smoke.com

You’ve got a long way to go, baby.

Legal and tax challenges have hit the booming online tobacco business as states seek to limit direct cigarette sales — and get their cut of whatever sales do go through.

Tobacco sales online could eventually reach $10 billion annually, according to site owners’ optimistic estimates. Independent sites like supercheapcigarettes.com, cigarettesexpress.com, and smokesoutletmall.com face challenges as states confer on how to coordinate tax collection. Meanwhile, tobacco companies themselves are fighting legal challenges to online and direct-mail sales.

But it’s not R.J. Reynolds or Philip Morris in court this time. Smaller tobacco companies have taken the lead on clearing legal hurdles to alternative distribution. That’s no surprise, really, since RJR and PM’s dominance in traditional channels drove competitors to seek alternatives in the first place.

Most active is Brown & Williamson, Louisville, KY. The company filed suit against the State of New York in October, challenging its ban on Internet, phone, and direct-mail cigarette sales. Filed in U.S. District Court in the Southern District of New York, the suit calls the ban “unconstitutional interference with commerce.”

The landmark suit could shape the whole future of tobacco on the Internet. New York was the first state to pass a law banning online sales. If it’s overturned, that lays the foundation for explosive growth — and a hit to traditional retailer sales. If it’s upheld, other states could enact their own bans. Then the broader issue becomes whether states can limit any Internet sales — liquor, pharmaceuticals, financial services — that compete with local businesses.

“The future of e-commerce will be jeopardized if all 50 states can set their own rules for what can be sold over the Internet, or if they can ban out-of-state sales to protect state tax revenues or local merchants,” says B&W attorney David Remes in a statement.

A federal judge issued a temporary restraining order last November to prevent New York from enforcing the law. A hearing date is set for June.

In October, B&W formed BWT Direct to sell cigarettes directly to consumers via catalog, and plans to begin Internet sales next quarter. The subsidiary — B&W’s first-ever direct sales effort — has shipped several thousand catalogs to consumers in nine states (but not New York) after testing well in North Carolina early last year. BWT Direct plans to roll out nationally, but no timetable has been set. (BWT won’t ship catalogs in New York until the case is fully resolved.)

State-specific catalogs — with prices adjusted to include state taxes — sell smaller brands that have been muscled off store shelves such as Barclay, Capri, Misty, and Pall Mall. (Filtered Pall Mall, introduced in January, will sell only through traditional retail channels.)

Catalogs go to consumers 21 and older in a B&W database of current users who opted in for special offers. The company works with database marketing firm Right Choice, St. Louis, to verify customer ages against driver’s license and voter registration records, says B&W spokesperson Steve Kottak. “We ensure that only adults 21-plus get our products, even though the legal age in many states is 18. We also ensure that all federal, state, and local excise taxes are paid. A lot of direct-mail and Internet sources don’t.”

B&W sells cigarettes to a wholesaler, who affixes the appropriate excise tax stamps and then sells them to BWT Direct, which pays all sales taxes.

TAXING CONCERNS

According to B&W’s suit, New York cites four reasons for banning Internet, mail order, and telephone sales of cigarettes. The state contends they would jeopardize healthcare funding (by reducing excise taxes which fund state healthcare), threaten the state’s economy, enable minors to buy without proof of age, and make it harder to measure in-state smoking levels. “A blunderbuss law that blocks all sales to legitimate consumers over three of the nation’s major avenues of commerce is not needed,” the suit contends.

The biggest issue — in New York and beyond — may be lost taxes. B&W asserts that federal and New York state laws “provide ample means” to make sure state taxes are paid. “This program could be a model for how other programs are run,” Kottak adds.

New York is already hurting: It lost $146 million in tobacco income last year when its March 2000 tax hike to 55 cents per pack cut consumption. But it’s not alone fighting Internet scofflaws.

This year, state legislatures will consider adopting the Uniform Act and Uniform Agreement to better coordinate tax collection on e-commerce sales, including tobacco. The act was published in December by the Streamlined Sales Tax Project, with 30 states on board and another 12 observing. Four states — Kansas, Michigan, North Carolina, and Wisconsin — will host pilot tests of new technology to implement tax collection. State legislatures are expected to begin debating the accord this session.

A federal directive has shielded Internet sales from being taxed, in order to foster e-commerce growth. But online sales have now reached a level that threatens states’ traditional tax base.

“Forty-five states and the District of Columbia depend on sales tax as a revenue source, and there is growing concern that those tax bases will erode as consumer preference for e-commerce grows,” reports the National Conference of State Legislatures (NCSL), which heads up the streamlining project. States lost $500 million in uncollected sales tax last year, according to Forrester Research, Boston. They’ll lose a projected $11 billion in taxes in 2003 because of e-commerce sales, NCSL reports.

A streamlined system would benefit marketers, too: NCSL estimates that a retailer doing business across the country has to know sales and use tax rules in as many as 7,500 jurisdictions. (Look at BWT Direct’s state-specific catalogs, for example.)

The new system boasts high-tech execution, uniform definitions and tax rates, a one-stop vendor-registration system, and minimal vendor audits. “Multi-state businesses face a number of challenges in complying with the existing sales and use tax laws,” says project co-chairman Charles Collins, Jr. of the North Carolina Department of Revenue. “Our primary focus has been on easing or eliminating the tax collection burden for vendors while promoting a level playing field in the marketplace.”

At the same time, a handful of states including California, Washington, and Wisconsin are pressing tobacco sites — and their customers — to pay up. California and Washington tapped the Jenkins Act, a federal law requiring shippers to list each recipient’s name, address, brand, and amount purchased. The 50-year-old law was designed to thwart bootleggers; states are using it now to squeeze Internet sites. California and Washington demanded customer names from sites, then dunned consumers for the taxes — around $9 a carton. Wisconsin’s Revenue Department buys cigarettes online and, after getting a shipment, requests names of all customers in the state. Sites that don’t comply get reported to federal prosecutors.

Such efforts are scattershot at best, but it forebodes tough consequences for tobacco marketers who don’t set up a tax-collection system before launching their own direct-to-consumer sites. BWT Direct could serve as a model — with or without New York.

tax max

For a copy of the Uniform Act and Uniform Agreement, visit streamlinedsalestax.org.

fagged out

Freefags.com uses a promotional loophole to avoid cigarette “sales” altogether. The U.K. site gives away 200 free cigarettes with every promotional lighter it sells for £25 (limit one per customer).