CSP Magazine

An Active Roll

As legislative actions increase regarding commercial RYO machines, what will the future hold?

Josh Winrich got the letter on a Friday last fall. It told him his roll-your-own (RYO) cigarettes shop in La Crosse, Wis., was operating as a manufacturer and distributor—and therefore must comply with laws governing those businesses.

By that Monday, Wisconsin Department of Revenue agents had shown up on his Holy Smokes store’s doorstep, instructing him to shut down his machines, and uprooting the certainty of his business model.

According to the state, retailers must obtain manufacturer and distributor permits, sell more than 50% of the RYO cigarettes wholesale to other retailers or vending machine operators, and obtain certifications from the Wisconsin Department of Justice and Wisconsin Department of Safety and Professional Services.

“We were just doing what we thought was necessary to protect the other businesses across the state that are following the law and following the regulations,” Stephanie Marquis, spokesperson for the Wisconsin Department of Revenue, tells CSP, estimating that there are between 50 and 100 of the RYO shops in the state.

A lawsuit has since led to a temporary injunction on the department’s actions (pending a more permanent decision.) And Winrich is back at work, having lost two weeks of business and about $20,000 in gross revenue in the shuffle. “It was pretty devastating,” he says. “And we lost many of our customers that were renting our machines that are just now starting to come back.”

Robert Petersen, owner of four Ciggy Shacks, is one of the plaintiffs in the suit and says such shops simply aren’t manufacturers. “Actually, we’re in the rental business,” he says. “They put their own tobacco tubes and tobacco in the machine, they decide how hard or how little they want the cigarette packed, and they push the button. They have the right to roll their own cigarettes for personal consumption.”

The Toll of Taxation

But while Petersen sounds confident in his convictions, issues surrounding the RYO shops have become a regular hot-button topic of discussion at city, state and federal levels. In addition to the retailer-as-manufacturer question, the focus has been on the use of lower-taxed, mislabeled pipe tobacco vs. traditional RYO tobacco; and the sales of unstamped (and therefore contraband) cigarettes— with all seemingly coming back to a disparity in taxation.

New York City has filed several lawsuits against RYO retailers for selling cigarettes without tax stamps, as violations of the federal Contraband Cigarette Trafficking Act and the state’s Cigarette Marketing Standards Act. Eric Proshansky, a city attorney, explains NYC’s viewpoint. “From our perspective, people go in without cigarettes, and they come out with cigarettes,” he says, “So therefore the store is selling cigarettes, and if you’re selling cigarettes, the law says that you have to put tax stamps on them and taxes have to be paid on them and you have to certify that the cigarettes are fire-safe—and these stores don’t do these things.”

Because there isn’t a structure by which the retailers are authorized to collect the tax, he says, the city is “instructing them that what they’re doing is illegal and that they should stop.” Two companies, Island Smokes and New York Smokes, subsequently ceased operations, and Proshansky says the city is aware of five more RYO shops, with suits against two more and the other three in negotiations with the city.

Big Tobacco obviously also has a stake in how the RYO issue plays out. From 2009 to 2010, when the issue came to light, cigarette shipments declined from 308.6 billion sticks to 292.7 billion, according to the Treasury Department’s Alcohol and Tobacco Tax and Trade Bureau’s December 2010 statistical report.

“Philip Morris USA believes that the businesses that operate commercial RYO machines are cigarette manufacturers,” says David Sutton, spokesman for the Richmond, Va., company, “and should make tax payments, be regulated by the FDA and make state settlement payments just like other cigarette manufacturers,”

Still, Don Perdue, a West Virginia delegate who also happens to be chairman of the House’s Health and Human Resources Committee in the state, was surprised when he was approached by tobacco lobbyists. “We don’t normally track together very well,” he says. He says he was struck by the “issue of fairness,” and in the first iteration of his bill wanted to “level the playing field” by requiring RYO shops to impose the 55-cent state tax on every pack sold that other retailers have to charge.

He soon learned that the RYO shops would still have an advantage, using socalled “pipe tobacco” taxed federally at $2.83 pound vs. rolling tobacco taxed at $24.78 a pound.

Industry execs contend that the pipe tobacco used in the RYO machines is mislabeled to take advantage of the tax differential. According to Craig Williamson, president of the Washington, D.C.-based Pipe Tobacco Council, true pipe tobacco has higher sugar content, is moister, is cut differently and smolders rather than burns. “You can’t use pipe tobacco in the machines, because it really gums up the machinery,” Williamson says.

That difference means the RYO shops could still sell cigarettes for $8 less a carton. “There still was an issue of fairness to a degree. Also, one of the things we try to do is use taxes on cigarettes to do good things to overcome some of the bad things,” he says, referring to state-funded tobacco control programs. “We’re going to give these outfits a pass and say it’s OK to sell them cheaper?”

The bill, as it stood at press time, was revised to ban business from possessing the RYO machines, including a $25,000 fine. “I believe very strongly that the people that are doing this are scamming the system,” Willliamson says. “It’s government’s duty to make sure that in society, everybody operates at the same level.”

Associations, such as the Minneapolisbased National Association of Tobacco Outlets (NATO) and the Fairfax, Va.-based American Wholesale Marketers Association (AWMA), also hope to help maintain that even level. In February, both came out with formal positions on the issue.

Anne Holloway, vice president of government affairs at AWMA, explains the association’s position: “AWMA supports efforts to ensure retailers that operate or offer consumers the use of RYO machines should be required to have a manufacturer’s license; register with the FDA under the Family Smoking Prevention & Tobacco Control Act; pay all applicable taxes; be treated as non-participating manufacturers for purposes of the Master Settlement Agreement.”

NATO adopted a similar position, and Thomas Briant, executive director, says, “We’re opposed to these machines unless they can be operated in compliance with all federal and state laws that apply to manufactured cigarettes.” Looking to the future, the efforts at cities, states and associations could become redundancies if the U.S. Department of the Treasury, the Alcohol and Tobacco Bureau (TTB) prevails in court.

In 2010, a preliminary injunction was granted restraining TTB from enforcing its ruling that such businesses are tobacco product manufacturers and must obtain a permit from TTB; obtain a bond and comply with applicable regulatory record-keeping, reporting and inventory requirements; and be liable for paying cigarette taxes.

 Because the case was tied up in court at press time, Tom Hogue, director of congressional and public affairs, couldn’t comment. But the TTB has also sought public comments to physically distinguish between pipe tobacco and RYO tobacco. “Our primary concern,” Hogue says, “is that the appropriate standards to effectively distinguish between these tobacco products can be determined; we will publish a Notice of Proposed Rulemaking that will set forth these specific criteria.”

Meanwhile, Arkansas, South Dakota, Florida, Virginia, Alabama, Massachusetts and other states are weighing in on RYO.

“I think almost every entity that is involved directly or indirectly in the cigarette trade, whether it’s federal government, state government or certainly manufacturers, they have a dog in this fight,” says John Singleton, spokesman for Reynolds American Inc. “I’m not sure how this is going to be resolved, but I think the retailers who are putting in these machines are going to see actions on a number of different fronts.”  

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