REPORT FROM THE COMMISSION TO THE COUNCIL AND THE EUROPEAN PARLIAMENT ON THE STRUCTURE AND RATES OF EXCISE DUTY APPLIED ON CIGARETTES AND OTHER MANUFACTURED TOBACCO PRODUCTS

Contents

Summary

I. Community excise-duty arrangements

1. General remarks

2. Excise duty on cigarettes

3. Excise duty on manufactured tobacco other than cigarettes

II. Review of structure and rates of excise duty

1. General remarks

2. First Commission report

3. Second Commission report

III. Scope of the third review

1. General

2. Operation of the single market

A. General remarks

B. Cigarettes

C. Other manufactured tobacco

3. Real value of excise duty

A. Cigarettes

B. Other manufactured tobacco

4. Wider objectives of the Treaty

5. Frequency of reviews

IV. Conclusions

List of annexes

Summary

The report describes briefly the current Community excise-duty arrangements which entered into force on 1 January 1993 and were slightly modified in 1999. They provide for common taxation structures in the Member States and lay down a system of minimum rates for manufactured tobacco and harmonised procedures for the holding and movement of excisable goods.

The report draws attention to the fact that the Directives on the approximation of excise-duty rates lay down an obligation to examine the structure and rates of such duties. It also refers to the previous Commission reports of 1995 and 1998.

It looks in detail at the legislation currently in force from the following viewpoints: the smooth operation of the single market, the real value of excise-duty rates and the wider objectives of the Treaty. An analysis of the evolution of prices and excise rates for tobacco products in the European Union shows that there are still considerable differences between Member States. With the aim of achieving greater approximation of tax levels between Member States, therefore, the report examines the implications of possible amendments to the existing rules, whilst keeping the main pillars of the acquis unchanged. In addition, competing tobacco products must be taxed similarly, unless they possess special features that justify the application of different rates. As regards the real value of excise duties, care must be taken to ensure that the minimum specific amounts are kept in line with inflation. Finally, as regards the wider objectives of the Treaty and given the characteristics of manufactured tobacco products, particular attention is given to the health-protection aspects and to the relationship between such protection and the price of these products.

The main conclusions of the review of the structure and rates of excise duties are as follows:

-a minimum fixed amount, expressed in Euro, should be introduced in addition to the existing minimum percentage requirement for excise incidence;

-Member States should be allowed greater flexibility to levy a minimum excise duty on cigarettes;

-the definition of cigars should be amended;

-the minimum rates for fine-cut tobacco intended for the rolling of cigarettes need gradual adjustment.

I. Community excise-duty arrangements

1. General remarks

1.1 Excise duties are taxes on the consumption of goods such as cigarettes, cigars, cigarillos and smoking tobacco. Excise duty on tobacco is an important source of revenue for the Member States, accounting for between 0.32% and 1.90% of GDP (see Annex A). Since Member States are free to set excise-duty levels nationally provided that they comply with the Community minimum levels, excise-duty rates vary a great deal from one Member State to another. When deciding on the level of these rates, Member States take into account such factors as health, agricultural policy, fraud and employment provided that they will not disturb the functioning of the internal market.

1.2 The current arrangements were introduced on 1 January 1993. They are the outcome of discussions which started in 1985 with the White Paper on completing the internal market, in which the Commission proposed full harmonisation of excise duties on manufactured tobacco. However, the Council chose not to take this approach and harmonisation extended only to taxation structures. Minimum rates were also set. In 1999, with the adoption of Directive 1999/81/EC [1] some technical amendments were introduced, without altering the structure of excise duties.

[1] Council Directive 1999/81/EC of 29 July 1999 amending Directive 92/79/EEC on the approximation of taxes on cigarettes, Directive 92/80/EEC on the approximation of taxes on manufactured tobacco other than cigarettes and Directive 95/59/EC on taxes other than turnover taxes which affect the consumption of manufactured tobacco (OJ L 211, 11.8.99, p. 47).

1.3 Excisable goods move between Member States under duty-suspension arrangements. [2] Businesses wishing to move goods under such arrangements must be authorised in the Member State where they are established and consignments must be accompanied by an administrative document. In accordance with the principles of the single market, private individuals enjoy greater freedom to purchase duty-paid goods for their own use in the Member State of their choice and to transport them to another Member State without having to pay duty again.

[2] Council Directive 92/12/EEC of 25 February 1992 on the general arrangements for products subject to excise duty and on the holding, movement and monitoring of such products (OJ L 76, 23.3.92, p.1), as last amended by Directive 2000/44/EC of 30 June 2000 (OJ L 161, 1.07.2000, p. 82).

2. Excise duty on cigarettes

2.1 Under current Community rules, [3] excise duties levied on cigarettes by the Member States must include a proportional (ad valorem) component calculated on the basis of the maximum retail selling price and a specific component (levied on each unit of the product). These two components, taken together, must account for at least 57% of the retail selling price, inclusive of all taxes, of cigarettes belonging to the most popular price category; this is referred to hereafter as the "57% rule". The specific component of excise duty may not be less than 5% or more than 55% of the amount of the total tax burden resulting from the aggregation of the proportional excise duty, the specific excise duty and the turnover tax levied on these cigarettes. Once these two components have been established for this category of cigarettes, they are applied to cigarettes of all price categories.

[3] Council Directive 95/59/EC of 27 November 1995 on taxes other than turnover taxes which affect the consumption of manufactured tobacco (OJ L 291, 6.12.95, p. 40), as amended by Directive 1999/81/EC of 29 July 1999 (OJ L 211, p.47).

2.2 Article 4 of Council Directive 92/79/EEC of 19 October 1992 on the approximation of taxes on cigarettes states that not less frequently than every three years, and for the first time not later than 31 December 2000, the Council, acting on the basis of a report and, where appropriate, a proposal from the Commission, shall examine the overall minimum excise duty and the structure of excise duties and, acting unanimously after consulting the European Parliament, shall adopt the necessary measures. The report by the Commission and the examination by the Council shall take into account the proper functioning of the internal market and the wider objectives of the Treaty.

3. Excise duty on manufactured tobacco other than cigarettes

3.1 The Community rules currently in force [4] relate to cigars and cigarillos, fine-cut smoking tobacco intended for the rolling of cigarettes, and other smoking tobacco. Article 3 of Directive 92/80/EEC lays down minimum rates of excise duty for these products. Member States can levy proportional excise duty calculated on the basis of maximum retail selling prices, specific excise duty or composite excise duty, subject to certain defined limits.

[4] Council Directive 92/80/EEC of 19 October 1992 on the approximation of taxes on manufactured tobacco other than cigarettes (OJ L 316, 31.10.92, p. 10), ), as amended by Directive 1999/81/EC of 29 July 1999 (OJ L 211, p.47).

3.2 The current minimum rates on 1 January 2001 are as follows:

- cigars and cigarillos: 5% of the retail selling price inclusive of all taxes or EUR 10 per 1000 items or per kilogram;

- fine-cut smoking tobacco intended for the rolling of cigarettes: 30% of the retail selling price inclusive of all taxes or EUR 25 per kilogram.

- other smoking tobacco: 20% of the retail selling price inclusive of all taxes or EUR 19 per kilogram.

In any case, Member States can opt for a wholly proportional or a wholly specific excise duty, or a combination of both types.

3.3 Article 4 of Council Directive 92/80/EEC of 19 October 1992 on the approximation of taxes on manufactured tobacco other than cigarettes states that not less frequently than every three years, and for the first time not later than 31 December 2000, the Council, acting on the basis of a report and, where appropriate, a proposal from the Commission, must examine the rates of duty laid down, and, acting unanimously after consulting the European Parliament, shall adopt the necessary measures. The report by the Commission and the examination by the Council shall take into account the proper functioning of the internal market, the real value of the rates of duty and the wider objectives of the Treaty.

II. Review of structure and rates of excise duty

1. General remarks

1.1. As stated above, the Directives on the approximation of excise duties stipulate that the rates and structure of excise duty are to be reviewed every three years. The Commission is required to present a report, which may or may not be accompanied by proposals for revising the Directives.

2. First Commission report

2.1 In September 1995 the Commission presented its first report, which, in addition to tobacco, dealt with alcoholic beverages and mineral oils. [5]

[5] COM(95)285 final, 13.09.95.

2.2 The first report noted that, in general, little approximation had taken place. It identified a number of issues where changes might be justified, but concluded that more detailed analysis and consultation with interested parties was necessary before final decisions were taken. Amongst the issues identified were difficulties related to the manner in which the minimum incidence for cigarettes is expressed and certain fraud problems with fine-cut smoking tobacco intended for the rolling of cigarettes.

2.3 On 19 September 1996 the European Parliament adopted its opinion on the Commission's review and called upon the Commission to draw up proposals for legislation to resolve the problems identified in its report.

3. Second Commission report

3.1 As part of the process of consultation of interested parties and in order to prepare the second report, the Commission decided to hold a Conference on excise duty in Lisbon in November 1995. This was the first stage of an ongoing consultation process. The Conference's aim was to evaluate the operation of the Community excise-duty arrangements which had been in force since January 1993, and in particular to assist the Commission in its task of planning future excise-duty policy.

3.2 The second report, presented by the Commission in May 1998, [6] suggested that only a few technical amendments to existing Community legislation were necessary. After consulting the national administrations and the trade organisations and bearing in mind that the previous review was fairly recent, the Commission concluded that the structures and rates of excise duty could remain unchanged.

[6] COM(98)320 final, 15.05.98

3.3. As far as cigarettes were concerned, the Commission concluded that Member States should be given greater leeway for adjusting the incidence of the overall minimum duty in the event of a change either in the retail selling price of cigarettes in the most popular price category or in value added tax. Similar leeway should be granted for adjustments to the specific component of excise duty expressed as a percentage of the retail selling price. In addition, Member States were allowed to levy a minimum excise duty on cigars, cigarillos and smoking tobacco. The minimum specific amounts for tobacco other than cigarettes were adjusted in line with inflation.

3.4. The report was accompanied by a proposal for a directive amending the existing tobacco legislation to incorporate the recommended technical adjustments. On 25 February 1999, the European Parliament [7] approved the proposal, simply requesting an amendment of the review period for the rates and structures of excise duties on tobacco products. The proposal was adopted by the Council on 29 July 1999 as Directive 1999/81.

[7] OJ C 153,1.6.1999, p. 37

III. Scope of the third review

1. General

1.1 The report is required to examine the smooth operation of the single market, the real value of excise-duty rates and the wider objectives of the Treaty.

1.2. Apart from these general considerations, the Commission was asked by a large number of Member States, in a statement entered in the minutes when Council Directive 1999/81/EC was adopted, [8] to consider a more fundamental review of the rates and structures of excise duties on tobacco products. The statement by the delegations must be seen in the context of the discussions which took place in the Council at the end of 1998 and in early 1999 about the scope and content of the second review, which was restricted to technical amendments to the current legislation.

[8] "The Belgian, Danish, German, French, Irish, Dutch, Austrian, Portuguese, Finnish, Swedish and British delegations expect that, in its next review report provided under Article 4 of Directive 92/79/EEC and Directive 92/80/EEC, the Commission presents sufficient elements in order to proceed to an overall review of the structures and the rates for tobacco products".

1.3. The Commission agreed that a more in-depth review should be conducted of the structure of excise duty on tobacco products, involving consultation of national administrations, business and interest groups, the system having remained unchanged for several years.

1.4. A broad consultation process preceeded this review. The Commission requested the Member States to give their views on a possible overall review of excise rates and structures for tobacco products on the basis of a questionnaire. The replies were used as a basis for subsequent bilateral discussions between the national administrations and the Commission departments concerned, in the course of which each Member State was informed of the problems raised and the comments and proposals made by the others. Trade associations were also invited to submit position papers and had the opportunity to discuss the matter during bilateral meetings. The Commission also looked closely at the other Treaty objectives such as health, agricultural policy and employment. Furthermore, the Commission feels that enhanced tax convergence is necessary in order to improve the excise system and the functioning of the internal market before the forthcoming extension of the European Union.

2. Operation of the single market

A. General remarks

2.1. The arrangements for intra-Community movements of commercial consignments underpin a system whereby tax is levied by the Member State of destination in a manner compatible with the abolition of border controls. In general, no major problems relating to the functioning of this system have been reported.

2.2. An analysis of the changes of prices and excise rates for tobacco products in the EU shows that there are still considerable differences between the Member States. Cigarettes belonging to the most popular price category are nearly four times as expensive (all taxes included) in the United Kingdom as in Spain. The difference between the two countries in the excise burden in euro terms is over 400%. When manufacturers determine the price level of their products in a given Member State they will take account of several factors, including production costs, local purchasing power, the competitive position of their product on the market and the level of taxation. It is impossible to determine the exact impact of each of these factors on the final price; differences in excise duty undoubtedly contribute to price differences, but they are not the only explanation. Price and tax differences between Member States are well in excess of differences between Member States in per capita gross domestic product, expressed in purchasing power standards (PPS), which, except in the case of Luxembourg, are at most around 75% (see Annex B).

2.3. As already indicated in the previous report, fraud takes place on a large scale in the tobacco sector. Many Member States in their replies to the questionnaire attributed the incidence of fraud and smuggling largely to price differences. They believe approximation of EU duty rates would certainly help reduce fraud within the EU, but is not sufficient in itself and has to be accompanied by other anti-fraud measures. The previous report also drew attention to the findings of the High Level Group on Fraud in the tobacco and alcohol sectors, which made clear the incentive for Member States, in co-operation with the Commission, to take the necessary steps to implement the recommendations contained in the report. Some Member States have indicated that as a result of these efforts, intra-Community fraud appears to have declined over the last few years. Fraud involving non-EU countries, on the other hand, seems to have increased. In some Member States, smuggling of tobacco products from neighbouring East European countries, where prices and taxes are low, has reached alarming proportions and is disrupting the domestic market. Therefore it will be necessary that Member States and the Commission continue to implement the recommendations of the High Level Group on Fraud in the tobacco and alcohol sectors and that an appropriate balance is maintained between trade facilitation and effective control.

2.4. In addition, the significant differences in retail selling prices within the EU encourage people to buy in low-tax Member States for consumption where they live, which is very often a Member State where duty is high. This is perfectly legitimate and indeed one of the benefits of the internal market, provided the products are purchased by individuals for their own personal needs. Serious problems may arise, however, when border crossings become more frequent and the quantities transported exceed the purchasers' own needs. In this case, excise duty is chargeable in the Member State of destination (see Articles 8 and 9 of Directive 92/12/EEC), but the respect of this obligation by travellers is difficult to enforce. Moreover, contraband is more and more organised on a large scale by criminal organisations. Sales via the Internet, whereby consumers buy tobacco products which are sent to them by the vendor, the excise duty being paid in the Member State where the vendor is established (in general a Member State with low prices and tax rates) instead of the Member State where the goods are consumed (in general a Member State with high prices and tax rates), also seem to be increasing. In such cases, the vendors often do not respect the application of the provisions of Article 10 of Directive 92/12/EEC, according to which they are liable to pay the excise duty in the Member of destination when products subject to excise duty are sent or transported directly or indirectly by a vendor to private persons in another Member State. Various systems, trying to exploit the rate divergencies between Member States and the conformity of which with existing legal provisions is doubtful, have been set up both by the vendors and the buyers.

B. Cigarettes

2.5. The rates of duty applied by Member States to cigarettes are shown in Annex C. The way in which the overall minimum rate of excise duty is expressed (as a percentage of the retail selling price) can give a misleading impression about the degree of approximation of rates of duty. Even though the difference between the highest level of 65.14% and the lowest level of 50.47% (see column 12 of the table on cigarettes in Annex C) appears to be rather small, the amount of excise levied in absolute terms is more than four times higher in the Member State levying the highest tax than in the Member State levying the lowest tax. Sweden, which has obtained a derogation from the 57% rule until 31 December 2002, applies the fifth-highest rate of tax in absolute terms in the EU.

Excise incidence for cigarettes

2.6. The 57 % excise incidence for cigarettes is related to the cigarettes of the price category most in demand, according to the data established at 1 January of each year in a given Member State. Member States determine this category either on the basis of the fiscal marks sold for cigarettes or on the basis of available sales statistics. If at 1 January of a certain year the category changes, Member States have to verify if they still meet the 57 % excise incidence. According to information received from the Member States, the price category of cigarettes most in demand does generally not fall within the market segment of the lower priced cigarettes.

2.7. During the consultation process, most Member States seemed to be in favour of the 57% incidence rule for cigarettes, though some drew attention to its shortcomings and pointed out that application of a minimum rate alone would not bring about greater approximation. The 57% rule has not prevented the perpetuation of wide differences in rates and retail price levels. This is illustrated by Sweden's difficulties in complying with the minimum rate despite the fact that its cigarette prices are among the highest in the EU.

2.8. Despite the fact that the reference to the 57 % incidence in relation to the cigarettes of the price category most in demand may have some shortcomings, the system has also some advantages. It allows to compare the overall excise duty levied in the different Member States, which under the existing rules, can choose between a rather specific or a rather ad valorem taxation system.

2.9. Directive 1999/81/EC allowed Member States greater leeway in adjusting the incidence of the overall minimum duty in the event of a change either in the retail selling price of cigarettes in the most popular price category or in value added tax. Member States where the level of duty is around or just above the minimum rate of 57% regard this as a useful facility. Unfortunately, the amendment does not provide a long-term solution for Member States with high taxes situated around 57%, since they have to increase their taxes to comply again with the 57% rule at the latest as from the second year following that in which the rule was no longer respected. This requirement to increase duty for no other reason than to comply with the 57% incidence rule can widen tax differences within the EU if low-excise Member States do not have to raise their taxes to reach the 57% incidence.

2.10. A more fundamental solution has to be found, as was also suggested by some Member States and by the trade. After discussions with the Member States, the Commission looked at various ways of improving the existing rules. Neither the Member States, nor the trade feel that drastic changes of the existing system, such as a thorough reform of the structure of excise taxation, are necessary. Bearing this in mind, the Commission is of the opinion that more convergence between the taxation level of the different Member States, aiming at restricting fraud and smuggling, should be reached without any further complication of the existing system and taking into account structural and historic differences between Member States.

2.11. At present, a minimum excise duty of 57% has to be charged on the retail selling price (all taxes included) of cigarettes of the price category most in demand, which includes VAT. One alternative would be to oblige Member States to respect a minimum overall tax incidence expressed as a combined percentage of VAT and excise on the retail selling price (all taxes included) for cigarettes of the price category most in demand.

2.12. Such an approach, however, has its limitations and would not solve all the problems. If high-tax Member States had to increase their rates to comply with the new minimum, discrepancies in tax and prices within the EU would increase. In addition, the percentage for the minimum tax incidence would have to be set in such a way as to take into account wider Treaty objectives as well, such as health, which means the combined tax incidence would have to be about 73% of the retail selling price (inclusive of all taxes) for cigarettes of the price category most in demand. This percentage is obtained by adding to the minimum excise incidence of 57% of the retail selling price the average effective VAT rate applied for cigarettes in the EU. It has to be noted that under the Sixth VAT directive, Luxembourg is still allowed to apply an intermediate rate of 12% to manufactured tobacco products. The introduction of a combined tax incidence would, however, have some peculiar effects. It would oblige five Member States, some of which already have high rates of taxation, to increase their excise duties still further, while other Member States with low excise duties could keep their taxation level unchanged. The Commission is therefore not at all convinced that this alternative would enhance tax convergence within the EU.

2.13. A valid alternative to the existing rule would be to introduce a fixed minimum amount expressed in euros in addition to the minimum excise incidence of 57% of the retail selling price in order to guarantee a minimum level of excise duties on cigarettes in all Member States.

2.14. Member States' excise duties would then have to meet two requirements: the 57% rule and a minimum expressed in euros per 1000 cigarettes of the price category most in demand. The underlying idea behind this additional requirement is that Member States where price levels are relatively low may meet the 57% requirement but still have a very low incidence of overall excise duty, expressed in euros. The introduction of such an additional amount in euros was also suggested or supported by several Member States either in their reply to the questionnaire or during the bilateral discussions. The Commission believes that a minimum fixed amount of this kind would significantly reduce the incentive for smuggling by establishing a floor under excise duty.

2.15. Instead of fixing the minimum euro amount on the basis of the average excise yield for cigarettes belonging to the price category most in demand, which is about EUR 90 per 1000 cigarettes, the Commission proposes a considerably lower amount of EUR 70, to avoid a majority of Member States having to increase their rates of excise duty. Setting the minimum at EUR 70 means only a few Member States have to increase their excise duties. Since retail prices of cigarettes generally increase over time in line with inflation, merely applying the current rates in a given Member State brings about an automatic increase in excise. If the future rate of inflation in a Member State is 2-3% per year, for instance, prices would increase by about 7% to 8% over a period of 3 years without any change in its excise rates. Moreover, the 57% rule and the fixed amount are worked out in relation to the most popular price category and the level of taxation thus established is then applied to all categories of cigarettes. For Member States where the immediate introduction of this minimum euro amount would be problematic for economic reasons, a phased introduction spread over a limited period of time could be considered. Considering that price levels for cigarettes - including taxes - are much lower in most candidate countries than in the EU, such a phased introduction could also be considered for them upon accession.

2.16. Since one of the Commission's aims is to bring about greater approximation of the excise burden on cigarettes, however, an escape clause is needed to ensure that the higher-taxing Member States do not have to keep raising excise duty to comply with the 57% rule. It is in fact not logical that a Member State like Sweden with a very important excise charge needs a derogation from the 57% excise rule, whilst other Member States with a very low excise charge do not encounter any difficulty to respect the 57% excise incidence. If such a derogation would not have been granted in the past, the excise charge in real terms would have been much higher with probably a disturbed national market characterised by a high level of fraud and smuggling. Instead of a continuous prolongation of the derogation for respecting the 57% rule for this Member State and to avoid similar requests from other Member States, a more solid and easy solution has to be found. Such a solution can be found in the introduction of an additional amount of excise duty at a high level, above which Member States do no longer have to respect the 57% rule. Therefore, Member States applying an effective excise charge of at least EUR 100 per 1000 cigarettes for the category most in demand should not therefore be required to apply the 57% rule.

2.17. The figures of EUR 70 and EUR 100 have to be seen in the context of the 57% minimum incidence, and the Commission considers it necessary to review them whenever it examines the rates and structures of excise duties under Article 4 of Directive 92/79/EEC and Directive 92/80/EEC in order to maintain the original ratio between the fixed sum and the 57% incidence.

2.18. The Commission considers that the above mentioned amendments will guarantee more rate convergence between the Member States, and, as such, will improve the functioning of the Internal Market and will reduce market distortions between the Member States. These amendments also allow to incorporate in the taxation policy the wider objectives of the Treaty, in particular the health protection, as explained in more detail in point 4 hereafter.

Level of the specific element of the excise duty

2.19. At present, Member States have to apply both a specific and a proportional (ad valorem) excise duty on cigarettes. The specific component of the excise duty may not be less than 5% or more than 55% of the amount of the total tax burden resulting from the aggregation of the proportional excise duty, the specific excise duty and the turnover tax levied on these cigarettes.

2.20. These percentages provide the Member States enough flexibility to determine freely the relative importance of both excise elements, taking into account the characteristics of their national market for cigarettes, provided that they respect the 57% rule. Neither the Member States nor the trade showed any real interest in changing the existing percentages, indeed some were explicitly opposed to a change. The Commission will not, therefore, be proposing any amendment of the existing structure of excise duty on cigarettes.

Minimum excise duty on cigarettes

2.21. On a number of occasions Member States have been confronted with the appearance of cheap cigarettes on their domestic market, often with disruptive effects.

2.22. At present, Article 16(5) of Directive 95/59/EC allows Member States to levy a minimum excise duty on cigarettes provided that this does not have the effect of raising the total tax to more than 90% of the total tax on the most popular price category. This means that each packet of cigarettes offered for sale to consumers must bear at least a minimum amount of excise duty. The rule is intended to provide Member States with a certain level of revenue and ensure that cigarettes are not sold at prices too far below normal market levels.

2.23. Some Member States reported that this mechanism was not allways adequate to prevent a drastic rise in supply at the lower price segments of the market, and wanted an increase in the amount of the minimum excise duty that can be charged on these cigarettes. Others, while they have not yet felt the need to apply or introduce a minimum excise duty for cigarettes, nevertheless also thought an increase in the limit set in Article 16(5) might prove useful at some time, if only as a measure to prevent drastic price cutting.

2.24. The appearance on the market of cheap cigarettes can lead to unfair competition and can encourage young people to smoke. Therefore, the Commission will propose an amendment to the existing provisions allowing Member States to levy a minimum excise duty on cigarettes, provided that this does not exceed the excise duty levied on cigarettes belonging to the most popular price category. Introducing such a provision into the existing Directive will give Member States greater flexibility in coping with price wars.

C. Other manufactured tobacco

2.25. Annex D shows the rates of excise duty levied by the Member States on cigars, cigarillos, hand-rolling tobacco and other smoking tobacco. Cigar consumption represents barely 1% of the total EU consumption of all tobacco products. The market for fine-cut tobacco intended for the rolling of cigarettes accounts for around 7% of the total EU market for tobacco products. The market for other smoking tobacco is less than 1% of the total.

2.26. In general, the internal market for these products operates fairly well. Directive 1999/81/EC allowed Member States to introduce a minimum excise duty for cigars and smoking tobacco, a facility previously only available to a limited extent for fine-cut tobacco. This, together with the fact that Directive 92/80/EEC laid down minimum levels for the rates, gives the Member States a great deal of flexibility to take national considerations into account in setting tax levels. As Directive 1999/81/EC has only recently been adopted, only a few Member States have so far made use of this provision or are likely do so in the near future.

Cigars and cigarillos

2.27. Several Member States informed the Commission of the increasing sale last year on the tobacco market of a product which has in fact existed for many years. In terms of function, taste, filter and presentation it can be regarded as a cigarette or cigarette substitute, except that it is has the colour of a cigar or cigarillo, rather than the white, colour of a cigarette and the wrapper is filled with cut tobacco rather than a threshed blend. The manufacturing process is similar to that for cigarettes. Under the current legislation, the product is taxed in the Member States at the same rate as cigars and cigarillos, which is considerably lower than the rate for cigarettes. This product is not only competing with cigarettes, it is also disrupting the market for cigars and cigarillos. Being cheaper than cigarettes, it is increasingly attractive to young people. To avoid such products being taxed at the low rate for cigars and cigarillos instead of the rate for cigarettes, the Commission proposes to amend the definition of cigars and cigarillos in Article 3 of Directive 95/59/EC amended to exclude such products. Such an amendment should also ensure uniform taxation of these products and restrict application of the lower minimum rate to cigars and cigarillos, which are more labour intensive to manufacture than cigarettes.

Fine-cut tobacco intended for the rolling of cigarettes

2.28. The substantial differences in tax levels among Member States for fine-cut tobacco intended for the rolling of cigarettes, combined with major differences in pre-tax prices, encourage smuggling between neighbouring countries and give rise to distortions in the internal market. As the previous review pointed out, it is to some extent up to the high-tax Member States to resolve this problem by reducing their national rates and/or tightening up their controls. On the other hand, there is also a big difference at Community level between the minimum excise incidence of 57% of the retail selling price for cigarettes of the price category most in demand and the minimum rates of either 30% of the retail selling price or EUR 25 per kilogram for fine-cut tobacco.

2.29. The two products have different characteristics; nevertheless they are competing in a way. In all EU markets, smokers of fine-cut tobacco are predominantly in lower-income socio-economic groups than cigarette smokers. When cigarette prices go up, smokers who can no longer afford the more expensive cigarettes may shift to rolling tobacco instead. From a health point of view, both products are harmful. So there is little justification for big differences in the minimum rates for these products at Community level.

2.30. During the bilateral discussions with Member States, it became clear that many of them maintain a certain ratio between the taxation of fine-cut tobacco and cigarettes, even if there is no obligation to do so. In setting this ratio, they take into account the difference between a semi-finished and a finished product, the purchasing power of different groups of smokers, differences in cost price between the two products and the relatively labour-intensive process of manufacturing fine-cut tobacco.

2.31. The Commission believes the minimum rate for fine-cut tobacco should be brought more closely into alignment with the 57 % minimum incidence rule for cigarettes belonging to the most popular price category. Given the different characteristics of the two products, it seems reasonable that the minimum excise for fine-cut tobacco should be fixed at about two third of the minimum excise incidence for cigarettes. This would raise the minimum incidence for fine-cut tobacco from 30% to 39%. Increasing the minimum specific duty by the same percentage as the ad valorem minimum rate would give a new specific minimum excise duty of EUR 33.

2.32. These new minimum rates will thus reflect the practice of a large majority of Member States (see Annex E). Member States which do not currently maintain such a ratio between their rates for cigarettes and fine-cut tobacco or which set their rates at a very low level will be given the necessary time to adjust to the new minimum rates. The Commission therefore proposes to increase the minimum rates by stages between now and the year 2004 as follows:

-1 January 2001: 30% of the retail selling price inclusive of all taxes or EUR 25 per kilogram;

-1 January 2002: 33% of the retail selling price inclusive of all taxes or EUR 28 per kilogram;

-1 January 2003: 36% of the retail selling price inclusive of all taxes or EUR 30 per kilogram;

-1 January 2004: 39% of the retail selling price inclusive of all taxes or EUR 33 per kilogram.

3. Real value of excise duty

3.1 The review must also look at the real value of excise duty. It is therefore useful to examine the rate adjustments made by Member States in order to see to what extent they reflect inflation. National authorities generally take account of inflation in drawing up their budget. It may be assumed that, all things being equal, they will usually raise excise duties in line with inflation, and indeed some even adjust excise duties ahead of inflation.

A. Cigarettes

3.2 Under the current legislation, the minimum incidence of excise duty on cigarettes is set at 57% of the retail selling price (inclusive of all taxes) of cigarettes of the price category most in demand in each Member State, on the basis of data established at 1 January of each year. Since this minimum is expressed as a percentage of the retail selling price, it tracks inflation automatically and so does not require any adjustment.

B. Other manufactured tobacco

3.3 As indicated in point 3.2 of Chapter I, the minimum rates applicable to cigars, cigarillos, hand-rolling tobacco and other smoking tobacco are expressed both as a percentage of the retail selling price and as a specific amount.

3.4 Most Member States apply rates which rely mainly, if not exclusively, on an ad valorem component, ensuring that inflation is more or less automatically taken into account. Furthermore, Member States which apply specific taxation have tended to adjust their duty levels in line with inflation.

3.5 In order to maintain the ratio established when the rates were first set in 1992, the minimum specific amounts were adjusted in line with inflation in the 1998 review. As that review and the accompanying proposal for a Directive recommended a five-year review period for the rates and structures of excises on tobacco products, an adjustment for inflation was already foreseen for the years 1999-2000 and the minimum specific amounts for other tobacco products from 1 January 2001 were as follows:

- EUR 10 for cigars and cigarillos;

- EUR 25 for hand-rolling tobacco;

- EUR 19 for other smoking tobacco.

4. Wider objectives of the Treaty

4.1. The Treaty clearly states that it is the Community's responsibility to adopt measures with the aim of establishing the internal market, including provisions for the harmonisation of legislation concerning excise duties to the extent that such harmonisation is necessary to ensure the establishment and functioning of that market. Article 152 of the Treaty also provides that a high level of human health protection shall be ensured in the definition and implementation of all Community policies and activities, [9] and 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 and activities.

[9] Article 152 provides in extenso that:

4.2. Excise duty is primarily an instrument for generating revenue at national level, but policy-making in this area has to take into account the wider objectives of the Treaty and try to reconcile these with improvements in the operation of the internal market. Given the characteristics of manufactured tobacco products, particular attention has therefore to be paid to the health aspects and to the relationship between consumer protection and the price of the products.

4.3. Smoking is one of the leading causes of morbidity and mortality in the EU, where half a million people die each year from the effects of tobacco consumption. The death rate will continue to rise sharply and according to statistics from the World Health Organisation and the International Centre for Cancer Research, smoking will remain the biggest single form of avoidable death in the Community.

4.4. The level of taxation of tobacco products, through its impact on their final price, obviously has a significant effect on consumption. Taxation has to be seen as an important element of a policy aimed at reducing the consumption of tobacco. It must form part of an overall strategy of prevention and dissuasion which would include, for instance, rules regarding additives in tobacco products, the tar and nicotine content of cigarettes, the sale of cigarettes and other tobacco products to young people and measures to curb smoking in public places.

4.5. In the course of consultations with the Member States, it became clear that all of them are very conscious of the fact that tobacco is a health risk. They all attach considerable importance to the health aspect, but while they share the same objective - reducing tobacco consumption - they are at present not all setting about achieving it in the same way. They do all agree that a minimum level of taxation of these products within the EU is necessary, and are strongly supported by health pressure groups. Some already have a high level of taxation and see other measures for curbing consumption as vital, since high taxation raises the massive problem of smuggling. A number of Member States saw duty increases as the key to cutting smoking, especially among the young. Excise duties have to generate a certain level of revenue, and if price differentials become too wide this may be affected by smuggling. Although health considerations play a major part in setting the rate of excise duty, some Member States take other important factors into account as well, including employment and budget resources.

4.6. Fine-cut tobacco intended for the rolling of cigarettes and cigarettes are both harmful to health, but it is difficult to draw precise comparisons, as the tar, nicotine and carbon-monoxide yields of fine-cut smoking articles, which are made by the consumers themselves, vary considerably depending on such factors as the weight of tobacco, the type of paper and whether or not a filter is used. Nevertheless, the industry, supported by certain studies, claim that tar yields on fine-cut smoking articles are broadly in line with factory-made cigarettes. From a health point of view, therefore, the two products should be taxed alike, taking due account of their characteristics.

4.7. As already indicated in the previous report, the public-health objective of reducing consumption through high taxation will fall short of its target if tobacco products evade this taxation. Moreover, if tobacco products evade normal marketing channels (with tax being paid in the Member State where it is actually due), they may evade other rules as well, such as those regulating sales to minors, tar levels, nicotine and carbon-monoxide content, additives, labelling, etc. This factor must be taken into account when a tax increase is being considered. Consumers who cannot afford to buy tobacco legally but cannot do without it are tempted to get it on the black market and as a rule Member States with external borders do see the smuggling of cheap, low-tax tobacco products as a threat. In some cases, illegal sales of smuggled cigarettes could present an increased health risk as there is no means of controlling their quality and content.

4.8. The aim is to reconcile all the abovementioned objectives by establishing a reasonable minimum level of taxation at EU level, taking into account inter alia the functioning of the internal market and consumer health protection. Above this minimum level, Member State governments are free to determine the level of excise duty in the light of national objectives and priorities.

4.9. The World Health Organisation is currently in the process of negotiating an International Framework Convention on Tobacco Control. The Commission has obtained in October 1999 a mandate from the Council to participate on behalf of the Community in these negotiations. It may be noted that the draft text of the Convention includes elements relating to tobacco taxation and to tobacco smuggling. The next negotiating round is scheduled for April-May 2001.

5. Frequency of reviews

5.1. Both Article 4 of Directive 92/79/EEC on the approximation of taxes on cigarettes and Article 4 of Directive 92/80/EEC on the approximation of taxes on manufactured tobacco other than cigarettes stipulate that the Council, acting on a proposal from the Commission, must examine the structure and rates of excise duty not less frequently than every three years.

5.2 An in-depth examination of the operation of the single market and of the rates and structure of excise duties on the different tobacco products was carried out for the purposes of this review. As the present report makes clear, some major changes to the existing legislation are necessary and the report is therefore accompanied by a proposal for amending the relevant Directives.

5.3. The Commission takes the view that a three-year period is too short to provide the proper perspective for assessing changes in Member States' legislation. A four-year period would be more appropriate for assessing the operation of the single market and the influence of any changes in legislation.

5.4. For that reason, the Commission believes Article 4 of both Directives should be amended to provide for a review every four years. Taking into account the time required for discussions in the Council, the European Parliament and the Economic and Social Committee, it would be logical to provide that the four-year period for the next review should run from the time discussions on the previous review in the Council are finalised. It goes without saying that the Commission can make proposals on its own initiative at any time before the end of the four-year period where it considers this necessary or where account needs to be taken of changes on the tobacco market.

5.5. Since the next review will not take place before 2005, the Commission intends to propose an increase in the minimum specific duty for tobacco products other than cigarettes (inflation-adjusted rates have already been set for the period from 1 January 2001; see point 3.5 above).

5.6. An additional adjustment of the specific excise amounts for these products is needed to take inflation into account for the period 1 January 2001-31 December 2002. On the basis of Eurostat data, the rate of inflation can be estimated at around 1.9% a year or at 3.8% over the period as a whole. Applying this percentage to the minimum specific amounts calculated under points 2.32 and 3.5 and rounding up to the nearest unit gives us the following minimum figures:

- for cigars and cigarillos: EUR 11 at 1 January 2003;

- for fine-cut tobacco intended for the rolling of cigarettes:

-at 1 January 2003: EUR 31.

-at 1 January 2004: EUR 34;

- for other smoking tobacco: EUR 20 at 1 January 2003.

5.7. The Commission will incorporate this schedule of increases into its proposal amending Directive 92/80/EEC.

IV. Conclusions

1.1. The review of the structure and rates of excise duty on manufactured tobacco products leads us to conclude that a number of important amendments to the existing legislation are necessary, though keeping the main pillars of the acquis unchanged rather than establishing a new system. The amendments envisaged are the result of an in-depth examination by the Commission of the rates and structure of excise duty on tobacco products involving consultation of national administrations, business and interest groups.

1.2. Where cigarettes are concerned, the Commission believes Member States should apply both the minimum excise incidence rule and a fixed minimum amount expressed in euros. Member States which already charge a high level of excise duty should, however, be allowed greater leeway in setting their rates. Member States will also be given greater flexibility in levying a minimum excise duty on cigarettes.

1.3 The Commission also considers that the existing definition of cigars should be amended in order to bring a specific cigarette-like product into the scope of taxation of cigarettes.

1.4. The minimum rates for fine-cut tobacco intended for the rolling of cigarettes should be brought gradually into line with the rate for cigarettes.

1.5. The specific minimum amounts for tobacco other than cigarettes should be adjusted for inflation.

1.6. The structure and rates of excise duty should be reviewed every four years rather than every three years.

ANNEX

List of annexes

Annex A: Revenue from excise duty on manufactured tobacco as a percentage of gross domestic product(1999)

Annex B: Gross Domestic Product at current market prices per thousands of PPS

Annex C: Current rates for cigarettes in the Member States

Annex D: Current rates for manufactured tobacco other than cigarettes in the Member States

-Annex D.1 : cigars and cigarillos

-Annex D.2 : fine-cut tobacco intended for the rolling of cigarettes

-Annex D.3 : other smoking tobacco

Annex E: Rates for fine-cut tobacco intended for the rolling of cigarettes as a percentage of the rates for for cigarettes

Annex A

REVENUE FROM EXCISE DUTY ON MANUFACTURED TOBACCO AS A PERCENTAGE OF GROSS DOMESTIC PRODUCT (1999)

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This table contains the excise revenues on all tobacco products: cigarettes, cigars, cigarillos and smoking tobacco. VAT is not included in the indicated figures.

Annex B

Gross Domestic Product at current market prices per thousands of PPS (purchasing power standards)

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Source : Eurostat

Annex C

Cigarettes

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PT: Portugal may apply a reduced rate of up to 50% less than the overall minimum rate to cigarettes consumed in the most remote regions of the Azores and Madeira, made by small-scale manufacturers each of whose annual production does not exceed 500 tonnes. (Article 3.2 of Directive 92/79/EEC)

Annex D.1.

Cigars et cigarillos

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General remartk: The rates and amounts shall be effective for all product belonging to the group of manufactured tobacco concerned, without distinction within each group as to quality, presentation, origin of the products, the materials used, the characteristics of the firms involved or any other criterion (Article 3.2 of Directive 92/80/EEC).

DE, DK, SE: *The specific excise is given per /1000 items

Annex D.2

Fine-cut smoking tobacco (intended for the rolling of cigarettes)

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General remark: The rates and amounts shall be effective for all product belonging to the group of manufactured tobacco concerned, without distinction within each group as to quality, presentation, origin of the products, the materials used, the characteristics of the firms involved or any other criterion. (Article 3.2 of Directive 92/80/EEC)

Annex D.3.

Other smoking tobaccos

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Annex E

Rates for fine-cut tobacco intended for the rolling of cigarettes as a percentage of the rates for cigarettes - year 2000

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