Strengthening measures to whitewash the vaping market

#industry news

The tax Service has strengthened control over representatives of the vaping industry, Forbes has learned. The tax authorities call for questioning manufacturers who, according to documents, produce a suspiciously small number of vials of vaping liquid compared to the volumes of nicotine purchased

The Tax Service has strengthened inspections of manufacturers of electronic cigarettes and nicotine-containing liquids ("slurry" in vaper slang, a mixture of propylene glycol, glycerin, flavorings and nicotine. — Forbes), two tax consultants told Forbes and confirmed by one of the heads of a large company in the industry, who wished to remain anonymous.

From December 1, 2023, mandatory labeling of liquids and disposable electronic cigarettes will begin — a unique digital code from the Honest Sign system will be applied to the packaging. However, legal manufacturers of vaping products have been participating in the labeling experiment since February 2022. Tax authorities verify the data of the "Honest Mark" on labeling with declarations on paid excise taxes and, in case of discrepancies, require explanations and documents from entrepreneurs, a market participant told Forbes. In addition, the tax service requests information from vape shops about suppliers of liquids, says another Forbes interlocutor familiar with the market situation. Some gray manufacturers illegally apply the simplified taxation system (USN), while the "simplified tax system" is prohibited from being used in the production of excisable goods. "After tax audits, they fly off the simplified tax system, they are charged additional income tax, VAT and excise taxes for three years," says the Forbes interlocutor.

In addition, the tax service pays close attention to entrepreneurs whose volumes of purchased raw materials significantly differ from the declared output of finished products. "We are well aware of how much raw materials should be used to produce goods," stressed the head of the Federal Tax Service, Daniil Egorov. 

"Representatives of a number of manufacturers were called in for questioning, since, according to the tax service, the volumes of purchased raw materials significantly differed from the volume of finished products produced," a market participant told Forbes.

"We are recording the intensification of tax inspections of manufacturers and sellers of nicotine-containing products. Mass inspections began in October," Yevgeny Fedotov, head of the tobacco consulting agency Fedotov Group, confirmed to Forbes.

There is no automatic traceability of nicotine raw materials now. But from March 1, 2024, the sale of tobacco raw materials and nicotine will be carried out through the Honest Sign system, by analogy with the mechanism by which alcohol is now sold through the Unified State Register of Medical Sciences. "The tax service will be able to see all the way from raw materials to the finished product — how much nicotine was produced and how many vials of liquid the entrepreneur sold. During the inspections, Rosalkogoltabakcontrol will be able to verify the data in the system with real production residues. Discrepancies are a sign that the company illegally sold the liquid," explained the head of the Fedotov Group. 

Manufacturers of vaping liquids, as a rule, use nicotine raw materials — nicotine diluted with glycerin and acids, but some work with pure nicotine. The maximum nicotine content in a liquid is 20 mg per 1 ml, or about 2% of the liquid, as required by GOST adopted in 2018. India is the largest producer of nicotine in the world. Specialized plants, in particular in China and the EU, purify tobacco extract to nicotine. "Nicotine is a poison, and its import is subject to licensing. In Russia, about five companies have a license to import nicotine," Fedotov explained. — However, in neighboring countries, for example in Belarus, it is much easier to obtain a license to import nicotine than in Russia. Therefore, some nicotine enters Russia from some countries of the Eurasian Economic Union (Belarus, Kazakhstan, Armenia, Kyrgyzstan). It is possible that illegal imports may go to Russia directly from China and Europe." "Nicotine is freely sold for cash on the black market," says an industry participant.

Forbes sent a request to the Federal Tax Service, but did not receive a response at the time of publication.

Additionally, Deputy Prime Minister Dmitry Grigorenko instructed Rospotrebnadzor to conduct unscheduled on-site inspections of tobacco shops and vape shops (Forbes has a copy of the order). It is accompanied by a list of legal entities and individual entrepreneurs for unscheduled on-site inspections on 43 sheets. Forbes sent a request to Rospotrebnadzor.

Inspectors check documents, declarations, and the display of goods during store raids — tobacco and nicotine-containing products cannot be openly displayed in storefronts, sold to minors and remotely, and from December 1, inspectors will check for labeling, explained Forbes Sergey Fedoseev, head of the legal department of the Union of Nicotine-Containing Products Enterprises (SPINI). 

"It is a huge omission that there are no excise stamps for vaping liquids," Yevgeny Fedotov believes. "It's impossible to tell from the bottle whether the liquid was legally produced or not." Before the start of mandatory labeling on December 1, the only option for verification, according to him, is to study the manufacturer's documents. "There are not so many state inspectors, and vape shops are almost at every turn," he stated. The number of vape shops in Russia's million-plus cities alone reached 16,900 on April 1, 2023, the 2GIS mapping service reported. 

With light steam

In Russia, about 79% of offline stores selling vapes and liquids to them do so in violation of the law, and the share of illegal nicotine-containing liquids on sale is about 93%, estimated at the end of 2022 by the National Scientific Competence Center in the field of combating Illicit Trafficking in Industrial Products (NSCC). First of all, illegal liquids include liquids from which excise taxes have not been paid, explained Yevgeny Fedotov. "In the segment of electronic nicotine and liquid delivery systems, a significant part of which is imported, the situation remains difficult, despite the ongoing process of whitewashing the market," says the director of the Department of Legal Affairs and External Corporate Relations of the ITMS Group of companies (the former division of British American Tobacco in Russia, produces, in particular, Kent, Dunhill cigarettes, systems tobacco heating glo and disposable electronic vaporizers Vuse) Oleg Barvin.

If the tobacco market is consolidated and there are several large corporations that manage sales and act as "forest attendants", then there are a huge number of small companies in the vaping market, explains a market participant. "Very low entry price, steady demand, high margins and insufficient attention from regulatory authorities," he lists the reasons for the high proportion of illegal trafficking. "The production of liquids is elementary, it can be loaded in your garage and have millions of revolutions," stated one of the Forbes interlocutors. "Manufacturers work in a gray field for the sake of superprofits. Much cheaper than legal ones, they still don't sell their goods," says the owner of a chain of tobacco and vaping stores, who asked for anonymity.  

"The legislation has not kept pace with business development. When vaping began to win back some consumers from tobacco companies, the state realized that it was necessary to regulate this area," Sergey Fedoseev summed up. 

Shock excise taxes

"Next year will be decisive for the industry," Fedoseev believes. Starting from December 1, the sale of disposable electronic cigarettes and liquids without labeling will be illegal. From 2024, the excise tax on nicotine liquids will double — from the current 20 rubles per 1 ml to 42 rubles. From 2025, it is planned to increase to 44 rubles, in 2026 — to 46 rubles.

The Ministry of Finance expects that the increase in excise taxes will bring 10 billion rubles to the budget. The amount of the excise tax is "kind of prohibitive," noted Deputy Finance Minister Alexei Sazanov. In addition to the increase in the budget, the Ministry of Finance expects a decrease in the consumption of nicotine-containing products.

"A sharp doubling of excise taxes is an excessive measure and entails unpredictable consequences," says Fedoseev. — This will make legal products uncompetitive, because illegal goods without excise taxes are cheaper. The few legal manufacturers are now confused whether to continue their activities or go into other industries." 

The tax burden on vaping in Russia is higher than abroad, Fedotov points out. A "shock" increase in excise taxes will reduce the already small legal market, at least at the first stage, he agrees. "The state needs to strengthen control." Italy and Hungary, after increasing excise taxes, were forced to lower rates due to sharp budget losses, the expert gave an example.

The risks of going into the shadows

A market participant called the increase in excise taxes "a blow below the belt." In his opinion, it is bona fide players who will suffer, and those who switched from cigarettes to vape will have to pay more. "The price of 10 ml of liquid after the increase in excise duty will be from 990 rubles. The average user consumes 60-90 ml of liquid with a maximum permissible strength of 20 mg/ml. For the specified volume of liquid, three to five replaceable evaporators (cartridges) will be required. Therefore, the minimum budget for a steam room will be 6690 rubles per month. Moreover, 3024 rubles (45% of the cost) is excise duty and VAT, — a market participant gave calculations. — When using disposable electronic cigarettes, the budget of the vaper will be slightly higher: from 7000 to 9000 rubles per month. If we compare it with the monthly budget for cigarettes, then with an average pack price of 208 rubles (less in the regions) and an average consumption of 19 cigarettes per day, the smoker's budget is 6025 rubles per month."