TIGHTER enforcement on illicit tobacco sales could potentially lead to the government recovering close to RM100 million in lost tax revenue for every one percentage point (ppt) drop in illegal cigarette consumption, estimates from JT International Bhd (JTI) show.

“We are happy that the government is finally coming to grips with the severity of the crisis — the policy announcements made in Budget 2021 are indeed the most comprehensive in years. However, resolute enforcement of these new measures needs to follow as well as continuous adherence to the intent of addressing illegal trading in Malaysia. This remains a concern in our view and enforcement agencies need to step up,” says JTI managing director Cormac O’Rourke in an email response to questions from The Edge.

In Budget 2021, the government outlined the importance of improving revenue collection strategies by cracking down on smuggling operations at the country’s borders. Several other measures will also be implemented from January 2021, including strengthening the Multi-Agency Task Force (MATF), which is chaired by the Ministry of Finance and led by the Royal Malaysian Customs Department.

“The effectiveness of the MATF must be measured by a set of key performance indicators to hold all enforcement agencies accountable. Only then would we see tangible results in tackling the black economy,” O’Rourke adds.

O’Rourke: We are happy that the government is finally coming to grips with the severity of the crisis

British American Tobacco (Malaysia) Bhd (BAT) MD Jonathan Reed says that action by the government cannot come soon enough given that the tobacco black market remains a significant threat to the sustainability of the group. “For the quarter ended Sept 30, 2020, illicit cigarettes made up 65% of total cigarette consumption in the country, representing an annual RM5 billion loss in tax revenue for the government,” he says.

For the nine-month period ended Sept 30, 2020, BAT posted a 31.8% y-o-y drop in net profit to RM169.12 million, while revenue fell 10.3% y-o-y to RM1.66 billion. In a Nov 9 report, RHB Investment Bank analyst Soong Wei Siang says his sensitivity analysis suggests a 6%-7% upside to BAT’s FY2021 earnings for a 1ppt drop in illicit trade’s market share.

The Conditional Movement Control Order (CMCO) that started last month has pushed BAT to develop new strategies to ensure the sustainability of its business, Reed says. It has adjusted its protocols to comply with the standard operating procedures implemented by the government while adopting health and safety measures to protect its team.

“Because of this, we have been able to continue operations with minimal disruptions during the current CMCO period,” he adds.

JTI’s O’Rourke says even though its distribution activities were impacted during the MCO period in March due to a lack of clarity over which economic sectors could operate then, he does not envisage any major downside from the current restrictions in force.

“What we see is a balancing-off effect, that is, borders being closed has improved domestic market volumes, offsetting for the most part, volumes lost due to restrictions on the entertainment sector.

Reed: The CMCO has pushed BAT to develop new strategies to ensure the sustainability of its business

“And we do expect to see industry sales volumes stabilising in the second half of the year with the reopening of businesses, although the retail trade and our business remain vulnerable to the repercussions of the crisis as there is weaker consumer spending. This is where we need to be careful not to allow the illegal trade to thrive as seen during the early stages of the partial lockdown,” he says.

Companies Commission of Malaysia (SSM) data shows JTI, whose profits have been declining since the financial year ended Dec 31, 2015 (FY2015), saw a 45.9% y-o-y drop in net profit to RM29.29 million on the back of a 2.3% y-o-y dip in revenue to RM1.16 billion in FY2019.

While the regulatory and enforcement measures announced in Budget 2021 will help curb illicit trafficking in cigarettes, Philip Morris Malaysia Sdn Bhd (PMM) MD Naeem Shahab Khan says any increase in illicit cigarette prices will only happen later next year once these measures are enforced.

“This must also be paired with strong enforcement of these new policies to ensure there will be a reduction in the entry of illicit cigarettes in Malaysia. Currently, the average price of illicit cigarettes is about RM4 to RM6 per 20-stick pack, which is still at a significant gap from the average lowest-priced legal cigarettes at RM10.90 per pack,” he tells The Edge.

Naeem says since the onset of the pandemic, PMM has implemented business-continuity plans to support the supply of its products across the markets where it operates.

“We acknowledge the increasing efforts by the government in tackling the illicit trade of cigarettes. Nevertheless, the illicit trade and Covid-19 resurgence have made the business environment more challenging for us. As such, we are taking bold measures in reviewing our business and commercial activities to ensure the continued access of adult smokers to better alternatives such as IQOS,” he says.

Naeem: Any increase in illicit cigarette prices will only happen later next year

“Since its launch in Malaysia back in November 2018, we have continued to put significant focus on IQOS, our heat-not-burn (HNB) device, which has seen steady growth in its uptake among adult smokers in Malaysia through the quarter ended Sept 30, 2020.”

SSM data shows that PMM recorded a 1,359% y-o-y jump in net profit to RM18.56 million in FY2019, as revenue surged 678.4% y-o-y to RM1.08 billion.

“We believe this signals, first and foremost, an increasing need for better alternatives to cigarettes for the adult smokers in Malaysia who would otherwise continue smoking,” Naeem says.

He adds that a large volume of its electronic HNB devices are manufactured in Malaysia by a supplier who has been producing IQOS devices for local and export markets since 2013. Malaysia is today known as a hub for the electrical and electronics industry, with major global players operating in the country and using it as a gateway to the growing Southeast Asia region.

PMM has yet to assess the potential impact of the government’s move to impose a 10% excise duty on devices for all types of electronic and non-electronic cigarettes including vapes, and to tax all vape liquids at a rate of 40 sen per millilitre from Jan 1.

While it understands the need for the government to generate other sources of revenue by bringing vape liquids under the excise regime, Naeem says PMM is of the view that the devices play a much broader role in the industrial and manufacturing landscape. As such, a hastily proposed excise regime inclusion might have an adverse effect in a delicate ecosystem of exports and localisation of manufacturing.

“To address the vaping black market, the answer is in better enforcement of existing laws on the ground and a holistic approach of risk-based regulation.”

However, BAT’s Reed believes the move to introduce a tax framework for vape liquids is a step in the right direction towards regulating the vaping industry and providing the one million consumers of these products with safety and quality controls.

JTI Malaysia’s O’Rourke says vaping alone accounts for about 10% of total consumption in the market. “Therefore, we understand the government’s intent on imposing an excise duty on electronic cigarette devices and liquid consumables. The value of the vaping market is estimated at around RM2 billion a year, for which no taxes are currently collected.”

He points out, however, that the measures do not address the legality of the segment, especially where the products contain nicotine. “A more holistic and all-encompassing approach and framework is required on the sale and distribution of reduced risk products in Malaysia. As such, changes to the Poisons Act 1952 are needed to reflect the new reality of the market and to ensure that Malaysian consumers have access to reduced risk products that adhere to a regulatory framework that is fit for purpose.”