Reducing shadow tobacco market: ‘A mix of horror, thriller, and explicit pornography’

This year, perhaps for the first time in recent years, Ukraine has seen a significant decline in the illegal cigarette market. Since the beginning of the year, its volume has fallen from 25% to 18% at the beginning of summer.

This means that almost every fifth cigarette on the market is now sold without paying the money that the budget desperately needs. At the beginning of the year, a quarter of all cigarettes sold bypassed the state budget, which means a loss of tens of billions of hryvnias.

Criminals do not want to lose this money. They are extremely aggressive in their opposition to the state.

The fight against the shadow tobacco market is part of the government's efforts to stamp out the shadow economy, which, according to various estimates, is between 30% and 50%. Kyiv’s international partners, including the IMF, insist on this.

A mix of horror and thriller

"Illegal cigarette producers have already crossed all possible and impossible boundaries in their opposition to the investigation and the state. They beat up police officers to prevent sampling, weld up factory doors and premises, turn off the electricity in settlements for days and weeks. And they even steal the seized goods, which they catch when they are being sent by post," says Danil Getmantsev, Chairman of the Committee on Finance, Taxation and Customs Policy.

According to him, the fight against the tobacco shadow now resembles a horror movie scenario.

"It's a mixture of a horror movie, a thriller, and outright pornography," Getmantsev said at an August 9 committee meeting, describing law enforcement attempts to counter it and the resistance from illegal immigrants.

The Economic Security Bureau states that the current market for counterfeit tobacco products in Ukraine is largely formed by what is produced domestically.

This production does not include those companies that have licenses and those who work completely illegally in basements and underground workshops. Law enforcement officials consider the share of outright illegals to be much smaller than that of the "gray" ones. There is also smuggling. But its share is quite small at 2.2% of the total volume of illicit tobacco products.

In addition, there is a huge network of tens of thousands of outlets that specialize in selling illegal tobacco products.

"This is an infrastructure that has been created over 30 years. This is an infrastructure that has deep roots in law enforcement and fiscal authorities, and let's be honest. This is an infrastructure that has billions, billions of non-hryvnias at its disposal, do you understand? And to say that someone in this country can solve this issue in a year, six months, two years even – it is impossible to do so," Getmantsev said.

He believes that in the future, it is necessary to deal with the sellers and prevent the share of smuggling from increasing.

Investigators are aware of the places of production of "gray" counterfeit. They also know the sales schemes and beneficiaries.

Blocking the production of these "gray" producers has significantly reduced the volume of the "shadow" market.

"We are conducting large-scale investigative actions at five large production facilities in Ukraine where, according to the investigation, the largest mass of illegal products is produced. These are Vynnyky Tobacco Factory in Lviv Oblast, Ukrainian Tobacco Production in Rivne Oblast, Imperial Tobacco in Odesa, Marshall Fine Tobacco Ukraine in Ternopil and Tabako Dim in Kyiv," said Serhiy Perkhun, Acting Head of the Economic Security Bureau (ESBU).

In total, this year alone, the ESBU has seized illegal products worth almost 1 billion hryvnias ($24.3 million). More than 350 criminal proceedings have been registered. A total of 263 people have been charged. 189 indictments have been sent to court, of which 103 guilty verdicts have already been delivered.

But the resistance from counterfeiters is fierce.

"Just imagine that at Vladyslav Helzin's factory in Hoshcha (Ukrainian Tobacco Production – ed.), investigators still cannot take samples on any of the lines. They are physically prevented from doing so. At Hryhoriy Kozlovskyi's factory (Lviv Tobacco Factory – ed.), out of 17 lines, samples have been taken from six, and 11 are blocked," says Getmantsev.

The head of the Rada's tax committee calls such actions a manifestation of preposterousness.

"Who are you people? Who are you to physically oppose the state? Are you sane?" he says emotionally in his address to the beneficiaries of these industries. 

He notes that despite the resistance, this year the illegal activities of a former Kyiv-based money laundering operation were stopped. Two lines, products and raw materials were seized from Tabako Dim LLC in Kyiv. The license was revoked. Imperia.Tabak.LTD LLC from Liubashivka in Odesa Oblast also had its license revoked and its products seized. The same is true for Orion Tabakko LLC from Odesa. The equipment was seized. The license was revoked.

Thus, the lawmaker is convinced that all illegal tobacco production has been stopped. The active fight against the shadow market continues for the fourth month in a row.

18% is still a lot

The fight against the shadow economy has resulted in a significant increase in budget revenues. The State Tax Service notes that in June-July 2024, excise tax revenues increased by 33.6% year-on-year to 4.6 billion hryvnias ($116.8 million).

The lion's share of this amount was paid by legal producers – multinational companies operating in Ukraine. Their representatives share a positive assessment of the changes in the market.

"According to Kantar Ukraine, a company that monitors the illegal trade in tobacco products in Ukraine, the share of the shadow sector in April 2024 decreased to 18% compared to 25.7% in October 2023. The best evidence of the effectiveness of the fight against the illegal market is the increase in excise tax revenues by 33.6% in June-July, to 4.6 billion hryvnias year-on-year (according to the State Tax Service). In addition, according to experts of the Ukrainian Business Council, the number of receipts for the sale of legal products is growing, which is also a very positive indicator," the press service of Philip Morris Ukraine told LIGA.net.

Interestingly, the opening of the company's new relocated factory in Lviv Oblast coincided with the start of massive searches of "gray" cigarette dealers by the ESBU.

However, according to legal producers, 18% of the shadow cigarette market is still too high.

"It is important that law enforcement agencies continue to actively counteract the illegal market, as the average level of this indicator in Europe is about 8.2%," the tobacco company's press service added.

In addition to illegal production, law enforcement and tax authorities are also looking at the sale of counterfeit products. Typical schemes here include selling cigarettes off the books for cash and related manipulations with non-cash payments. Tax authorities and the ESBU should pay special attention to this in the near future.

To counteract this, the parliament is proposing to make such transactions economically unprofitable and wants to increase the tax burden on wholesalers and impose heavy fines for such transactions.

"This is a highly profitable wholesale trade, so the figure of the existing tax burden needs to be clarified and worked out," Getmantsev said following the Committee's meeting.

However, this is currently just an initiative of individual MPs that has not even been formalized in the form of a bill.

Given the share of the "shadow market" in the Ukrainian economy, bringing businesses out of the shadow can significantly replenish the budget. Tetiana Koshchuk, a taxation expert at the Growford Institute, believes that the impact of stamping out the shadow market on budget revenues can be estimated at 500 billion hryvnias ($12.1 billion) a year. But it is difficult to cope with this in one fell swoop.

The Ukrainian shadow tobacco economy has been growing steadily since 2018. Back then, it accounted for 4.7% of the market. This process accelerated after the start of the full-scale war. By the end of 2023, according to Kantar Ukraine, every fourth cigarette in Ukraine was produced illegally.

In March 2024, the overall level of illicit trade in tobacco products in Ukraine decreased to 19.1% from 25.7% in October last year. At that time, this was due to a decrease in the share of illegal products with Duty Free labeling from 12.9% to 9.2%. The ban introduced at the time made it impossible to document sales through duty-free shops.