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THE INDUSTRY AUTHORITY ON RETAILING Official Publication of the International Premium & Pipe Retailers Association (IPCPR) APRIL 2011

> Nat Sherman’s Unique Esquire Collaboration, 80th Anniversary > Regulation Battle Over In-store RYO Production > Still : Alfred Dunhill’s White Spot SS_Apr11_Pg_30-57 mid 3/22/11 12:16 PM Page 48

>REGULATION FOCUS

have been subject to the TTB Ruling, In-Store RYO Production: along with a distributor that sells the RYO Filling Stations and a retailer who allows consumers to use the machines, Fighting Back the TTB successfully challenged the TTB Ruling. The federal court’s decision is currently A leading RYO machine manufacturer squares off in court with the on appeal to the Sixth Circuit Court of federal government; court enters preliminary injunction prohibiting the Appeals in Cincinnati. TTB from regulating in-store production of roll-your-own . FROM HANDROLLING >BY BRYAN M. HAYNES TO CARTON PRODUCTION Consumers can produce cigarettes for their personal use in a number of differ- federal judge in Akron, Ohio has personal consumption or use, as the ent ways. Consumers may purchase entered a preliminary injunction manufacture of tobacco products. Under packaged tobacco and papers Aprohibiting the Alcohol and the TTB Ruling, retailers who supply and roll the cigarettes either by hand or Tobacco Tax and Trade Bureau (TTB) of machines— whether electronic or manu- by using a hand-rolling machine. the United States Treasury Department al—for consumers to produce cigarettes Consumers may also purchase tobacco from further regulating in-store produc- in a retail environment for personal use and pre-fabricated cigarette tubes (com- tion of roll-your-own cigarettes by con- would have been classified as “manufac- prising all parts of the cigarette except sumers. TTB’s Ruling No. 2010-4, turers of tobacco products” under the the tobacco, including cigarette paper, “Cigarette-making Machines in Retail Internal Revenue Code and subject to the tipping paper, and filter). Establishments,” issued on September same permitting requirements as indus- 30, 2010 (“the TTB Ruling”), took the trial-scale manufacturers. >Above: Phil Accordino, co-owner of RYO unprecedented step of classifying an RYO Machine Rental, LLC (“RYO Machine Rental LLC, builds, sells, and leases customer-operated in-store machines with an individual’s production of cigarettes in a Machine”), a company that manufac- ATM-like interface that produce a carton of retail environment, for his or her own tures the RYO Filling Stations that would cigarettes in about 10 minutes.

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As a practical matter it is virtually taxed at a rate of 25.2 cents per 200. duce cigarettes for consumers; rather, impossible for consumers to produce cig- Packaged tobacco (roll-your-own and consumers operate the machines on their arettes by hand using tubes. Since at least pipe tobacco) is taxed from $2.83 to own, using a user interface similar to an the 1930s, consumers have used tabletop $24.78 per pound. (One pound of tobacco ATM. The retailer’s involvement in the and handheld cigarette-making machines makes approximately 400 cigarettes.) operation of the machine is limited to to produce cigarettes using tubes and repairs and maintenance. packaged tobacco. The most basic of THE RYO FILLING STATION The transaction in the retail environ- these models are made of plastic and The RYO Filling Stations are not signifi- ment typically works as follows: The operate manually to form the tobacco cantly different from the electronic ciga- consumer buys tobacco and tubes from into a roll and push the tobacco into the rette machines that have been used by the retailer. The consumer also pays the tube. They make one cigarette at a time. consumers for many years, except the retailer to rent the RYO Filling Station. There are also a variety of electronic RYO Filling Stations are more efficient, The consumer can never buy pre-pro- machines that consumers use to produce although nowhere near as efficient as the duced cigarettes from the retailer, nor cigarettes for their personal use using commercial machines used in TTB- can the consumer ever be guaranteed tobacco and tubes, including the RYO licensed factories. For example, even the that the use of the RYO Filling Station Filling Stations manufactured by RYO most antiquated machines used in facto- will produce a fixed number of ciga- Machine. Most of these electronic mach- ries today produce about 800 cigarettes rettes. Consumers are permitted to pro-

> The TTB ruling asserts that any retailer who provides the use of any machine, including the RYO Filling Station, for consumers to produce cigarettes for their personal use, is deemed to be a manufacturer of tobacco products…[and] must comply with various Internal Revenue Code provisions applicable to industrial-scale manufacturers, including obtaining a permit to manufacture tobacco products, obtaining a bond…

ines are capable of producing 200 ciga- per minute. The most advanced duce cigarettes with the RYO Filling rettes every 20 minutes. Consumers can machines used in factories today pro- Station only for their personal use. produce 200 cigarettes using the RYO duce about 20,000 cigarettes per minute. Filling Station about every 10 minutes. The RYO Filling Station produces about INSIDE THE TTB RULING Some consumers produce cigarettes 20 cigarettes per minute, or 2.5 percent of The TTB ruling asserts that any retailer using electronic machines they own. the production capacity of the most anti- who provides the use of any machine, Other consumers briefly rent machines, quated commercial machines and 0.1 including the RYO Filling Station, for such as the RYO Filling Station, from percen of the production capacity of the consumers to produce cigarettes for their retailers for a small fee and produce most advanced commercial machines. personal use, is deemed to be a manufac- their cigarettes in the retailer’s store. The RYO Station would have to operate turer of tobacco products. The TTB ruling Consumers have been renting these continuously for more than 16 hours to states that a retailer must comply with machines to produce cigarettes in a retail make the same number of cigarettes that various Internal Revenue Code provi- environment for many years. Until advanced machines make in one minute. sions applicable to industrial-scale man- September 2010, TTB did not attempt to RYO Filling Station distributors and ufacturers, including obtaining a permit assert jurisdiction over this activity. retailers are required to follow all federal, to manufacture tobacco products, obtain- Whether produced manually or elec- state, and local laws applicable to the ing a bond, complying with record-keep- tronically, cigarettes produced by con- machines and their use. Retailers are ing requirements, and complying with sumers for their personal use are already strictly prohibited from selling finished packaging requirements. The TTB ruling subject to federal excise taxes assessed by cigarettes produced by the machines to also asserts that the retailer must pay TTB. Cigarette papers are taxed at a rate consumers. Retailers are also strictly pro- additional taxes associated with the con- of 12.6 cents per 200. Cigarette tubes are hibited from using the machines to pro- sumer’s production of cigarettes, totaling

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>REGULATION FOCUS

about $10.00 for 200 cigarettes. A CHALLENGE IN FEDERAL COURT duces , cigarettes, smokeless tobac- The TTB ruling notes that it is illegal RYO Machine Rental, Tobacco Outlet co, pipe tobacco, or roll-your-own tobac- to manufacture cigarettes without a per- Express and Tightwad Tobacco, LLC co solely for the person’s own personal mit and cites the criminal and civil penal- challenged the TTB Ruling on October consumption or use …”. ties associated with the illegal manufac- 28, 2010 in the United States District The plaintiffs also argued that the ture of cigarettes. TTB asserted that retail- Court for the Northern District of Ohio. TTB Ruling was not the product of notice ers must immediately discontinue the use The plaintiffs asked the court to prohibit and comment rulemaking as required by of machines such as the RYO Filling enforcement of the TTB Ruling. The the Administrative Procedure Act. By Station until they receive a TTB permit to plaintiffs requested a temporary restrain- defining retailers as “manufacturers of manufacture tobacco products, effective- ing order and preliminary injunction tobacco products,” the TTB Ruling pur- ly shutting down the entire industry. against the ruling until the case could be ported to obligate entire new classes of Under the TTB Ruling, any retailer heard on the merits, as well as a perma- businesses to apply for and obtain a per- that provides a machine for consumers to nent injunction against the ruling. mit from TTB. The plaintiffs asserted that produce cigarettes, in a retail environ- The plaintiffs argued that the TTB TTB’s failure to undergo the formal ment for personal use or consumption, Ruling directly contradicts the pertinent notice and comment rulemaking process would have been regulated as a manu- provisions of the Internal Revenue Code, when issuing the TTB Ruling invalidates facturer of tobacco products. The TTB which provide that consumers who pro- the rule. Ruling would cover the full range of duce cigarettes for personal use are not Finally, the plaintiffs argued that the machines discussed above, that have manufacturers of tobacco products. TTB Ruling was inconsistent with TTB’s been in use for many years without TTB Specifically, the ruling contradicts the hands-off approach to so-called “Brew- regulation, ranging from the simple man- congressional definition of “manufactur- on premises.” Like the manufacture of ual plastic machines that produce one er[s] of tobacco products” as “any person tobacco products, TTB is also authorized cigarette at a time, to the manual crank who manufactures cigars, cigarettes, by Congress to regulate breweries and to machines, to the slower electronic smokeless tobacco, pipe tobacco, or roll- collect taxes on the production of beer. machines, to the more efficient RYO your-own tobacco except that such term Like the personal use exemption for the Filling Stations. shall not include…a person who pro- manufacture of tobacco products, the

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>REGULATION FOCUS

production of beer is exempt from TTB proprietor of the “Brew-on premises” from enforcing the ruling pending the regulation and taxation so long as the does not provide physical assistance to final resolution of the case. The effect of beer is produced by adults “for personal consumers in the production of beer or the court’s decision is that the RYO or family use and not for sale,” subject to provide finished product to consumers. Filling Stations are permitted to operate specified quantity limits. Because the personal use exemption for indefinitely without regulation by TTB. “Brew-on premises” are functionally the regulation and taxation of brew- In entering the injunction, the court indistinguishable from the consumer eries is worded almost identically to found that the plaintiffs were likely to production, in retail environments, of the personal use exemption for the reg- succeed in their claim that TTB violated cigarettes using materials purchased ulation and taxation of tobacco product the Administrative Procedure Act by from the retailer. Proprietors of “Brew-on manufacturing, the plaintiffs argued issuing the ruling without inviting notice premises” may furnish space, brewing that no meaningful distinction can be and comment from the public. The court equipment, ingredients, bottling sup- drawn between the operations of TTB- also found that the plaintiffs were likely plies, and advice and expertise to con- authorized “Brew-on premises” and to suffer irreparable harm as a result of sumers. They may also furnish raw the operations of retailers that allow the ruling, which would either prohibit materials used in the production of beer consumers to rent RYO Filling Stations or significantly impact consumers’ abili- to consumers. They may assist con- to produce cigarettes for personal use. ty to use the RYO Filling Stations. sumers, including cleaning, maintaining TTB appealed the preliminary injunc- and repairing equipment. THE COURT’S DECISION tion on February 11, 2011. Pending Consistent with the personal use After initially denying the plaintiffs’ appeal, the court’s preliminary injunc- exemption for the production of beer in request for a temporary restraining tion remains intact. retail environments, TTB has ruled that order, the court held a hearing on a person may operate a “Brew-on November 12, 2010 and entered a Troutman Sanders Tobacco Team, premises” meeting the foregoing November 15, 2010 temporary restrain- Troutman Sanders LLP, 1001 Haxall requirements without qualifying as a ing order, which prohibited TTB from Point, Richmond, Va. 23219, Tel: (804) licensed brewery or paying federal enforcing the TTB Ruling. Then on 697-1317, Fax: (804) 697-1339; Web: excise taxes on beer produced by con- December 14, 2010, the court entered a www.troutmansanders.com, Email: sumers at the facility, so long as the preliminary injunction prohibiting TTB [email protected].

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54 SMOKESHOP April 2011