Special Report: Government cracks down on cigarette smuggling, counterfeiting

MANILA, Philippines — The illicit trading of cigarettes has become rampant in the Philippines, depriving the government of billions in revenues that could have been allocated for its priority programs, particularly the provision of health facilities and services.

From smuggling cigarettes to using fake tax stamps, the practice has evolved into sneaking unregistered cigarette-making machines into the country, with small factories producing fake cigarettes bearing famous brands.

Just recently, the Bureau of Customs (BOC) celebrated its 117th anniversary by smashing seven illegal cigarette-making machines seized by the bureau to serve as a warning against manufacturers and smugglers of fake cigarettes.

Last month, the Bureau of Internal Revenue (BIR) destroyed various contraband, including three filter maker machines, two packaging machines, a cigarette-making machine, 484 master cases of various cigarette brands, raw materials and other cigarette-making paraphernalia.

These incidents paint a picture of how the landscape of illicit cigarette trading has changed.

But what causes the proliferation of smuggling and counterfeiting in the country?

Earlier, Finance Secretary Carlos Dominguez III said an increase in illegal cigarettes was to be expected following the government’s actions against Mighty Corp., a big player that was allegedly using fake tax stamps.

Dominguez said this caused a huge vacuum in the market, prompting small manufacturers to fill the void and take advantage.

On the other hand, some groups, including the Federation of Philippine Industries Inc. (FPI) claimed that huge spikes in prices, often led by increases in excise tax, have enabled the illicit trade of tobacco products to flourish.

‘VAT losses increased’

In a position paper sent to Senate ways and means committee chairman Juan Edgardo Angara, FPI chairman Jesus Lim Arranza cited a study titled “Multi-Industry Illicit Trade Research Study” of the University of Asia and the Pacific, which found that the government’s excise tax and VAT losses due to the illicit trading of cigarettes increased from P2.6 billion in 2012 to P19.9 billion in 2014 and P17.9 billion in 2015, the same period when the Sin Tax Reform Law was implemented.

“The rise in smuggling and illegal trade of cigarettes dissected in the study… covered the period from 2012 to 2015, the same period when excise taxes on tobacco products significantly increased,” Arranza said.

Considering the impact of these activities on the government’s revenues plus underlying health risks, Finance Assistant Secretary Antonio Lambino said the government saw the need to tighten its enforcement against cigarette smugglers and counterfeiters to stop them.

“The BIR and the BOC have really been serious about catching not only smuggled imports but also illegal production in the Philippines,” Lambino said in an interview.

BIR deputy commissioner Maria Cabreros said the BIR and the BOC have indeed improved their cooperation with each other as well as other law enforcement agencies to increase their success in apprehending illegal traders.

“For enforcement activities, the BIR, in coordination with other agencies (e.g., BOC, National Bureau of Investigation), has been conducting raids and been seizing illicit cigarettes together with the machine,” Cabreros said.

The BIR and the BOC established last year a joint task force, which focuses on capturing smugglers and counterfeiters of cigarette products in the country.

Both agencies also created their respective strike teams to serve as lead and point coordinator of all their enforcement activities on smuggled articles and counterfeit products.

‘Largest tax settlement in Philippines’

Due to the government’s fervent effort to fight illicit cigarette trade, the government in 2017 cracked down on Mighty Corp., resulting in the “largest tax settlement in Philippine history.”

The company paid P25 billion to settle its tax liabilities with the government, and gave another P5 billion in VAT from the sale of its business and assets to Japan Tobacco International Philippines Inc.

Government authorities were also able to haul a huge amount of counterfeit and smuggled products last year, preventing them from reaching the market and landing in the hands of Filipino consumers.

Based on data from the Intellectual Property Office, the inter-agency National Committee on Intellectual Property Rights seized P20.25 billion worth of fake cigarettes and cigarette-making paraphernalia in 2018.

This accounted for 85.91 percent of the total value of seized fake products last year, which jumped almost threefold to P23.6 billion from P8.2 billion the previous year.

Moreover, data gathered by the private sector showed the amount of seized illicit cigarettes almost doubled to 157.03 million sticks in 2018 from 89.071 million in 2017. These were valued at P628.12 million, almost twice the P356.28 million worth of fake cigarettes confiscated the previous year.

Industry data also showed that the government seized P874.1 million worth of unaffixed cigarette tax stamps during the period.

Government authorities had been successful in raiding seven factories around the country last year. The largest of these busts was conducted by BOC operatives on five warehouses in Quezon City, where they uncovered not only fake cigarette tax stamps, but also smuggled rice, used clothing and other fake goods.

The BIR, together with the NBI, also discovered fake cigarettes in a warehouse in Bugallon, Pangasinan during a raid in November last year. This operation led to the arrest of 28 Chinese and Filipinos working in the factory.

A total of 17 Chinese were also caught by the BOC manufacturing P200 million worth of fake cigarettes bearing the brands Marvel, Fortune, Jackpot, Champion and Mighty in Gapan City, Nueva Ecija.

Representatives from the BIR and the Philippine National Police infiltrated two warehouses in San Simon, Pampanga, yielding P10 million worth of cigarettes with fake tax stamps and cigarette-making equipment.

Fake cigarettes, stamps, equipment and other paraphernalia were also seized during separate operations in Guiguinto, Bulacan; Misamis Oriental; and Cagayan de Oro.

This year, the government has so far been able to run two successful operations against illegal cigarette manufacturers.

A total of eight cigarette-making machines worth P200 million were discovered in two warehouses located at Global Aseana Business Park and San Simon Industrial Park, both in Pampanga last January.

About P385 million worth of fake cigarettes, tax stamps, raw materials and machines were also seized early this month in Tacloban.

Working with China

Meanwhile, Dominguez earlier directed the BOC and BIR to work with their counterparts in China to stop the illicit entry of cigarette-making machines that are being used in manufacturing fake tobacco products.

As a result of enhanced enforcement activities, the latest study from Oxford Economics found that consumption of illicit cigarettes in the Philippines dropped by 51.37 percent to 5.3 billion cigarettes in 2017 from 10.9 billion the previous year.

This translated to an illicit cigarette trading incidence of 6.5 percent, 6.6 basis points lower than the 2016 level of 13.1 percent.

It was also estimated that tax losses due to illicit consumption fell by 46 percent to P9.4 billion from P17.4 billion in the previous year.

“The decline in domestic illicit consumption coincided with the government indictment of Mighty Corporation for tax fraud,” Oxford Economics said.

“These events followed a directive from the Department of Finance – issued at the beginning of 2017 – instructing the BIR to tighten monitoring and enforcement, which included a wider investigation into the use of fake tax stamps. Over the course of 2017, there were numerous cases of large seizures, including both domestic and non-domestic illicit cigarettes,” it added.

The government, according to Lambino, hopes to see a lower incidence for 2018 due to a more aggressive government effort to keep a tight lid on cigarette smuggling and counterfeiting.

“If you look at the decisive actions that the BOC and the BIR have carried out, we really see enforcement mechanisms being applied rigorously and vigorously. So we’re seeing the seizing of machines, the seizing of illegal imports the ones with the fake labels and the like,” he said.

The cigarette industry, however, thinks more could be done to strengthen the fight against illicit trade.

An industry source has said cigarette firms want the government to increase and intensify penalties for those who violate Section 164 of the National Internal Revenue Code, with respect to the importation of machines; Section 263, with respect to the removal of excisable goods from manufacturer’s premises or customs houses without pre-payment of excise taxes; and Section 265, with respect to the use of counterfeit or recycled tax stamps.

The industry is also calling on the government to institutionalize a system for private third-party monitoring of production volumes at manufacturing sites of excisable goods.

They are also pushing for the adoption of more fiscal tools, such as the Internal Revenue Stamps Integrated System, to provide an effective system of fiscal authentication at a reasonable cost to the industry.

The industry also wants the government to institutionalize the task forces formed by the BIR and BOC by earmarking funds for the operations of these teams.

‘Enforce BIR’s regulatory powers’

Some industry players have also expressed concern that there might be illegal cigarette-manufacturing operations that have located inside free ports and special economic zones. This was made apparent by the government’s operations in warehouses located at Global Aseana Industrial Park and San Simon Industrial Park this year and last year.

As such, the private sector wants the government to enforce the regulatory powers of the BIR over manufacturers of cigarettes and tobacco products operating inside these economic zones.

Cigarettes and tobacco products have been some of the largest sources of the government’s tax revenues.

In the first nine months of 2018, tobacco excise tax collections hit about P106.89 billion, exceeding the government’s target of P96 billion for the nine-month period.

This is following the implementation of the Tax Reform for Acceleration and Inclusion Law, which increased the excise tax on cigarettes to P35 per pack as of July 2018.

Moving forward, the Department of Finance (DOF) is pushing for the approval of Senate Bill 1559, which proposes to raise cigarette excise tax to P60 per pack in the first year of implementation, with an additional nine percent per year thereafter.

The measure, according to DOF estimates, is expected to raise incremental revenues of P30.1 billion, which can be used to help cover the funding gap for the Universal Health Care program.

A simulation made by the DOF, Department of Health and the World Health Organization also showed that such increase in tax would avert approximately 713,000 deaths, and result in 3.2 million Filipino adults quitting smoking. It is also seen to bring down smoking prevalence in the country to 16.8 percent.

Some sectors, however, have expressed concern that further hiking cigarette excise taxes might lead to higher cases of illicit trading.

“We fear that the high tax proposals under SB 1599… could aggravate the situation and lead to even higher incidence of illicit trade,” Arranza said in his letter to the Senate.

During a hearing conducted by the Senate ways and means committee, Philippine Tobacco Institute representative Carmen Herce cited Euromonitor International, which projects that further tax increases could increase the incidence of illicit cigarettes from 13.3 percent to 14.2 percent from 2019 to 2022, resulting in revenue losses of P14.2 billion to P16.8 billion.

In response, Lambino said “smuggling should never be used as an excuse not to improve our tax policy.”

“Smuggling should be addressed through enforcement,” hesaid.