The publication examines the prerequisites and trends in the formation of the illegal market for e-liquids, the peculiarities of excise taxation of these products and counteraction to illicit trade in them; The publication summarizes foreign experience in the relevant field, analyzes the dynamics of the level of e-liquid illicit trade in Ukraine and the factors that caused it; It reveals the practice of domestic abuse of illegal vaping products and suggests measures to counteract them.
CONCLUSIONS
1. The growth of the vape market as an alternative to conventional cigarettes prompted the introduction of taxation, and the introduction of excise taxes and a number of bans were the main reasons for the development of the illegal market.
There are three approaches to excise taxation of e-cigarettes in the world. By means of: a) A specific tax rate; b) An ad valorem rate; and c) A combination of these approaches. The most common global practice of taxing e-liquids is to apply a specific excise tax rate depending on the volume of the liquid. This practice is used in the EU, the UK, Norway, Albania, Azerbaijan, Kazakhstan, Kyrgyzstan, South Korea, Serbia, Montenegro, and other countries.
Currently, excise taxes on e-liquids have been introduced in 18 EU countries, but they are not harmonized. The European Commission recognized the right of countries to introduce non-harmonized excise taxes for these products, but refrained from providing recommendations on their taxation until the information gaps are better filled in on: the peculiarities of the spread of e-liquids in the EU market, problems that may arise in the field of tax administration, and the impact of e-cigarette use on human health.
Approaches to the excise tax on e-liquids in the EU differ, with nicotine and non-nicotine liquids being taxed. A number of countries apply differentiated excise rates (depending on the presence of nicotine in the liquid or its concentration). Bulgaria and Romania have imposed excise taxes only on e-liquids with nicotine. These approaches take into account the potential of vapes to overcome nicotine addiction. Croatia has chosen a zero tax rate. However, most member states apply a single excise rate to all e-liquids.
At the same time, in the EU, the excise tax burden on e-liquids is significantly lower than on CCs.
2. High excise tax rates may lead to the formation of an illegal e-liquid market. Given the peculiarities of the tax control system and the physical characteristics of vapes, the functioning of this market has its own peculiarities. On the one hand, the large number of market operators increases the risks of illicit trade. On the other hand, e-liquids (pure nicotine) are much easier to move across customs borders than conventional cigarettes, and customs authorities have limited technical means to control small shipments made by courier delivery services and to conduct an examination of the composition of liquids.
Ingredients of e-liquids such as glycerin and flavors are used by a number of industries (food, medicine, and cosmetics) and are not subject to special regulation. These substances are readily available to manufacturers of illegal e-cigarettes and can also be used by consumers to prepare e-liquids on their own (with any mixture, which is dangerous).
3. Problems arise when certain types of vapes are banned after they have become popular on the national market. Their consumption cannot be stopped immediately, which increases the risks of shadowing the relevant market, especially in the context of insufficient institutional capacity of controlling authorities. If such an illegal product is distributed, we still have to talk about the loss of tax revenues, since banned e-liquids are an alternative to consuming unbanned legal tobacco products. The worst situation is when both budget revenues are lost and public health goals are not achieved. Therefore, the implementation of prohibitions requires increased attention to the issue of counteracting illicit trade in e-liquids.
4. Trends in the development of the e-cigarette market in the world include the establishment of clear standards, requirements for product content and quality. At the same time, illegal vape importers and manufacturers are seeking to saturate the market with cheaper alternatives, bypassing legislation and government oversight that protect consumers of legal products. Even developed countries with moderate shadow economies face challenges in curbing the dominance of illegal e-cigarettes. In the US, EU, UK, and Australia, the market is saturated with smuggling. To support measures to counter the spread of illegal e-cigarettes, the budget allocates additional funds for controlling authorities, primarily the Border Guard Service, to counteract smuggling.
Spot identification of illegal vape outlets does not yield tangible results. In order to develop effective measures to counteract illicit trade, it is important to combine the efforts of the legislative and executive authorities, law enforcement agencies, and legal vaping manufacturers.
5. The continued absence of state regulation and taxation of e-liquids in Ukraine has contributed to the shift in demand for them, and the introduction of an excise tax on these products in 2021 has intensified the shadowing of the market. The spread of illegal e-liquids in Ukraine is due, on the one hand, to the peculiarities of their market, and, on the other hand, to gaps in legislative and other regulation and insufficient institutional capacity of controlling authorities to prevent illegal trafficking of this type of product.
Starting from January 1, 2023, Ukraine increased the excise tax rate on e-liquids from UAH 3,000 to UAH 10,000/1 liter (or EUR 0.22/1 ml, which is higher than the rate in many EU countries). This created additional price advantages for illegal market operators.
However, the entry into force on July 11, 2023, of legislation prohibiting the production, wholesale and retail trade, and import of e-liquids with flavor additives for sale in Ukraine was devastating for the domestic legal e-cigarette market. These are the liquids that are in the greatest demand.
According to our calculations: the share of the illegal e-liquid market in the first half of 2023 was 76%; The size of the illegal e-liquid market in the second half of 2023 increased to 99%. The situation has not changed in 2024.
The spread of illegal vapes in Ukraine is confirmed by survey data on the use of this type of product and information from law enforcement agencies. In particular, there are frequent cases of illegal liquids for e-cigarettes being submitted for examination, and seizures of e-cigarettes with production dates pasted over. In July 2024, a large-scale illegal production of e-cigarettes was shut down. The State Customs Service notes a more than tenfold increase in the import of empty e-cigarette cases into Ukraine compared to 2023.
Ukraine has lost the ability to control the development of the vape market through taxation, product standardization, etc.
Excise tax losses due to the ban on e-liquids with flavoring additives and the almost complete shadowing of their market during the year of the ban amounted to UAH 774 million.
However, given that the e-liquids market has been developing largely in the shadow segment, the excise tax losses from the entire illegal market (with a capacity of more than 300,000 liters per year and a growing trend) amount to UAH 3 to 4 billion.
Just 4-5 forty-foot containers are enough to meet the domestic demand for illegal e-liquids for a year. This product can be easily transported in large volumes and in small batches.
6. The sharp decline in the population of Ukraine since the beginning of the full-scale war has led to a decrease in demand for all types of goods, including e-cigarettes. At the same time, the decline in the purchasing power of the population provokes a shift to illegal products. At the same time, while the older generation is more likely to choose CCs among the available illegal offers, young people often choose vapes.
Today, in Ukraine, as in the rest of the world, the tobacco market for conventional tobacco products is gradually shrinking, and newer nicotine products are becoming increasingly popular. However, while the transition to vapes in the domestic reality means a concomitant loss of tax revenues, the transition to fully legal heat-not-burn products ensures that taxes are paid on each pack purchased. In this context, the use of HTPs has advantages over smoking conventional cigarettes, the market for which remains 18% illegal.
The state cannot influence the price of illegal e-cigarettes, it is determined by the ratio of supply and demand in the market. At the same time, illegal players are interested in their products having price advantages over their alternatives. Therefore: 1) It is better to prevent further scaling of the illegal vape market; 2) It is important to pay due attention to the development of measures to counteract the illicit trade in e-liquids.
In particular, if the excise tax on HTPs is somewhat lower than on CCs, this will create conditions for appropriate price changes and protect against undesirable changes in the structure of the market for tobacco products and their alternatives.
7. In Ukraine, raids by authorized institutions in the field of state control over excisable goods reveal large-scale schemes for the illegal production and sale of e-cigarettes of well-known brands, cartridges and capsules for electronic devices. The sale of e-cigarettes with counterfeit excise stamps or without any labeling at all is a typical tax evasion scheme. A common practice of abuse is the establishment and maintenance of illegal production of e-liquids. Full cycles of mass production of counterfeit products are organized, using specialized industrial equipment and facilities. Even after the ban on the use of flavors and additives in e-liquids, the main common components used for e-liquids are: nicotine, propylene glycol, glycerin, and flavors. The latter ingredient is still in high demand among consumers of this type of product, despite the legal ban.
In particular, to circumvent the ban, stores sell empty e-cigarette devices (not banned, not taxed), flavors (food flavors that are not taxed), and nicotine (with an excise tax stamp) separately. The consumers can make a flavored vape from all these components on their own. Such sales are not prohibited by the current legislation, although finished vapes can be classified as prohibited illegal products.
9. Counteracting smuggling of vaping products is one of the important elements of the fight against their illegal trafficking. The technical re-equipment of checkpoints at the state border (to optimize their operation) with scanners and intelligent video control systems is a key element in counteracting smuggling of vaping products. Since illegal vapes, cartridges and e-liquids are transported to consumers, including by the mail, it is important to minimize the flow of illegal e-cigarette trafficking through this channel.
Having studied the practice of foreign countries, including the United States, Australia, and the EU, it can be argued that the priority of state policy in the field of combating the illegal vape market is to identify the largest oases (outlets, operators) of illegal production and trafficking of these products.It is necessary to identify and investigate the channels of supply of illegal vapes from retail outlets to distribution entities and subsequently to illegal manufacturers.
It is necessary to improve the control tools for raw materials used for the production of e-liquids (especially nicotine), as well as empty e-cigarette devices, which are imported into Ukraine and may later be sold in illegal schemes. When seizing the equipment used for the illegal production of vaping products by law enforcement officers, it is relevant and appropriate to conduct examinations to establish the origin of this equipment and its supply channels.
An important measure to reduce the illicit market of liquids used in e-cigarettes is to strengthen the coordination of control measures of state fiscal and law enforcement agencies. In particular, the ESB, tax and customs services, border guards and police.