The inability of the authorities to stop cigarette smuggling

As the full-scale war in Ukraine continues, there is a significant loss of tens of billions of hryvnia due to the illegal trade in counterfeit cigarettes, which could be used to supply the Armed Forces. Why is the government failing to stop this flow of counterfeit tobacco and what factors are contributing to its continued growth?

How much does the Ukrainian budget lose from illegal cigarettes?

According to market research conducted by Kantar Ukraine in October of this year, the share of illegal tobacco products on the market reached 25.7%. Back in June, this figure was 19.5%. This percentage of “shadow” is an absolute anti-record in the entire history of research into illegal trade in Ukraine, starting in 2011.

That is, during a full-scale war, every fourth pack of cigarettes is sold without paying the taxes provided for by law, which Ukraine uses entirely to support the Armed Forces and purchase weapons.

According to Kantar Ukraine, because of this, the state budget may lose 23.5 billion hryvnia in tax revenue this year.

This is more than half of all funds allocated by the government for the “Drone Army” in 2023 (40 billion UAH) and significantly exceeds the costs of the Main Intelligence Directorate of the Ministry of Defense (18.7 billion UAH), which is forced to attract funds from volunteers to purchase boats and other necessary equipment.

That is, these funds would make it possible to increase funding for the purchase of drones for the Armed Forces of Ukraine by one and a half times and provide intelligence officers for the Ministry of Defense.

According to Kantar, the leaders in the level of distribution of illegal products are 8 regions of Ukraine, where 70% of such products are sold: Dnepropetrovsk - 17%, Odessa - 12%, Lviv - 9%; Kharkov region - 9%; Khmelnytskyi - 7%; Kirovogradskaya - 6%; Chernivtsi region - 5%, Rivne region - 5%. At the same time, the main channels for the distribution of illegal products remain kiosks (39%), shops (30%), street vendors (18%) and open markets (11%).

According to the State Tax Service, at the same time, the volume of tobacco products legally sold by retail business entities in September-October in almost all of these regions fell significantly (with the exception of Kirovograd).

At the same time, sales channels on Telegram are actively developing, which specialize in small-scale wholesale trade: they offer even lower prices for orders of 500 packs or more, thus stimulating the resale of illegal cigarettes through traditional retail channels. Bulk cigarettes without packaging (just in a cardboard box), small-scale batches of tobacco (including with flavoring additives), filters and cartridges for small-scale industrial production of illegal cigarettes also appeared on sale.

Therefore, despite the annual increase in excise tax rates on tobacco products by 20%, in 2022, revenues from it to the state budget decreased for the first time in recent years - to UAH 58.9 billion from UAH 63.4 billion in 2021.

Next year they should grow to 87.3 billion hryvnia. This is almost the same amount as the state budget will receive from the redirection of “military personal income tax” to the production of drones and projectiles. But the planned state budget revenues from the excise tax on cigarettes may be in question due to the growth of the illegal market.

However, the Chairman of the Verkhovna Rada Committee on Finance, Tax and Customs Policy, Daniil Getmantsev, assures that excise tax revenues are growing, despite the increasing share of illegal products on the market. According to him, legal production of cigarettes returned to the level of 2021, and excise tax revenues from tobacco products in January-November 2023 increased by 41.8%, or by UAH 21.9 billion, compared to the same period last year.

“Based on the results of 2023, we expect excise tax revenue from tobacco products in the amount of UAH 80.3 billion, which will ensure the fulfillment of the revenue indicator (UAH 70.62 billion) by 113.7% (plus UAH 9.7 billion). According to preliminary calculations and taking into account the dynamics of production and import of tobacco products, there is no risk of not meeting the 2024 targets in the current situation,” Getmantsev is convinced.

Why is the black market for cigarettes growing?

The share of direct taxes in the retail price of a pack of cigarettes reaches 70-80%. This is an excise tax (which has been growing by 20-30% annually since 2017), 5% excise tax on retail sales and 20% VAT.

In addition, legal producers pay corporate income tax, military and labor taxes, as well as other taxes and fees. Participants in the illicit market avoid paying all or most of these fees. This makes the illegal tobacco business extremely profitable.

Data from the report of the Temporary Investigative Commission of the Verkhovna Rada on the investigation of possible violations of legislation that could lead to a decrease in revenues to the state and local budgets (VSK on economic security) indicate that some local tobacco manufacturers sometimes pay tens of times less taxes than international companies .

Thus, companies with foreign investment pay an average of 3-4 million hryvnia in taxes per 1 ton of raw materials received. At the same time, Tax Service data show that five local manufacturers who imported raw tobacco to Ukraine in 2023 paid from 0 to 67 thousand hryvnia in taxes per ton.

The most common types of illegal products on the Ukrainian market are cigarettes with signs of counterfeiting and products that are intended for sale in the duty-free zone (with the inscription Duty Free) or for export and are sold illegally in Ukraine.

According to the latest data from Kantar Ukraine, over the past six months, both the share of counterfeit tobacco products on the Ukrainian market has increased (from 6.9% to 11.3%) and the share of so-called “fake Duty Free” cigarettes (to 12.9% from 10. 9% in June 2023).

The research data shows that 26% of counterfeit cigarettes were produced by the Ukrainian Tobacco Production and United Tobacco companies, and have signs of counterfeit excise stamps.

The remaining 74% of counterfeit cigarettes are counterfeit brands of international tobacco companies that do not have excise stamps at all.

At the same time, the chairman of the Verkhovna Rada Committee on Finance, Tax and Customs Policy, people’s deputy from the Servant of the People, Daniil Getmantsev, announced the cessation of the work of the United Tobacco factory a year ago, calling it “a landmark victory over the “Russian world” in the battle in Zheltye Vody "

Now Getmantsev claims that despite the appearance on sale of products indicating the manufacturer “Unidet Tobacco”, the factory in Zheltye Vody is not operating.

“As of today, this enterprise does not carry out production activities. The equipment is under control and is not in use,” the deputy assured.

At the same time, 72% of illegal tobacco products marked Duty Free or intended for export have an inscription stating that their manufacturer is the Vinnikovsky Tobacco Factory.

In March, the State Bureau of Investigation (SBI) conducted searches at this factory. 1.6 million packs of cigarettes without excise stamps were found at the manufacturer’s warehouse, but further results of these searches were not reported.

What are the dangers of illegal cigarettes?

VSK Chairman for Economic Security Yaroslav Zheleznyak admits that despite appealing to law enforcement officers, it is not possible to reduce the volume of illegal production and sale of cigarettes.

“We have transmitted points of sale and specific data on factories that produce illegal products many times... In short, nothing happened. Law enforcement officers cover it all up, and the story leads to specific people in power. Every illegal factory operates under the “roof” of these people,” states the deputy.

According to him, there are also cases when law enforcement officers cancel the seizure of large quantities of illegal cigarettes, allegedly for their transfer for the needs of military personnel, but in the end they end up being sold again on the “black market.”

The main article of the Criminal Code, dedicated to the fight against the illegal production of illegal tobacco products (Article 204 of the Criminal Code “Illegal production, storage, sale or transportation for the purpose of selling excisable goods”), refers to the jurisdiction of the Bureau of Economic Security, which has not yet begun full-time job. Rebooting the BEB is one of Ukraine’s important obligations to international partners.

“In general, until we reboot the BEB, which should deal with this normally, nothing will happen,” Zheleznyak is sure.

Economist and coordinator of expert groups of the Economic Expert Platform Oleg Getman agrees with him. However, in his opinion, the work of the VSK was able to mobilize law enforcement agencies.

“The heads of the Tax Service, Customs and National Police were called. They were forced to report some good news at its meetings. Accordingly, orders were sent to the regions and the police actually closed the points that sold counterfeit goods. As soon as the service life of VSK began to end, the indicators began to deteriorate sharply,” says Getman.

He notes that from the beginning of 2023, the legal production of cigarettes in Ukraine began to recover, however, after a decrease in the attention of law enforcement officers in the fourth quarter, this trend reversed.

“But in any case, this is “manual control,” so it is extremely important to finally reboot the Bureau of Economic Security with the participation of international partners, and do the same with the Internal Revenue Service. Then, without temporary commissions and without manual control, law enforcement agencies will work normally, but until then we will have negative results,” the expert adds.

The head of the Tax Committee of the Rada, Daniil Getmantsev, believes that the already adopted changes to the legislation will reduce the share of the “black market” in the near future.

“The Kantar study conducted in October demonstrates the high level of operation of the so-called Duty Free scheme, which was still operating due to the fact that Law No. 3326, by which we prohibited such activities, had not yet entered into force,” says Getmantsev.

According to him, this scheme was used by some companies that have official licenses. The cessation of the work of other participants in the “black market” directly depends on the effective work of law enforcement officers.

“There are generally illegal productions, clandestine workshops that fill the market with cheap products, which must be dealt with by law enforcement agencies,” added Getmantsev. In his opinion, some of the schemes will help close the adoption of amendments developed together with business to Law No. 481, which, among other things, regulates production and turnover of tobacco products.

Raising excise taxes instead of fighting the “shadow”

In 2024, the excise tax on tobacco products is scheduled to increase by another 20%. According to Oleg Getman, this will increase revenues to the state budget, however, the shadow market will also grow.

“Of course, raising the excise tax will increase the shadow share. Perhaps our legislators believe that these are acceptable losses,” the expert believes.

The European Business Associations call on the Office of the President to fulfill the promise given to business in the summer to actively fight the “shadow”, uniting the efforts of all responsible law enforcement and regulatory structures - the Tax Service, the Prosecutor's Office, the National Police, the Security Service of Ukraine, and also to ensure a full reform of the Bureau of Economic Security.

The American Chamber of Commerce (ACC) also states that in 2023, legal businesses have not seen an effective fight against the illegal tobacco market. At the same time, authorities are trying to complicate the operating rules for legal players.

“During this year, the tobacco industry observed how various kinds of legislative initiatives appeared one after another, such as: ensuring the traceability of excisable products, a ban on the display of legal products, state regulation of the production and turnover of excisable products, another increase in excise taxes for legal products and other legislative innovations , which only complicated the activities of legal businesses and did not at all eliminate the shadow sector,” the ACC notes.

The American Chamber of Commerce called on government officials to immediately strengthen efforts to identify and suppress the activities of illegal tobacco manufacturers. After all, the shadow market not only distorts competition and harms honest businesses, but also reduces state budget revenues.

“In the context of a full-scale war, insufficient filling of the state budget and a slowdown in economic and military assistance from international partners, the growth of the shadow sector of the economy, according to business representatives, is unacceptable,” the ACC notes.

At the same time, it is worth noting that the Strategy for combating the illicit production and trafficking of tobacco products for the period until 2021, adopted back in 2017, has ceased to operate without achieving its goals. Since then, a new state action plan in this area has not yet been adopted.

Consequently, due to the lack of a systematic policy and the growth of the “shadow market” of tobacco, the state is unable to achieve any of its goals - neither increasing state budget revenues nor reducing the prevalence of smoking. In addition, the “black market” fuels the development of crime and corruption in law enforcement agencies, and also leads to a deterioration in the working conditions of legal producers, which further impacts the economy and tax revenues.