Committee Reports > List of Committees > Joint > 1976 > Committee on the Secondary Legislation of the European Communities > Report No. 41 - Tobacco, Taxes Affecting Consumption

REPORT

1. Introduction

The Joint Committee has completed its examination of the Commission’s proposal for a Fifth Council Directive on taxes other than turnover taxes which affect the consumption of manufactured tobacco (R/414/76). This proposal deals with the measures to be adopted for the second stage of the harmonisation of excise duties on cigarettes. The first stage of the harmonisation was introduced in July, 1973 by the First Council Directive 72/464/EEC. It was originally intended to last for two years but has been extended to 30th June, 1977. The Council is obliged by the terms of Directive 75/786/EEC to adopt the measures for the second stage by 1st July, 1976.

Ireland and the United Kingdom have been allowed to postpone implementation of the First Directive until 1st January, 1978 but from that date the Directive, with whatever changes emerge from the present proposals, will apply in those countries.

2. Legal Basis

The Commission is obliged by Article 99 of the EEC Treaty to examine how the legislation of Member States concerning inter alia excise taxes “can be harmonised in the interest of the common market” and to submit proposals to the Council. Measures relating to excise duties on cigarettes are based on this Article and also on Article 100 which provides for the issue of Council Directives for the approximation of national laws and administrative measures which “affect the establishment or functioning of the common market”.

3. Directive 72/464/EEC

The harmonising of excise duty on cigarettes in stages began on 1st July, 1973 when Directive 72/464/EEC of 19th December, 1972 was implemented in all the Member States except Ireland and the United Kingdom. As already indicated implementation of the Directive in the latter states has been posponed until 1st January, 1978.

In the original Community of the Six two different systems operated. In Germany excise tax was levied as a fixed amount per cigarette. In the other five States excise duty was levied as a percentage of the tax-inclusive retail price. It was decided to combine these systems in a harmonised system under which in each Member State the duty charged would consist partly of a specific component (tax per cigarette) and partly of an ad valorem component (based on retail selling price).

Eventually the ratio which the specific bears to the ad valorem element will be the same in all Member States but during the transitional periods Member States are to be allowed a range of choice. In the first transitional period the specific charge may vary between 5 and 75% of the total. As a corollary of this the ad valorem charge may vary between 25 and 95%. In the first instance the specific charge is fixed by reference to cigarettes in the most popular price category but when fixed, the specific charge applies to all cigarettes at the same rate. Member States are also entitled to maintain a minimum excise duty. This is fixed at not more than 90% of the total excise duty levied on cigarettes in the most popular price category.

In Ireland and the United Kingdom excise duty is charged on tobacco leaf by weight. Both countries are, however, committed to adopting the new system on 1st January, 1978.

4. Proposed Amendment

The draft Fifth Directive contains the amendments which the Commission propose for the second transitional period which will run from 1st July, 1977 to 31st December, 1980.

The main changes proposed are:—

(a) the specific component of the excise duty is to vary between 15% and 50% of the total tax burden;

(b) VAT is to be included for the purpose of calculating the total tax burden;

(c) Member States may, by way of derogation from Article 4 (1) of the 1972 Directive, exclude customs duties in calculating the ad valorem charge.

The provision for a minimum excise duty is to remain.

5. Justification of Harmonisation

The harmonisation of excise duties on cigarettes is intended to neutralise the effects of duties on competition and so facilitate market interpenetration while protecting the revenue of the Member States. In the particular circumstances of the cigarette industry in the Community it seems to the Joint Committee that there are factors inhibiting free and fair competition which the harmonisation of excise duties will do little to counteract. France and Italy have State-owned industries which enjoy the advantages of production and retailing monopolies and which are not subject to normal commercial requirements in terms of profits and fund-raising. Moreover these countries have extensive leaf-growing interests which supply a major share of the monopolies’ requirements so that the industries derive considerable cost advantages under the Common Agricultural Policy in the form of buyers’ premiums which reduce net leaf costs below world price levels. Moreover, in the free enterprise section of the Community industry, there are marked disparities in the periods allowed by different states for the payment of duty so that the industries in those states which give the longest periods are enjoying virtually a state subsidy. Free competition therefore calls for much more than aligning excise duties. However, this country as well as the rest of the Community is committed to the harmonisation of those duties and the important thing, therefore, is to ensure that whatever mix of specific and proportional taxes is accepted does not add to the disadvantages which Irish manufacturers already suffer compared with their counterparts in other Member States.

6. Effect on Revenue

Although the system which the 1972 Directive introduced and which the present proposal seeks to amend is concerned only with the structure of the excise on cigarettes and does not deal with the rate which may be applied, it is nevertheless possible that it could affect revenue yield. The application of a high specific charge per cigarette in a two-tier harmonised duty structure could lead to the possible disappearance from the market of cheaper brands of cigarettes, a consequential reduction in consumption and, accordingly, a lower revenue yield. On the other hand, the results of the application of a high proportional excise element based on retail selling price are somewhat unpredictable: e.g. there could be an inducement to manufacturers to cut their costs, thereby reducing the retail price and consequently, the revenue per packet, with a resultant possible increase in consumption leading to a situation in which revenue yield would be maintained or increased. If, however, costs continued to increase, under a high proportional duty system, that increase would be magnified by the high proportional element, leading to increased retail prices, greater revenue per packet but possibly lower consumption and less revenue overall. The Joint Committee has been informed by the Department of Finance that the question of the ratio between the specific and proportional elements is under study and that it is not possible to form a clear view as yet on the implications from a revenue point of view.

7. Effect on Manufacturing Industry

The representatives of the Irish Tobacco Manufacturers’ Advisory Committee (ITMAC) with whom it discussed the matter, have convinced the Joint Committee that the duty structure has considerable investment implications for the industry. In order that its members can effectively plan their business in the short term up to 1st January, 1978 and in the long term up to time of final harmonisation, ITMAC is pressing strongly for an early determination of the final tax structure. The Joint Committee supports ITMAC in this position and urges that every effort be made not only to have an early decision taken on the present proposal but also to have the structure which will ultimately apply determined with the least possible delay.

While the Irish cigarette industry is seeking an early decision on the final tax structure it has made it clear to the Joint Committee that it does not welcome the proposed changes though it accepts that some changes are inevitable. The proposed tax structure will entail heavy and exceptional capital and marketing investment which could affect employment. However the industry is confident that it can remain viable and can compete provided that the proportional element of taxation does not dominate. ITMAC considers that the highest negotiable specific component in the total tax burden should be sought. In its view a predominantly proportional structure of taxation would be inimical to a free competition market environment and to the continuation of an economically viable free enterprise sector without subsidy and recourse to cartel trading prohibited by the EEC Treaty. The Irish industry maintains that, by reason of its traditional skills and higher-quality higher-cost structure of production, it would in particular be severely affected. A predominantly proportional structure would multiply any price advantage enjoyed by lower cost competitors. The limit of 50% on the specific element of the duty is regarded by the industry as the absolute limit at which it could operate.

ITMAC believes that failure to negotiate an acceptable tax structure could have serious consequences for the Irish industry. To attempt to counteract an unfavourable system of taxation by developing low-cost products for which the industry has no established skill and no market reputation would involve heavy additional investment in re-training and re-equipment. In a small market cost penalties which arise from a change in the tax system and are not material to competitiveness would deter investment and favour importation from longer run producers. The Irish industry could find itself unable to compete with Continental producers who enjoy cost advantages from a protected position in a large domestic market. Moreover a high proportion of the proportional element of taxation could induce increasing import penetration of the United Kingdom market thus creating spare United Kingdom capacity for the production of cigarettes which is now being undertaken on contract in Ireland thereby reducing Irish exports.

The Joint Committee considers that it is essential that the Irish industry be given every opportunity of remaining economically viable in conditions of more intensive competition. It trusts that this will remain a major consideration in negotiations on the tax structure.

The Joint Committee has been informed that the industry welcomes the aspects of the present proposal which relate to the inclusion of VAT in determining the specific element and the continued inclusion of a 90% minimum excise rate.

8. Acknowledgement

The Joint Committee wishes to acknowledge its indebtedness to the Irish Tobacco Manufacturers’ Advisory Committee which gave it considerable assistance in examining this matter.

(Signed) CHARLES J. HAUGHEY,

Chairman of the Joint Committee.

30th June, 1976.