to the consumer. Smokers of fine-cut tobacco must therefore make separate purchases of fine-cut tobacco and rolling paper, or tubes and making devices, before preparing fine-cut smoking articles for use;
  • As a semi-finished product, fine-cut tobacco has a lower value added than factory made cigarettes and is not a luxury product within the category;
  • The fine-cut tobacco manufacturing process is relatively labour intensive;
  • Fine-cut tobacco is predominantly consumed by price-sensitive consumers in the lower income groups;
  • There are many small and medium sized, often family owned, enterprises producing fine-cut tobacco. These are mainly located in economically less developed regions of EU member states with often high levels of unemployment.

Pipe tobacco
Pipe tobacco is a niche market product with low and steadily declining volumes. With its small production runs and generally more traditional- and more labour intensive manufacturing processes it has an even lower tax bearing capacity than fine-cut tobacco. This much lower tax bearing capacity should be reflected in the rates applied to pipe tobacco, taking into account the specific characteristics of the smallest smoking tobacco category.

The commission's endorsement of the tax differential

In its Consultation paper on the structure and rates of excise duty applied on cigarettes and other manufactured tobacco, the Commission endorsed the tax differential between fine-cut tobacco and factory made cigarettes by stating that "...given the different characteristics of the two products, it seems reasonable that the minimum excise for fine-cut should be fixed at about two thirds of the minimum excise incidence for cigarettes."

EU Excise review criteria

In its tobacco excise reviews, the Commission is required to take account of the functioning of the internal market, the real value of duty rates and the wider Treaty objectives.

The functioning of the internal market
The internal market for fine-cut tobacco is generally functioning well. According to the best of ESTA's knowledge only the UK and to a lesser extent France -that both apply excise rates on fine-cut tobacco that are generally much higher than those in neighbouring Member States- are being confronted with the inflow of considerable amounts of legal and illegal cross border fine-cut tobacco. In this context ESTA stresses that anomalies within the internal market should be addressed by the setting of appropriate taxation levels for different product categories by individual Member States.

Any further harmonisation of excise rates between different tobacco product categories does not add anything to addressing these anomalies.

The real value of duty rates
ESTA acknowledges that the specific minimum rates for fine-cut (and pipe) tobacco could be adjusted for inflation. However, since for some of the new Member States the transitional periods to reach the current EU minimum rates do not expire until the end of 2009, ESTA considers that the increase of minimum rates before that time will be highly unfeasible.

The Wider Treaty objectives
Article 127 states that the objective of a high level of employment shall be taken into consideration in the formulation and implementation of Community policies. In this regard, ESTA considers that a disproportionate increase of fine-cut taxes relative to those of cigarettes will have a negative impact on the competitiveness of the predominantly small and medium sized enterprises in the smoking tobacco industry and will thus have negative effects on employment.

ESTA recognizes that in the light of the wider Treaty objectives, the Commission also has to take account of Article 152 (health protection). In this regard, ESTA stresses that the prime responsibility for health policy and the protection of the health of individual citizens lies with the Member States. Based on this principle, individual Member States can apply higher taxation than the EU minimum rates, if they conclude that this is the right approach to achieve their health objectives.

ESTA would also like to point out that experiences in a number of Member States have shown that an increase of fine-cut tobacco taxes relative to cigarettes does not result in lower consumption of tobacco products as a whole. Instead price sensitive fine-cut tobacco consumers seem to turn to illegally imported -increasingly counterfeit- cigarettes that often do not comply with EU legislation on ingredients, constituents and labelling. Therefore, ESTA considers that an increase of fine-cut tobacco taxes relative to cigarette taxes would not address public health objectives and might even be counter-productive from a public health point of view.

The current EU excise structure and minimum rates (ref Directive 2011/64/EC)

  • Cigarettes - mandatory mixed system, minimum excise incidence of 57% of the WAP (Weighted Average Price) and not less than €64 per 1000 cigarettes;
  • Fine-cut tobacco - freedom of structure, minimum excise incidence of 36% of the retail selling price or €32,- per kilogram;
  • Pipe tobacco - freedom of structure, minimum excise incidence of 20% of the retail selling price or €20,- per kilogram.

ESTA position on structure

Member States should remain free to choose ad valorem (based on the retail selling price), specific (on a per kilogram basis) or mixed excise (a mix of ad-valorem and specific) on fine-cut tobacco and pipe tobacco. The adoption of restrictive structural rules on fine-cut and pipe tobacco would not lead to the harmonization of levels of taxes between fine-cut markets in EU Member States, but only result in distortions within individual Member States' markets. Moreover, such an approach would not fit in the Commission's objective to come to a simplification of the current EU excise regime for tobacco products.

With regard to structure, it will also be of crucial importance to ESTA that for fine-cut tobacco the "or-clause" - that provides that Member States can choose to either comply with the EU minimum excise incidence or with the EU minimum specific rate - is maintained so as to preserve the right of Member States to apply the excise structure that they consider the most suitable for their markets.ESTA strongly feels that it would be inappropriate to significantly increase the EU-minimum rates for fine-cut tobacco and bring them into line with those of cigarettes since fine-cut tobacco has a lower tax bearing capacity than cigarettes, the EU market for traditional fine-cut products has remained stable for many years and the internal market for fine-cut tobacco is generally functioning well. Moreover in such a scenario, fine-cut tobacco would cease to perform a function as a buffer of a legal affordable product to cheap smuggled and counterfeit cigarettes.

Taking into account the Commission's reference to a tax differential at EU level between fine-cut tobacco and cigarettes of two-thirds, ESTA would not oppose an increase of the minimum excise incidence rate from 36% to 38% of the retail selling price, since this reflects the minimum excise incidence rate of 57% for cigarettes.

ESTA would also not oppose an increase of the minimum specific rate from €32, - to €43,- per kilogram (reflecting two-thirds of the current €64, - per 1000 cigarettes) if such an increase would be introduced gradually. In the frame of the current review, the minimum specific rate should not be raised above €36,- per kilogram, already reflecting double inflation.

It will also be indispensable that appropriate transitional periods are granted to those Member States that would be affected as a result of the increase of the EU minimum rates. Otherwise, the position of fine-cut tobacco as an affordable duty-paid product would be seriously threatened on many of these markets.

ESTA is strongly in favour of freezing the current minimum rates on pipe tobacco in order to help safeguard the existence of this declining niche market. In this respect, ESTA acknowledges the importance of agreeing on a revised definition for pipe tobacco that would as much as possible help in preventing the misuse of pipe tobacco for the rolling, or tubing of cigarettes.