The latest legislative proposals from the Ministry of Health could disrupt the declining trend in the gray market, which reached a historic low in the cigarette market in 2023. Experts warn that the ban on the sale of menthol cartridges for tobacco heaters could encourage smuggling and illegal production. According to a report by the Institute for Economic Forecasts and Analyses (IPAG), a decrease in the share of smuggled cigarettes has been accompanied by an increase in the share of counterfeit cigarettes, a trend facilitated by still low penalties for such offenses.
The ban on the sale of menthol cartridges for tobacco heaters, proposed by the government in mid-May, could lead to the expansion of the illegal market, according to the latest report from IPAG. The situation in the cigarette market is currently under control, with the share of the gray market in the domestic market falling below a historic minimum to less than 5% in 2023.
On May 15, the Ministry of Health presented a draft amendment to the law on health protection against the consequences of using tobacco and tobacco products. The draft proposes a ban on the sale of menthol cartridges for heated tobacco, which, according to the ministry, accounts for about 80% of sales. According to the cited statistics, approximately 1.5% of adult Poles use tobacco heaters.
“The share of the gray market in the Polish heated tobacco market is currently relatively low, but we are also facing another threat. Poland is preparing to implement the so-called delegated directive, which will prohibit the sale of flavored, fruit, and menthol cartridges, which currently account for about three-quarters of this market in Poland,” says Jacek Fundowicz, Vice President of IPAG, to Newseria Biznes. “A few years ago, the sale of menthol cigarettes was already banned, and everyone expected a sharp increase in the gray market. This did not happen because part of the demand shifted to flavored, aromatic heated tobacco cartridges. Now, with this last alternative taken away, the share of the gray market may indeed increase.”
EU countries were obliged to introduce a ban on the sale of flavored tobacco cartridges for heaters from October 23, 2023. However, the Court of Justice of the European Union is currently considering a complaint from Ireland challenging the legality of the solutions adopted in the directive. During its drafting, other member states, including Poland, Italy, Bulgaria, Cyprus, and Greece, also raised concerns about the regulation.
“Currently, some EU countries are delaying the implementation of this directive until the Court of Justice of the European Union determines whether such a ban is indeed compliant with European law,” says Jacek Fundowicz.
In Poland, the gray market phenomenon in the tobacco market has two forms. The first is the smuggling of cigarettes from abroad, mainly from the East, and their illegal sale on the domestic market. The second is the illegal production of counterfeit tobacco products of known brands and their distribution without the required excise stamps. According to the latest IPAG report, the highest share of the gray market in Poland, at 18-19%, was recorded in 2015 and has been steadily decreasing since then, falling to a historically low level of 4.7% last year. In 2023, however, the decline in the share of smuggled cigarettes was accompanied by an increase in the share of counterfeit cigarettes. According to IPAG estimates, the value of counterfeit cigarettes introduced to the Polish market in 2023 reached approximately PLN 0.5 billion. This represents an increase compared to the previous two years and a return to the level of 2020. On the other hand, the value of cigarette smuggling into Poland is approximately PLN 1.6 billion.
“The gray market in the tobacco product market is diverse. We have several segments of this tobacco market, and the situation is slightly different in each. In the traditional cigarette segment, which accounts for about two-thirds of the tobacco market, the situation is relatively favorable. The share of the gray market in this segment has been decreasing since 2015 and is currently at a historically low level. This is the result of a combination of various factors, including the geopolitical situation,” explains the Vice President of IPAG.
One of the main factors contributing to this decline in recent years has been the tightening of the eastern border, making the smuggling of illegal goods more difficult. For years, cigarette smuggling from Belarus was unofficially supported and co-organized by state services and enterprises. In 2021, due to the hybrid war on the Polish-Belarusian border, border protection was strengthened, and Belarusian services shifted their focus to controlling illegal migration rather than their previous activities. Further restrictions on cigarette smuggling from the East were influenced by Russia’s attack on Ukraine in February 2022, which caused supply shortages in the Ukrainian market due to war damage to cigarette manufacturing facilities.
IPAG also notes that in 2023, the value of illegal cigarettes intercepted by the Border Guard in cooperation with other services significantly increased. However, it is notable that while the value of smuggling from Russia and Ukraine continued to decline, there was a 12-fold increase in the value of smuggling attempts from Belarus (after a 94% drop in smuggling attempts from this country the previous year). According to experts, this indicates that after a period of relative calm, the organizers of this illegal activity are trying to resume their operations.
“In recent years, Polish services responsible for combating the gray market have cooperated, consulted with producers and legal distributors, and as a result, had better insight into the market situation. A control system was built, and the activities of Polish services fighting this illegal practice have become increasingly effective,” notes Jacek Fundowicz.
The new report “Gray Market 2024” indicates that the historically low share of the gray market in the tobacco market is largely the result of the so-called excise map adopted at the end of 2021, which is a schedule for gradually increasing taxes on tobacco products.
“Previously, we had abrupt excise tax increases, prices also rose sharply, and consumers looked for cheaper products in the gray market. In this context, the so-called excise map is a positive phenomenon that helps to reduce the gray market, as entrepreneurs have knowledge, a plan, and awareness of what lies ahead in the coming years. They can adjust their prices, which rise slowly, and consumers have time to get used to them,” says Wojciech Bronicki, partner at BBGTAX Tax Office. “In the case of traditional tobacco products, the gray market is declining. However, it is different for e-cigarettes, which are not covered by the excise map.”
According to the IPAG report, the specifics of the gray market phenomenon in the e-cigarette market are somewhat different from the cigarette market, but also result from the high share of taxes (including excise and VAT) in the final sale price, combined with relatively simple ways to bypass existing regulations and fragmented production.
“Here, the share of the gray market is exceptionally high, reaching even about 90% according to the industry association. At the end of 2022, attempts were made to curb this phenomenon by changing the tax burden on e-cigarette liquids, and it seemed to be heading in the right direction, but unfortunately, the illegal market found ways to circumvent it, so the improvement was practically imperceptible,” assesses Jacek Fundowicz.
According to the IPAG report, the biggest threat to maintaining a low share of the gray market in the domestic cigarette market is currently the planned amendment to the so-called tobacco excise directive (2011/64/EU) by the European Commission, which regulates, among other things, the general principles of taxation of nicotine products and minimum excise rates. The final shape of the proposals that may be included in the amendment is not yet known, but in 2022, the European press reported, among other things, the possibility of doubling the minimum cigarette tax (from 90 euros per 1,000 pieces to 180). The tax increases are being lobbied for by countries with the highest tax rates in Europe, such as Ireland, Germany, and France. In France, according to the latest KPMG report, every third cigarette comes from the illegal market, which is an infamous European record.
IPAG estimates that the value of the so-called tax gap related to the gray market in the illegal cigarette market amounted to almost PLN 1.7 billion in losses for the state budget last year. For 2023, the estimate was 18.9% (PLN 713 billion). This indicates a decrease in the share of the gray market in the economy, but also an increase in value in current prices due to GDP growth and inflation.
“The gray market is a difficult phenomenon for the economy. It affects both the state budget and economic entities, and it is an undesirable phenomenon in the market for everyone,” concludes Wojciech Bronicki.
The institute points out that one of the elements that still need improvement and can contribute to reducing the gray market in Poland is the level of penalties, which – compared to the high margins of illegal producers and distributors of tobacco products – are still seen as not severe enough. Despite their tightening since May 2021, this still encourages activities in the gray market.
