Public consultation Excise duties applied to manufactured tobacco PwC Perspective - Supporting Document

Transcription

1 Public consultation Excise duties applied to manufactured tobacco Perspective - Supporting Document February 2017

2 Executive Summary: E-cigarettes are not tobacco products, and therefore should not be considered for the directive E-cigarette excise would be premature at this stage, the reasons for which are detailed in this paper: 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

3 Agenda 1. Introduction to the Vapour category and its emerging characteristics 2. Government revenue potential of Vapour excise 3

4 1. Introduction to the Vapour category and its emerging characteristics

5 The nicotine landscape is highly fragmented across a number of different platforms and product formats Nicotine category landscape An overview Nicotine Category Landscape Combustible Tobacco based Non-combustible Non-tobacco based Factory Made Cigarettes Small cylinders of tobacco leaves rolled in thin paper are ignited, releasing smoke that is inhaled through a filter Snus & Smokeless Tobacco Electronic Cigarettes (Vapour) Nicotine Replacement Therapy (e.g. Patches) Small Cigars / Cigarillos Short, narrow cigars where tobacco leaves are wrapped in brown tobacco-based paper. Usually without a filter Cigars Tightly rolled bundle of dried tobacco leaf which is ignited. Does not contain filter, meaning a strong taste Water Pipes Uses a single or multi-stemmed instrument where a coal is burned to vaporise flavoured tobacco via a water basin Smokeless tobacco allows nicotine and tobacco flavours to be absorbed orally Tobacco Heating Products Heats tobacco to a temperature sufficient to vaporise nicotine into inhalable aerosol 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 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 5

6 Compared with other platforms in the nicotine space, e- cigarettes are recognised to have a reduced harm profile Nicotine products Relative harm profile Relative harm profile Weighted score, Scale from ~13 Factory Cigs. Cigarillos Cigars Water Pipes Snus 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 ~5 3.4 E-cigarettes 1.0 Patches Source: Estimating the Harms of Nicotine-Containing Products Using the MCDA Approach (Nutt et al.), research 6

7 Vapour currently has a fragmented category landscape, with different product formats available to consumers Summary of current Vapour market Current Product Formats Degree of customisability Disposable Rechargeable Tank Modular Full Modular Product Features Easy to use and carry Readily available Short product lifetime Easy to replace refills Reusable, with a limited selection of consumables Requires some product familiarity and initiation Customisable experience Customised experience with sufficient technical knowledge Price Point (UK) Device: ~ 5 Device: Consumable: ~ 3 each Device: Consumable: ~ 5 7 per bottle Device: ~ 100 (in total) Consumable: ~ 5 7 per bottle EU Market Share and Value 2 (2016) 2% ( 0.04bn) 8% ( 0.2bn) 90% ( 2.2bn) 1) Some artisanal, premium vaping devices (e.g. Juul) retail at higher price points (~ 30 per device) 2) Including device and consumables Source: Euromonitor, research 7

8 The category has shown high growth rates across a core set of European markets Vapour growth since 2010 EU markets EU Vapour market size , mn (constant 15 rates) 2016 is expected to show a slower rate of growth on account of the increased levels of regulation 1 in e-cigarettes 1,956 1,272 1,529 Other GER FRA POL 760 ITA UK Five core EU markets (UK, Italy, Poland, France and Germany) comprise ~35% of global Vapour revenues 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/ml Source: Euromonitor, research, analysis 8

9 There are three primary factors that have supported category growth: 1 Vapour offers smokers a reduced risk pathway to tobacco cessation while satisfying core needs 2 The fragmented nature of the category is driving rapid innovation across the value chain, from manufacturers to retailers 3 The category lends itself to non-traditional distribution channels, such as direct-to-consumer online sales 9

10 Pathway to smoking cessation Category fragmentation Distribution channels In the UK, growth has primarily been driven by smoker migration to Vapour Findings from Action Smoking and Health (ASH) Report: Use of electronic cigarettes among adults in Great Britain May 2016 Electronic cigarette incidence among adult exsmokers and never smokers in UK , % of respondents Users evenly divided between smokers (51%) and exsmokers (47%) Only 4% of users have never smoked, indicating limited gateway into the nicotine category 20 There is only 0.2% vaping incidence in the UK from the never smoked group 18.8% Of the never smoked group in the UK, 2% have tried e- cigarettes with only 0.2% converting to regular use 15 Findings from Public Health England Report: E-cigarettes: an evidence update August % Most common reasons for usage linked to smoking cessation (2014 survey of Vapour users, n=505) 5 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 2.0% 0 0.2% Ex-Smokers Current Trial Never Smoked Trial Ex-Smokers Current Use Never Smoked Current Use Source: Public Health England, Action Smoking and Health (ASH) 10

11 Pathway to smoking cessation Category fragmentation Distribution channels Across the EU, growth is driven by current or ex-smokers who enter the category to reduce tobacco consumption 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 % 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%) Proportion of respondents to have trialled e-cigarettes, EU 31% Current smoker Importance of reason to use e-cigarettes, current users, EU % of respondents 4% 29% 67 % Stop / reduce smoking 11% Ex-smoker Only 3% of the never smoked group have ever used e-cigarettes 4% 7 2% 24% 3% Never smoked Consider E-cigs as fashionable Source: European Commission Special Barometer 429 (May 2015), analysis Don t Know Not Important Important 11

12 Pathway to smoking cessation Category fragmentation Distribution channels The majority of smokers perceive vaping to offer reduced harm while still satisfying core needs Perception of harm from e-cigarettes relative to smoking among current smokers, UK 2016, % of respondents Current vaper satisfaction levels from e-cigarettes compared with smoking, UK 2014 and 2016, % of respondents > 70% of smokers who vape perceive Vapour as reduced harm 18% 7% 33% 37 % 26% 23% 27 % 36% 25% 26% % In 2016, over half of users believed vaping to be more or equally satisfying as smoking Vapour product satisfaction has improved since % Current Vaper 22% 1% Ex-Vaper 12% 1% Never Vaped 10 0 More satisfying Equally satisfying Less satisfying Don t know More / equally harmful Less harmful A lot less harmful Completely harmless Source: ASH, analysis 12

13 Pathway to smoking cessation Category fragmentation Distribution channels and some studies show Vapour to be superior to Nicotine Replacement Therapy products (NRTs) in aiding cessation Effectiveness of Vapour devices for smoking cessation Academic literature examples 1 Brown et al. (2014) Real-world effectiveness of e-cigarettes when used to aid smoking cessation: a crosssectional population study 2 Bullen et al. (2013) Electronic cigarettes for smoking cessation: A randomised controlled trial 3 Biener et al. (2015) A longitudinal study of electronic cigarette use among a population-based sample of adult smokers 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 20.0% 15.4% 10.1% 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 7.3% 5.8% 4.1% 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 6x E-Cig NRT No aid Nic. E-Cig Patches Placebo Non-daily users Daily users Source: Systematic review on the effectiveness of vapour devices for cessation, Malas et al. (2016), University of Victoria, research 13

14 Pathway to smoking cessation Category fragmentation Distribution channels This is in spite of e-cigarettes not being given the reduced rate of VAT often awarded to smoking cessation products VAT implications for cessation products 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: UK EU reduced rate VAT examples 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 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 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 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, research 14

15 Pathway to smoking cessation Category fragmentation Distribution channels Vapour device use has also been shown to reduce tobacco prevalence among younger cohorts 1 Vapour device use and smoking cessation among youths Academic literature examples Friedman (2015) et al. How does electronic cigarette access affect adolescent smoking? (USA) 2 Dautzenberg et al. (2015) The e-cigarette disrupts other consumptions in Parisian teenagers ( ) 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 year olds was measured from 2003 to 2013 Results: States 1 with bans on e-cigarette sales to minors had a statistically significant basis point increase in the recent smoking rate among year olds relative to states with no such ban, negating over 77% of the downward trend: Smoking rates among year olds: States with vs. states without e-cigarette ban Before Ban After Ban -77% -0.3% Background: Cross-sectional survey among Parisian teenagers (N=3,279) ages between 12-19, comparing tobacco and e-cigarette prevalence rates in 2012 vs 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 and year old ages groups Tobacco and Vapour prevalence rates among Parisian teenagers, 2012 vs % year olds year olds 11% 8% 26% 39% 34% 12% 48% -1.3% -1.3% -1.3% States not to impose ban States to impose ban Tobacco Vapour Tobacco Vapour 1) As of January 2014, twenty-four US states had banned e-cigarette sales to minors 2) Adjusted R-square = Source: University of Victoria, research

16 Pathway to smoking cessation Category fragmentation Distribution channels The Vapour category is characterised by low barriers to entry, leading to a high degree of fragmentation Driving forces behind low barriers to entry and fragmentation 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 UK 1 The UK MHRA has received close to 30,000 e-cigarette product registrations for the UK market from over 250 players Category Fragmentation 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 1) Electronic Cigarettes (Fees) Regulations (2016), Tobacco Products Directive Source: research 16

17 Pathway to smoking cessation Category fragmentation Distribution channels This fragmentation has helped to drive rapid innovation across the value chain Innovations in the Vapour value chain R&D and Manufacturing Sales, Marketing and Wholesale Retail Major Players Innovation Examples 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 varieties 1 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 stores 2 Role of physical stores and online channels for the distribution of nicotine is evolving Consumer data provides opportunities for collaboration between retailer and manufacturer 1) Approximate number of discrete flavours available at Vape Club 2) Technavio: E-cigarette Market in the US Source: Technavio, research 17

18 Pathway to smoking cessation Category fragmentation Distribution channels The category also lends itself to non-traditional distribution channels, including online sales Drivers of distribution channel evolution 1 Sale through online channels that is permitted by regulation Examples of channel formats Vape Club Direct-to-consumer distribution of e- liquids, tanks, kits, coils and batteries. Focuses mainly on artisanal brands and products 2 Specialist store formats that present non-traditional propositions for consumers 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 3 Subscription-based distribution models that allow user customisation 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 Source: research 18

19 Pathway to smoking cessation Category fragmentation Distribution channels In the largest Vapour markets, the most common purchase channels are specialist shops and online Purchase channel primarily used in the seven largest Vapour markets 1 (excluding the US and China) Percentage of e-cigarette users, % Online channels well suited to subscription-based models and independent, artisanal brands More traditional supermarket channels do not have the variety of refill flavours available online Devices 4 5 Refills 5 0 Specialist shop Online Tobacconist Supermarket Kiosk Chemist Newsagent Other 1) Seven largest vaping markets outside the US and China by revenue: France, Germany, Italy, Poland, Russia, Korea and UK Source: Kantar 19

20 2. Government revenue potential of Vapour excise

21 Despite recent growth, there are two reasons why Vapour excise does not offer much government revenue potential 1 Vapour price elasticities of demand are currently too sensitive to support both category growth and government revenue opportunities 2 The fragmented and complex nature of the category may lead to enforcement challenges and a disproportionately high cost of collection 21

22 Price elasticity Complexity and cost of collection Vapour price elasticities of demand are sensitive due to the still-evolving product experience 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 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 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 Price Nicotine Platform Price Elasticity (η) P 0 % change in quantity η = % change in price Disposable e-cigarette -1.2 Rechargeable e-cigarette -1.9 ΔP P V 0 ΔV V Quantity Vaping elasticities are higher than tobacco on account of the stillevolving 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 Source: Huang et al. (2014), European Commission Special Barometer 429 (May 2015), research, analysis 22

23 Price elasticity Complexity and cost of collection The case studies of recent excise moves in Portugal and Italy demonstrate high price elasticity for Vapour Portugal Portugal introduced a Vapour excise in 2015 set at 0.60 per ml of e-liquid: Price per ml e-liquid ( ) +200% Excise Pre-tax price E-liquid Volume 1 (000 s litres) % 0.8 Italy Italy introduced a Vapour excise in January 2014 set at 0.37 per ml of e-liquid: Price per ml e-liquid ( ) % Excise Pre-tax price E-liquid Volume 1 (000 s litres) -50% 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 Estimated Vapour Price Elasticity 3 : 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 imposition 2 Estimated Vapour Price Elasticity 3 : ) 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 discretion 3) Arc price elasticity of demand calculated according to the formula η = ((Q 1 Q 0 )/(Q 1 + Q 0 ))/((P 1 P 0 )/(P 1 + P 0 )) Source: Euromonitor, ECigIntelligence, European Commission, Expert interviews, research, analysis 23

24 Price elasticity Complexity and cost of collection The case study of Minnesota, USA, corroborates the view that Vapour consumers are currently very price elastic Minnesota excise on e-cigarettes 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 Estimated e-cigarette sales pre and post introduction of excise in Minnesota July 2012 December 2013 E-cigarette units sold (000 s) Vapour excise in Minnesota introduced in July 2013 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 5 0 July 2012 Minneapolis, Minnesota July 2013 St Louis, Missouri Source: Tax Foundation: Evaluating an Excise Tax on Electronic Cigarette Consumption, Tobacco Regulatory Science, Volume 2, Number 2, April 2016, research 24

25 Price elasticity Complexity and cost of collection A 20 50% price increase on e-liquids in the EU due to excise could result in a ~ mn loss of industry value EU Vapour market 1 E-liquid excise scenarios E-liquid volumes 2, (000 s litres) Weighted average price per ml 3 ( ) E-liquid market size ( mn) Loss of e-liquid industry value ( mn) One-off government revenue Without Vapour Excise 3, ,340 No industry value would be lost with 0% excise - With 20% Vapour Excise Price elasticity of demand = With 50% Vapour Excise Price elasticity of demand = , ,212 (128) 1, ,009 (331) 7.2mn per member state 12mn per member state Our analysis suggests that e-liquid volumes would nearly halve under a 50% excise, significantly impacting a public health opportunity 4 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 ml 3) 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 England Source: Euromonitor, Vapebase, research, analysis 25

26 Price elasticity Complexity and cost of collection Excise enforcement could be challenged by the fragmented nature of the category Challenges with excise enforcement Major tobacco companies comprise less than half of the Vapour market by value, with 51% made up of smaller, artisanal players. Between , a study showed the number of E-Cigarette brands increased from 288 to 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 Global Vapour market share by manufacturer 2016 (stock tickers shown) % The big tobacco players make up 49% of the global Vapour market 51 For example, in a survey conducted on the 11 EU member states to have outlawed sales of e-cigarettes online 2, 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 PMI 4 MO 8 JT 9 BAT 10 IMB 16 RAI Others 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 2016 Source: ECigIntelligence, Goldman Sachs, research 26

27 Price elasticity Complexity and cost of collection In addition, imposition of excise may give rise to an illicit market and an increase in cross border trade Illicit and cross border trade risks UK alcohol and tobacco markets 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 year 1, 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) Annual excise collected vs. excise avoided ( bn and % of total) Alcohol estimate; Tobacco 2015 estimate UK Alcohol Market 1.2 (10%) 10.5 (90%) Excise collected UK Tobacco 1 Market 3.7 (28%) Excise avoided 9.5 (72%) 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 1) Based on a 2011 report by HMRC: Tackling tobacco smuggling: building on our success, updated for 2015 using input from expert interviews Source: UK Government, Expert Interviews, HMRC, research, analysis 27

28 Price elasticity Complexity and cost of collection Both the taxable commodity and method of taxation pose significant challenges and risks for excise administration Taxable commodities and methods in Vapour 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 liquid Potential problems may arise as new formats of nicotine-containing substances (e.g. gels, crystal salts) come onto the market Innovation would tilt towards less proven product 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 Significant challenges exist with all taxable commodity options 28

29 Price elasticity Complexity and cost of collection As a result of these administrative complexities, the cost of collection for Vapour excise may be disproportionately high 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 Cost of collection of UK excise (pence per 1 collected) Commodity Alcohol Tobacco 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, research 29

30 Overall, the costs associated with Vapour excise outweigh the limited government revenue potential Excise costs Vapour excise decision balance (illustrative) Excise revenue 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 Estimated EU government revenue if e-liquids incur 20% excise ( bn) 76 Tobacco 0.2 E-liquids Source: Public Health England, research, analysis 30

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