Public consultation Excise duties … & Customs Union...Device: £20 –£25 ... 1,529 13 1,272 12...

Public consultation – Excise duties applied to manufactured tobacco

PwC Perspective -Supporting Document

February 2017

www.pwc.co.uk

PwC

Executive Summary: E-cigarettes are not tobacco products, and therefore should not be considered for the directive

• There are a number of emerging characteristics in the nascent Vapour (electronic cigarette) consumer category

Category growth is largely due to the appeal of a smoking cessation product with a significantly reduced harm profile

The fragmented nature of the category and low barriers to entry have driven rapid innovation and product improvement

The category lends itself to non-traditional distribution channels, which have also aided growth

• Despite early growth and a clear consumer need for reduced risk nicotine products, the Vapour category continues to display a high price elasticity of demand that limits government excise revenue opportunities

Vapour price elasticity is higher than factory made cigarettes on account of the still-evolving product experience

Any future excise burden on the emerging Vapour category threatens to reverse category growth, while not offering a significant return for the government

• Furthermore, the costs arising from excise collection, policing illicit markets and administration would be disproportionately high given the complex and fragmented nature of the category

Vapour would present a number of challenges for excise enforcement on account of the fragmented category landscape

Excise on Vapour products would risk creation of an illicit market and an increase in illicit cross border trade

Administrative complexity and policing of the category would likely lead to a disproportionately high cost of collection

• Rather than impose excise at this early stage of category maturity, we believe that regulatory authorities should rather focus on targeted product regulation that would encourage organisation and formalisation of the category

2

E-cigarette excise would be premature at this stage, the reasons for which are detailed in this paper:

PwC

Agenda

1. Introduction to the Vapour category and its emerging characteristics

2. Government revenue potential of Vapour excise

3

PwC

1. Introduction to the Vapour category and its emerging characteristics

PwC

Nicotine Category Landscape

Tobacco basedNon-tobacco based

Combustible Non-combustible

Factory Made CigarettesSmall cylinders of tobacco leaves rolled in thin paper are ignited, releasing smoke that is inhaled through a filter

Snus & Smokeless Tobacco

Smokeless tobacco allows nicotine and tobacco flavours to be absorbed orally

Electronic Cigarettes (Vapour)

Electronic cigarettes, or e-cigarettes, produce an aerosol that is generated by an electric heating element. This vaporises a liquid formulation, often referred to as an e-liquid, which typically contains nicotine and other flavourings. Commonly, an LED light is lit when the device is used. E-cigarettes do not contain tobacco

Nicotine Replacement Therapy (e.g. Patches)

Medically-approved method of taking nicotine, usually used to help quit smoking or other more harmful tobacco-based products. Typical forms include patches, gums and sprays

Small Cigars / CigarillosShort, narrow cigars where tobacco leaves are wrapped in brown tobacco-based paper. Usually without a filter

CigarsTightly rolled bundle of dried tobacco leaf which is ignited. Does not contain filter, meaning a strong taste

Water PipesUses a single or multi-stemmed instrument where a coal is burned to vaporise flavoured tobacco via a water basin

Tobacco Heating Products

Heats tobacco to a temperature sufficient to vaporise nicotine into inhalable aerosol

The nicotine landscape is highly fragmented across a number of different platforms and product formats

5

Nicotine category landscape – An overview

PwC

Relative harm profileWeighted score, Scale from 0 – 100

Compared with other platforms in the nicotine space, e-cigarettes are recognised to have a reduced harm profile

6

1.03.4

15.9

67.0

99.6

0

10

20

30

40

50

60

70

80

90

100

E-cigarettes PatchesFactory Cigs. Cigarillos SnusCigars Water Pipes

~5

~13

• Different nicotine delivery products assessed and given a weighted harm score across set of criteria (including product-related mortality, dependence, injury, crime, environmental damage and economic cost)

• Electronic cigarettes (Vapour products) are shown to have a ~95% reduced risk relative to factory made cigarettes

Source: “Estimating the Harms of Nicotine-Containing Products Using the MCDA Approach” (Nutt et al.), PwC research

Nicotine products – Relative harm profile

PwC

Vapour currently has a fragmented category landscape, with different product formats available to consumers

7

Disposable Rechargeable Tank Modular Full Modular

Current Product Formats

ProductFeatures

• Easy to use and carry• Readily available• Short product lifetime

• Easy to replace refills• Reusable, with a limited

selection of consumables

• Requires some productfamiliarity and initiation

• Customisable experience

• Customised experience with sufficient technical knowledge

Price Point(UK)

Device: ~ £5 Device: £10 – £201

Consumable: ~ £3 each

Device: £20 – £25Consumable: ~ £5 – £7 per

bottle

Device: ~ £100 (in total) Consumable: ~ £5 – £7 per

bottle

EU MarketShare and Value2

(2016)

2% (£0.04bn) 8% (£0.2bn) 90% (£2.2bn)

Degree of customisability

Summary of current Vapour market

1) Some artisanal, premium vaping devices (e.g. Juul) retail at higher price points (~£30 per device)2) Including device and consumablesSource: Euromonitor, PwC research

PwC

The category has shown high growth rates across a core set of European markets

8

EU Vapour market size2010-2015, £mn (constant ’15 rates)

UK

ITA

POL

FRA

GER

Other

15

1,956

14

1,529

13

1,272

12

760

11

312

10

109

Five core EU markets (UK, Italy, Poland, France and Germany) comprise ~35% of global Vapour revenues

Vapour growth since 2010 – EU markets

1) According to the standards set by the EU in the Tobacco and Related Products Regulations in 2016, e.g. maximum tank size of 2ml and e-liquid nicotine concentration of 20 mg/mlSource: Euromonitor, PwC research, PwC analysis

2016 is expected to show a slower rate of growth on account of the increased levels of regulation1 in e-cigarettes

PwC

There are three primary factors that have supported category growth:

9

Vapour offers smokers a reduced risk pathway to tobacco cessation while satisfying core needs

1

The fragmented nature of the category is driving rapid innovation across the value chain, from manufacturers to retailers

2

The category lends itself to non-traditional distribution channels, such as direct-to-consumer online sales

3

PwC

Findings from Action Smoking and Health (ASH) Report: “Use of electronic cigarettes among adults in Great Britain” – May 2016

• Users evenly divided between smokers (51%) and ex-smokers (47%)

• Only 4% of users have never smoked, indicating limited gateway into the nicotine category

• Of the ‘never smoked’ group in the UK, 2% have tried e-cigarettes with only 0.2% converting to regular use

Findings from Public Health England Report: “E-cigarettes: an evidence update” – August 2015

• Most common reasons for usage linked to smoking cessation (2014 survey of Vapour users, n=505)

• 80% of respondents indicated electronic cigarettes use aimed at reducing number of cigarettes smoked, 79% indicated use might help cessation

• Trial due to curiosity less likely to lead to regular use than trial for cessation or harm reduction reasons

In the UK, growth has primarily been driven by smoker migration to Vapour

10

Electronic cigarette incidence among adult ex-smokers and never smokers in UK2012-2016, % of respondents

0

5

10

15

20

2012 2013 2014 2015 2016

0.2%

2.0%

8.4%

18.8%

Ex-Smokers Current Use

Ex-Smokers Current Trial

Never Smoked Current Use

Never Smoked Trial

There is only 0.2% vaping incidence in the UK from the ‘never smoked’ group

Source: Public Health England, Action Smoking and Health (ASH)

Pathway to smoking cessation | Category fragmentation | Distribution channels

PwC

Proportion of respondents to have trialled e-cigarettes, EU

Importance of reason to use e-cigarettes, current users, EU % of respondents

Across the EU, growth is driven by current or ex-smokers who enter the category to reduce tobacco consumption

11

Findings from European Commission Report “Attitudes of Europeans towards tobacco and e-cigarettes” – May 2015

A survey conducted across all 28 EU Member States revealed following:

• In 2015, 12% of all Europeans had used e-cigarettes compared to 7% in 2012

• 31% of current smokers in the EU have tried e-cigarettes (see opposite), compared to only 3% of the never smoked group

• In 24 States, the most common factor for e-cigarette use was to stop or reduce tobacco consumption

• Two thirds of users said that stopping or reducing smoking is an important factor

• Only 24% cited the attractiveness of Vapour as an important reason

• France had the highest proportion of respondents to have tried e-cigarettes (21%)

67 %

29%

7 2%

24%

Consider E-cigs as fashionable

4%

Stop / reduce smoking

4%

ImportantNot ImportantDon’t Know

11%

Ex-smoker Never smokedCurrent smoker

31%

3%

Only 3% of the never smoked group have ever used e-cigarettes

Source: European Commission Special Barometer 429 (May 2015), PwC analysis


PwC

Current vaper satisfaction levels from e-cigarettes compared with smoking, UK2014 and 2016, % of respondents

Perception of harm from e-cigarettes relative to smoking among current smokers, UK2016, % of respondents

The majority of smokers perceive vaping to offer reduced harm while still satisfying core needs…

12

37 %

22%12%

33%

27 %

26%

7 %

23%

25%

18%26%

36%

Never Vaped

1%

Ex-Vaper

1%

Current Vaper

5%

Completely harmless

A lot less harmful

Less harmful

More / equally harmful

Don’t know

> 70% of smokers who vape perceive Vapour as reduced harm

55

28

18

45

2926

0

10

20

30

40

50

60

70

80

Less satisfyingEqually satisfyingMore satisfying

%

20162014

Vapour product satisfaction has improved since 2014

In 2016, over half of users believed vaping to be more

or equally satisfying as smoking

Source: ASH, PwC analysis


PwC

Brown et al. (2014) – “Real-world effectiveness of e-cigarettes when used to aid smoking cessation: a cross-sectional population study”

Background: Cross-sectional study, representative population sample of N=5,863 smokers with at least one quit attempt in past 12 months

Results: Respondents who used e-cigarettes showed a higher rate of quitting than those using NRTs or no aid

Self-reported quitting rate by sample group

Bullen et al. (2013) – “Electronic cigarettes for smoking cessation: A randomised controlled trial”

Background: 13 week trial, N=657 randomized (289 nicotine e-cig, 295 patches, 73 placebo e-cig), plus telephone counselling

Results: 6 months post treatment verified abstinence: 7.3% for nicotine e-cigarettes, 5.8% patches, 4.1% placebo

Quitting rates by sample group

Biener et al. (2015) – “A longitudinal study of electronic cigarette use among a population-based sample of adult smokers…”

Background: Population-based survey of two US metro area adult smokers, n=695 (51% response rate), telephone interviews in 2011/12 and 2014

Results: Daily e-cigarette users are six times more likely to quit than non users, while non-daily e-cigarette users displayed reduced motivation to quit

Relative likelihood of quitting smoking among e-cigarette users

… and some studies show Vapour to be superior to Nicotine Replacement Therapy products (NRTs) in aiding cessation

13

1 2 3

No aid

15.4%

NRT

10.1%

E-Cig

20.0%

Placebo

4.1%

Patches

5.8%

Nic. E-Cig

7.3%

Daily usersNon-daily users

6x

Effectiveness of Vapour devices for smoking cessation – Academic literature examples

Source: Systematic review on the effectiveness of vapour devices for cessation, Malas et al. (2016), University of Victoria, PwC research


PwC

This is in spite of e-cigarettes not being given the reduced rate of VAT often awarded to smoking cessation products

14

E-cigarettes could be deemed to be smoking cessation products, which are typically subject to a reduced rate of VAT

EU Law on Reduced Rate – The Principle VAT Directive 2006/112/EC includes:

“Pharmaceutical products traditionally used for health care, prevention of illnesses and as treatment for medicinal and

veterinary purposes”

It is up to individual EU Member states to define what this applies to on a country by country basis

E-cigarettes with smoking cessation product profiles should arguably be subject to reduced rates of consumption tax (VAT) in order to encourage consumer adoption

Source: HMRC, Dutch Medicines Act, PwC research

UK

Under Annex III, a reduced rate VAT of 5% is applied for ‘smoking cessation products’, defined under s.7a Group 11 of the VAT act in 1994 as ‘pharmaceutical products designed to help people to stop smoking tobacco”. This includes patches, gums and inhalators that are sold for the primary purpose of helping people to stop smoking

Netherlands

Smoking cessation products such as patches and gums are subject to the reduced VAT rate of 6%. Although e-cigarettes currently do not fit under the scheme, a recent supreme court case has ruled sunscreen and toothpaste as medicines provided that they are (i) presented as medicines; (ii) assisting the prevention of disease dysfunction and pain, and (iii) the packaging makes such use clear to the ‘average consumer’


EU reduced rate VAT examplesVAT implications for cessation products

PwC

Vapour device use has also been shown to reduce tobacco prevalence among younger cohorts

15

Friedman (2015) et al. – “How does electronic cigarette access affect adolescent smoking?” (USA)

Background: Regression analysis comparing smoking rates of adolescents in US states with and without bans on vaping device sales to youth. Rates of decline in tobacco use of 12-17 year olds was measured from 2003 to 2013

Results: States1 with bans on e-cigarette sales to minors had a statistically significant2 100 basis point increase in the recent smoking rate among 12 – 17 year olds relative to states with no such ban, negating over 77% of the downward trend:

Smoking rates among 12-17 year olds: States with vs. states without e-cigarette ban

1 Dautzenberg et al. (2015) – “The e-cigarette disrupts other consumptions in Parisian teenagers (2012-2014)”

Background: Cross-sectional survey among Parisian teenagers (N=3,279) ages between 12-19, comparing tobacco and e-cigarette prevalence rates in 2012 vs. 2014

Results: Over the two year period, the decline in tobacco use coincided with a rise in the rate of vaping device trial for both the 12-15 and 16-19 year old ages groups

Tobacco and Vapour prevalence rates among Parisian teenagers, 2012 vs 2014

2

-1.3%

States not to impose ban

-1.3%-1.3%

-77%

States to impose ban

-0.3%

After BanBefore Ban

Vapour

26%

8%

Tobacco

15%11%

2012 2014

12-15 year olds 16-19 year olds

Tobacco

12%

48%

39%

Vapour

34%

Vapour device use and smoking cessation among youths – Academic literature examples

1) As of January 2014, twenty-four US states had banned e-cigarette sales to minors 2) Adjusted R-square = 0.922Source: University of Victoria, PwC research


PwC

Limited category familiarity

• No established product structure to enable consumer navigation of the category

• Power and value from the role of ‘category curator’ – through physical presence or informative ecommerce sites

• Lack of established demand level increases organised retail power

Low consumer brand loyalty

• High levels of consumer experimentation, fast pace of product change and variable access to the product mean a low level of consumer loyalty

• Limited opportunities to leverage existing tobacco supplier / channel relationships to build brand recognition

Device and e-liquid manufacturing

• Pace of technological innovation is the key source of competitive advantage rather than scale or efficiency

• Viable and cost-effective to manufacture e-liquids in small quantities

• Differentiation through product quality and taste

Low levels of regulation

• Low level of product regulation currently enforced by the Tobacco Products Directive (TPD), costing just £150 to legally register a e-cigarette product in the UK1

• The UK MHRA has received close to 30,000 e-cigarette product registrations for the UK market from over 250 players

The Vapour category is characterised by low barriers to entry, leading to a high degree of fragmentation

16

Driving forces behind low barriers to entry and fragmentation

Category Fragmentation


1) Electronic Cigarettes (Fees) Regulations (2016), Tobacco Products DirectiveSource: PwC research

PwC

This fragmentation has helped to drive rapid innovation across the value chain

17

• Early device technology pioneered by smaller engineering companies (e.g. Joyetech)

• Atomiser technology advanced rapidly to hold more e-liquid;clearomisers became the industry standard in 2011

• Flavours of e-liquids have grown to over 1,500 different varieties1

Major Players

Inno-vation

Examples

R&D and ManufacturingSales, Marketing and

WholesaleRetail

• High number of brands, comprised of both independent companies as well as the “Big 4” players

• Large vendors frequently acquire smaller companies to grow market share inorganically, e.g. Imperial’s acquisition of Blu® from Lorillard

• More than 200 e-cigarette vendors in the US with over 5,000 stores2

• Role of physical stores and online channels for the distribution of nicotine is evolving

• Consumer data provides opportunities for collaboration between retailer and manufacturer

Innovations in the Vapour value chain

1) Approximate number of discrete flavours available at Vape Club 2) Technavio: E-cigarette Market in the US 2015-2019Source: Technavio, PwC research


PwC

The category also lends itself to non-traditional distribution channels, including online sales

18

Vape Club

Direct-to-consumer distribution of e-liquids, tanks, kits, coils and batteries. Focuses mainly on artisanal brands and products

House of Vapes

Vaping shop / coffee lounge with 4 locations across London. Wide range of artisanal e-liquids from a variety of independent suppliers, consumed in store

Vapebox

Subscription-based service in the US. Customers tailor their preferences which are used to curate a bespoke box of vaping products, shipped directly to the consumer

Sale through online channels that is permitted by regulation

Specialist store formats that present non-traditional propositions for consumers

Subscription-based distribution models that allow user customisation

ExamplesDrivers of distribution channel evolution

Source: PwC research


1

2

3

Examples of channel formats

PwC

Purchase channel primarily used in the seven largest Vapour markets1 (excluding the US and China)Percentage of e-cigarette users, 2015

5655

1112

21

35

54556

10

25

40

0

5

10

15

20

25

30

35

40

%

TobacconistOnlineSpecialist shop

OtherNewsagentChemistKioskSupermarket

In the largest Vapour markets, the most common purchase channels are specialist shops and online

19


RefillsDevices

1) Seven largest vaping markets outside the US and China by revenue: France, Germany, Italy, Poland, Russia, Korea and UK Source: Kantar

More traditional supermarket channels do not have the variety of refill flavours available online

Online channels well suited to subscription-based models and independent, artisanal brands

PwC

2. Government revenue potential of Vapour excise

PwC

Despite recent growth, there are two reasons why Vapour excise does not offer much government revenue potential

21

Vapour price elasticities of demand are currently too sensitive to support both category growth and government revenue opportunities

1

The fragmented and complex nature of the category may lead to enforcement challenges and a disproportionately high cost of collection

2

PwC

The price elasticity of demand (η) is equal to % change in quantity demanded divided by % change in price. For example, for a product with an elasticity of -1.0, a 10% increase in price would result in a ~10% fall in volume, assuming a demand curve of the form:

Vapour price elasticities of demand are sensitive due to the still-evolving product experience

22

Price Elasticity of Demand is a measure of the relationship between a change in the quantity demanded of a particular good given a change in its price

Price

Quantity

ΔV

ΔP

P0

V0 V

P

η = −% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦

% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒

Vapour is a growing category in most markets, meaning it is currently difficult to arrive at an accurate estimate of its true price elasticity of demand

Some academic papers have attempted to estimate the price elasticity of demand for e-cigarettes, most notably Huang et al. (2014). A study of the US market applied a fixed-effects model to estimate own and cross price elasticity of demand for e-cigarettes. The study found e-cigarette prices to be very responsive to price changes, with a higher price elasticity of demand than for conventional cigarettes

Vaping elasticities are higher than tobacco on account of the still-evolving product experience: in 2015, 12% of Europeans had at one point tried e-cigarettes, with 2% converting to regular use. The needs of a smoker are not yet entirely fulfilled by the e-cigarette experience

Nicotine Platform Price Elasticity (η)

Disposable e-cigarette -1.2

Rechargeable e-cigarette -1.9

Source: Huang et al. (2014), European Commission Special Barometer 429 (May 2015), PwC research, PwC analysis

Price elasticity | Complexity and cost of collection

PwC

The case studies of recent excise moves in Portugal and Italy demonstrate high price elasticity for Vapour

23

Portugal introduced a Vapour excise in 2015 set at €0.60 per ml of e-liquid:

Consumption of e-liquid volumes fell by an estimated 92%, while the government only generated an estimated €1.3 million from the excise. The tax has since been reduced on e-liquids by 50% to €0.30 per ml, potentially due to lack of revenue

Portugal

Italy introduced a Vapour excise in January 2014 set at €0.37 per ml of e-liquid:

E-liquid consumption fell by an estimated 50% following the price increase, which generated only €3 million in revenue. There is an understanding that revenue collection was challenged as consumers looked to cross border purchases. There are also legal challenges with excise imposition2

Italy

2013

0.60

0.97

0.60

0.37

2014

Excise

+62%

Pre-tax price

Price per ml e-liquid (€)

E-liquid Volume1

(000’s litres) -50%

2014

716

432

2012 2013

357

Estimated Vapour Price Elasticity3: -1.39Estimated Vapour Price Elasticity3: -1.72

0.90

0.30

2015

0.60

Pre-tax price

Excise

2014

0.30

+200%-92%

10.3

0.8

2014 20152013

0.3

Price per ml e-liquid (€)

E-liquid Volume1

(000’s litres)

1) Volume of e-liquid estimated by dividing the total e-liquid market size by average price per ml 2) In 2013, the Italian government proposal for a 58.5% tax on e-cigarettes was blocked by the Italian Supreme Court for giving unconstitutionally broad discretion3) Arc price elasticity of demand calculated according to the formula η = ((Q1 – Q0)/(Q1 + Q0))/((P1 – P0)/(P1 + P0))Source: Euromonitor, ECigIntelligence, European Commission, Expert interviews, PwC research, PwC analysis


PwC

Estimated e-cigarette sales pre and post introduction of excise in Minnesota July 2012 – December 2013

The case study of Minnesota, USA, corroborates the view that Vapour consumers are currently very price elastic

24

20

15

10

5

0

30

25

E-cigaretteunits sold

(000’s)

July2013

July2012

St Louis, MissouriMinneapolis, Minnesota

Excise Rate: 95% ad valorem tax on all products containing tobacco derivatives

In Minnesota, tobacco excise and tax is set at 95% of the wholesale cost of any product containing or derived from tobacco. As most e-liquids contain nicotine derived from tobacco, they are not eligible for a tax waiver and are subject to the full 95% rate

The expansion of tobacco excise to cover e-cigarette products containing nicotine resulted in a collapse of the e-cigarette market in Minnesota and a likely increase in cross border trade

The resulting negative effect in the market caused a drop in sales of ~20,000 e-cigarette units (66%) in Minneapolis. In St. Louis, a Vapour market of comparable size to Minneapolis that does not have an excise tax, sales remained relatively flat

Minnesota excise on e-cigarettes

Vapour excise in Minnesota introduced in July 2013

Source: Tax Foundation: Evaluating an Excise Tax on Electronic Cigarette Consumption, Tobacco Regulatory Science, Volume 2, Number 2, April 2016, PwC research


PwC

1) Excluding Portugal and Italy, whose markets have already seen excise on e-liquids 2) Volume of e-liquid estimated by dividing the total e-liquid market size by price per ml3) Estimated by taking the weighted average prices of e-liquids across the 5 core EU markets (UK, Germany, France, Italy, Poland)4) Public health opportunity arising from 95% reduced harm profile of e-cigarettes vs. factory made cigarettes, according to Public Health EnglandSource: Euromonitor, Vapebase, PwC research, PwC analysis

A 20 – 50% price increase on e-liquids in the EU due to excise could result in a ~£130 – 330mn loss of industry value

25

E-liquid volumes2,

(000’s litres)

Weightedaverage price

per ml3 (£)

E-liquid market size (£mn)

Loss of e-liquid industry value

(£mn)

One-off government

revenue

Without Vapour Excise

3,410 0.39 1,340No industry value would be lost with

0% excise-

With 20% Vapour ExcisePrice elasticity of demand = -1.55

2,570 0.47 1,212 (128)£7.2mn per

member state

With 50% Vapour ExcisePrice elasticity of demand = -1.7

1,712 0.59 1,009 (331)£12mn per

member state

EU Vapour market1 – E-liquid excise scenarios


Our analysis suggests that e-liquid volumes would nearly halve under a 50% excise, significantly impacting a public health opportunity4

PwC

Excise enforcement could be challenged by the fragmented nature of the category

26

Global Vapour market share by manufacturer 2016 (stock tickers shown)

51

16

1098

41

0

10

20

30

40

50

60

%

OthersRAIIMBBATJTMOPMI

The big tobacco players make up 49% of the global

Vapour market

Major tobacco companies comprise less than half of the Vapour market by value, with 51% made up of smaller, artisanal players. Between 2012-2014, a study showed the number of E-Cigarette brands increased from 288 to 4661

For this reason, enforcement, registration and collection of tax will likely be very difficult from both a practicality and avoidance standpoint

Creating a framework that only larger manufacturers are likely to adhere to would distort competition. The larger producers would generally comply, whereas it would be more difficult to track the registration of smaller players who could sell at a lower price point or reap higher gross margins

For example, in a survey conducted on the 11 EU member states to have outlawed sales of e-cigarettes online2, only 2 of 33 websites had ceased online trading, proving the administrative challenges of enforcing laws on smaller players

In comparison, the alcohol, oil and tobacco industries are comprised of fewer and less artisanal players, meaning less administrative complexity in excise collection

Challenges with excise enforcement

1) “Four hundred and sixty brands of e-cigarettes and counting: implications for product regulation” (Shu Hong Zhu et al., May 2014) 2) Survey conducted by ECigIntelligence in May 2016Source: ECigIntelligence, Goldman Sachs, PwC research


PwC

In addition, imposition of excise may give rise to an illicit market and an increase in cross border trade

27

Annual excise collected vs. excise avoided (£bn and % of total) Alcohol 2005-2016 estimate; Tobacco 2015 estimate

1.2(10%)

10.5(90%)

Illicit trade presents a potential problem given the fragmented category landscape and the various excise regimes that exist for different product types. In the UK, HMRC reports that alcohol duty fraud costs the taxpayer around £1.2bn a year1, around 10% of the total duty that should have been received

The e-cigarette market is more fragmented than the alcohol market, so by comparison it is reasonable to expect a higher level of avoidance. As nicotine can be supplied at high concentration in small containers and purchased through different distribution channels, we would expect a greater level of excise duty evasion and cross border trade

In recent years, the UK has seen an increase in the amount of non duty paid tobacco, with cross border trade and counterfeit cigarettes now comprising almost 30% of the market (vs. 17% in 2011)

Given that the e-cigarette category is more fragmented than alcohol and tobacco, excise is likely to drive high levels of avoidance and illicit cross border trade

Excise avoidedExcise collected

Illicit and cross border trade risks – UK alcohol and tobacco markets

1) Based on a 2011 report by HMRC: “Tackling tobacco smuggling: building on our success”, updated for 2015 using input from expert interviewsSource: UK Government, Expert Interviews, HMRC, PwC research, PwC analysis

9.5(72%)

3.7(28%)

UK Alcohol Market UK Tobacco1 Market


PwC

Both the taxable commodity and method of taxation pose significant challenges and risks for excise administration

28

Taxable Commodity

Method of taxation

Administration challenges Likely industry / consumer response

E-liquid% Nicotine

Multiple e-liquid concentrations currently available on the market, which would all need to be covered by arbitrary excise tiers based on nicotine strength

• Higher levels of cross border illicit trade• Consumers may self mix highly

concentrated nicotine with zero nicotine liquids, creating unsafe consumption levels

Per ml liquidPotential problems may arise as new formats of nicotine-containing substances (e.g. gels, crystal salts) come onto the market

• Innovation would tilt towards less provenproduct formats, leading to potential slowdown of category growth

• Public health benefit would suffer on account of slower product development

Device

Per device

Vast array of devices and components available, which would pose a significant administrative challenge to register each individual product

• Pricing models would adapt in order to minimise exposure to excise treatment

• Manufacturers may reduce device prices but charge more for consumables

Taxable commodities and methods in Vapour


Significant challenges exist with all taxable commodity options

PwC

As a result of these administrative complexities, the cost of collection for Vapour excise may be disproportionately high

Cost of collection of UK excise (pence per £1 collected)

29

Cost of Collection – incorporates the cost of registering tax payers, administering the charge to excise duty, reporting and collection of the excise duty plus standard and illicit trade enforcement

• Before an excise is imposed, cost-benefit analysis of the creation and enforcement of an e-cigarette excise duty must take place across the EU

• Figures on the cost of collection of excise duties are rarely published – if they are, they often do not take into account the initial set up costs for each country to establish the new excise duty regime

• In the UK, the cost of collection for tobacco excise is ~0.7p per £1 collected. Total collection of the excise was around £9.5 billion, meaning total cost of collection is estimated at ~£65 million

• Administration costs due to the greater workload in assessing the multitude of products and producers in the e-cigarette market will likely result in a cost of collection significantly higher than alcohol and tobacco per £1 collected

Commodity 2011 2012 2013

Alcohol 0.43 0.38 0.41

Tobacco 0.72 0.70 0.70

Due to the added complexity arising from the fragmented

nature of the industry, Vapour excise cost of collection is likely to

be higher

Source: HMRC, PwC research


PwC

Overall, the costs associated with Vapour excise outweigh the limited government revenue potential

30

Excise costs

Excise revenue

Vapour excise decision balance

(illustrative)

• Current smokers restarting a full-time consumption habit and ex-smokers returning to tobacco as a result of an excise increase would have a significant impact on the EU public purse as a result of healthcare, social and societal opportunity costs, which we estimate could be over £700mn per year

• The costs of policing illicit trade would add an additional burden to EU Member states

• Furthermore, Vapour would likely incur a high cost of collection as a result of increased complexity vs. alcohol and tobacco excise administration

• Across the EU Member states, total potential revenue from applying a 20% excise to e-liquids amounts to ~£7mn per member state

• This is significantly below the ~£76bn revenue generated from tobacco excise and tax in the EU

• These estimates assume that excise is collected on all sales; in reality this will be much more challenging due to the fragmented market, channels and variable product formats

76

Tobacco E-liquids

0.2

Estimated EU government revenue

if e-liquids incur 20% excise (£bn)

Source: Public Health England, PwC research, PwC analysis

PwC

This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, PricewaterhouseCoopers LLP, its members, employees and agents do not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.

© 2017 PricewaterhouseCoopers LLP. All rights reserved. In this document, “PwC” refers to PricewaterhouseCoopers LLP which is a member firm of PricewaterhouseCoopers International Limited, each member firm of which is a separate legal entity.

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