Ukraine’s ‘lost’ cigarettes flood europe

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The hang glider pilot insisted it was a routine flight, and that strong winds had blown him over the border from Hungary into Ukraine. But the man arrested by Ukrainian authorities last July, with his flight suit and night vision gear, looked suspiciously like other hang gliding smugglers along the border smugglers who take off from Ukraine, fly into Hungary, and each drop as much as 100 cartons of contraband cigarettes.

Ukraine is home to some of the world s cheapest cigarettes at $1.05 per pack making the country a bonanza for smugglers, whether by glider or more mundane pathways on the ground. Cars and trucks filled with Ukrainian made Marlboros and Viceroys get waved through border checkpoints by customs guards who seem more than eager to accommodate, for a price. Loads also move by bus and train, bound for other European countries where high taxes make packs cost as much as $5 (Germany) or $10 (United Kingdom).

The backbone of this underground commerce the acquisition of the cigarettes themselves is by far the easiest part of the entire operation. The world s four leading multinational tobacco companies, Philip Morris International, Japan Tobacco International (JTI), Imperial Tobacco, and British American Tobacco (BAT), have produced billions of excess cigarettes in Ukraine, fueling a teeming black market that reaches across the European Union. Today, Ukraine is rivaled only by Russia as the top source of non counterfeit brand cigarettes smuggled to Europe, EU officials say.

The booming trade in tobacco smuggling has major consequences, say industry experts. The growing traffic pushes huge supplies of cheap, untaxed, and unregulated cigarettes into the rest of Europe, undercutting otherwise successful attempts to curtail smoking. Worse, officials say, the trade is boosting organized crime gangs, who find the soft penalties and big profits hard to resist.

The numbers tell the story. Each year, Ukraine s cigarette consumption and legal exports top 100 billion sticks, according to Ukraine s Ministry of Health. Yet in 2008, tobacco companies manufactured and imported nearly 130 billion cigarettes 30 percent in excess of what the local market can consume. These extra cigarettes disappear in the market, feeding an illicit trade that is worth, conservatively, $2.1 billion annually. Ukrainian cigarette production, meanwhile, has steadily risen since 2003, according to an analysis by ICIJ of data compiled by SOVAT, a tobacco and alcohol industry association, and Ukraine government statistics. In fact, cigarette production in Ukraine increased one third between 2003 and 2008 from 96.8 to 129.8 billion with JTI and Philip Morris leading that trend.

What happens to those 30 billion lost cigarettes ? The huge surplus has reached such proportions that it has become a parallel industry, experts say, with all sides benefiting from it, from manufacturers to organized crime gangs who control the black market. In addition, hundreds of thousands of Ukrainians, Romanians, Hungarians, and Poles along the border rely on the trafficking of cigarettes for their livelihood, buying the cheap smokes in Ukraine and unloading them tax free in European countries where prices are far higher.

Distribution of smuggled discount cigarettes with Ukrainian excise stamps is also flourishing on the Internet through numerous Moldova based online stores, which deliver them to customers worldwide.

Tobacco companies are benefiting from selling to smugglers, says Kostyantyn Krasovsky, head of the tobacco control unit of the Institute of Strategic Research at Ukraine s Ministry of Health. They sell it to them at the same prices they sell to legal wholesalers. Krasovsky adds that in dealing with smugglers, tobacco companies can potentially gain extra profits when a batch is confiscated by customs and destroyed. It s even better for them another smuggler will come and buy the same quantity.

Even after recent hikes, cigarette taxes in Ukraine remain among the lowest in Europe. The low price of Ukrainian cigarettes means high profits for smugglers, who have pushed the product all over Europe. Enforcement is lax at best most big seizures of smuggled Ukrainian smokes take place not in Ukraine but in neighboring Romania, Poland, and Hungary.

Blame Game

Attracted by high smoking rates and the potential for rapid returns on investments, multinational tobacco companies rushed to acquire the state run cigarette factories after the Soviet regime collapsed in 1991. Today, the big four tobacco companies Philip Morris, BAT, JTI, and Imperial control 99 percent of the Ukrainian cigarette market.

The former Soviet Union, particularly the most populous countries such as Russia and Ukraine, represented a massive opportunity for the tobacco companies. Men were already smoking in large numbers but the companies knew they could push many more women to smoke, and they did, said Dr. Anna Gilmore, a senior public health researcher at the University of Bath, in the UK, who has written extensively about the tobacco industry in the former Soviet Union. As a result, Eastern Europe is now one of only two regions in the world where both numbers of cigarettes sold and profits are increasing (the other region is Asia), and this makes it extremely important to the industry.

The Tobacco Atlas, published by the American Cancer Society and the World Lung Foundation, identifies Ukraine as one of the countries with the highest annual rates of cigarette consumption per person in the world 2,526 cigarettes.

The tobacco companies, for the most part, acknowledge that they are churning out more cigarettes than the local market can absorb, but they say they sell only to licensed distributors and periodically reduce the output of certain brands that are popular among smugglers. Beyond, that, they claim, it s up to law enforcement to prevent smuggling. Objectively, we know that our brands produced in Ukraine are found in Europe, said Dmytro Redko, JTI s director of corporate affairs in Ukraine. We do our best to prevent such shipments, although we can t halt them completely. That is the function of the Ukraine government.

JTI, which is owned in part by the Japanese government, manufactures some of the brands that smugglers cherish the most, including Ronson. Redko says his company is constantly decreasing production of Ronson, though he would not disclose the exact figures of this brand s output. In 2008, JTI manufactured roughly 37 billion cigarettes in Ukraine, roughly 30 percent of the nation s total production. According to Redko, when JTI bought British manufacturer Gallaher in 2007, it also inherited what he called Gallaher s outflow issue smuggled cigarettes and the company has since tried to correct it.

BAT also has had its share of troubles in Ukraine despite the fact that the company s output in Ukraine has declined 30 percent since 2003. In a 2007 corporate report the company acknowledged that it had to cease production of its Pall Mall brand in the country after an audit showed that local production was not proportionate to local demand, and cigarettes were widely being smuggled to Germany. BAT stated in the report that the company s actions helped reduce the smuggling of its products from Ukraine by 3 billion cigarettes in 2005 and 2006. It is our belief that if all manufacturers took this approach, outflows from Ukraine could be significantly reduced, BAT s chief of anti illicit trade, Pat Heneghan, told ICIJ in an e mail.

Philip Morris, maker of Marlboro, is the top producer of cigarettes in the Ukraine, with 44 billion sticks manufactured in 2008 an increase in production of more than 85 percent since 2003. Marlboro, EU officials say, remains the number one brand seized in Europe. Ukrainian law enforcement officials say that Philip Morris brand L&M is routinely seized at the border. Philip Morris International s director of brand integrity, Andrew Robinson, told ICIJ that the country does indeed have an ongoing problem of diversion of genuine products from Ukraine i
nto the EU, but, he stressed, the company s production is commensurate with demand. Robinson added that Philip Morris has implemented a sophisticated system of product tracking and tracing in Ukraine, and that it actively cooperates with law enforcement to prevent smuggling.

Imperial Tobacco officials declined to comment for this story. In 2008, Imperial manufactured more than 30 billion cigarettes in Ukraine, according to industry and government statistics, the third largest production after that of Philip Morris and JTI.

Everyone s Windfall

The big tobacco multinationals in Ukraine are not strangers to the smuggling business in the 1990s the firms colluded with criminal networks to smuggle cigarettes and gain market share around the world. Since 2004, Philip Morris and JTI have settled lawsuits brought by the EU and publicly committed to fight smuggling. The agreements require both companies to make substantial payments to the member states every time their brands are seized.

Experts say, however, that only a tiny portion of all contraband cigarettes are caught by Ukrainian customs. In 2008, customs officials seized about 66 million cigarettes less than one percent of what they believe was smuggled out of the country.

Then there s the problem of corruption. Several of the more than 120 criminal smuggling cases prosecuted in 2008 in the picturesque region of Chernivtsi, on the border with Romania, involve customs agents who aided the smugglers, Ukrainian police say. In just the first two months of this year, three cases have been prosecuted in Chernivtsi in which customs officials overlooked the smuggling of 10.3 million cigarettes more than half of them JTI s Ronsons.

Tobacco companies say they monitor their wholesalers for suspiciously large sales of cigarettes. Smugglers, in turn, have started to split large purchases into many smaller purchases to avoid detection. We don t know really who is buying from the wholesalers, as these are small batches said JTI s Redko.

Krasovsky, of the Ministry of Health, says tobacco companies are doing little to stop smuggling. By checking the seized packs production dates, he said, manufacturers could monitor where cigarettes have been bought and cut off wholesalers who deal regularly with smugglers. Instead, he adds, tobacco companies supply cigarettes to a wholesaler that has a huge warehouse in the border with Poland it s obvious where those cigarettes are going to go.

Internet merchants are also making a windfall from Ukraine made cigarettes. A Web search for cheap Ukrainian cigarettes yields about two dozen online stores, most of them located in neighboring Moldova. The sites offer all the well known brands, from Marlboro to Winston, with Ukrainian tax stamps and health warnings. The price is $22 for a carton (10 packs) of Marlboro about three times cheaper than prices in the EU. The sellers claim that they will skip customs inspections at the destination country. If customs does try to charge a duty tax, customers are advised to reject the package and ask for their money back. Also plentiful on Ukrainian Internet sites are classified ads offering Ukrainian cigarettes delivered to the EU in large quantities, on constant basis and without any paperwork.

One such ad, posted on January 9, 2009, offered delivery of cigarettes from Ukraine to Europe. In response to an online inquiry, a person who introduced himself as Oleh Dmytruk responded by saying that delivery of red Marlboro can be made to Germany at 18 Euros (about US$25) per carton. The minimum purchase 1,000 cartons.

In Krasovsky s view, the only way to halt smuggling is to make the trade unprofitable for manufacturers. He and other tobacco control advocates propose that, much like in the Philip Morris EU agreement, tobacco companies in Ukraine be forced to buy back their seized cigarettes at market prices.

But the economics of smuggling may be too sweet for at least some tobacco companies to stop. Asked whether the tobacco industry loses money to the illicit trade in Ukraine, JTI s Redko responded candidly What do you mean by loss? From the point of view of a company operating on the market, production of extra goods means extra profits.

Europa — press releases — press release — excise duties/ minimum retail prices of
cigarettes: infringement proceedings against ireland

The European Commission has decided to send Ireland a reasoned opinion the second stage in the infringement procedure provided for in Article 226 of the EC Treaty because of the fixing of minimum and maximum retail prices for cigarettes by that country. The Commission takes the view, based on well established case law of the Court of Justice of the European Communities, that such prices infringe Community law, distort competition and benefit only manufacturers, by safeguarding their profit margins (see IP/06/483). Unless the legislation in the Member States concerned is brought into compliance within two months of receipt of the reasoned opinion, the Commission may decide to refer the case to the Court of Justice of the European Communities.

I strongly support Member States in their efforts to implement new health policy. However, this must respect Community law.» said Taxation Commissioner L szl&#243 Kov cs. «Introducing minimum retail prices for cigarettes is against Community law and mainly benefits manufacturers who are able to protect their profit margins .

Health protection objectives may be adequately attained by increasing excise duties

The Commission recognizes that price and tax measures are effective means for reducing tobacco consumption. However, tax and price measures must be in line with other Treaty obligations.

In this respect, the European Court of Justice has already stated that

  • imposing a minimum price is incompatible with the current legal framework (Directive 95/59/EC), since the setting of a minimum price by public authorities inevitably has the effect of limiting the freedom of producers and importers to determine their selling price (see also case C 302/00, Commission/France)
  • minimum prices are not necessary, since the health objectives may be attained by increased taxation of tobacco products. (Case C 216/98, Commission/Greece).

The Commission fully supports Member States in designing measures on tobacco control in order to ensure a high level of public health protection. Among the measures that could be used, the European Commission advocates minimum taxes to tackle cigarettes consumption. This would have the same impact on the prices and would not hamper price competition to the sole benefit of manufacturers.

This is demonstrated by a legislative proposal currently pending before the Belgian Parliament to modify the legislation on minimum retail prices of cigarettes in Belgium (see IP/06/866).

Background

Cigarettes are taxed by means of a specific and an ad valorem excise duty. Specific excise duties are taxes on the quantities of cigarettes. Ad valorem excises are a percentage applied to the price of the cigarettes. Consequently, for cheap cigarettes, the ad valorem excise duty will be small.

In order to increase the price of cheap cigarettes, Member States can either increase the specific excise duties and/or the minimum ad valorem excise duties. Minimum excise duties (calculated on the quantity) are independent of the price of the cigarettes and also ensure that all cigarettes, whether cheap or premium brands, are properly taxed.

The Council, acting on the basis of a report from the Commission, must re examine the rates and structures of excise duties on tobacco products before the end of 2006. In the context of this review, the Commission will examine whether and to what extent the current EU directives can be improved with a view to health protection whilst also respecting the principle of «proportionality».

Commission case reference number is 2006/2083.

New For the press releases issued on infringement procedures in the taxation or customs area see

For the latest general information on infringement measures against Member States see