By Scott Orr
There’s a sign in the window of the Hi Roll Tobacco shop in downtown Reedsburg, Wisconsin, that reads simply: "The Machine is Back On."
"The Machine" is a controversial device used to roll tobacco into cigarettes at a pace of about a carton every 10 minutes. And while no one questions its efficiency, its presence at Hi Roll Tobacco and similar retail outlets across the country has sparked heated debate in state capitals and in Washington, D.C.
This is no small issue for tax collectors and tobacco retailers. The spread of industrial-sized roll-your-own (RYO) cigarette machines could threaten a tax revenue stream worth hundreds of millions of dollars and send destabilizing ripples across the tobacco retailing landscape.
"This is growing into a major controverÂsy," said Corey Fitze, director of governÂment relations for NACS. Left unÂchecked, the tax disparity that allows Hi Roll Tobacco and its ilk to sell cartons of cigarettes for less than half the price of national brands could forever change the way cigarettes are manufactured, marketed and sold.
Fitze says Congress should step in and pass legislation providing for marÂket certainty. This legislation could say that, as of a certain date in the future, reÂtailers who utilize these machines are regulated as cigarette manufacturers, while clarifying that they should not be retroactively taxed for sales made prior to that date.
Alternatively, the legislaÂtion could codify that retailers who own these machines are not manufacturers, thereby eliminating the cloud of doubt regarding the retroactive taxation of their profits earned from the machines.
"We don’t want to punish those who have jumped in to take advantage of the current situation, but we realize that the current framework is not sustainable. We just want a common sense solution to a situation that has the potential to cause significant harm," he said.
The controversy stems from a disparity in tobacco taxes included in the 2009 Children’s Health Insurance Program Reauthorization Act, better known as S-CHIP. S-CHIP raised taxes on rollÂ-your-own tobacco to around $25 per pound, keeping it on par with taxes on packaged cigarettes. But Congress did not include a similar hike on pipe tobacÂco, which is now taxed at less than $3 per pound.
So, if tobacco suitable for "rolling your own" cigarettes with an industrial-sized machine is packaged and sold as "pipe tobacco," there is a substantial price differential leading to enhanced profits for RYO retailers, leaving behind retailers without these machines.
Is it any wonder, then, that since the 2009 tax increase, the volume of pipe tobacco sold in the United States has more than tripled to 21 million pounds while traditional rolling-tobacco sales volumes, in contrast, fell roughly 60%.
It’s hard to say with complete certainÂty, how much of that growth is caused by RYO shops with mass production maÂchines and how much is coming from people actually rolling their own smokes at home. The obvious inference, howevÂer, is that the increase is due to the inÂcreasing prevalence of the machines.
According to the Internal Revenue Code, pipe tobacco is "any tobacco which, because of its appearance, type, packaging, or labeling, is suitable for use and likely to be offered to, or purchased by, consumers as tobacco to be smoked in a pipe." Roll your own tobacco, meanÂwhile, is "any tobacco which, because of its appearance, type, packaging, or laÂbeling, is suitable for use and likely to be offered to, or purchased by, consumers as tobacco for making cigarettes or ciÂgars, or for use as wrappers thereof."
The federal Alcohol and Tobacco Tax and Trade Bureau (TTB) acknowledges that there is no clear regulatory stanÂdard to differentiate between the two products, but it is working on a solution: "We are currently evaluating methods to differentiate between the two prodÂucts and foresee providing specific guidÂance in this regard in the near future."
Last year, the TTB announced that retailÂers who rent RYO machines for customer use are "manufacturers" of cigarettes. As "manufacturers" of cigarettes, such proÂprietors are required to comply with TTB’s various permit and licensing reguÂlations, including certain recordkeeping, reporting and inventory requirements.
But wait, the ink was barely dry on the TTB order when it was challenged by the RYO machine industry in federal court in Ohio. The court issued a tempoÂrary restraining order blocking the TTB from enforcing the policy. That ruling is currently on appeal to the Sixth Circuit Court of Appeals.
According to NACS, one of the opÂtions at Congress’ disposal would be to simply codify the TTB order into law, and likely end a series of actions taking place at the state and local level. Or, conÂversely, Congress could legislate that TTB was wrong in its order, and clarify that retailers who own RYO machines are not manufacturers. Either course of action would provide the market cerÂtainty the industry desires.
In New York City, a pair of roll your own establishments was the target of a lawsuit filed by the city that characterÂized the shops’ services as effectively selling cigarettes, which must incur the full state and city tax of $5.85 per pack.
"By selling illegally low-priced cigaÂrettes defendants not only interfere with the collection of city cigarette taxes, they also impair the city’s smoking cessation programs," the city said in its suit.
Jonathan Berhrins, an attorney repÂresenting the shops, said the stores were not obligated to charge cigarette taxes because they do not produce cigarettes for resale: "We are selling the contents that produce the cigarette and it’s up to the user to make them," he said.
In September, the Wisconsin DepartÂment of Revenue issued a notice to RYO shops demanding that they obtain manÂufacturer and distributor permits. It was that order that brought the rolling machine at the Hi Roll Tobacco shop screeching to a halt.
Like the similar federal order, the Wisconsin order was blocked by a temÂporary restraining order sought by RYO Machines LLC, the Ohio-based manuÂfacturer of RYO machines and several Wisconsin retailers.
The order, however, hardly ends Wisconsin’s interest in the industry. "We are disappointed with the court’s decision, but we remain dedicated to enforcing our tobacco laws and regulaÂtions fairly and equitably," said StephaÂnie Marquis, a spokesperson for the DeÂpartment of Revenue.
Meanwhile, the restraining order prompted a resumption of rolling at Hi Roll Tobacco and the sign in window announcing that the machine was turned back on. The question now is for how long?
Scott Orr is a freelance writer based in Washington, D.C.