Russian E-cig Market: Smugglers' Casino

Jason Liang

Since 2018 when e-cigarettes gained popularity among Russians, the e-cigarette market in the country has ballooned. From heat non-burn (HNB) products, which were most popular at first, to disposable and pod vapes and open systems, a wide range of e-cigarettes have gone down strikingly well among young consumers. This popularity has spurred a rapid expansion in Russia's e-cigarette market size. As shown in the 2021 E-cigarette Industry Blue Book jointly released by Juanjuan Think Tank and ECCC, Russia's e-cigarette market value was calculated to be approximately RMB 10 billion in 2021 based on the shipment data, of which disposable vapes accounted for a hefty proportion of more than 90%.

However, as the e-cigarette market develops by leaps and bounds, Russia's progress in regulatory policies in this regard has failed to keep pace with the growth rate. In fact, the State Duma has passed a series of draft bills on e-cigarettes since the second half of 2019, indicating that Russia started to pay attention to the regulation of the e-cigarette market at the government level. At the same time, a package of market management measures has been taken, for example, limiting transportation, formulating a special tax law, and including e-cigarettes in the unified labeling system. But an insufficient understanding of e-cigarette industrial technology and expertise, complicated trade channels of the Commonwealth of Independent States, a lack of regulatory resources at the government level, and hostility of the traditional tobacco industry towards new-type nicotine products have conspired to bring a hindrance to Russia's policy making and implementation and then result in the status quo of Russia's e-cigarette market.

A smoking room at a shopping mall in downtown Moscow

Source: © РИА Новости медиабанк / Кирилл Каллиников

How products flow into the grey market

As stipulated in Article 145 of the Tax Code of the Russian Federation, organizations and private entrepreneurs shall have the right to apply for and enjoy an exemption from payment of VAT for a year if, in the last three consecutive calendar months, the amount of receipts from the sale of goods (work and services) of those organizations or private entrepreneurs, excluding tax, did not in the aggregate exceed RUB 2 million.

Article 201 (The Procedure for the Application of Tax Deductions) stipulates that deductions shall be made only for amounts of excise duty which were actually paid upon the import into the territory of the Russian Federation and other territories under its jurisdiction of goods which were released for free circulation.

Mr. Dmitry Vladimirov, Head of the Union of Enterprises of the Industry of Nicotine-Containing Products (SPINI), said, "A large number of products illegally enter Russia without customs duties and dues and at very cheap prices. In most cases, they claim that these products are from China and bound for Belarus through Russia to bypass customs checks. That's because nicotine products are allowed to be imported to the member states of the Eurasian Economic Union (EAEU) as long as they have licenses issued by authorized bodies of these member states. But when these importers exit the Russian territory, their goods are left. Later, 'other tricks' will be played to dump the products left into the Russian market."

An e-cigarette seller also mentioned that there is a constant supply of and stable demand for Chinese e-cigarettes in Russia.

Some dealers often buy them in bulk and mark them up two or three times for retail on the Internet through wholesale markets, websites, or personal mail. All of them are illegal unlabeled products.

In practice, when nicotine heating devices, high-concentration nicotine liquids, and open system devices are brought into the Federation of Russia by individuals rather than declared to customs for approval as ordered goods, individual users do not pay excise tax as "individual conveyance of e-cigarettes" does not meet the excise tax payment criteria stipulated in Article 179, Chapter 22 of the Tax Code of the Russian Federation.

On November 17, 2022, Mr. Aidar Metshin, a representative of the United Russia Party, submitted to the State Duma a bill that sets out the number of unlabeled e-cigarettes that Russian citizens can carry for personal purposes (Up to five can be carried in aircraft as far as we know). This bill is aimed at clamping down on the free circulation of unlabeled e-cigarettes imported from EAEU member states in Russia.

Mr. Aidar Metshin, also a deputy of the State Duma, ever pointed out at a Parliament meeting that illegal products currently account for up to 90% of Russia's e-cigarette market.

Illegal e-cigarettes circulated in the market

Source: © ГУ МВД России по городу Москве

Regulating the grey market is difficult

A journalist with RIA found during a secret investigation that virtually all the e-cigarettes sold at Sadovod, one of the largest wholesale markets in Moscow, are illegal or counterfeit.

Falsified certificates of conformity for e-cigarettes are readily and freely available on the Internet. More than that, almost all tobacco shops and large markets have copies of legitimate trademarks of well-known e-cigarette brands and stick them on products that don't take any quality tests. For those popular e-cigarettes, their outer packages are often in demand even though there are no certificates of conformity.

Many merchants have their own sales websites and channels. Through these websites, they collect market feedback on their products and show their clients the real-time sales volumes of the most popular products.

Various types of media such as social software and live-streaming platforms are used by merchants as sales channels. A WhatsApp seller said that e-cigarettes at half the price of those genuine ones sell very well on WhatsApp and hundreds can be easily sold retail in a short time.

Some well-known brands are pretty popular in Russia. When cheap but good imitations are available, consumers will naturally not choose those genuine ones. In face of the problem, these brands' companies have introduced anti-counterfeiting QR codes. But in the practical market circulation process, these QR codes could also be copied. This has dealt a blow to these brands' genuine products, resulting in a decline in their sales volumes.

Mr. Vasily Sokolov, a legal operator of Zenmod.shop licensed by the federal government, said, "It's quite difficult for the government to regulate the e-cigarette market because the watchdogs lack resources to collect and submit evidence against all the shops suspected of illegal trading to the court. It's all the more so when it comes to those sales websites that engage in illegal trading. If one illegal sales website is shut down, a new one will be opened easily. That's because such illegal trading can profit them way more than opening a website costs them." The good news is that the federal government has passed a new law, i.e. Law on Blocking Illegal E-cigarette Trading Websites before Approval. Scheduled to take effect in March 2023, the law aims to put in place the source-based examination that starts from websites, which will make regulation less difficult.

Sadovod wholesale market

Source: © РИА Новости / Мария Рубникович

The problematic grey market

In July, the Moscow government seized 150,000 fake e-cigarettes. A test report indicated that they were harmful to people's life and health because of a remarkably higher nicotine level than that specified on the package. It was said that this large seizure was delivered from China under the guise of small household appliances. And the customs duties evaded were estimated at RUB 30 million (about RMB 3.55 million).

Besides, to legalize the devices, the dealers forged accompanying documents and quality certificates and sent them to trading enterprises, and sold the devices through online shops. As their acts violated the second part of Article 238 of the Criminal Code of the Russian Federation ("production or sale of goods and products which do not meet safety standards"), the dealers were prosecuted.

On July 27, a 13-year-old pupil's e-cigarette exploded in his hand in Khimki, a city near Moscow. The pieces cut the boy's lips, nose, hands, and chest. According to some experts, the e-cigarette in his hand was a shoddy fake.

Mr. Evgeny Fedotov, Head of Fedotov Group, a tobacco consultancy firm, said that there are few requirements on e-cigarettes in the form of laws and regulations in Russia so far. But like other electronic devices, e-cigarettes must be checked for compliance with relevant technical laws and regulations and their EMC also needs to be studied. "Because of this, the samples will be sent to certified laboratories in EAEU member states." Though the laboratories don't check the quality of the e-liquids in the samples, they at least check whether the devices are assembled correctly and have the risk of explosion. But despite this, the quality of illegally imported e-cigarettes still cannot be ensured.

Inspectors from a government watchdog check an e-cigarette retail shop

Source: © ГУ МВД России по городу Москве

The grey market expands year by year

Data released by SPINI shows that the market share of fake e-cigarettes—based on the data SPINI can collect currently—has grown by 20% every year since 2019. By 2025, the value of the market share will reach RUB 55 billion (about RMB 6.5 billion) in monetary terms.

According to Mr. Dmitry Vladimirov, it's impossible to ascertain the accurate growth rate and size of the grey market so far as the industry has no specific code in the Russian Classification of Economic Activities.

Based on the official customs data, a SPINI director is certain that the real size of the grey market should be about ten times that of the figure given by SPINI, although there is no reliable information on the number of companies manufacturing and selling e-cigarette appliances and e-liquids yet. In monetary terms, the value of the grey market will reach RUB 550 billion (about RMB 65 billion) by 2025.

Additionally, inexperienced inspectors just cannot be sure whether the goods in front of them are legal. So far, only a small fraction of e-cigarettes that have been included in the track-and-trace labeling system enter Russia legally and bear all legal responsibilities.

According to an expert with Fedotov Group, the total amount of purchases in the Russian e-cigarette market approached 253 million last year. The proportion of products that were legally imported, however, was less than 10%.

Graph showing the growth of Russia's illegal tobacco market based on SPINI data (Unit: RUB 1 billion, about RMB 118 million)

Source: исследование СПИНИ

"Honest Sign" facilitates regulation

As stipulated by the Tax Code of the Russian Federation, two types of excise taxes are levied on e-cigarettes which are classified as a kind of device: One for the e-liquid and the other for the device. The latter is levied based on the average cost of the device which is between RUB 62 and RUB 180. As for the former, VAT is levied per milliliter of the e-liquid, which is RUB 17. Add all the numbers up and the cost is about RUB 400 (about RMB 47).

But with the imposition of the excise tax on e-liquids, the tax rate on e-cigarettes in Russia becomes several times higher than that in Kazakhstan. So if they are imported to Russia via EAEU member states, for example, Kazakhstan, their tax cost can be greatly cut. As a result, legal imports are several times more expensive than illegal ones and fare very poorly in sales.

"Honest Sign" in the process of commodity circulation

Source: © РИА Новости  медиабанк / Виталий Белоусов

On February 15, the "Chestny Znak (Honest Sign)" system was piloted, applying special Data Matrix codes to disposable vapes and e-liquids. Sellers or manufacturers need to register their products in this national track-and-trace digital system, and devices are used in a specific number of codes. In this way, the source of product production can be traced through the sales chain.

Actually, the system was first implemented on cigarettes. According to the data from the Center for Research in Perspective Technologies (CRPT) which operates the system, the system has been proven to be an effective solution to other products including cigarettes. Thanks to the system, the turnover of illegal cigarettes went down by a quarter in a year. 

Therefore, the pilot program has obtained support from allied authorities in Russia. From December 1, "Honest Sign" will be enforced for e-cigarettes. By then, products without the "Honest Sign" will be prohibited from circulation on the market.

In retail outlets, if an "Honest Sign" is scanned and is found to be inconsistent with the corresponding e-cigarette product, then the paying will be prohibited and no receipt will be given. More than that, the shops involved will be prosecuted for breaching criminal law.

But the federal government also provides a buffer period for the implementation of the policy, allowing unsigned e-cigarettes to be sold wholesale until April 1, 2023 and to be sold retail until November 15, 2023.

According to the 2023 fiscal tax plan of the Russian federal government, Russia will work to keep an increasingly tighter rein on the illegal e-cigarette market and incorporate the market circulation into the compliance system through tough administrative measures in the next year. This comes as a combined result of a strong desire for increasing the government's fiscal revenue and a firm resolution to protect the legitimate rights and interests of consumers. 

The success of "Honest Sign" in the tobacco market has provided valuable experience for the Russian government to crack down on the illegal e-cigarette market. Meanwhile, EAEU has passed the decision of labeling e-cigarettes according to unified rules. All of which has spoken volumes about the determination of the governments to mount a full-scale effort to regulate the illegal e-cigarette market. Besides, unified quality standards, equal excise tax rates, and mutual access to customs entry and exit information will put Russia and other EAEU member states in a better position to regulate these grey markets.

Please stay tuned for more reports about Russia's e-cigarette market and EAEU's new e-cigarette label.