New York City files lawsuit against 'roll-your-own' cigarette shop Island Smokes over blatant tax evasion, seeks to close perceived tax loophole

Michelle Rivera

NEW YORK , November 21, 2011 (Associated Press) – There is no place in the U.S. more expensive to smoke than New York City, where the taxes alone will set you back $5.85 per pack. Yet, addicts who visit Island Smokes, a "roll-your-own" cigarette shop in Chinatown, can walk out with an entire 10-pack carton for under $40, thanks to a yawning tax loophole that officials in several states are now trying to close.

The store is one of a growing number around the country that have come under fire over their use of high-speed cigarette rolling machines that function as miniature factories, and can package loose tobacco and rolling papers into neatly formed cigarettes, sometimes in just a few minutes.

The secret to Island's low prices is simple: Even though patrons leave carrying cartons that look very much like the Marlboros or Newports, the store charges taxes at the rate set for loose tobacco, which is just a fraction of what is charged for a commercially made pack.

Customers select a blend of tobacco leaves, intended to mirror the flavor of their regular brand. Then they feed the tobacco and some paper tubes into the machines, and return to the counter with the finished product to ring up the purchase.

The savings come at every level. Many stores sell customers loose pipe tobacco, which is taxed by the federal government at $2.80 per pound, compared with $25 per pound for tobacco made for cigarettes. The shops don't pay into the cigarette manufacturer trust fund, intended to reimburse government health programs for the cost of treating smoking-related illness. And the packs produced by "roll-your-own" shops are generally also being sold without local tax stamps, which in New York include a $1.50 city tax and a $4.35 state tax.

New York City's legal department filed a lawsuit against Island Smokes on Nov. 14, arguing that the company's Manhattan store and another on Staten Island are engaging in blatant tax evasion.

Every package of cigarettes sold in the state, the suit argued, must bear a New York tax stamp. Businesses that sell unstamped cigarettes are violating both local law and the federal Contraband Cigarette Trafficking Act, city lawyers said. The suit, filed in federal court in Manhattan, also accused the store of violating a state law requiring cigarettes to meet fire safety standards.

"By selling illegally low-priced cigarettes, defendants not only interfere with the collection of city cigarette taxes, they also impair the city's smoking cessation programs and impair individual efforts at smoking reduction, thereby imposing higher health care costs on the city and injuring public health," the complaint said.

Mayor Michael Bloomberg, who has advocated for aggressive legal action against cigarette sellers who avoid taxes, was to announce the lawsuit at a news conference Monday.

A pack contains 20 cigarettes and sells for around $13 in New York City after taxes are added. That compares with the national average in 2010 of $4.80 a pack, according to the Centers for Disease Control and Prevention. A pack from Island Smokes can cost less than $4 a pack.

Everything about the business is legal, precisely because the company is neither selling cigarettes, nor manufacturing them, said Jonathan Behrins, a lawyer for Island Smokes. It is simply selling loose tobacco and tubes, he said, and giving customers access to the rolling machines to make the cigarettes themselves.

"What's the harm?" he said. "They are not selling unstamped cigarettes."

Behrins said the business, whose owners include a New York City police captain, opened in April. It has developed a clientele of people who are trying to save money, and don't mind spending some time at the machines, rolling their own product.

"It's a certain demographic that rolls their own. They don't really want to be bothered with Bloomberg reaching into their pockets."

He likened the operation to a brew-your-own-beer store, and chafed at the idea that it might cost the city substantial tax revenue. Some smoke shops use roll-your-own machines that can churn out a carton of 200 cigarettes in eight minutes, but Behrins said Island's machines are far slower. City investigators said it took them about 45 minutes to make one carton.

"This is why I don't understand why the city has us in their sights," said Behrins.

Legal battles over shops using roll-your-own machines are ongoing in several states.

Wisconsin's Department of Revenue this year informed machine owners that they need manufacturing and distribution permits to operate. Enforcement of the order has been put on hold while a judge considers the matter.

In West Virginia, a judge ruled in September that a tobacco shop there was violating state and federal law by failing to charge excise taxes on cigarettes made by customers in automated, on-site rolling machines.

New Hampshire's Supreme Court ruled in July that a roll-your-own tobacco shop there was effectively a cigarette manufacturer, and thereby had to pay into the national fund that reimburses Medicare for smoking-related illnesses. The New Hampshire attorney general said those payments amount to about $5.33 per carton. The Massachusetts attorney general has also classified retailers who use roll-your-own machines as manufacturers.

That argument has also been adopted by the U.S. Treasury Department's Alcohol and Tobacco Tax and Trade Bureau, which issued a ruling Sept. 30 that retailers who give customers access to roll-your-own cigarette machines are manufacturers, and are subject to the same licensing rules as other cigarette makers. Those regulations, among other things, would require the shops to apply for a permit before going into business, post a bond, and keep certain inventory records.

All of those rulings are being fought by manufacturers of the machines, which include companies like RYO Machine Rental of Cincinnati, which said it has 1,700 machines at stores in 40 states.

Behrins called the legal attacks "downright frightening," and blamed them on governments trying to drum up extra cash in tight times.

"They are looking for money every way they can. Parking tickets. Red light cameras. You name it. They are just ringing it up to bring in revenue."

He also echoed claims, made by Island Smokes in some of its marketing materials, that the roll-your-own cigarettes produced in its stores are healthier than commercially produced packs, because they don't contain some of the same chemical additives.

That brought a rebuke from New York City's health commissioner, Dr. Thomas Farley.

"Claiming that this is healthier is a second scam ... it's totally false," he said. He said the health risks from cigarettes come from inhaling the cancer-causing agents produced by burning tobacco leaves. "There is nothing safe about an 'all natural' tobacco leaf."

Farley also defended the city's high taxes on cigarettes, saying that studies had shown that they are pressuring people into quitting, or not taking up the habit, and thereby saving lives.

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