Pakistan’s Big Tobacco Problem

The tax officers swooped as soon as the truck pulled out of the covert warehouse. Inside the vehicle, they found what they were hunting for: More than 1.3 million black-market cigarettes, all with branding from a subsidiary of one of the world’s largest tobacco companies, Philip Morris.

When the officers ventured inside the building, in the northern Pakistani city of Mandra, they discovered vast tobacco manufacturing and packing machines and a huge stock of cigarettes. After trawling through them, they counted nearly 60 million illegal smokes.

In a bristling report on of the raid in mid-2017, the Rawalpindi regional tax office itemized what it described as “glaring details” that Philip Morris (Pakistan) itself was using the undeclared warehouse — a former factory for the tobacco giant — to churn out black-market cigarettes.

“Huge cigarette manufacturing and packing machines were parked at the premises despite the fact that [Philip Morris] had submitted a categorical report… that all machines of [the] Mandra factory have been scrapped,” according to the regional tax office, as reported by the Business Recorder, a financial daily.

“The logical conclusion [is] that the undeclared warehouse is being misused for [the] storage and sale of undeclared/concealed production of non-tax paid cigarettes.”

In some ways, the seizure was not surprising. That financial year, Pakistan’s top two cigarette manufacturers, British American Tobacco and Philip Morris, said their output had slumped due to competition from cheaper black market cigarettes. According to research sponsored by Philip Morris, illegal tobacco consumption had grown to account for almost 44 percent of Pakistan’s market. (This claim was contested by the Pakistan National Heart Association, which conducted its own survey and found that illicit trade made up only 9 percent.)

But the Mandra raid also illustrates another widespread issue: The world’s largest tobacco companies have been complicit in the black-market trade of their own products.

Just a few months earlier, Pakistani tax officials had found another illicit cigarette factory in a small valley nestled among the mountains near the border of Afghanistan. Inside they reportedly found manufacturing equipment they concluded had come from Philip Morris. Health officials later told reporters the investigation is stalled.

A local who lives in a nearby village confirmed there had been a cigarette factory in the valley, but said it was closed in 2016. OCCRP approached officials at the Federal Board of Revenue on the subject of the investigation, but did not receive a response to its questions.

Black-market tobacco had long been a problem in Pakistan, which has a very high prevalence of tobacco use — with over 23.9 million users, by one tally. Every year, 125,000 die from tobacco-induced diseases there. But by 2019, Pakistan’s authorities were facing mounting pressure to bring the illegal tobacco trade under control.

The year before the country had acceded to an international anti-tobacco-smuggling treaty called the Illicit Trade Protocol, which mandates that governments introduce tracking and tracing systems to determine the origin of tobacco products, and monitor and control the movement of cigarettes. The IMF also required that Pakistan implement track and trace when it negotiated a US$6 billion bailout with Islamabad in mid-2019.

An effective track-and-trace system would force the world’s largest tobacco companies, including Philip Morris and British American Tobacco, to be transparent about how many cigarettes they make and the taxes they owe. But after a shady bidding process, which is now being challenged in court, Pakistan’s tax authorities awarded the contract to a Pakistani military company working with Swiss software provider Inexto.

Critics say Inexto’s software is a “black box” based on a system devised by the tobacco industry that does little to help curb smuggling. The company has been barred from working on key aspects of the European Union’s track-and-trace system because of its ties to the tobacco industry. Nonetheless, its software is being used to track and trace cigarettes in Russia, West Africa, and Mexico.

Inexto declined to comment on the tender process, citing ongoing litigation, and said accusations it is too close to the tobacco industry are “entirely unfounded.” (See the box below for Inexto’s full response.)

Now an OCCRP investigation has raised crucial questions about how Inexto’s software was chosen for Pakistan’s system, in what one industry trade body has called a “dangerous precedent” for other countries around the world.

A man exhales smoke from a Capstan cigarette, a brand made by Pakistan Tobacco Company, in Karachi. Credit: REUTERS/Akhtar Soomro

‘Strong Resistance’

Pakistan has relied on tobacco companies to honestly declare their own production for years. For just as long, it has been plagued by under-reporting.

Academic Hana Ross, a researcher at the University of Cape Town who studies tobacco control, said that although under-reporting of cigarette production is a problem in many countries, the level in Pakistan borders on “obnoxious.” Pakistan’s Social Policy and Development Centre estimates that allowing tobacco companies to self-declare cost the country 15 to 47 billion rupees ($143 million to $448 million) in lost taxes each year, between 2015 and 2018.

The Federal Board of Revenue, Pakistan’s tax authority, tried to make sure Philip Morris Pakistan and Pakistan Tobacco Company — local subsidiaries of Philip Morris International and British American Tobacco, respectively — which together account for some 98 percent of the market — were reporting accurate figures by sometimes posting inspectors in their factories. But the results were patchy at best, said Hamid Ateeq Sarwar, a member of the FBR.

“The physical presence of people usually yields results in initial days, but dies down after 20 or 30 days, even if we change the people,” he said.

🔗Here’s what Philip Morris and British American Tobacco said about cigarette smuggling and track and trace:

Philip Morris: “Illicit trade is a scourge on society and the economy, it harms consumers by exposing them to unregulated products and damages legitimate businesses – including our own. To deter illicit tobacco flows, Philip Morris International (PMI) invests significantly in supply chain controls through preventive and protective measures, implements track-and-trace solutions in line with strict regulatory requirements, and applies comprehensive due diligence of customers and suppliers. Beyond the anti-illicit trade programs we implement around the world, we work with a broad range of state and non-state actors to help advance global efforts against this complex issue.”

British American Tobacco: “We are committed to fighting the illicit trade in tobacco products, which is a serious, highly organised crime that deprives governments of revenue, favours youth access, harms legitimate business, threatens national security and undermines public health initiatives. To fight the illicit tobacco trade, we believe that a well-coordinated and collaborative solution is needed between the public and private sectors. We implement robust supply chain control measures, policies and procedures to prevent our products from becoming part of this criminal trade and believe these same standards should apply across all supply chains that involve tobacco, tobacco products and tobacco machinery equipment ”

The government started calling for bids to build a modern track-and-trace system in 2007, but the plan faltered. Several other attempts were also unsuccessful. Reports, court documents, and people close to the process blame these failures, at least in part, on tobacco industry interference.

“Due to strong resistance from cigarette manufacturers (particularly the two largest ones – Philip Morris International and Pakistan Tobacco Company), this plan could not be implemented,” wrote Aftab Baloch, advisor to the Federal Tax Ombudsman of Pakistan, in an editorial describing 10 years of the FBR’s attempts to implement track and trace.

The government’s resolve strengthened, however, after the IMF made having a tobacco track-and-trace system up and running by the end of March 2020 one of the conditions of Pakistan’s bailout. In August 2019, the FBR issued another tender and this time, with $6 billion of international assistance on the line, they followed through.

The FBR started the process by turning to two former British American Tobacco employees as consultants, one of whom helped draft its tender documents.

First it offered the job to Dave Anderson, whose LinkedIn profile shows he had left BAT, where he was Regional Operations Director for Eastern Europe, Middle East, and Africa, a year before. But, said Sarwar, it dropped him soon after because the World Bank pointed out his ties to the tobacco industry.

Despite that, the FBR next hired Jeannie Cameron, who was head of international advocacy and regulatory affairs for British American Tobacco in London from 2001 to 2011.

Hamid Ateeq Sarwar, the head of the inland revenue department member of the board of the FBR,was unclear whether FBR was aware of the consultants’ connection to British American Tobacco. However, he said, there wasn’t much choice.

“International consultants are not keen to come over to Pakistan,” he said.“Everyone… whom we hired was either linked to BAT or to the other company, Philip Morris.”

Anderson said he had never actually taken the job. Cameron confirmed she worked for the FBR for six months, and that she had tried to create a fair tender process. Asked about FBR’s selection of the final winner, she said: “In my view, all possible participants were close to the tobacco industry.”

Flawed Tender

Bids for the system were originally due on Sept. 5, 2019 but the FBR extended the deadline twice, first to Sept. 20, then to Sept. 27. In the space of these few weeks, the tax authority also dramatically changed the terms of the tender.

Documents seen by OCCRP detail the changes. Previously, technical expertise was a key consideration: 80 percent of each bid would be rated according to the bidder’s technical capability and 20 percent according to price. But in the new tender, any offer that met certain vaguely defined technical requirements would be considered, and the cheapest one would win.

This shift was a crucial one. It took the focus off how effectively the system would police the illicit trade in tobacco and turned it into a price war.

What prompted the revisions? It is still unclear, but on Sept. 12, days before they were announced, tobacco manufacturers had a closed door meeting with the FBR’s chairman, Syed Shabbar Zaidi. One of the rejected bidders alleges in court filings that, in that meeting, the tobacco manufacturers influenced Zaidi to change the tender terms. They are among three losing bidders who have cases pending in the courts of Karachi and Islamabad disputing how the bidding process was run.

A spokesperson for the FBR initially denied to OCCRP that any such meeting took place. When pressed, however, he said the tobacco companies had as much right to see Zaidi as anyone else, as they are taxpayers in Pakistan.

“They can come and meet [the] chairman anytime, how can this be a basis of any ill will or mischief?” he said in a message.

Out of 13 bidders, only one, which appears to be a food export business, was disqualified for technical reasons. When the results were announced on Oct. 14, 2019, it transpired that two of the bidding consortia had been disqualified for giving a conditional price.

But the winning bidder, Pakistani military telecommunications company National Radio and Telecommunications Corporation (NRTC), which was working with Inexto, had mistakenly quoted a price that was 1,000 times lower than it had intended (.731 rupees, or less than a penny, per thousand tax stamps, rather than 731 rupees, or $4.74). NRTC was allowed to revise its bid after all proposals had been evaluated and it had been recommended for the license.

The FBR accepted NRTC’s argument that the difference was merely an “obvious arithmetic and accidental typographical slip.”

One of the companies whose bid was rejected cites this decision as evidence that NRTC was given an unfair advantage. Another company contests the process as a whole.

A third consortium questioned the technical qualifications of NRTC in a letter to the International Tax Stamp Association: NRTC’s proposed track-and-trace system is based on Codentify, software originally developed by Philip Morris International. They call Inexto a “front company” for Codentify, which they say is a “black box” controlled by the tobacco industry. As such, they maintain, it violates the terms of the treaty that mandated Pakistan implement track and trace in the first place.

“Given that the system is not open source, some observers have suggested Codentify may contain hidden features known only to the tobacco industry,” the filing says. “NRTC should be immediately disqualified as the solution offered in non-compliance with [the] World Health Organization… and [the licensing process] itself.”

Sarwar, the FBR board member, defended the choice, saying the NRTC deal included a clause that allows the FBR to cancel it if they find any “clear and close ties [with the tobacco industry], that there’s common shareholding by a parent company, or something like this.”

🔗INEXTO’S RESPONSE

Inexto declined to comment on the FBR’s tender process, citing the pending court cases. The company also denied it had any knowledge of the alleged meeting between the tobacco companies and Zaidi.

The company disputed allegations that it is too close to the tobacco industry, calling them “entirely unfounded and perpetrated by other parties for their gain.”

However, Inexto did admit that it was not working on the “upper layers” of the EU’s track-and-trace system, including the primary and secondary data repositories and ID issuance, because of rules that bar former tobacco industry employees from being involved.

Inexto also denied it was marketing Codentify, saying it had redeveloped the software into a “completely new product line” that works across industries such as food and drink, cars, and pharmaceuticals.

Conflict of Interest

Zaidi, it turns out, has a relationship with the tobacco industry that dates back years.

Before being appointed as chairman of the FBR in May 2019, he was a senior partner at the accounting firm A. F. Ferguson & Co., a Pakistani member firm of the PricewaterhouseCoopers network, which worked in different capacities for both Philip Morris and Pakistan Tobacco Company.

When he was appointed, local media outlets expressed concerns, with one arguing that his relationships with “some of the largest corporate entities in Pakistan, who have billions of rupees of tax-related matters outstanding with the FBR,’’ represented a dangerous conflict of interest. They mentioned no names, but given that the two major tobacco manufacturers together account for some 37 percent of Pakistan’s excise taxes, this could very well apply to them.

The FBR initially threatened court action over Zaidi’s appointment, according to media reports, but the federal government then said Zaidi would work on an “honorary and pro bono basis” in a bid to allay any concerns.

But interviews with a health official and a lawyer who were present at a hearing before Pakistan’s Senate Special Committee on Causes of Decline in Tax Collection of Tobacco Sector in December 2018, five months before Zaidi’s appointment to the FBR, raise more questions about his impartiality.

At the hearing, Zaidi personally represented the tobacco industry, including Pakistan Tobacco, as they were quizzed on a recent drop in their tax payments, according to a lawyer and a health official present in the room. (Pakistan Tobacco confirmed it had been represented by Zaidi in his capacity as a senior partner of PwC before the Senate Committee).

The committee had been formed to investigate a sudden drop in tax collection in the tobacco sector. The plunge in tax revenues came with the fall in the volume of cigarettes being produced in the country in the 2016-17 tax year. The drop of 19.2 billion sticks the tobacco companies reported, which they blamed on the illicit trade of cigarettes, cost the treasury 30.5 billion rupees (over $291 million) — around 2.5 times more than Pakistan’s annual health affairs and services budget.

In response to the tobacco industry’s complaints that their market share had been eroded due to smuggling and counterfeiting, the FBR lowered taxes for low-cost cigarettes produced in the country, meaning the Big Tobacco subsidiaries could sell their legally produced cigarettes for less.

After the new tax tier was introduced, the two companies’ profits in calendar year 2018 jumped by at least 15 percent, even as the Pakistani government saw tax revenues slightly increase from the 2016-2017 low. Combined with the reported drop in production, Malik Imran Ahmad, country representative in Pakistan for the Campaign for Tobacco-Free Kids, estimates the government lost some 77 billion rupees (about $549 million) in tax revenue between fiscal year 2016-2017 and March 2019 due to this decision.

The Senate committee’s report slammed the tax break as a “knee-jerk reaction” that “benefited the multinationals in increasing profits substantially.” The World Bank argued the move had boosted smoking rates in Pakistan because it meant the big tobacco companies could sell their cigarettes far more cheaply making them more affordable.

Yet Zaidi appeared at the Senate hearing and tried to justify their rising profits. Ahmad said he was surprised to see Zaidi, but had expected the tobacco industry to bring in a big hitter.

“He said that he is a partner with Ferguson and he has been managing the accounts of both companies,” he said. Ahmad said that Zaidi appeared to be “just fudging all the figures, trying to cover up everything.”

Pakistan Tobacco Company confirmed Zaidi had represented them and expressed support for the new tax bracket, arguing the government had raised excise duties “excessively.” The change, the company said, created “a level playing field in the cigarette market.”

Philip Morris did not respond to a request for comment on the matter.

Zaidi declined to speak to OCCRP, saying that he was on sick leave and did not want to discuss professional matters. Asked about his past employment at an accounting firm and whether he had conflicts of interest with the tobacco industry, he said, “The question[s] are by and large not appropriate.”

Cigarette packs with health warning displayed in a kiosk painted with Pakistan's national flag. Credit: REUTERS/Akhtar Soomro

Five months after the hearing, Zaidi became head of the Federal Board of Revenue. Another five months after that, the FBR chose to install NRTC’s and Inexto’s track-and-trace solution.

At the end of May 2019, soon after his appointment, Pakistan’s Cabinet passed a health tax of 10 rupees per cigarette pack. Media reports said Prime Minister Imran Khan backed it. But the FBR refused to implement it.

Ahmad claimed Zaidi had prevented the levy from passing, soon after he became head. “He gave benefit afterward to the tobacco industry,” he said. “This was a direct collusion between him and the tobacco industry.”

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