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Phillip Morris circumvents investment ban

March 10, 2019 | Expert Insights

Phillip Morris International Inc. (PMI) has been paying for the manufacturing costs of Marlboro cigarettes in India circumventing a nine-year old ban on Foreign Direct Investment (FDI) in the tobacco industry.

Background

Philip Morris International Inc. is an American multinational cigarette and tobacco manufacturing company, with products sold in over 180 countries outside the United States. The most recognized and best-selling product of the company is Marlboro. Other brands that PMI currently manufactures include Benson & Hedges, Bond Street, L&M, Lark and St. Dupont Paris.

Godfrey Phillips India Ltd. is a tobacco manufacturer headquartered in India. The Company was originally established as "Godfrey Philips Ltd." in London in 1844. GPI was the first UK company to mass-produce cigarettes, apart from being one of the founding companies of Imperial Tobacco along with John Player & Sons. The company is a part of a Delhi based conglomerate Modi enterprises chaired by KK Modi.

With tobacco being addictive and the single greatest cause of preventable death globally, the company is highly controversial. It has been the subject of litigation and restrictive legislation from governments. With the worldwide decrease in smoking in the 21st century, shares of Philip Morris were no longer considered the "safe haven" they once were. The company ranked No. 108 in the 2018 Fortune 500 list of the largest United States corporations by total revenue.

According to the International Agency for Research on Cancer (IARC) monograph, there is sufficient evidence in humans that tobacco smoking causes cancer of the lung, oral cavity, naso-, oro- and hypo-pharynx, nasal cavity and paranasal sinuses, larynx, esophagus, stomach, pancreas, liver, kidney (body and pelvis), ureter, urinary bladder, uterine cervix and bone marrow (myeloid leukemia).

Analysis

The Indian government in 2010 prohibited foreign direct investment (FDI) in cigarette manufacturing, saying the measure would enhance its efforts to curb smoking. Despite the ban, PMI has found a way to bypass the policy by paying for the manufacture of Marlboro cigarettes in India.

A year before the FDI ban, PMI struck an exclusive deal with India’s Godfrey Phillips to locally manufacture the world-famous Marlboro cigarettes, according to company documents dated between May 2009 and January 2018. Since then, Godfrey Phillips has publicly acted as a contract manufacturer of Marlboro cigarettes in India, while Philip Morris’s majority-owned local unit acts as a wholesale trading company and promotes the brand.

Dozens of internal documents that have been reviewed by Reuters show PMI indirectly paying costs related to manufacturing cigarettes in India. The documents has caused for some blowback from former Indian Enforcement officials who feel that the indirect payments violate regulatory rules. The officials think that the dealings should be investigated for circumventing rules.

Six invoices issued by Godfrey showed billing of 45.5 million Indian rupees ($644,200) to Philip Morris between December 2013 and January 2018 for manufacturing-related charges. Philip Morris paid for items ranging from large cigarette-making machines to costs of smaller equipment such as barcode scanners and printers deployed in Godfrey’s factories. 

The agreement between Philip Morris’ local unit and Godfrey arranged a mechanism for the transfer of funds around the time they struck the 2009 deal. The agreement states that Godfrey could purchase machinery necessary to solely manufacture Marlboro cigarettes and would then invoice PM India who will then pay for the costs. The agreement specified PM would make periodic payments calculated according to the normal depreciation charge of the machinery, plus 10 percent per annum on its net book value.

On the account of being investigated, Jain of Nishith Desai Associates, who reviewed the documents for Reuters said that the company was able to circumvent the FDI prohibition in cigarette manufacturing by paying for the machines through invoices. The Indian regulations only restrict direct foreign investments into a company and were silent on such indirect payments for machines.

“The company can argue in its defense that it is only funding the equipment purchases and not investing directly in an Indian cigarette manufacturing company, and they would be technically correct,” Jain told Reuters.

Assessment

Our assessment is that PM India’s move to trade in the Indian Tobacco Industry after the prohibition could lead to them being investigated by the Enforcement Directorate. However, the company has built a strong case against directly funding the industry.

 

Image Courtesy: Nikita2706 [CC BY-SA 3.0 (https://creativecommons.org/licenses/by-sa/3.0)]