Roll Your Own Comes Under Fire

A wave a legislative proposals and legal steps are trying to capture the lost tax revenue

Standing outside a local tavern one Saturday in early March, a friend of mine looked across the street at a new business featuring roll-your-own (RYO) cigarette machines. Nodding his head toward the store, he remarked that pretty soon, he was going to stop buying his regular brand of cigarettes and "start going there." To truly understand his frustration, you need to realize that he is an adult smoker who lives in New York City where a pack of his regular cigarettes cost him $12.25 that very morning.

While New York residents face the highest state cigarette excise tax (an astounding $4.35 per pack), adult smokers across the country are feeling the pinch and deciding they are not going to take it anymore. This sentiment has led to growth in RYO retailing, which allows a consumer to buy cigarette paper and loose tobacco to roll their own cigarettes, but only pay tax on the cigarette paper and loose tobacco. It also has led to a wave a legislative proposals and legal steps to capture that lost tax revenue.

In a major step on the legislative front, a coalition of more than 80 national and state associations and retail stores successfully lobbied Sen. Max Baucus (D-Mont.) to place RYO language in the Senate Transportation Bill that passed on March 14. Specifically, the proposed legislation calls for expanding the definition of a tobacco manufacturer to include businesses operating a RYO machine. As such, the operator would be liable for federal excise taxes on the tobacco products manufacturer.

Coalition members urged support of efforts to close a loophole in the Internal Revenue Code. The coalition includes industry heavyweights such as NACS, the American Wholesale Marketers Association, National Association of Tobacco Outlets, Petroleum Marketers Association of America, 7-Eleven Inc., Cumberland Farms, Kum and Go, Kwik Trip and Valero Retail Holdings.

"For more than a year, certain retailers have been exploiting an unintended tax loophole that has enabled them to manufacture cigarettes with RYO machines and sell them at drastically reduced prices," the coalition wrote. "This places other retailers at a competitive disadvantage that is becoming unsustainable as the problem spreads across the country."

And spread it has. This year alone, Washington State House lawmakers have taken up a proposal that would require RYO cigarette retailers to become certified and pay a $100 annual certification fee. The measure would also require them to buy tax stamps. The state Senate took it one step further with Senate Bill 6564 that aims to outlaw RYO machines in retail locations.

Washington State is not alone. Legislators in South Dakota also debated whether or not tobacco shops that offer machines for rolling your own should be classified as manufacturers. The measure passed in both chambers and was signed by Gov. Dennis Daugaard on March 12.

Those are just two examples.

Legislators and traditional retailers are not the only industry players that have raised concerns about RYO. In a position paper, Philip Morris USA, a division of The Altria Group, raised concerns about placing RYO machines in certain retail outlets. Among its concerns raised, PM USA said the cigarettes produced do not comply with state fire standards and compliant cigarette laws; do not bear required warning labels; and do not meet Food and Drug Administration (FDA) standards. The company also noted that the operators of the RYO establishments are acting as manufacturers, but are not making the required state tobacco settlement payments or paying the required amounts into escrow, and the operations unfairly disadvantage legitimate retailers and taxpaying cigarette manufacturers, as well as deprive the federal, state and local governments of substantial tax revenues.

PM USA further stated that retailers who operate or offer RYO machines to customers should be required to comply with all federal and state regulatory requirements; have a manufacturer's license; register with the FDA under the Family Smoking Prevention and Tobacco Control Act; pay all applicable taxes; and be treated as non-participating manufacturers for purposes of the Tobacco Master Settlement Agreement.

RYO merchants are not taking these efforts lying down. In February, courts in Connecticut and Wisconsin ruled with retailers that challenged attempts to classify them as manufacturers of tobacco products — and subject them to all the regulatory and taxation requirements that come with the classification.

In Connecticut, the Superior Court denied the state's request for an injunction prohibiting a RYO retailer from offering self-serve machines. Notably, the court found that the state was not likely to succeed in its claim that retailers were manufacturers as defined by state law, and that the state failed to demonstrate any harm or lost revenue.

The Dane County Circuit Court in Wisconsin entered a preliminary injunction prohibiting the state Department of Revenue from regulating RYO Filling Station retailers as manufacturers. In that case, the court found that retailers would be irreparably harmed by the regulation; retailers were likely to succeed on the merits of their claim that they were not manufacturers; and the Department of Revenue violated the State Administrative Procedures Act by attempting to regulate the retailers as manufacturers.

On the federal legal front, a 2010 case involving the Tobacco Tax and Trade Bureau (TTB) and RYO retailers is expected to be heard this month. A federal district court granted an injunction against TTB and its attempt to classify RYO retailers as manufacturers in September 2010.

"We are just at the beginning of the debate, not the end," Julie Rautio, spokesperson for RYO Machines, told Convenience Store News. "These bills are starting to get scrutiny in many states. Raising the loose tobacco tax is a very fair policy debate, but classifying something that is for personal use as manufacturing is not. The tax part of the debate is really a smokescreen."