EUROPEAN COMMISSION Brussels, 12.1.2018 COM(2018) 17 final REPORT FROM THE COMMISSION TO THE COUNCIL on Directive 2011/64/EU on the structure and rates of excise duty applied to manufactured tobacco



Contents 1) Introduction 2) Background 3) Issues and findings a) Harmonisation of the tax treatment of novel products such as electronic cigarettes at EU level b) Illicit trade in raw tobacco c) Tax-induced substitution of cigarettes by low-price cigarillos d) Tax-induced substitution of cigarettes by fine-cut tobacco e) Illicit trade in water-pipe tobacco f) Minimum Excise Duty on cigarettes 4) Conclusion and way forward



1)Introduction

On 8 March 2016, the Council (ECOFIN) requested the European Commission to undertake the necessary studies to submit a legislative proposal for revision of Directive 2011/64/EU of 21 July 2011 on the structure and rates of excise duty applied to manufactured tobacco., In the event that the Commission decided not to submit a proposal, the Council requested to be informed of the reasons for this decision. This report presents the results and conclusions of an external study on this subject and sets out the reasons why the Commission has decided to not submit a proposal for revision of Directive 2011/64/EU at this moment in time. 2)Background Directive 2011/64/EU sets out harmonised rules at EU level on the structure and rates of excise duty applied to manufactured tobacco. In particular, it defines and classifies various manufactured tobacco products covered by the Directive according to their characteristics. The structure of the excise duties for the different types of products is also established in this Directive. The Directive was identified for evaluation under the Commission's Regulatory Fitness and Performance Programme (REFIT). An external evaluation of this Directive was finalized in 2014 and was followed by a Commission Report presenting the results and conclusions of the evaluation in 2015. This report was discussed by Member States in the Council (ECOFIN) and a set of conclusions on future action in this area was adopted on 8 March 2016. In order to comply with the request of the Council contained in these conclusions, the Commission started the preparation of an impact assessment and contracted an external consultant to carry out a study for this purpose. The object of the study was to contribute to the impact assessment for a possible revision of Directive 2011/64/EU. The issues analysed were among those identified in the evaluation carried out in 2014. 3)Issues and findings The external study on the possible revision of Directive 2011/64/EU focussed on six areas. The main issues analysed and the findings of the external study are summarized below. a)Harmonisation of the tax treatment of novel products such as electronic cigarettes at EU level E-cigarettes E-cigarettes are currently not covered by the tobacco excise duty directive. Member States may apply a national tax to e-cigarettes as they find fit under their own rules. At present nine Member States tax e-cigarettes under national rules and a few more are reported to be considering it. These different tax treatments might distort the functioning of the internal market. The study found that the information available on e-cigarettes was limited and it was consequently difficult to draw conclusions on how the market will evolve in the future. Moreover, opinions on possible health effects of e-cigarettes and, consequently, the appropriate tax treatment largely diverge. Therefore, from a health perspective a cautious approach should be adopted towards a potential harmonized taxation of e-cigarettes. The hypothetical excise duty loss caused by substitution between traditional cigarettes and novel products including e-cigarettes is estimated to be less than 2.5 % (EUR 2 billion) of the total revenue of excise duty on cigarettes. A positive tax rate might contribute approximately to EUR 0.3 – 0.5 billion to the budgets of Member States, although enforcement difficulties are expected. These figures have to be taken with great caution because the full effects of the rules of the Tobacco Products Directive, which entered into force on 20 May 2016, particularly on smaller producers, are still unknown. The Tobacco Products Directive covers a broader range of products than Directive 2011/64/EU, including smokeless tobacco, herbal products for smoking, and in particular e- cigarettes and their refill containers. The Tobacco Products Directive introduced, among others, specific requirements for the packaging, labelling, safety, monitoring and reporting of e-cigarettes. The Commission supports the recommendation of the external study to adopt a multi-phased approach, starting with collecting accurate data to fill the information gap. Compiling a robust information or evidence base is an essential component of better policy making. The data currently available does not provide sufficient evidence to support a proposal for a harmonized approach for taxation of e-cigarettes. The Commission expects that more data will become available as a result of the obligations under article 20 of the Tobacco Products Directive and has decided therefore to revisit the issue in the context of a REFIT evaluation and the next regular report on tobacco taxation due in 2019 pursuant to the obligation laid down in article 19 of Directive 2011/64/EU. By that time, it is expected that the effects of the requirements of the Tobacco Products Directive on the e-cigarette market will also be known better. Heat-Not-Burn tobacco products The study has revealed that by 2016, the Heat-Not-Burn tobacco products have been subject to large-scale commercialisation in a limited number of Member States only. At present, Member States have different approaches towards the tax treatment of these products, varying from taxation at the same rate as smoking tobacco under the current directive (Croatia, Germany, Greece, Latvia, the Netherlands, Slovakia, Slovenia, Romania and United Kingdom) to taxation at a different level on a national basis (Italy, Portugal, Hungary). These different tax treatments have the potential to distort the functioning of the internal market.

Moreover, many Member States have not decided on a fiscal regime, simply because the products are not sold on their market. Heat-Not-Burn tobacco products are currently used by less than half a million people across the EU and substitution with traditional tobacco products has been found to be negligible. The Commission is of the opinion that, given the novelty and evolutionary nature of the market, it would be extremely difficult at this stage to develop a harmonized explicit definition which captures these products both as they appear now and their future developments. Some of these products are already, albeit indirectly, covered by the directive because they contain tobacco. In the Commission's view, a possible treatment of these products would be to tax them at the same rate as smoking tobacco under the directive. Again, the Commission has decided to revisit this issue with the next REFIT evaluation and report on tobacco taxation due under article 19 of Directive 2011/64/EU. b)Illicit trade in raw tobacco Raw tobacco currently does not come within the scope of excisable goods as defined in Directive 2011/64/EU. During the evaluation in 2014, it was reported that raw tobacco was being diverted to the illicit circuit. This is because diverting raw tobacco to the illicit circuit could be an easier option compared to manufactured tobacco products because monitoring tools such as the Excise Movement and Control System (EMCS) are not used to monitor movements of raw tobacco. Illicit trade in raw tobacco is estimated at approximately 10 000 tonnes per year, about 1 % of the EU raw tobacco market. If cigarettes were produced from this amount of raw tobacco, this could cause a tax evasion between EUR 1 and 2 billion, amounting to 1.6 to 2.7 % of the current revenues from cigarettes. Including raw tobacco in the scope of excisable goods would enhance control but would also impose administrative and compliance costs on all legitimate operators. These costs are high compared to the value of production; about 35 % of the market price of EU raw tobacco. Compared to the overall EU raw tobacco market, these costs would represent about 8 % of its value. This would lead to loss of competitiveness of EU-grown tobacco compared to imported tobacco. The regulatory costs consist of setting up and receiving authorisation to operate a tax warehouse and setting up and moving goods under the EMCS system. This would give an advantage to growers and first processors outside the EU which would not have to bear these costs but could still export (raw) tobacco to the EU. Moreover, the amount of tax evaded that might possibly be recovered as a result of EMCS monitoring is unlikely to outweigh the administrative and compliance costs incurred by economic operators and, to a lesser extent, public authorities. The Commission would therefore support the recommendation of the external study which concludes that including raw tobacco in the scope of excisable goods would be disproportionate and that similar benefits might be achievable at lower costs by a common regulatory framework for growers and first processors in the EU. Some Member States have already introduced a national regulatory framework which requires economic operators to register and keep records of stocks and the flows of raw tobacco. c)Tax-induced substitution of cigarettes by low-price cigarillos The minimum excise duty rate applicable to the category of ''cigars and cigarillos'' is lower than for cigarettes. Borderline cigarillos have characteristics similar to cigarettes but can be sold for a lower price because they are classified as cigarillos and benefit from a more favourable tax treatment. Such borderline products might cause a reduction of revenue, distortion of competition and undermine tobacco-control policies. The study found, however, that tax-induced substitution of cigarettes by borderline cigarillos had significantly declined due to the entry into force on 1 January 2015 of a revised definition of the category ''cigars and cigarillos'' in the directive and the consequential adoption of appropriate tax structures by Member States. Therefore the Commission supports the recommendation of the external study that there is little rationale for further action on this matter at EU level. Moreover, the directive allows Member States to develop a tax structure reducing the incentive for low-price cigarillos which are competing with cigarettes. Member States could for example introduce or increase specific taxes or a minimum excise duty for this product category.