TOKYO (BLOOMBERG) - Japanese lawmakers are just weeks away from proposing changes that could erode tax advantages for Big Tobacco's new hope: heat-not-burn products that deliver a nicotine hit without all the smoke and tar of traditional cigarettes.
Changes in Japan may also serve as a template for legislators in other countries as global sales accelerate towards an estimated US$15 billion (S$20 billion) by 2021. Any shift will be important for Philip Morris International, British American Tobacco, and Japan Tobacco, which profit from lower taxes and have invested heavily in the new products in Japan.
Amid a broad debate on raising revenue to cope with Japan's debt, while trying to curb the health costs caused by smoking, rival groups within Prime Minister Shinzo Abe's ruling coalition must decide whether to base levies on weight, per unit, or even nicotine content. The new products are currently taxed by weight, like pipe tobacco, while the levy on cigarettes is per stick.
In the European Union, where taxes on heat-not-burn are also lighter, authorities are collecting more information for a study next year before any systematic change. The United States has no federal system for taxing these products, although some states and localities have imposed levies.
"Whatever happens in Japan now, you're gonna see that probably put into people's numbers for the wider global markets," said Mr Owen Bennett, an analyst with Jefferies in London. "I think it's the key data point in terms of how people view this space going forward."
With the clock ticking for the coalition's tax panel to produce a proposal by mid December, lawmakers are still a long way from arriving at a consensus position, according to people familiar with the discussions.
The people, who asked not to be named because the talks are private, describe three broad groups: The largest, drawn from the mainstream of Mr Abe's Liberal Democratic Party, wants the tax rate on all heat-not-burn products largely equalised, and raised to the level of regular cigarettes. They are driven by the need to increase revenue and believe levies on most tobacco products should keep rising slowly.
The LDP's tobacco caucus is fighting to limit tax hikes on any type of tobacco product, arguing that this would be a slap in the face to tobacco growing-constituents who helped the government increase its majority in an election last month.
Mr Abe's coalition partner Komeito is arguing to increase levies on both traditional and next-generation products, while maintaining heat-not-burn's tax advantage to try to curb the harm to public health from smoke.
Mr Tetsuo Saito, a key Komeito official in the debate, has said he supports raising the tax on regular cigarettes by 3 to 4 yen (S$0.036 to S$0.048) per stick.
Officials in the finance ministry, which will play a key role in drafting and implementing any changes, are broadly aligned with the LDP mainstream view, said people with knowledge of the matter. A spokesman for the ministry declined to comment.
Political analysts expect the tax-hike camp to give some ground to the tobacco caucus and the Komeito, but they warn it is not possible to determine how much yet. If negotiations prove too difficult, lawmakers could even defer making changes.
There could be a tax hike that narrows but does not eliminate the gap between regular and next-generation products, said visiting scholar Jun Okumura at the Meiji Institute for Global Affairs in Tokyo. That would be something for everyone and could get a favourable response in the media, he said.
Tobacco companies have argued it is too early to formulate new tax systems for heat-not-burn and that for now governments should focus on encouraging smokers to switch over to potentially less harmful alternatives.
"We definitely believe we should wait and see before making a decision," said BAT Japan's head of regulatory and public affairs Ryosuke Tsuji. The company has moved rapidly with its glo device in Japan, going from sales in test markets to nationwide within a year.
Japan Tobacco's outgoing president Mitsuomi Koizumi said a large increase in tax would be "troublesome for consumers". A spokesman for Philip Morris said the company is watching the debate in Japan but declined to provide detailed comments.
Although the US$5 billion global market for heat-not-burn is a fraction of the US$680 billion market for regular products, it may triple in size over the next four years while the traditional market stagnates, according to Euromonitor International estimates. The market for e-cigarettes, which work by heating and vaporising nicotine-laced liquid, is still bigger than heat-not-burn.
Philip Morris, which introduced its IQOS line in Japan in 2014, sold more HeatSticks in the country for the device last quarter than regular cigarettes. HeatSticks now account for about 12 per cent of the nation's total tobacco market, according to the company.
This makes Philip Morris most vulnerable to a tax hike right now, according to Mr Jonathan Leinster, an analyst at Berenberg in London. He said that while Japan Tobacco, the former government monopoly, is still the smallest player in the new field, it stands to lose from any change from the current weight-based tax because of the lightness of units for its Ploom Tech device.
Japan Tobacco shares have slumped 3.8 per cent this year, while BAT and Philip Morris International have each climbed more than 10 per cent.
Even though any hike may reduce the incentive for smokers to make a switch if Big Tobacco passed on the cost on to consumers, heat-not-burn products are likely here to stay. "Whether they want it or not, the opportunities at the moment are within these next-generation nicotine delivery devices," said Mr Ivan Genov, a tobacco analyst at Euromonitor in London. "This is the area where future growth is, even if taxation is at higher level."
