A billion dollars for the state budget: How MPs decided to tackle the illicit market of alcohol, tobacco, and fuel

Members of Parliament and law enforcement officials have decided to take serious action against the shadow market of excisable goods. On May 8th, a meeting of the Committee on Finance, Taxation, and Customs Policy of the Verkhovna Rada took place, during which issues related to the illegal circulation of tobacco products, alcoholic beverages, and fuel were discussed.

In brief, the situation with excisable goods, specifically the payment of relevant taxes in their production and sale, is challenging. The chairman of the relevant committee, Danylo Hetmantsev, believes that overall revenue losses from three excisable goods amount to at least $1 billion.

"Despite a significant increase in excise tax payments (the monthly plan for 2023 is consistently exceeded), organised criminal groups continue their activities; there is an evident increase in the amount of illegal alcohol in the market; some producers are controlled by russians; the tax burden on various entities differs several times on the legal market; and small-scale tobacco production thrives, using social media advertising to sell non-taxed products," states Danylo Hetmantsev.

Parliamentarians, together with law enforcement officials, have planned large-scale inspections of tobacco, alcohol, and fuel producers and sellers. They also threaten to completely eliminate not only underground production of excisable goods but also unsolicited trade. The specifics of their plans and whether they have already been able to implement these 'threats' were investigated by Mind.

How many excisable goods are in the shadow market? The numbers that demonstrate the scale of the shadow market of excisable goods are quite telling. According to a study by Kantar Ukraine, by 2023, the share of the illegal tobacco market reached nearly 22%. A year earlier, the share of the shadow market was around 17%, and in 2020, it was 7%. According to the estimates of the Economic Expert Platform, the illegal tobacco market accounts for 20%.

The situation in the alcohol market is even more alarming. Throughout 2022, the share of shadow turnover there reached 36%. Although, if compared to 2019, one can say (albeit with some exaggeration) that the situation has improved. Back then, the Cabinet of Ministers calculated that the shadow market for alcohol reached 55%. However, this result is associated not so much with the successful elimination of illegal activities but rather with a reduction in overall alcohol production.

The lowest percentage of shadow production is in the fuel market. According to the same Economic Expert Platform and the Association of Gas Producers of Ukraine, the share of illegal fuel is about 11%. At the beginning of 2020, this share was almost three times higher, at around 30%.

Overall, according to the estimates of the Economic Expert Platform, the state budget loses 37-42 billion UAH per year (approximately 0.8% of GDP) due to the existence of the illegal market of excisable goods. These figures, by the way, align with the assessment of the relevant committee.

How will the illegal market be fought? MPs, together with tax and law enforcement officials, have outlined a fairly broad scope of work.

Firstly, the State Tax Service will conduct inspections of:

• manufacturers of tobacco products and importers regarding production and circulation of tobacco raw materials;
• manufacturers of ethyl alcohol to uncover cases of unaccounted production;
• licensees engaged in the retail trade of tobacco products in violation of the legislation;
• manufacturers of liqueur and spirits regarding the production of unaccounted alcoholic beverages;
• petrol stations and other retail fuel outlets to verify the presence of a licence for retail trade, registration of fiscal cash registers, excise warehouse registration, etc.

Based on the analytical work of the State Tax Service, the information will be passed to law enforcement agencies.

Secondly, the ESBU will take measures to detect and stop:

• Illicit activities of alcoholic beverages and spirits production plants, including identifying individuals involved in illegal activities, managers of enterprises, and affiliated individuals with such enterprises;
• Illicit activities of entities conducting operations without obtaining the necessary permits, as well as entities illegally storing, selling, or transporting alcohol or alcoholic products;
• Illicit activities of businesses or individuals involved in tobacco production in violation of current legislation;
• Illegal fuel production or blending.

Furthermore, since the beginning of 2023, the detectives of the Economic Security Bureau of Ukraine have conducted 178 searches and 24 inspections. This was done to seize illicit excisable goods and equipment used in their production. As a result, 74 criminal proceedings have been registered in the Unified Register of Pre-Trial Investigations.

Thirdly, in addition to the responsibilities delegated to the ESBU, the National Police will also combat:

• uncontrolled illegal trade of alcohol products, including markets and retail networks;
• uncontrolled illegal trade of tobacco products, including markets and retail networks;
• illegal sale of tobacco and alcohol products through the internet, including the use of mobile applications such as Viber, WhatsApp, Telegram, and websites.

Who will be subject to tax and law enforcement inspections and sanctions? Tax authorities and law enforcement agencies will 'work out' several lists of producers and distributors of excisable products. Mind has access to certain data and documents that provide an understanding of who will be subject to inspections and subsequent investigative actions if violations are found.

1. Fuel market: According to the State Tax Service, there are estimated 88 fuel stations throughout Ukraine trading fuel without the necessary permits and without registering as economic entities. The approximate volume of fuel sold by these fuel stations is 6,600 tons per month. Additionally, tax authorities have identified several oil refineries that may produce unaccounted fuel without paying the corresponding taxes and fees. These include:

• An oil refinery in Dnipropetrovsk Oblast (Gubynykha) with a production volume of unaccounted fuel of 4,500 tonnes per month.
• An oil refinery in Poltava Oblast (Sagaidak) with a production volume of unaccounted fuel of 2,700 tonnes per month.
• An oil refinery in Cherkasy Oblast (Shramkivka) with a production volume of unaccounted fuel of 2,000 tonnes per month.
• An oil refinery in Kyiv Oblast (Kagarlyk) with a production volume of unaccounted fuel of 2,000 tonnes per month.
• An oil refinery in Vinnytsia Oblast (Luka-Meleshkivska) with a production volume of unaccounted fuel of 1,500 tonnes per month.

2. Alcohol market: According to the analysis and monitoring of the activities of distilleries conducted by tax authorities, as of May 1, 2023, there were at least seven groups of producers in Ukraine involved in the production and subsequent distribution of unaccounted alcohol. These include:

• Kharkiv group (companies Ukrspetspirt, Karavan, Artemivka) with a production volume of unaccounted alcohol of 1,500 tonnes per month.
• Vinnytsia group (Bershad Luks company, Yurkovetsky distillery) with a production volume of unaccounted alcohol of 500 tonnes per month.
• Kyiv group (Stadnytske operating location, Steel Group Energy company) with a production volume of unaccounted alcohol of 500 tonnes per month.
• Rivne group (Zirnensky and Kholmy distilleries, West-Distillers LLC) with a production volume of unaccounted alcohol of 150 tonnes per month.
• Lviv group (Storonybaby operating location, Strutyn operating location, Rava-Ruska distillery, Guralnia Brunytskykh and West Way companies) with a production volume of unaccounted alcohol of 150 tonnes per month.
• Kirovograd group (Mezhyrichka Vitamin Plant) with a production volume of unaccounted alcohol of 100 tonnes per month.
• Zhytomyr group (Chudniv branch of Zhytomyr Liquor & Vodka Distillery Factory) with a production volume of unaccounted alcohol of 100 tonnes per month.

3. Tobacco market: Member of the Tax Committee, Yaroslav Zhelezniak, in his Telegram channel, published a list of eight companies that, in his opinion, may be involved in the production of counterfeit tobacco products. According to him, such conclusions were made after calculations of the amount of taxes (excise, VAT, and income tax) paid by some tobacco producers per ton of raw materials. The companies with lower tax amounts for larger production volumes are considered more suspicious. Zhelezniak clarifies that it cannot be claimed with certainty that these are 100% violations, but it appears very questionable, and the tax authorities need to investigate. The companies listed are as follows:

• Tabako Dim LLC – ordered 114 tonnes of raw materials, total taxes paid amounting to 880,000 UAH, with 8,000 UAH in taxes per ton.
• Ukrainian Tobacco Production LLC – ordered 349 tonnes of raw materials, with only 9.26 million UAH in taxes paid, with 26,000 UAH in taxes per tonne.
• Vynnyky Tobacco Factory LLC – ordered 2,041 tonnes of raw materials (+283 tons of tobacco waste), only 3.05 billion UAH in taxes paid, with 1.31 million UAH in taxes per tonne.
• Fermentation Plant Tobacco LLC – ordered 3,674 tons of raw materials (+1,287 tonnes of tobacco waste), only 50,000 UAH in taxes paid, with 13 UAH in taxes per tonne.
• Imperial Gold Tobacco LLC – ordered 382 tonnes of raw materials, 0 UAH in taxes paid.
• Potestas LLC – ordered 839 tonnes of raw materials, with only 30,000 UAH in taxes paid, with 35 UAH in taxes per tonne.
• Empire.tobacco.ltd LLC – ordered 13 tonnes of raw materials, only 2.04 million UAH in taxes paid, with 157,000 UAH in taxes per tonne.
• United Tobacco LLC (licence revoked and production suspended) – ordered 3,030 tonnes of raw materials, only 6.64 million UAH in taxes paid, with 2,000 UAH in taxes per tonne.

What specific loopholes for counterfeiting will be closed, and what are the risks? The overall plan is to bring order to the excisable goods market by the end of 2023. Legislators  have high hopes for the electronic excise stamp, the implementation of which is envisaged in Draft Law No. 8236. The parliament has only approved it in the first reading. However, according to Hetmantsev, starting from March 1, 2024, the e-excise is expected to be launched for 'industrial use'.

A unified tracking system for the circulation of all excisable goods (alcohol, tobacco products, fuel) will be established. Manufacturers, importers, and sellers of such products will be required to register in this system. The very electronic excise stamp will be issued in the form of a unique QR code, which will be applied to the packaging/container of the product. It will enable the verification of the legality of the product and the tracking of its movement.

Yaroslav Zhelezniak, on his part, is surprised by the flourishing trade of tobacco products through these channels despite the state of war and the absence of air connections. "In peaceful 2021, when borders began to reopen after the pandemic and planes flew from Ukraine, 27 million packs of cigarettes were sold through Duty-Free. In 2022, when airports are not operational and a large part of the border is closed, the number of cigarettes sold in Duty-Free was 20 million packs. I'm not insinuating anything, but it's really strange," muses Zhelezniak, clarifying that a bill should be introduced to prohibit the operation of Duty-Free shops at road checkpoints.

Regarding the illegal alcohol market, there is also a lot of work to be done. The aforementioned list of companies to be inspected is not exhaustive. Oleg Hetman says that at least 20 factories produce unaccounted alcohol in Ukraine, with a production volume of 2 million litres per month. This alcohol is then used for the production of alcoholic beverages (also illegally), which are not subject to excise taxes. As a result, the state budget loses money.

"For several years now, there has been an increase in excise taxes at a rate exceeding the growth of people's incomes. It is the root cause of the situation with excisable goods. But instead of completely lifting restrictions on production and liberalising this market, lawmakers believe it is better to intensify control with zero results. I think the result of this 'pretend fight' is already known in advance – the volume of the illegal sector will only increase," says Danylo Monin, an economic and tax expert.

By the way, such concerns are also voiced by representatives of the Ukrainian Oil & Gas Association. In their opinion, if the pre-war level of fuel taxes is reintroduced starting from July 1, 2023 (such a step has already been announced), it may have a reverse effect. And while the fuel market currently looks much better compared to the tobacco and alcohol markets, in the end, the shadow economy may grow, and all attempts by lawmakers to eradicate illegal activities will fail.