Committee Reports > List of Committees > Joint > 1981 > Committee on the Secondary Legislation of the European Communities > Report No. 87 - Taxes other than Turnover Taxes which affect the Consumption of Manufactured Tobacco

REPORT

Introduction

1. The Joint Committee has considered a Commission proposal for a Council Directive amending Directive 72/464/EEC on taxes other than turnover taxes which affect the consumption of manufactured tobacco [Document 8449/80—COM (80) 69 final].

2. A detailed examination of the proposal was carried out for the Joint Committee by its Sub-Committee on Economic, Commercial and Financial Affairs under the Chairmanship of Senator Noel Mulcahy. Apart from considering memoranda received from the Irish Tobacco Manufacturers’ Advisory Committee (ITMAC), the Departments of Finance and Industry, Commerce and Tourism and the Office of the Revenue Commissioners, the Sub-Committee discussed the proposal with representatives from ITMAC and officials from the Departments concerned. The Joint Committee is indebted to Senator Mulcahy and his Sub-Committee for their work.

Historical Background

3. In the original Community of the Six, two different systems of excise duty on cigarettes 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 (tax-inclusive) retail price. In 1972 the Council of Ministers decided to combine these systems into 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 (or proportional) component (based on retail selling price). Of the three Member States who joined the Community in 1973, Denmark had a system like the German one, while Ireland and the U.K. operated a third system i.e. levying excise duty according to the weight of leaf tobacco.

Harmonisation in Stages

4. It is well to stress at this point that harmonisation does not affect (a) the actual amount of the excise duty to be levied by Member States or (b) the amount of VAT raised from cigarettes. It simply controls the form or structure in which excise duty is levied. The 1972 Directive provided that the harmonisation would be introduced in stages. The first stage ran from 1973 to 1978, the second from 1st July, 1978 to 31st December, 1980 (now further extended to 30th June, 1981). The Commission has now proposed a further Directive which will implement the third stage which is scheduled to run to 31st December, 1986.

First Stage of Harmonisation

5. The first stage of the harmonisation of excise duty on cigarettes began on 1st July. 1973 when the basic Directive 72/464/EEC of 19th December, 1972 was implemented in all the Member States, except Ireland and the United Kingdom. Implementation of the Directive in the latter States was postponed until 1st January, 1978. This Directive provided a range within which Member State could choose the proportion of specific tax in their excise duties and this range was fixed at between 5 and 75 per cent of the total excise duty levied on cigarettes in the most popular price category. This Directive also provides that at the final stage of harmonisation—

the same ratio is to be established for cigarettes in all Member States between the specific element of the taxation and the ad valorem element;

and this is to be done in such a way that

the range of retail prices reflects fairly the differences in the manufacturers’ delivery prices.

Second Stage of Harmonisation

6. For the second stage of harmonisation in accordance with Directive 77/805/EEC, the specific excise duty is fixed at not less than 5 per cent and not more than 55 per cent of the total tax charged (excise duty plus VAT). The previous Joint Committee in its Forty-first Report (Prl. 5597) dealt with the Commission proposal for the second stage.

Some Effects of the Second Stage

7. The Commission has furnished a table which relates to price structures on 1st January, 1980 of the most popular cigarettes and it shows that four Member States (the Benelux countries and France) apply specific components close to the authorised minimum of 5 per cent, Italy has so far failed to reach the 5 per cent minimum, while the remaining four Member States (Federal Republic of Germany, Denmark, United Kingdom and Ireland) apply a specific component close to the authorised maximum of 55 per cent. In Ireland the specific component is 54.8 per cent. The Commission state that judging by the information received from the Member States, the effects of the measures introduced by them during the second stage have been very limited. They point out that this is not to ignore the significant changes which have taken place in the structure of both the United Kingdom and Irish markets. However, it should be noted that these changes, which have in both cases considerably compressed the price range, arose from the substitution of end-product taxation for taxation of the raw tobacco, a step which was accepted in principle in 1972 but which, owing to the five-year derogation that was granted for its implementation coincided with the changeover to the second stage or was still affecting the market at that time.

Scope of Commission Proposal

8. The proposed third stage would have run from 1st January, 1981 to 31st December, 1986. It envisages that the range of the specific component of the excise duty on cigarettes would gradually be further narrowed and would fall within the parameters of 10 per cent to 35 per cent of the total tax burden. In attaining this objective two intermediate stages are proposed—

(i)that from 1st January, 1981 to 31st December, 1982 the specific component within the range of 5 per cent to 55 per cent would be maintained, and

(ii)that between 1st January, 1983 and 31st December, 1984 a specific component within the range of 7.5 per cent to 42.5 per cent be reached.

9. The proposal does not complete the process of harmonisation nor does it establish the eventual fixed proportion envisaged by the 1972 Directive. But the Commission in its explanatory memorandum concludes that eventually the specific component should be 20 per cent at the final stage [paragraph 25 of memorandum].

10. The proposal also includes two other amendments of less importance viz:—

(a) the retention of a facility for a minimum excise duty [Article 4(4) of Directive 72/464/EEC] but that it be reduced from the present rate of 90 per cent to 80 per cent i.e. of the total excise levied on cigarettes in the most popular price category, and

(b) the abolition of an optional facility providing for the exclusion of customs duty from the basis of calculation of the proportional excise duty on cigarettes [Articles 9 and 10 (b) (4) of Directive 72/464/EEC (as amended)].

Effect on Irish Legislation

11. If the specific component proposals as outlined were adopted. no changes would be required by Ireland until 1st January, 1983 since we already operate within the parameters of 5 per cent to 55 per cent. However, from 1st January, 1983 an alteration to the specific element of taxation on cigarettes would call for a recasting of the components of the excise duty applicable to maintain the overall yield of revenue. The Committee understands that Section 66 and the Third Schedule of the Finance Act, 1980 (No. 14 of 1980) which at present provides the legal basis for excise duty rates on tobacco products, would need to be amended. It is also understood that the proposal for a minimum excise facility of 80 per cent [paragraph 10 (a) above] would require no action on our part; Ireland has never implemented nor availed of the facility because the issue has never arisen, duty in all instances having been above the minimum. The Committee is informed that in principle, however, Ireland favours the acceptance of the option of a minimum excise duty at a high rate as it could be of particular advantage where a duty includes a high proportional element. Eventually this facility could act as a guard against a fall in tax revenue in the event of low quality low-cost cigarettes coming on the market. Abolition of the facility for exclusion of customs duty from the basis of calculation of the proportional excise duty on cigarettes [paragraph 10(b) above] would not affect existing legislation since Ireland has not used the facility.

Effects on the Irish Tobacco Industry

12. The representatives of the Irish Tobacco Manufacturers’ Advisory Committee (ITMAC) in their submission to the Joint Committee and in discussions with the Sub-Committee on Economic, Commercial and Financial Affairs have convinced the Joint Committee that the proposed Directive should be opposed and rejected by Ireland. ITMAC point out that the Community approach to the harmonisation of tax structures for cigarettes has been of deep concern to the Irish industry ever since Ireland acceded to the Community and that the matter is now critical because the Commission’s latest proposals, should they be adopted, would lead to the decline and ultimate demise of the tobacco industry in Ireland. The Joint Committee is satisfied that this is a situation which cannot be allowed to develop along these potentially disastrous lines for an industry which employs around 2,000 persons, in which £45.5 million is invested and which has a turnover of £210 million per annum.

13. The justification for the harmonisation process is that it will eliminate distortion of competition and obstacles to the interpenetration of markets caused by differing tax structures in the Member States. The narrowing of the permitted range of specific taxation is justified by the Commission on the grounds that equal efforts of adaptation should be made by all Member States. The Joint Committee is not convinced that differing structures of excise duty are the most important factor either in the elimination of distortion or obstacles to market interpenetration. Even the Commission accepts that the effects of the measures so far adopted have been “very limited” and that the “degree of market interpenetration overall is not great”. Other factors distorting the market at present are—

(i)Excise Credits: in some countries there is an extended time period for the payment of the tax e.g. Belgium, 91 days; Netherlands, 107 days. In effect, this means the provision of interest-free capital for these periods.

(ii)Monopolies: In France and Italy the tobacco industry is a government monopoly for production and retailing. These countries have extensive leaf-growing interests deriving cost advantages under the Common Agricultural Policy which reduce net leaf costs below world price levels.

14. Ad valorem tax tends to exaggerate, or “multiply” (the term used by the industry) relative basic price differences and therefore an expensive, high value cigarette is taxed more heavily than a cheap cigarette. Accordingly a tax structure with a high ad valorem content gives cheaper, low quality cigarettes a competitive advantage over higher quality brands in terms of final price. Industries operating under the ad valorem system are aimed at low cost production. The fact that the Irish duty had been wholly weight specific prior to our joining the European Community resulted in the concentration by the Irish industry on the production of high quality cigarettes using the most expensive leaf. ITMAC state that for these reasons, the production costs of Irish-type cigarettes are higher than those of continental products and maintain that a high proportional duty would so magnify the disparity that Irish products would lose out to imports on the domestic market and would be virtually precluded from competition in EEC export markets. Neither do they see a solution along the lines of a change over to the production of continental-type cigarettes.

15. The Irish cigarette market is small as compared with the market in other Community countries, yet it is supplied by three significant manufacturers each with its own production facility in this country. Thus the industry in Ireland cannot avail itself of the economies of scale which are achieved in the bigger manufacturing plants of the EEC. ITMAC realise that such economies of scale are not of themselves sufficient to undermine the competitiveness of the Irish industry but they would be translated into real price advantages at the retail level, if they were multiplied out by high rates of proportional taxation.

16. ITMAC point out that Irish manufacturers have to be profitable in order to provide the base on which they can raise money on the financial markets. This money is necessary to keep production plants up to date and to fund the day to day running of the business. In order to maintain their profit levels it is important that Irish manufacturers can compensate for incurred cost increases by raising prices. However, with any increase in the multiplier and consequently a greater possibility of cheap imports from other Member States (or ACP countries) ITMAC are convinced that it would become more and more difficult to raise Irish prices. It would become more attractive, particularly to importers, to reduce prices to gain volume at the expense of local manufacturers. This is most likely to lead to retaliatory price cutting by local manufacturers and hence the destabilisation of the market.

Recent Decision of European Court of Justice

17. It is noteworthy that in a group of cases (209 to 215/73 and 218/78) recently before the European Court, the Advocate-General emphasised the point that very high ad valorem taxation markedly limits the scope for competition between operators in the market. He went so far as to say that there appeared to exist a conflict between Community competition law on the one hand and fiscal policy on the other. The Court appears to have accepted the Advocate-General’s opinion when stating (in paragraph 128 of the judgement) that “a result of the multiplier effect, combined with the minimum excise enforced by the Belgian state to ensure its fiscal income, is that all competitive action . . . by the manufacturer or importer, which has an effect on the retail price, is limited.” ITMAC state that this entirely accords with their view that a system of high tax multipliers, through proportional taxation, is incompatible with the Community’s policy on competition, which is enshrined in the Treaty of Rome.

Views of Other Bodies

18. The Section for Economic and Financial Questions of the EEC Economic and Social Committee has disagreed, in an opinion of 3rd February, 1981, with the Commission’s main proposal for tax harmonisation. The Committee on Economic and Monetary Affairs of the European Parliament has questioned the Commission’s approach in the recent Beumer Report. The Joint Committee also understands that a majority of the Member States do not seem to be in favour of further harmonisation at present.

Conclusions

19. The Joint Committee is convinced of the validity of the general case put forward by ITMAC for a rejection of the present proposal and can find no answer to many of the criticisms of the proposal. It sees no merit in further harmonisation along the lines proposed in isolation from other factors and is very impressed by the evidence produced which highlighted the potential and real dangers for the Irish tobacco industry in the implementation of the proposal. The Joint Committee is also convinced that the whole approach of the Commission in this case should be reviewed and that approaches towards the goal of harmonisation, other than in the narrow area covered by the present proposal, should be examined. An examination by the Commission of other factors, which continue to distort competition at present, could include the existence of producer monopolies and cartels in some Member States and the harmonisation of excise credits and other non-tax inequalities. The Joint Committee recommends that this examination should be made and reported on before any further transitional measures are implemented.

20. In view of the serious implications which the adoption of the proposed Directive would have for the Irish tobacco manufacturing industry the Joint Committee requests that a debate take place in Seanad Éireann. In this connection the Joint Committee refers to the Order of Seanad Éireann of 18th February, 1981.

Acknowledgement

21. The Joint Committee wishes to record its appreciation of and express its thanks for the considerable assistance it received from the Irish Tobacco Manufacturers’ Advisory Committee in considering this matter.

(Signed) ALEXIS FITZGERALD,

Chairman of the Joint Committee.

11th March, 1981.