Annual Report and Accounts 06

Annual Review and Summary Financial Statement and Directors’ Report and Accounts 2006 WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da About this combined Report The format of our reporting has been changed to accommodate the inclusion, for the first time, of an Operating and Financial Review (OFR). In preparing the OFR, we have sought to take into account, where considered appropriate, the best practice set out in the UK Accounting Standards Board’s ‘Reporting Statement: Operating and Financial Review’. We have responded to the spirit of the OFR by offering shareholders a balanced and comprehensive analysis of our current business and describing the significant industry trends that are likely to influence our future prospects. For the first time, we have published our Key Performance Indicators, some other important Business Measures and the Group’s Key Risk Factors. We have also attempted to avoid having too much information in one publication. Our corporate website bat.com has a wealth of material about the Group and, in May 2007, we plan to publish our latest Social Report, detailing progress during 2006 on a range of commitments and actions. We will carefully consider the structure and content of our future reporting in the light of developments in the field and the advice and comments we receive about this publication.

 The full content of this combined Report is under this flap. Leave it open as a reference to find your way to the different topics covered.

Cautionary Statement: the Operating and Financial Review and certain other sections of this document contain forward looking statements which are subject to risk factors associated with, among other things, the economic and business circumstances occurring from time to time in the countries and markets in which the Group operates. It is believed that the expectations reflected in these statements are reasonable but they may be affected by a wide range of variables which could cause actual results to differ materially from those currently anticipated. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Annual Report and Accounts 06

Annual Review Directors’ Report and Accounts

OPERATING AND FINANCIAL REVIEW BRITISH AMERICAN TOBACCO GROUP Overview 49 Directors’ report 01 An introduction to British American Tobacco 53 Remuneration report 02 Chairman’s statement and financial highlights 67 Corporate governance statement 73 Report of the independent auditors Business and strategic review 74 Group income statement 04 Chief Executive’s industry overview 75 Group statement of changes in total equity 06 Our strategy 76 Group balance sheet (including Key Performance Indicators) 77 Group cash flow statement 10 Our strategy in action 78 Notes on the accounts (including Business Measures) 137 Five year summary Regional and financial review 139 Quarterly analyses of profit 20 Regional review 140 Principal subsidiary undertakings 26 Financial review 142 Principal associate undertakings 26 Profit from operations 26 Interest cover 26 Effective tax rate 27 Adjusted diluted earnings per share BRITISH AMERICAN TOBACCO p.l.c. 27 Dividends per share 143 Report of the independent auditors 28 Cash flow 144 Accounting policies 28 Treasury operations 145 Balance sheet 29 Changes in the Group 146 Notes on the accounts 29 Changes in accounting policies 30 Share buy-back programme ibc Contact information 30 Key Group risk factors

SUMMARY CORPORATE GOVERNANCE AND SUMMARY FINANCIAL STATEMENT Summary corporate governance 33 Summary corporate governance 34 Board of Directors 35 Management Board 36 Summary remuneration report Summary financial statement 41 Independent auditors’ statement 42 Group income statement 43 Group balance sheet 44 Group statement of changes in total equity 45 Summary financial statement and notes Additional information 48 Shareholder information WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da IN THIS COMBINED REPORT This year, for the first time, British American Tobacco has produced a combined report which amalgamates in one bound document, the Annual Review and Summary Financial Statement together with the Directors’ Report and Accounts. This combined report is bound together as the ‘Annual Report and Accounts 06’. Please read the explanatory notes below.

Part 1 – Annual Review

IN THE REVIEW The Annual Review and Summary Financial Statement of British American Tobacco p.l.c. for the year ended 31 December 2006 is intended for investors who do not require the full detail of the Directors’ Report and Accounts, which is produced as Part 2 of this combined report. The Annual Review comprises an Operating and Financial Review and a Summary Corporate Governance Statement, Summary Remuneration Report and Summary Financial Statement. The Operating and Financial Review has been prepared to a standard which fulfils the requirements for a business review in accordance with section 234ZZB of the Companies Act 1985, taking into account, where considered appropriate, the best practice set out in the UK Accounting Standards Board’s ‘Reporting Statement: Operating and Financial Review’. The Annual Review does not contain sufficient information to allow for a full understanding of the results of the Group and state of affairs of the Company or of the Group. For further information, reference should be made to the Directors’ Report and Accounts 2006 (see below) which incorporates the full accounts, the Report of the independent auditors on those accounts, the Directors’ Report and the Remuneration Report. The Annual Review is issued to all shareholders.

Special feature As part of the OFR, we have produced a special feature on our Brazilian subsidiary, Souza Cruz, to highlight how our strategy is working in a key market.

Part 2 – Directors’ Report and Accounts

IN THE REPORT The Directors’ Report and Accounts of British American Tobacco p.l.c. for the year ended 31 December 2006 is produced as Part 2 of this combined report. By reference to the Annual Review in Part 1 above, it incorporates the Operating and Financial Review as part of the Directors’ Report on page 49. The Directors’ Report and Accounts is issued, as part of this combined report, to shareholders who elected to receive it together with the Annual Review. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Annual Review 2006 British American Tobacco 01 Operating and financial review

AN INTRODUCTION TO BRITISH AMERICAN TOBACCO

British American Tobacco was ‘born’ international over 100 years ago. We now employ over 55,000 people and are the second largest stockmarket listed tobacco group in the world. OVERVIEW We are also well positioned in all regions of the world, operating in over 180 markets. This geographical balance provides stability, while our presence in markets where volumes and profits are expected to grow gives us confidence for the future. NITOUTO OBIIHAEIA TOBACCO AMERICAN BRITISH TO INTRODUCTION AN

We produce and market a wide and diverse range of brands Our vision is to achieve leadership of the global tobacco to suit consumers’ preferences, with a particular focus industry through strategies focused on delivering growth, on our four Global Drive Brands (GDBs) – Dunhill, Kent, improving productivity, demonstrating responsibility and Lucky Strike and Pall Mall. Offering consumers choice and developing a winning organisation. These linked strategies innovation in our brands sets us apart from our competitors are working well, as we continue to build a business that is and is contributing to the continuing growth of our GDBs. sustainable and creates long term value for our shareholders. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 02 British American Tobacco Annual Review 2006 Operating and financial review

CHAIRMAN’S STATEMENT AND FINANCIAL HIGHLIGHTS

“These strong results based on excellent organic growth continue to provide a solid platform for a sustainable business. Our consistent and balanced approach to the four elements of our strategy for creating shareholder value is working well.” Jan du Plessis, Chairman

British American Tobacco has had another good year, exceptional items are excluded, reflecting higher profits with 7 per cent growth in our underlying profit from from Reynolds American and ITC. The contribution from operations and a 10 per cent increase in adjusted diluted Reynolds American was £285 million, with the early

OVERVIEW earnings per share. The improvement in profit was driven results from the acquisition of the Conwood smokeless by volume growth of 2 per cent and net revenue growth tobacco business being distinctly encouraging. of 5 per cent. The impact of exchange rates for the year The improvement in profit from both subsidiaries and as a whole was not material, although it was significantly associates, together with a lower effective tax rate and negative in the last six months, especially in the last the benefit of the share buy-back programme, more quarter, and has continued into the current year. than offset the impact of higher net finance costs and Our Global Drive Brands were exceptionally successful, minorities. As a result, adjusted diluted earnings per share growing by 17 per cent. They now represent over rose by 10 per cent to 98.12p, just ahead of our long 21 per cent of the Group’s volume from subsidiaries, term goal of achieving, on average, high single figure while international brands as a whole account for some growth in earnings. 40 per cent of the total. By the close of business on 1 March, we expect that Kent volume grew by 16 per cent to 45 billion, while some 35 million shares will have been bought back Dunhill improved by 6 per cent, with encouraging since 1 January 2006 at a cost of £500 million and at performances both in its new and its existing markets. an average price of £14.19 per share. Since 2003, when

HIMNSSAEETADFNNILHIGHLIGHTS FINANCIAL AND STATEMENT CHAIRMAN’S Lucky Strike grew marginally and the star, once again, the buy-back programme started, around 246 million was Pall Mall, up 40 per cent. shares have been repurchased at a cost of £2,191 million, equivalent to an average price of £8.91 per share. We There were net exceptional charges of £175 million, continue to view the purchase of our own shares as an reflecting the restructuring costs relating to the factory excellent investment. closure programme, partly offset by the gains on a disposal of brands. The annual savings from our supply Following a review of the Group’s capital structure, chain programme in 2006 amounted to £148 million, the Board has decided that there is scope to increase bringing the total to £374 million per year since we significantly both the dividend payout ratio and the started four years ago. share buy-back programme. We also saved a further £99 million from the overheads The previous policy was to pay out at least 50 per cent and indirects programme, bringing that total over the of long term sustainable earnings in dividends, with the same four year period to £355 million on an annualised payout ratio in 2005 being 53 per cent. The Board has basis. The current overheads and indirects programme decided to raise the payout ratio to 65 per cent by 2008 will be completed in 2007. However, we intend to maintain in progressive steps and is therefore proposing a final our focus on costs and will be announcing a further five dividend for 2006 of 40.2p, an increase of 22 per cent. year target, along with the final results from the first This takes the total for the year to 55.9p, an uplift of five years, in March 2008. We will also pursue additional 19 per cent and raises the dividend payout ratio for supply chain savings over the same five year period. 2006 to 57 per cent. The dividend will be paid to shareholders on the Register at 9 March 2007. In line Our associate companies grew their volume by 4 per cent to with our current practice, the interim dividend for 2007 241 billion and our share of their post-tax results amounted will be approximately one-third of the total for 2006. to £431 million. This represents a 10 per cent increase, if WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Annual Review 2006 British American Tobacco 03 Operating and financial review

In addition, the level of the share buy-back will rise FINANCIAL HIGHLIGHTS from around £500 million to some £750 million per year, starting in 2007. The increase in the buy-back programme Profit from operations: like-for-like £ million is likely to mean that, before the Annual General Meeting 2,797 in 2008, the combined interest of Richemont and Remgro 2,607 (R&R) will rise above 30 per cent. Not only is this the level +7% at which, under normal circumstances, an offer would have to be made by R&R for the remaining shares in British American Tobacco, but such an outcome is specifically prohibited by the existing agreement between R&R and 2005 2006 the Company. Operating profit, excluding exceptional items and the impact arising Following discussions with both the Takeover Panel and from the change in terms of trade in Italy, increased from £2,607 million to £2,797 million. R&R, the Panel has indicated, subject to final approval,

that it is prepared to waive the 30 per cent rule, if the Adjusted diluted earnings per share OVERVIEW independent shareholders approve such a waiver at the pence Annual General Meeting. This will allow the Company 98.12 89.34 to continue the share buy-back programme, despite the fact that the R&R shareholding will increase above +10% 30 per cent. The existing agreement restricting R&R’s voting rights to 25 per cent will remain in place.

R&R have given their consent to this proposal and in return 2005 2006 have asked British American Tobacco to obtain a secondary Adjusted diluted earnings per share increased from 89.34 pence to listing for its ordinary shares on the Johannesburg Stock 98.12 pence per share. Exchange, if and when requested by them. British American Tobacco has agreed to this. The proposal will be put to Group volumes the Annual General Meeting on 26 April for approval and billions the Board recommends the independent shareholders to 678 689 vote in favour. +2% The Board does not anticipate that it would continue the HIGHLIGHTS FINANCIAL AND STATEMENT CHAIRMAN’S buy-back once R&R’s interest had reached 35 per cent of the issued share capital of the Company. At the current share price, and at the proposed buy-back levels, this 2005 2006 threshold is unlikely to be reached in the next seven years. Group volumes from subsidiaries were 2 per cent higher at 689 billion.

While the increased level of the share buy-back programme Dividend per share declared will create value for shareholders, it continues to preserve pence financial flexibility because it can be suspended in the event of 55.9 an opportunity to make a significant acquisition that is both 47.0 financially and strategically attractive in the longer term. +19% Rupert Pennant-Rea will retire from the Board at the end of the Annual General Meeting. I would like to thank him for the significant contribution he has made over the last 2005 2006 11 years, not only as a Director but also as Chairman of Dividends declared in respect of 2006, were 55.9 pence per share the Audit Committee. (2005: 47.0 pence), up 19 per cent. 2006 has been a good year and I believe we can look ahead with confidence in our ability to achieve further growth and value for shareholders. Over the past five years, British American Tobacco has delivered an average annual total shareholder return of 26 per cent, compared to 7 per cent for the FTSE 100. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 04 British American Tobacco Annual Review 2006 Operating and financial review

CHIEF EXECUTIVE’S INDUSTRY OVERVIEW

“Whether new challenges come from our own evolving standards or from regulatory restrictions, we can grow if our positioning and strategy are right.” Paul Adams, Chief Executive UIESADSRTGCREVIEW STRATEGIC AND BUSINESS

We have reported another good set of numbers for 2006 ‘fourth dimension’, namely, harm reduction, for the but what is the state of the tobacco industry and how is millions of adults globally who will continue to be British American Tobacco expecting to fare in the future? tobacco consumers. Before looking forward, it is worth examining our recent Current and future market past. Over the last five years we have grown volume, Currently smokers consume over five trillion cigarettes with our four GDBs leading the way, up 57 per cent a year globally. against a backdrop of quickening regulatory changes, China, the world’s largest cigarette market, makes up excise increases and declines in the incidence of smoking. 35 per cent of global volumes. Outside China, over half Not all the changes have been external, some are the global market is held by the six biggest international self-imposed. Five years ago we pioneered the industry’s manufacturers which, in 2006, were: Philip Morris, with first voluntary code, a set of restrictions on our marketing a global market share of 18.7 per cent, British American activity worldwide. The conclusion I’ve drawn is that Tobacco (including associates’ total volumes) with it is still possible for us to succeed in an ever tougher 17.1 per cent, Japan Tobacco with 7.7 per cent, Imperial environment. Whether new challenges come from our Tobacco with 3.5 per cent, Gallaher with 3.1 per cent own evolving standards or from regulatory restrictions, and Altadis with 2.1 per cent. we can grow if our positioning and strategy are right. Regulation of the industry and its products has We have a strong and complete portfolio of brands at increased in recent years, including graphic health

HE XCTV’ NUTYOVERVIEW INDUSTRY EXECUTIVE’S CHIEF different price points. As well as our GDBs, it includes an warnings on packs, advertising and promotion restrictions unrivalled range of regional and local brands which play and, more recently, restrictions on public place smoking. a vital role in our success in many markets. We have a full Future regulation will largely be framed by the World range of tobacco products and we have a track record Health Organisation’s Framework Convention on Tobacco of innovation that our competitors struggle to match. Control, which entered into force in 2005. Increases In addition to the opportunities for top line growth, there in excise rates in many of the higher-price markets are are very significant opportunities to make cost savings leading consumers to switch to cheaper brands and this through our productivity initiatives. As you can read on trend is expected to continue. However, in emerging page 14, we are ahead of schedule and the more work markets, consumers are increasingly trading up, so we do in this area the more we identify further savings. premium brands are growing. We also believe that we have the right responsibility Over the next decade, we expect the average daily strategy for both the short and the long term and we consumption of cigarettes to fall in many of the world’s position responsibility as a key part of our overall business largest markets. We also expect a declining incidence strategy. Consequently, we have invested significantly of smoking generally, leading to smaller percentages more in R&D, particularly around harm reduction. of populations being smokers, particularly in currently high margin markets such as Canada, Germany and We agree that risky products such as tobacco should be Japan. However, the number of adults over the age regulated. Currently, tobacco regulation broadly focuses of 20 in the world is forecast to grow 11 per cent by on three areas: preventing people from starting to smoke, 2015. As a result, although the proportion of adults encouraging quitting and protecting people around smokers. smoking will probably decline, global volumes are However, we strongly believe that these prevention, expected to be broadly unchanged at some five trillion cessation and protection efforts are missing an important in 2015. This future market represents a volume and WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Annual Review 2006 British American Tobacco 05 Operating and financial review

profit pool where, for those who are best positioned, The following section contains: there will still be a great deal to play for. 06 Our strategy Unfortunately, the market has also attracted illicit – Growth manufacturers and distributors of tobacco. We estimate – Productivity that some 6 per cent of tobacco consumption, about – Responsibility

300 billion cigarettes a year, is supplied by smuggled REVIEW STRATEGIC AND BUSINESS – Winning organisation or counterfeit trade. It is a key concern for us. How – Our key performance indicators much of the industry will become illicit in the future? We continue to work proactively with governments 10 Our strategy in action and customs authorities to try to stem this rising tide. 10 Growth – Our approach to marketing While volumes are forecast to decline in some – Strategy markets, mainly the current higher margin markets, – GDB strategy is working they are set to grow in others, mainly in lower margin – Other international brands markets. Nevertheless, global industry profits are also – Relationships with customers set to increase over the next decade. British American – GDB performance Tobacco’s broad geographic base means that we are well represented in many of the lower margin markets where 14 Productivity volume and profitability are expected to grow, and that – Supply chain savings we are not so reliant on high margin markets, where – Overheads and indirects volumes are declining faster than the global average. 14 Responsibility So, despite a changing business environment, we are – Dow Jones Sustainability confident that the tobacco industry has a secure future Indexes and that British American Tobacco has the strategy and – Climate change products to prosper in it. – Harm reduction The evidence of the past decade bears this out. Although 18 Winning organisation the total global volume of cigarettes has been broadly – Employees static over that time, our global market share has grown – Employee opinion

significantly as a result of both acquisitions and organic OVERVIEW INDUSTRY EXECUTIVE’S CHIEF growth, and our operating profit has increased by over 60 per cent. GROUP NUMBERS 2006 Gross turnover Conclusion £25,189 million The tobacco industry is mature and all players, including us, face some big challenges, but we still have lots of Revenue after deducting duty, excise room for growth. British American Tobacco’s strong brand and other taxes portfolio and record of innovation, our trade marketing £9,762 million expertise, our cost savings potential, the global diversity Profit from operations of our earnings base, our presence in emerging markets £2,622 million and the future size of those markets: these are all reasons for us to believe that our business can continue to grow. Net capital expenditure £419 million Research & Development expenditure £76 million Charitable and community donations £17.6 million Employees 55,145 Global cigarette volumes 689 billion WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 06 British American Tobacco Annual Review 2006 Operating and financial review

OUR STRATEGY

Our vision is to achieve leadership of the global tobacco indirect costs (anything we spend money on other than industry, through strategies for creating shareholder value leaf, wrapping materials, cigarette making machinery based on Growth, Productivity, Responsibility and a and labour costs). Winning Organisation. We define leadership in both a quantitative and qualitative RESPONSIBILITY

UIESADSRTGCREVIEW STRATEGIC AND BUSINESS sense. Quantitatively, we seek volume leadership among Because we manage a product that poses real risks our international competitors. Qualitatively, we aim to to health, we strongly believe that our business must lead our industry as the preferred partner of key demonstrate responsibility in everything it does. We aim stakeholders and in demonstrating responsibility. to balance our commercial objectives with stakeholders’ changing expectations of a modern tobacco business. See diagram 1 Our Business Principles and our Standards of Business Conduct set out what we require of our companies and GROWTH employees in terms of responsible corporate behaviour We aim to grow our revenues and profits and to grow and personal integrity. our share of the global market. We have two routes to We support tobacco regulation that balances the do this: organic growth and mergers and acquisitions. preferences of consumers with the interests of society, Organic growth means increasing our market share in establishes an open-minded approach to harm reduction existing markets and through entering new markets. as a policy, and enables our businesses to continue to To achieve organic growth, we focus on key market compete and prosper. segments that offer the best long term prospects, Harm reduction is an important element of our strategy. including Premium and International Brands. We also aim For more about our approach, see page 17. to optimise the performance of our Global Drive Brands and to exploit opportunities for profitable volume growth in the Value-for-Money and Low Price segments. We see WINNING ORGANISATION innovative products that offer consumers meaningful, To achieve our vision of industry leadership, we recognise value-added differentiation as key to organic growth. that we must continue to have the right people and the We aim to continue sustaining or developing strong right working environment. We aim to develop leaders positions in our largest and most profitable markets. at all levels, to foster a confident culture that embraces

U STRATEGY OUR change and innovation, to attract and retain talented Strategically important and financially attractive people and to ensure continuous improvement mergers and acquisitions may also provide us with throughout the Group. growth opportunities.

OUR KEY PERFORMANCE INDICATORS PRODUCTIVITY Measuring our performance Our approach to productivity concentrates on smart We have a wide range of measures and indicators by cost management, marketing efficiency and capital which the Board assesses performance compared to effectiveness; deploying our global resources more the Group’s strategy. effectively to increase profits and generate funds to reinvest in our business. This includes ensuring that The Group’s goal to create shareholder value through we use our marketing resources and capabilities in the the strategies of Growth, Productivity, Responsibility most efficient way, reducing unnecessary complexity and Winning Organisation is best measured by the main and using our cash and other assets effectively. We financial drivers of the business. To ensure management’s are saving money by turning a multinational business focus is aligned with the interests of our shareholders, operating in over 180 markets into an integrated global these measures form the basis upon which the levels enterprise that can really take advantage of its scale. of incentives for the global organisation are decided. They are described below as our seven Key Performance Greater integration across our supply chain is helping us Indicators (KPIs). Some of these KPIs are used to set the to reduce costs, increase speed to market and improve targets for the Group’s performance over three years and effectiveness. We are also reducing our overheads and some are focused on the short term. These KPIs were chosen WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Annual Review 2006 British American Tobacco 07 Operating and financial review

as they are mainly based on published results or can be Diagram 1: Group strategy calculated from them. They are therefore reliable and are not based on subjective measures or interpretations. A number of other Business Measures, financial and non-financial, are monitored and assessed on a frequent Achieve leadership basis to ensure that all the Group’s strategies are delivered. of the global REVIEW STRATEGIC AND BUSINESS Although all these are not included in management’s tobacco industry incentives, we believe that these Business Measures are all contributing to the success of the Group, particularly over the longer term. We have therefore included, in this Review, some additional Business Measures relating to the Responsibility Growth Productivity Responsibility and Winning Organisation elements of our strategy. Our progress under Productivity is, of course, covered by the information we already publish about the Supply Chain Winning Organisation and Overheads and Indirects programmes. These measures and the performance relating to them, are discussed on pages 14 to 19. The Remuneration Committee sets targets at different levels, based on the Group budget approved by the Board in December. The KPIs used in 2006 have been retained for 2007. Measuring short term performance 1 Net revenue growth Net revenue for 2006 grew by 5 per cent. The long term goal is to grow net revenue, on average, by 3-3.5 per cent per annum. 1 Net revenue growth STRATEGY OUR The net revenue figure is calculated as the revenue of £ million the Group after the deduction of any duties, excise and 9,301 9,672 Long term target, on average other taxes, as published in the Group Income Statement +7% +5% on page 42. 3-3.5% 2 Global Drive Brand volume A key strength of the Group is its diversified Global Drive Brands (GDBs) portfolio. The growth of the four GDBs Dunhill, Kent, Lucky Strike and Pall Mall is therefore a 2005 2006 key driver of the Group strategy and is measured as one of the KPIs. 2 Global Drive Brand volume billions In 2006, GDB overall volume grew by 17 per cent to 146.1 Long term target, on average, 124.9 +17% high single figures 146 billion compared to 9 per cent growth in 2005. Our +9% target is to achieve high single figure growth. GDB volumes are calculated as the total volumes of the four brands sold by our subsidiaries.

More information about the GDBs and their individual 2005 2006 performances, is provided in this Review on pages 12 and 13. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 08 British American Tobacco Annual Review 2006 Operating and financial review

OUR STRATEGY

3 Share of global volume amongst key players The purpose of this measure is to ensure that the Group The long term goal is to become the leading international generates sufficient cash to fund its operations, pay tobacco company and British American Tobacco is dividends to its shareholders, operate the share buy-back currently second. programme and undertake other investment opportunities that may arise. In 2006, our share of global volumes amongst key players

UIESADSRTGCREVIEW STRATEGIC AND BUSINESS grew by 0.2 per cent. Share of global volume is calculated Measuring long term performance as the volumes sold by Group subsidiaries as a percentage 6 Earnings per share of the volumes sold by all international players, namely Adjusted diluted earnings per share (Adjusted EPS) Philip Morris International, Japan Tobacco, Imperial grew at an average of 12.4 per cent per annum since the Group, Gallaher and Altadis. The information used to beginning of 2004. This compared favourably to the long complete this calculation is based on publicly available term goal of growing at the rate of high single figures information and internal company analysis. per annum, on average, over the medium to long term. Adjusted EPS grew 10 per cent in 2006 (2005: 17 per cent). In our endeavour to grow global volumes, we assess all available acquisition opportunities on a frequent basis, Adjusted diluted EPS is the best measure to assess the but will only make a move when it is both financially underlying performance of the business, as it excludes and strategically attractive. all significant distortions (one-off and exceptional items that occur) but includes the potentially dilutive effect of 4 Organic operating profit growth employee share schemes. The detail of the calculation The Group’s long term aim is to grow organic underlying and the adjustments made, are explained in note 7 to operating profit by 6 per cent per annum, on average. the accounts included in the Annual Report and Accounts. For 2006, it was 7 per cent and for 2005, it was 9 per cent. This calculation removes the impact of the exceptional Organic profit used in this assessment is the operating items shown as memorandum information on the Group profit of the Group’s subsidiaries, excluding any exceptional Income Statement on page 42. These items are the items – the items shown as memorandum information on restructuring costs and impairment of a business, offset the Group Income Statement on page 42. by gains on disposal of brands. In addition, the calculation also adjusts for certain distortions in net finance costs 5 Cash flow arising under IFRS. The Group’s free cash flow in 2006 was £1,541 million, marginally below 2005. U STRATEGY OUR Free cash flow is defined as net cash from operating activities (including dividends from associates, restructuring costs and taxation) less net interest, net capital expenditure and dividends to minorities – the change in free cash flow is described on page 28. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Annual Review 2006 British American Tobacco 09 Operating and financial review

7 Total Shareholder Return 3 Share of global volume amongst key players The Group’s strategy is focused on increasing shareholder percentage value which is measured using Total Shareholder Return Long term target (TSR), compared to the FTSE 100 Index and also to the Fast Moving Consumer Goods (FMCG) peer group. The 17.1% Group has achieved a top quartile performance in both No.1 these categories since 1999. The goal is to be in the top REVIEW STRATEGIC AND BUSINESS quartile of each of the two comparator groups over a three year average. 4 Organic operating profit growth Over the past five years, the Group has delivered an £ million average TSR of 26 per cent compared to 7 per cent for 2,797 Long term target, on average 2,607 +7% the FTSE 100 Index (see page 37 for performance graph). +9% TSR performance combines both the share price and dividend performance of the Company during the 6% performance period, as set against the two comparator groups. The FMCG comparator group is reviewed annually to ensure that it remains both relevant and 2005 2006 representative and to, as far as possible, reflect the Company’s financial and business trading environment. 5 Cash flow £ million

TSR is measured according to the return index calculated 1,582 1,541 Specific target set for each year by Datastream, on the basis of all companies’ dividends +18% –3% being reinvested in the shares of the companies. The return is the percentage increase in each company’s index over a three year period. The measures and the outcome for the current and previous years are explained in the

Summary Remuneration Report on page 36, where the 2005 2006 Group’s employee share schemes are described. 6 Earnings per share pence STRATEGY OUR 98.20 Long term target, on average, 89.34 +10% +17% high single figures

2005 2006

7 Total shareholder return (annual %) 7 Total shareholder return (annual %) (1 January 2004 – 31 December 2006) FMCG group (1 January 2004 – 31 December 2006) FTSE 100

Upper Quartile Median–15.3% BAT–32.2% 35 Upper Quartile Median – 19.9% BAT – 32.2% 70 Lower Quartile Lower Quartile 30 60

25 50

20 40

15 30

10 20

5 10

0 0

–5 –10

The FMCG comparison is based on three months’ average values. The FTSE 100 comparison is based on three months’ average values. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 10 British American Tobacco Annual Review 2006 Operating and financial review

OUR STRATEGY IN ACTION

GROWTH expect both current and long term growth opportunities. Our approach to marketing We also continue to invest in our regional and local We recognise that our marketing must be conducted brands, especially where they play a strategic role in responsibly, ensuring that we communicate our product a particular market’s portfolio. and brand benefits to adult consumers. In 2001, we We also take opportunities to invest in brands that show developed, along with two major international competitors,

UIESADSRTGCREVIEW STRATEGIC AND BUSINESS specific promise, particularly in the growing segments, the International Marketing Standards (IMS). They set such as Vogue, our premium superslims offer, and Kool, out detailed guidance on all aspects of tobacco marketing our premium menthol offer. from print, billboards and electronic media to promotional events, packaging and sponsorship. In 2006, in accordance See chart 1 with the IMS, we ended our sponsorship of Formula 1 GDB strategy is working motor racing. Our strategy is working. In 2006, our Premium GDBs alone We want to keep our marketing activity responsive to a grew by 9 per cent. Each of our four GDBs grew in 2006, fast changing world. During 2007, we will therefore be including Lucky Strike which returned to marginal volume revising our own set of Standards, to include newer media growth and continued to improve its share in most of its not captured in the original 2001 version (e.g. internet core markets. We grew our GDBs in each of our operating sales and text messaging), enhanced adult age verification regions, with double digit GDB increases in Asia-Pacific, procedures and tighter restrictions on promotion and Europe, Africa and Middle East and Latin America. sampling. These and other changes will help ‘raise the The 2 per cent overall volume growth is not concentrated bar’ further in terms of addressing what is acceptable in one country or region. We saw increases in all regions tobacco marketing worldwide. except for America-Pacific, where volume declines in Our marketing approach focuses on using insights into Canada offset gains in Japan. consumer lifestyles and values to develop relevant products. Our investment in consumer relevant innovation is These insights drive the development of our product and delivering results in both volume and value terms. 2006 communication campaigns, to differentiate our products saw a number of highly successful product launches in from our competitors’ offerings in ways that resonate which we offered consumers additional value at a higher with adult consumers. This includes the work of our Trade price point. Dunhill Fine Cut cigarettes in numerous Marketing & Distribution teams to place and promote the markets and Pall Mall superslims across key Eastern

U TAEYI ACTION IN STRATEGY OUR right brands in the right retail outlets for the right consumers. European markets, such as Russia, were just two specific Strategy product innovations that drove volume and higher net Central to our marketing approach is the premise that revenue from our GDBs portfolio. They are concrete one size does not fit all and we believe a key strength of examples of us meeting the preferences of consumers British American Tobacco is our diversified Global Drive who, in turn, are choosing to trade up to products that Brands (GDBs) portfolio. These brands deliver rational deliver higher margins. Innovation is strengthening the choices such as product, blend and price along with foundations for our future growth. other perceived consumer benefits like strength and See chart 2 taste. Our growth strategy is built on the success of our four GDBs, Dunhill, Kent, Lucky Strike and Pall Mall. Other International Brands We focus our resources to develop these brands in the While our investment and managerial focus remains key International, Premium, Lights and Adult Smokers firmly on our four GDBs, 2006 saw robust growth across Under 30 (ASU30) marketing segments, where we our broader range of International Brands (IBs), with total WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Annual Review 2006 British American Tobacco 11 Operating and financial review

International Brand growth at 11 per cent for the year. 1 Strategic segment volume in 22 key markets Vogue, our premium superslims offer, led the way with billions an impressive 32 per cent growth due to excellent results 199 208 in South Korea, Russia, Italy, France and Ukraine. Kool 171 156 153 grew by 16 per cent, as the menthol category continues 139 144 150 to expand worldwide. In addition, we saw robust growth from Benson & Hedges, Rothmans and Craven ‘A’. Our REVIEW STRATEGIC AND BUSINESS efforts to appeal to consumers who are choosing to 2005 2006 trade down in price but still want an international brand ASU30 Lights IBs Premium succeeded with Viceroy, which grew by 19 per cent in 2006. Based on data from the 22 markets, our share in each segment increased in 2006 to ASU30 (30.2%), Lights (26.6%), IBs (21.8%) 3 See chart and Premium (29.4%). Relationships with customers 2 GDB volume growth The increasingly restrictive environment in which we billions can communicate with consumers means that Trade 146 Marketing & Distribution (TMD) is a key element of 125 113 114 our marketing activity. We recognise the importance 93 100 of the retail outlet. That is why we strive to achieve and maintain benchmark business partnerships with the retail trade in all the strategic channels where we do business. 2001 2002 2003 2004 2005 2006 To achieve benchmark status, we must operate consistently in the most effective and efficient manner Since 2001, our four GDBs (Dunhill, Kent, Lucky Strike and Pall Mall) have increased combined volume by 57%. to serve our trade customers, both independent outlets as well as our major account customers. We measure 3 Other International Brands – volume growth our performance in this area extensively and the most billions recent external and independent survey carried out in 133 129 122 127 2006 revealed that, in a majority of countries, retailers 116 118 perceive British American Tobacco as having the best TMD organisation compared to other tobacco companies. U TAEYI ACTION IN STRATEGY OUR The foundation for this success is our ‘Win Win Win’ strategy. We recognise that in order for our strategy 2001 2002 2003 2004 2005 2006 to succeed, it is imperative that there is a benefit for all Since 2001, other International Brands (excluding the four GDBs) rose three participants – our customers, ourselves and, above by 3%. all, our consumers. All three must stand to win in some way. This approach resonates with our trade partners, as reflected in our global deal with Shell signed in 2006, the first of its kind within the FMCG sector. Our GDBs, plus two strategic brands in appropriate markets, now have guaranteed, prominent display space in 5,500 Shell convenience stores around the world. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 12 British American Tobacco Annual Review 2006 Operating and financial review

OUR STRATEGY IN ACTION CONTINUED

GDB performance Kent Dunhill Kent continues to play its key role in our portfolio as Dunhill provides us with a Premium/Super Premium the free standing premium brand for consumers seeking brand to meet the needs of consumers at the top end a mild and smooth taste. Kent aims to be the leading of the tobacco market. In 2006, we extended Dunhill’s brand for ASU30 smokers and perceived consistently geographic reach, as well as the product segments in as the brand that delivers ‘the modern way to smoke’. UIESADSRTGCREVIEW STRATEGIC AND BUSINESS which Dunhill competes. Kent has continued to demonstrate the innovative 2006 saw the successful enhancement of the House of nature of a brand designed for the 21st century Dunhill via the rapid roll-out of Dunhill Fine Cut cigarettes, through a number of linked initiatives. These include the relaunch of Top Leaf and the pilot launches of the the introduction of a new global pack and the core Essence (superslims) and Senses (menthol) ranges. charcoal range’s use of 3-Tek filter technology. A new These initiatives succeeded in Dunhill’s core markets communication campaign in Russia, Japan, Romania and such as Australia, Malaysia, South Korea and Taiwan, Chile resulted in accelerated organic growth of the brand where they supplemented existing Dunhill offers, while in these markets. In Switzerland and the Netherlands, stretching the price mix to premium plus levels. These British American Tobacco launched the brand via the developments also helped in the promising launch and migration of Barclay consumers to Kent. Initial results are roll-out of Dunhill in new markets, particularly in Western promising, with exceptionally strong consumer response Europe and the Middle East. Furthermore, a number from both existing smokers and those switching from of key product innovations that commanded premium competitor brands. plus price points were successfully launched. We believe The net result of these initiatives saw Kent become the that the equity of the brand, combined with tangible number one brand in Romania, as well as achieving over a product benefits delivered by these innovations, provides billion cigarettes a month in sales in Russia. Kent delivered consumers with what they want. the fastest rate of growth among our premium GDBs, Manufacture of the Dunhill Signed Range cigars with its fourth consecutive year of double digit growth. was moved to Nicaragua in 2006. This change will Lucky Strike significantly reduce our supply chain complexity, allow 2006 was a milestone year for the Lucky Strike brand, us to continue to deliver a premium cigar and invest in as it managed to return to volume growth and achieved the further growth of the range. record market share in Germany, Spain, France, Indonesia, U TAEYI ACTION IN STRATEGY OUR 2007 sees the centenary of the Dunhill tobacco brand Argentina and Italy. and several ambitious initiatives will roll-out worldwide In 2006, Lucky Strike focused on establishing itself as the in celebration. brand that provides ‘a rich tobacco experience’ through the launch of an innovative pipeline of product and packaging initiatives. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Annual Review 2006 British American Tobacco 13 Operating and financial review

Lucky Strike’s new premium pack designs add quality, heritage and product expertise cues and further differentiate the Original Red from the Original Silver variant. The new ranges, with Madura, Fireleaf Silver and Mentha Piperita variants, deliver unique tobaccos to provide a choice of rich taste and uncompromised smoking pleasure. UIESADSRTGCREVIEW STRATEGIC AND BUSINESS Lucky Strike launched new Roll Your Own (RYO) products in an effort to capitalise on growth without diluting its premium image. In smokeless products, the market success of Lucky Strike snus in Sweden and the pilot learnings achieved in South Africa, are encouraging signs that the brand’s equity can be successfully stretched into other 33 billion cigarettes sold in 2006 tobacco categories. 6 per cent increase on 2005 Pall Mall Pall Mall aims to redefine consumers’ experience at the Value-for-Money price point by delivering on its promise of ’imagination in tobacco’ with innovative product and brand attributes. Pall Mall achieved an outstanding 45 billion cigarettes sold in 2006 performance in 2006, driven by good organic volume and 16 per cent increase on 2005 share growth in its established markets such as Germany, Poland and Spain, as well as many successful launches in all regions. Pall Mall’s success is driven by the strong and globally consistent brand mix, supported by a solid innovation pipeline, ensuring Pall Mall has a leadership position in responding to consumer needs in the Value-for-Money segment. The launch of House of Pall Mall in Switzerland 22 billion cigarettes sold in 2006 included the introduction of four different tobacco 0.4 per cent increase on 2005 products (small cigars, RYO, Superslims and Stix) along ACTION IN STRATEGY OUR with a range of King Size cigarettes offering more choice. In Germany, Pall Mall successfully captured consumers moving from Stix to other tobacco products within the brand family and achieved its highest ever share of the 46 billion cigarettes sold in 2006 German market by the year end, to become the second 40 per cent increase on 2005 largest tobacco brand. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 14 British American Tobacco Annual Review 2006 Operating and financial review

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PRODUCTIVITY In addition, we will establish new capabilities for driving Savings generated by our productivity initiatives are ahead growth through consumer relevant innovations, delivered of plan. The substantial efficiencies made in the supply through an effective and efficient, integrated supply chain. chain, supported by savings through our overheads and Improvements in global supply chain operations to date indirects programmes, are releasing funds for reinvestment were recognised by a European Supply Chain Excellence in research, product innovation and growth, as well as Award, presented by the magazine ‘Supply Chain Standard’ UIESADSRTGCREVIEW STRATEGIC AND BUSINESS being a significant driver of operating profit growth. in November 2006. Supply chain savings Overheads and Indirects Our focus on primary supply chain efficiencies has The Overheads and Indirects cost reduction programme delivered benefits of £148 million in 2006, bringing the ended its fourth year and delivered savings of £99 million. annual savings for the four years of the programme up to Since its inception in 2003, annualised savings have £374 million. These savings are predominantly the result reached £355 million and are well on the way to reach of efficiencies within our manufacturing and logistics the £400 million target by 2007. operations and initiatives surrounding the specification, Savings are, in part, being driven by the adoption of purchase and usage of packaging and leaf materials. smarter procurement processes around the Group, with There has been further rationalisation of our manufacturing procurement specialists working with key business managers capacity, with 12 factories closed in the year, including to find mutual benefits. The amount of indirect expenditure Guelph in Canada and Southampton in the UK, and (those items that are not involved in cigarette production) cigarette manufacture in Bologna in Italy has ceased. In that is channelled through procurement has increased to addition, a further four factory closures were announced, a level that now covers most areas of the business and including Zevenaar in the Netherlands, and a number the processes established are being embedded within of downsizing exercises have been completed. These the business for sustainable benefit. initiatives, together with the Group’s ‘Bullseye’ best The move to shared services in both IT and Finance is practice audits have increased overall productivity by gaining momentum and is now delivering real value. nearly 10 per cent in the year. We have also redeployed 650 individual machinery assets around the Group. RESPONSIBILITY The job losses resulting from closures and downsizings have Responsibility is a key element of our business strategy been addressed with care and responsibility. Mitigation

U TAEYI ACTION IN STRATEGY OUR but how do we measure or assess our performance? activities have included fair redundancy packages, extensive We look to external benchmarking to provide us with outplacement support and, where appropriate, community an objective view on how we are doing and use the Dow wide initiatives aimed at new job creation. The Company’s Jones Sustainability Indexes (DJSI) as our primary Business Mitigation-Plus programme in response to the Darlington Measure. With regard to our environmental impacts, we factory closure in the north east of England is one of those have the data and have been reporting on the trends for to have received recognition, a best practice award in 2006 several years. On pages 15 to 17, we have included some from the UK-based Management Consultants Association. of these measures in a section on the key topic of climate The Product Complexity Reduction programme targets change. In harm reduction, we can report some encouraging the elimination of irrelevant complexity across our brand signs of increasing engagement around an area which is portfolio. Working together, our Operations and Marketing central to our business strategy. teams have defined standards covering all the key attributes Dow Jones Sustainability Indexes of our brands, from packaging design through to product In 2006, we were, for the fifth year running, the only specifications and leaf blends. As a result, we have been tobacco company included in the DJSI. Launched in able to rationalise and simplify the number of combinations 1999, the DJSI are global indices tracking the performance and specifications we use in our supply chain by more of the leading companies worldwide. The indices are than 30 per cent. We have also reduced the number of based on a detailed assessment of companies’ economic, stock keeping units we sell by 24 per cent, leaving a more environmental and social performance, and on how well focused, consumer-relevant portfolio. they integrate sustainability strategies into their business. The productivity, complexity and capacity optimisation Externally, these benchmarks are used by asset managers programmes will continue over the next few years and to make investment decisions and by other stakeholders will realise significant savings. looking at sustainable businesses. Internally, participation WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Annual Review 2006 British American Tobacco 15 Operating and financial review

in the indices gives us an objective third party perspective 4 Dow Jones Sustainability Indexes on how we are managing the business and allows us to benchmark our performance against the best in the sector Was 2006 score Was score same or better higher than and the sector averages. Dow Jones Criteria than 2005? sector average? Economic Dimension ✖ ✔ The tobacco sector group is based upon an assessment Environmental Dimension ✔✔ of 10 tobacco companies, although the names of all the Social Dimension ✔✔ REVIEW STRATEGIC AND BUSINESS companies are not publicly disclosed. In 2006, our overall score remained equal to last year’s at 79 per cent against Economic Dimension a sector average that increased significantly to 66 per cent. Corporate Governance ✔✔ ✔✔ We achieved the top score in 13 out of 19 categories, Risk & Crisis Management Codes of Conduct/Compliance/ ✔✔ improved our score in 16 and scored better than the sector Corruption & Bribery average in 18. We shall continue to submit ourselves for Customer Relationship Management* ✖✖ consideration, with the aim of maintaining our position in Combat Smuggling ✖ ✔ the indices. However, because inclusion is determined by Environmental Dimension a third party, we have chosen not to regard inclusion itself Environmental Policy/Management ✔✔ as a Business Measure. Chart 4 shows how we report our Environmental Performance (Eco-efficiency) ✔✔ performance in the DJSI. Our annual target is to record Environmental Reporting ✔✔ a higher score than the sector average in a minimum of Management of GMO ✔✔ 15 out of 19 categories. Fuels for Tobacco Curing ✔✔ Raw Material Sourcing ✔✔ See chart 4 Social Dimension Climate change Labour Practice Indicators ✔✔ We consider it to be part of our responsibility to measure, Human Capital Development ✔✔ monitor and reduce our energy use and greenhouse gas Talent Attraction & Retention ✔✔ (GHG) emissions and report on our global performance in Social Standards for Suppliers (new) ✔ accordance with Global Reporting Initiative (GRI) guidelines, Corporate Citizenship/Philanthropy ✔✔ ✔✔ publicly on an annual basis. Social Reporting Responsible Marketing Policies ✔✔ We view reductions in emissions as being the top priority, Occupational Health & Safety ✔✔ **TARGET reached ✔ followed by mitigation. Where no further reduction or ACTION IN STRATEGY OUR mitigation is possible, we will look to offsetting. *We were previously sector leaders in this category but a change in the scoring system resulted in a significant fall in our score in 2006. Reduction – our performance on reducing emissions **Our target is to record a higher score than the sector average in a minimum We have reduced both the absolute amount and intensity of 15 out of 19 categories.

(per unit production) of our CO2 emissions in recent years. This has been achieved by energy conservation initiatives, investment in energy efficient technologies, use of renewable fuels and through consolidation of our manufacturing footprint. We also work to reduce waste sent to landfill and increase the amount of waste recycled. Emissions

CO2 is a GHG, a major contributor to climate change. 5 Emissions tonnes CO per million cigarettes equivalent In 2000, the Group committed to reducing CO2 emissions 2 by 5.2 per cent by 2008, in line with the Kyoto protocol. 1.38 1.26 1.23 This was achieved by 2004. We have set progressively more 1.13 stretching targets each year since 2004. In 2006, the target 0.83 0.79 was 0.78 tonnes CO2 per million cigarettes equivalent and we achieved 0.79 tonnes, a reduction of 5 per cent over 2005. Over the last five years, our emissions have reduced by 43 per cent. 2001 2002 2003 2004 2005 2006 Since 2001, our emissions have fallen by 43%. See chart 5 WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 16 British American Tobacco Annual Review 2006 Operating and financial review

OUR STRATEGY IN ACTION CONTINUED

Waste to landfill In terms of reducing GHG emissions, we are working Waste sent to landfill creates methane, which is 21 times with leaf and material suppliers, through both the SRTP

more potent as a GHG than CO2. and BEST programmes, to achieve further improvement and we will be establishing minimum environmental By reducing the amount of total waste generated and performance criteria for suppliers during 2007. increasing recycling rates, we have reduced waste sent

UIESADSRTGCREVIEW STRATEGIC AND BUSINESS to landfill by 59 per cent since 2001. Mitigation activities – The British American Tobacco Biodiversity Partnership See chart 6 We are also working with our Non-Governmental Recycling Organisation partners (Earthwatch Institute (Europe), Increasing recycling rates reduces the amount of waste Fauna & Flora International, the Royal Botanic Gardens, that is sent to landfill. Our 2006 global recycling rate Kew and the Tropical Biology Association) within the was 81.2 per cent. Biodiversity Partnership to avoid, minimise and mitigate our impacts on biodiversity and minimise the use of Through proactively seeking new partners and destinations ecosystem services, such as soil, water and wood. for recycling, we have increased our recycling rates over the last five years. There are now 10 companies within We have categorised our projects in accordance with the Group achieving 95 per cent recycling rates. definitions from the Intergovernmental Panel on Climate Change (IPCC), splitting the contribution to the Climate See chart 7 Change agenda into the following: Working with our Supply Chain • Understanding impacts, adaptation and vulnerability Suppliers are increasingly seen as a critically important • Mitigation stakeholder group and there are growing expectations that businesses should use their influence to encourage Of the current 43 projects within the partnership good standards of corporate responsibility in their supply programme portfolio, 25 address understanding impacts, chains. We accept this responsibility and work not only adaptation and vulnerability, and 17 address the mitigation to set high standards for our suppliers but to support part of the IPCC definitions. 14 of the projects address them in achieving continuous improvement. both and 15 are relevant to neither aspects of climate change but are relevant to biodiversity conservation. We see this as particularly important for a very large business such as ours, with a primary supply chain that Water use U TAEYI ACTION IN STRATEGY OUR includes some 250,000 farmers who grow tobacco leaf In many areas where we operate, climatic variations and other international suppliers from whom we buy may cause water to become a scarce resource. In 2006, other raw materials such as packaging and paper. we have reduced our water use by 7 per cent and over the last five years it has come down by 41 per cent. Our major supply chain programmes include our Business Enabler Survey Tool (BEST), which sets out in detail the See chart 8 standards we expect of the suppliers from whom we buy Offsetting raw materials other than leaf. BEST assesses suppliers across We do not use the information below to formally offset 102 performance criteria, covering, for example, suppliers’ our CO emissions, as many of the trees that we sponsor business ethics; environment, occupational health and 2 are not owned by us. safety management; employee rights and the supplier’s ability to trace the sources of raw materials, including However, since the 1970s, Group companies have sourcing wood from sustainably managed forestry. promoted forestry programmes to ensure a source of wood fuel for tobacco growers. The Edinburgh Centre for Social Responsibility in Tobacco Production (SRTP) is a Carbon Management has helped the Group to quantify significant programme that aims to ensure that we only the CO take-up and storage by these forests since 1998. purchase tobacco leaf from responsible and sustainable 2 At the end of 2005, the carbon storage associated with sources, by working to address the social and environmental the programmes in Brazil, Kenya, Pakistan and Uganda issues associated with tobacco leaf growing and processing. was estimated at 400,000 tonnes of carbon, equivalent

We have also encouraged other manufacturers to adopt a to 1.46 million tonnes of CO2. This compared to the

similar approach, an initiative that is gaining considerable 0.85 million tonnes of CO2 emitted from Group companies’ support. Our supplier review methodology has been operations in 2005. This study will be updated in 2007. adopted by a number of tobacco manufacturers, while others have adopted similar programmes of their own. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Annual Review 2006 British American Tobacco 17 Operating and financial review

During 2007, we will investigate potential ways to offset 6 Waste to landfill our emissions, although our first priority will always be tonnes per million cigarettes equivalent to reduce them as far as possible. 0.056 0.050 Harm reduction 0.042 We believe that harm reduction, which is a key element of 0.036 0.035 0.023

our business strategy, ought to be able to find common REVIEW STRATEGIC AND BUSINESS ground with the goals of public health policy.

We agree that risky products such as tobacco should be 2001 2002 2003 2004 2005 2006 regulated. Currently, tobacco regulation broadly focuses Since 2001, we have reduced our waste to landfill by 59%. on three areas: preventing people from starting to smoke, encouraging quitting and protecting people around smokers. 7 Recycling percentage of waste recycled However, we strongly believe that these prevention, 81.2 cessation and protection efforts are missing an important 69.4 72.3 72.5 63.6 ‘fourth dimension’, namely, harm reduction, for the 57.3 millions of adults globally who will continue to be tobacco consumers. The World Health Organisation predicts that, even 2001 2002 2003 2004 2005 2006 with increasingly strict regulation, there will be as many or more smokers globally in 10 years’ time as there are Since 2001, we have increased our recycling by 24%. today, as falling tobacco consumption is offset by a 8 Water use strongly rising world adult population. cubic metres per million cigarettes equivalent 8.73 In public policy, harm reduction is an established concept. 8.01 7.84 It recognises that positive health outcomes can be achieved 6.61* 5.58 in ways other than through disincentives, punitive measures 5.18 or the prohibition of certain lifestyle choices. Smoking poses real and serious health risks, but nicotine, 2001 2002 2003 2004 2005 2006 at the levels smokers take, does not. If smokers could take ACTION IN STRATEGY OUR nicotine from pleasurable tobacco products with far lower Since 2001, our water usage has decreased by 41%. risks than smoking, we believe that tobacco related harm *For comparison purposes, the 2004 figure excludes data from Peru relating to the use to health would reduce far faster than current public of irrigation water by farms owned by a company we acquired in late 2003. It is unusual for the Group to own farms. The 2004 figure, including Peru, is 8.01. health efforts can achieve alone. We believe we can contribute to reducing the harm of tobacco use through innovative products, while also supporting the long term sustainability of our business. What we are doing Encouraged by public health stakeholders, we have extended some major cigarette brands to Swedish-style snus, a smokeless tobacco product mainly sold in Sweden and recognised by health experts, such as the UK’s Royal College of Physicians, to be much less harmful than smoking. We are marketing snus in Sweden, have started sales in Norway and, building on our experience in South Africa, have begun a pilot in Japan. We plan to extend these initiatives elsewhere in due course. We are planning to lobby for an amendment to the EU ban on snus sales in the EU except for Sweden. We believe there is no rational justification for continuing to bar smokers from choosing a less hazardous alternative to cigarettes. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 18 British American Tobacco Annual Review 2006 Operating and financial review

OUR STRATEGY IN ACTION CONTINUED

We are also developing a scientific framework for are afforded the same opportunities for promotion, training evaluating the relative risks of different tobacco products, and career development as other staff. Our Employment both combustible and non-combustible. Currently, there is Principles are available to all staff on the Group’s intranet. no accepted approach to measuring tobacco consumers’ The Group continues to encourage employee ownership exposure to the toxicants believed relevant to tobacco through its provision of employee share plans, including the related disease. This is vital to enable development of

UIESADSRTGCREVIEW STRATEGIC AND BUSINESS Partnership Share Scheme and the Share Reward Scheme. lower risk tobacco products. However, we cannot develop a framework alone. To ensure that the work and supporting In addition to the global survey (see below), we encourage research are robust, we are expanding our engagement employee engagement through individual discussions, team with external scientists. briefings, local surveys, publications and regular meetings with recognised employee representatives. Research and development Our research and development activities are focused on See chart 9 developing new products and new processes, as well as Employee opinion maintaining and improving the quality of existing products. The extent to which our employees, at every level of Research is also carried out on risk characterisation, the business, feel engaged and committed to delivering building a framework to assess the relative risk of novel superior results is key to delivering our leadership vision. and conventional products and a better understanding of how consumers use them. Risk reduction, such as The most authentic way to measure progress is to collect developing technologies that have the potential to lower views from employees themselves. The best judge (and exposure to toxicants in smoke, is also a central part of indeed the best influencer) of the extent to which we are the research and development programme. Research is making tangible progress in what underpins our Winning also undertaken into aspects of the science and behavioural Organisation strategy has to be our employees, at every science related to smoking and we continue to provide level and in every part of the business. We therefore work funding for independent studies. to create an environment where employees feel that they can speak honestly about their company and the issues of importance to them, placing emphasis on the role of WINNING ORGANISATION employee opinion research. British American Tobacco will be a winning organisation when it is recognised by its employees as being a great Our international employee opinion survey, ‘Your Voice’,

U TAEYI ACTION IN STRATEGY OUR place to work, where outstanding people are attracted, is run by ISR (International Survey Research), a leading challenged and have the opportunity to grow. global employee research organisation, to gather detailed views from employees to enable regional, functional and Employees local action planning. Your Voice was conducted as a global Creating a safe place to work has to be our primary census for the first time in October 2005, in over 70 markets, consideration for employees. We measure and track followed by a further census in November 2006, capturing performance using a measure of the Lost Workday the feedback from over 38,000 employees. The survey Case Incident Rate (LWCIR). covers all levels of employees and will now be run at Over recent years, the rate has been reducing, although two yearly intervals. the acquisition of ETI in Italy in late 2003 had a negative Benchmarking effect on safety performance in 2004. As British American To establish how employee opinion within British American Tobacco’s standards for safety were adopted, performance Tobacco compares with other organisations, our global in Italy has improved. In 2006, we aimed to achieve a employee opinion survey data is compared with ISR’s further 10 per cent reduction to a rate of 0.44. In fact, global FMCG companies norm. the rate fell to 0.42 from 0.49. Positive as this trend is, we continue to aspire to achieve a rate of 0.1-0.2, Many of these companies (e.g. Diageo, Nestlé, considered to be a best practice standard for comparable Coca-Cola and Unilever) also appear in the peer group multinational organisations. of FMCG companies used to assess our performance in the Long Term Incentive Plan (LTIP) – see page 37. We are committed to providing a work environment that is free from harassment, bullying and discrimination. 2006 survey results There is no discrimination against people with disabilities The overall response rate for the survey in 2006 improved who apply to join the Group and those with a disability over the previous year to reach 89 per cent. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Annual Review 2006 British American Tobacco 19 Operating and financial review

In all of the 15 categories in the 2006 survey, employee 9 Lost Workday Case Incident Rate (LWCIR) opinion in British American Tobacco is significantly more LWCIR = No. of lost workday cases through injury or occupational illness positive than in the FMCGs benchmarked by ISR. to employees x 200,000 ÷ total hours worked by all employees 0.72 There were also significant improvements in most of the 0.63 0.55 categories compared to the previous survey. 0.48* 0.49 0.42 See chart 10 REVIEW STRATEGIC AND BUSINESS Using the survey results

Of course, it is positive for us to know that our employees, 2001 2002 2003 2004 2005 2006 for example, understand our global vision and are proud to be associated with the Company, but how can the Since 2001, the LWCIR has decreased by 42%. *For comparison purposes, the 2004 figure excludes new companies acquired. If these survey be used to improve performance? acquisitions are included, the 2004 figure is 0.64. ISR research shows that employee attitudes about leading indicators (e.g. strategic direction, leadership, talent, customer focus) tend to be significantly more favourable in high performing organisations. The lagging indicators (e.g. morale, efficiency, commitment) tend to follow naturally. As the leading indicators tend to be 10 Your Voice survey 2006 the key drivers of improved organisational performance, British American Tobacco vs. ISR global FMCG companies norm we concentrate our efforts on these particular areas. Favourable scores Differences from benchmark A number of the indicators (e.g. strategic direction, Survey follow up morale) are drawn from a range of the categories shown 75 8 Pay and benefits in Chart 10 and do not correspond directly to a single 55 8 category heading. Information and communication 77 7 We are performing well in terms of many of the leading Leadership indicators, including strategic direction and customer 72 6 focus. In response to scores that were less positive, we Respect for our employees 69 6 have committed to put more focus on leading indicators Learning ACTION IN STRATEGY OUR such as leadership and talent. Recent actions include 64 6 setting clear targets for local representation on top teams Talent and in succession plans. 60 6 Team working The survey results are used at global, regional, local and 79 5 Alignment functional levels, while the learning from companies with 76 5 good results is captured and shared around the Group. Structure 68 5 The survey results also provide detailed information Corporate about any areas of concern. If issues have been raised, responsibility 80 4 the companies work with employees on action plans Culture 79 4 to improve in the highlighted areas. Freedom through The Your Voice survey is a major undertaking across the responsibility 71 2 Enterprising spirit Group and is key to the way we measure our performance 67 2 compared to the Group strategy. We will continue to seek Open minded and respond to our employees’ opinions. 57 2

0 204060801000 10 WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 20 British American Tobacco Annual Review 2006 Operating and financial review

REGIONAL REVIEW EINLADFNNILREVIEW FINANCIAL AND REGIONAL

■ Europe ■ Asia-Pacific ■ Latin America ■ Africa and Middle East ■ America-Pacific ■ Associates EINLREVIEW REGIONAL

REGIONAL DATA Volumes Revenue Operating profit 2006 2005 2006 2005 2006 2005 bns bns £m £m £m £m Europe 247.7 244.0 3,545 3,497 781 784 Asia-Pacific 141.9 137.1 1,839 1,758 616 531 Latin America 152.6 149.3 1,791 1,555 611 530 Africa and Middle East 103.3 102.6 1,489 1,405 468 434 America-Pacific 43.8 45.0 1,098 1,110 424 436 689.3 678.0 9,762 9,325 2,900 2,715

Unallocated costs (103) (96) Operating profit before exceptional items page 26 2,797 2,619

Revenue and operating profit, before exceptional items, restated at comparable rates of exchange page 26 9,774 9,325 2,799 2,619 WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Annual Review 2006 British American Tobacco 21 Operating and financial review

REGIONAL SUMMARY The following section contains: The reported Group profit from operations was 8 per cent higher at £2,622 million or, as explained on page 26, 21 Regional review 7 per cent higher on a like-for-like basis, with Asia-Pacific, –Europe Latin America and the Africa and Middle East regions – Asia-Pacific contributing to this good result. – Latin America – Africa and Middle East REVIEW FINANCIAL AND REGIONAL Group volumes from subsidiaries increased by 2 per cent – America-Pacific to 689 billion on both a reported and like-for-like basis. – Unallocated costs The reported Group revenue rose by 5 per cent to – Results of associates £9,762 million and also increased by 5 per cent on a like-for-like basis. This excellent volume and revenue 26 Financial review growth was achieved across a broad spread of markets. – Profit from operations – Interest cover The four Global Drive Brands continued their impressive – Effective tax rate – subsidiaries performance and achieved overall volume growth of – Adjusted diluted earnings 17 per cent. per share Kent volume grew by 16 per cent with significant – Dividends per share declared increases in Russia, Romania, Ukraine and Chile, and –Cashflow share growth was also achieved in its major market, – Treasury options Japan. Dunhill rose by 6 per cent, driven by strong –ChangesintheGroup performances in South Korea, Taiwan, Australia, South – Changes in accounting policies Africa and the Middle East, although it was lower in – Share buy-back programme Malaysia due to a reduced total market. 30 Key Group risk factors Lucky Strike volumes rose marginally as the growth in – Litigation Spain, France, Italy and Indonesia was largely offset by – Regulation declines as a result of lower industry volumes in Germany – Operations and Japan. Pall Mall continued its exceptional growth – Excise and sales tax and achieved an increase of 40 per cent, driven by – Illicit trade and intellectual

Spain, Greece, Poland, Russia and Bangladesh. property REVIEW REGIONAL – Information technology – Financial WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 22 British American Tobacco Annual Review 2006 Operating and financial review

REGIONAL REVIEW CONTINUED

Europe in the other tobacco segments, although overall cigarette In Europe, profit at £781 million was slightly lower mainly market share increased as Pall Mall and Winfield performed as a result of very competitive trading conditions in a well. In Spain, despite strong growth in volumes and a number of markets and the inclusion in the comparative much higher share, the results were adversely affected period of a one-off benefit in Italy, resulting from the by the significantly reduced market profitability resulting change in terms of trade following the sale of Etinera. from intense price competition. EINLADFNNILREVIEW FINANCIAL AND REGIONAL Excluding this benefit, profit increased by £9 million, The impressive performance in Russia continued through with strong growth from Russia, Hungary, Italy and strong volume and profit increases, with an improved France, largely offset by declines in Spain, Poland, product mix and lower production costs. A higher overall Germany, the Netherlands and Ukraine. Regional volumes market share resulted from significantly increased volumes on a like-for-like basis were 2 per cent higher at 248 billion, of Kent and Vogue, supported by good Pall Mall growth. with growth in Russia, France, Spain and Hungary partly In Romania, the Group continued to grow volumes and offset by declines in Ukraine, Italy and Germany. profit, consolidating its leadership position in a reduced In Italy, profit grew strongly driven by improved margins market, affected by substantial excise increases. after industry price increases and a successful productivity Volume performance was driven by its premium brands, programme which has considerably reduced the overall particularly by Kent, which is now the largest selling cost base. The growth in Global Drive Brands’ market share brand, as well as Dunhill and Vogue. was more than offset by the decline in domestic brands. In Ukraine, profitability was adversely affected by Profit in Germany was slightly down due to excise driven the considerable decline in volumes. However, Kent, volume declines in the overall market and down-trading Lucky Strike and Pall Mall grew market share. Profit grew to lower price and margin products after the end of significantly in Hungary, benefiting from the recovery of Stix production. These factors were partly offset by cost the legal market after improved border controls, efficiency reductions and the good cigarette market share growth programmes and the strong volume growth from Viceroy of Pall Mall and Lucky Strike, which led to a higher overall and Pall Mall. In Poland, industry profitability was severely cigarette market share. affected by increased excise rates and aggressive price competition. Volumes were down, although Pall Mall Profit in France grew strongly, benefiting from higher and Vogue grew both share and volume. volumes, an improved product mix and lower costs. In Switzerland, profit was higher due to the inclusion See chart 1 EINLREVIEW REGIONAL of the vending machine business acquired last year Asia-Pacific and despite price competition. The continued growth In Asia-Pacific, regional profit rose by £85 million to of Parisienne volume and share was offset by the decline £616 million, mainly attributable to good performances in in other brands, resulting in overall volumes the same Australasia, Malaysia, South Korea and Pakistan. Volumes as last year and a lower market share. at 142 billion were 4 per cent higher as strong increases In the Netherlands, profit was lower due to higher in Pakistan, Bangladesh, South Korea and Vietnam were excise levels and an adverse product mix, partly offset partially offset by declines in Malaysia and Indonesia. by cost savings, while cigarette market share increased. Profit grew strongly in Australia, as a result of improved Profit in Belgium was affected by intense price competition margins from a combination of product cost reductions, WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Annual Review 2006 British American Tobacco 23 Operating and financial review

price increases and a substantial reduction in overheads. 1 Europe Good performances from Winfield and Dunhill, and like-for-like information the launch of Pall Mall, contributed to a higher overall 242 248 3,473 3,545 market share in a reduced total market. New Zealand also showed strong profit growth in local currency as margins increased but this was eroded by the weakening EINLADFNNILREVIEW FINANCIAL AND REGIONAL of the currency. Volumes were in line with last year 772 781 despite the growth of Dunhill and Pall Mall and market 2005 2006 share was slightly down. Volume Revenue Operating profit (billions) (£ million) (£ million) In Malaysia, profit increased strongly due to productivity initiatives and higher margins, as well as the absence of 2 Asia-Pacific like-for-like information one-off costs which reduced profit in 2005. Dunhill and Pall Mall grew market share but total volumes declined 1,758 1,839 due to reduced industry volumes as a result of the growth of illicit trade and the impact of significant excise increases 137 142 in the past two years. In Vietnam, volumes increased 531 616 despite the higher prevalence of illicit brands. Pall Mall 2005 2006 grew strongly following its launch in the middle of the Volume Revenue Operating profit year and Craven ‘A’ continued its growth. However, profit (billions) (£ million) (£ million) was lower as a result of increased marketing investment. In South Korea, impressive profit growth was achieved from higher volumes and strong market share gains by Dunhill and Vogue, helped by supply chain cost reductions. Industry volumes increased, reflecting volume distortions last year as a result of the excise increases at the end of 2004. Volumes and market share grew in Taiwan, but profit was adversely impacted by higher marketing investment and down-trading after manufacturers’ price increases.

In Pakistan, market leadership was strengthened with REVIEW REGIONAL excellent performances by Gold Flake and Capstan, resulting in a strong market share increase. Profit was up significantly with strong volume growth and higher margins. In Bangladesh, volumes and market share were higher while profit significantly increased, with improved margins after industry-wide price increases. In Sri Lanka, good profit growth was achieved with higher margins and an improved product mix.

See chart 2 WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 24 British American Tobacco Annual Review 2006 Operating and financial review

REGIONAL REVIEW CONTINUED

Latin America result of an improved product mix and higher margins. Profit in Latin America increased by £81 million to Peter Stuyvesant’s volumes were in line with last year, £611 million due to good performances across the while both Rothmans and Dunhill continued their strong region, coupled with a stronger average exchange rate growth, with Dunhill recording its highest ever sales. in Brazil. Volumes grew in many of the markets which However, reduced volumes for other brands resulted in a led to an overall increase of 2 per cent to 153 billion. lower market share. In Nigeria, volumes and market share EINLADFNNILREVIEW FINANCIAL AND REGIONAL grew with strong performances by Benson & Hedges and In Brazil, volume and market share increased, benefiting Pall Mall. Improved margins and volumes resulted in a from marketing initiatives and continuing anti-illicit higher profit. trade operations by the government. Profit increased substantially as a result of higher volumes, improved In the Middle East, volume and profit continued to grow margins and the appreciation of the local currency. with good results from Iran, Iraq and the Arabian Gulf, partly offset by the Levant. Dunhill was the main driver The strong profit growth in Mexico was driven by for the good performances in the Middle East. Profit in higher margins, efficiency programmes and synergy Egypt benefited significantly from higher volumes and benefits from the contract manufacturing agreement a reduction in costs. with Canada. Volumes were slightly down as the growth in international brands, notably Pall Mall, was more In Turkey, industry price increases led to higher margins, than offset by the decline of local low-price brands. In which, together with lower production costs, ensured Argentina, strong volume growth was achieved through a continued reduction in underlying operating losses. an excellent performance by Viceroy and a reduction in However, the move to direct distribution in this market illicit competition. However, profit was lower due to resulted in one-off costs which, together with lower severe price competition. volumes, adversely impacted profitability.

In Chile, profit grew strongly as volumes and prices See chart 4 increased, the product mix improved and the currency America-Pacific strengthened. GDBs, Kent, Lucky Strike and Pall Mall, The profit from the America-Pacific region decreased led the volume and share increases. In Venezuela, higher by £12 million to £424 million, while volumes were margins and increased volumes, led by Belmont and down 3 per cent to 44 billion. The increases in profit Consul, resulted in an excellent increase in profit and and volumes from Japan were more than offset by market share. The Central America and Caribbean area

EINLREVIEW REGIONAL lower contributions from Canada. showed a significant profit increase as a result of higher volumes and margins, an improved product mix, supply Profit in Canada was down £39 million to £280 million, chain savings and the benefits from productivity initiatives. largely due to lower volumes following the growth of illicit product and a shift to low-priced brands, as well See chart 3 as the costs incurred in the move to direct distribution. Africa and Middle East This was partially offset by the impact of efficiency savings, Profit in the Africa and Middle East region grew by with the move of production to Mexico, and the stronger £34 million to £468 million, mainly driven by South Canadian dollar. The premium segment now represents Africa, Nigeria, the Middle East and Egypt. Volumes were 53 per cent of the total market compared with 57 per cent slightly higher at 103 billion, as a result of Nigeria, Egypt last year. Imperial Tobacco Canada’s total cigarette market and the Middle East, partly offset by decreases in Turkey. share was down 1 share point to 53 per cent. In South Africa, despite the weaker average rand In Japan, volume, market share and profit grew strongly exchange rate, good profit growth was achieved as a despite the decline in the total market. Market share WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Founded in 1903 by Albino Souza Cruz with just 16 employees, Souza Cruz is today the undisputed leader in the Brazilian cigarette market and is among the largest companies in the country. Souza Cruz employs around 6,000 people and sells over 78 billion cigarettes a year. It also provides more than 117,000 tons of tobacco leaf for export to more than 50 countries on five continents. This special feature focuses on how our global strategy of Growth, Productivity, Responsibility and Winning Organisation is working in Souza Cruz, a company contributing significantly to the success of British American Tobacco.

BrazilSpecial feature WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Home to nearly 30 million smokers, Brazil is the sixth largest cigarette market in the world. Brazil produces around 10 per cent of the world’s tobacco and is the largest exporter of tobacco leaf. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Spanning the full production cycle from ‘seed to smoke’, Souza Cruz runs three processing plants, two factories and an internationally acknowledged R&D centre. An outstanding distribution operation results in 80 per cent of volumes being delivered in less than 24 hours.

Processing plant, Santa Cruz do Sul WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Innovation and creativity remained key to the company’s early success.

Heritage that resulted in greater output and further rapid development. In 1903, at the age of just 32, Innovation and creativity remained Portuguese immigrant Albino key to the company’s early success, Souza Cruz and 16 employees with Dalila the first of a series of began to produce cigarettes using an brands based on women’s names. innovative rolling machine based in The welfare of his workers was of a house in the heart of Rio de Janeiro. paramount importance to Albino The machine was the first of its kind Souza Cruz. In 1910, he introduced in Brazil and was able to roll five the coffee break to provide a dedicated cigarettes simultaneously producing rest period for employees and, in Dalila, the first brand from Souza 1951, another trail-blazing initiative Cruz & Cia. As demand for this initial was launched in the form of medical product rapidly grew, it soon became care for staff at the Bonfim factory. Albino Souza Cruz – necessary for production to move to founder of Souza Cruz larger premises and in 1910, Souza Souza Cruz was listed on the Rio de Cruz purchased a snuff plant in the Janeiro and São Paolo Stock Exchanges Rue Conde de Bonfim, with snuff in 1946 and 1957 respectively and manufacture gradually replaced Albino Souza Cruz continued to chair by cigarettes. the company until 1962. Two years later, he passed away in Lisbon, leaving In order to grow his company still behind him a lasting legacy of one of further, Albino Souza Cruz transferred Brazil’s most successful business groups stock control to the British American and top-performing companies within Tobacco Group in 1914, a move British American Tobacco.

Packaging from an early Souza Cruz brand WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Piola restaurant, São Paulo WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Cinema foyer – Reserva Cultural, São Paulo

Hollywood – one of Souza Cruz’s leading brands WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Souza Cruz leads the Brazilian cigarette market.

Growth Global Drive Brands Although the leading cigarette brands Local brand strength in Brazil are local brands produced by 72% Souza Cruz leads the Brazilian Souza Cruz, British American Tobacco’s Souza Cruz has over cigarette market, with six of the Global Drive Brands also have a 70 per cent of the country’s top-selling brands and growing presence in the market. legal cigarette market a share of over 70 per cent of the Kent’s launch in 2002 focused on legal market. Its best-selling brand brand innovation and was based is Derby, which became a market around its activated charcoal filter leader in just three months when it technology – a first in the Brazilian was launched in 1993 and now has cigarette market. In 2005, the 3-Tek a share of around 32 per cent. 32% charcoal filter was introduced, again Derby accounts for one out In total, Souza Cruz sells 16 brands highlighting Kent’s commitment of every three cigarettes sold in Brazil including Capri, Charm, to using new technology to deliver legally in Brazil Hilton, Plaza and Ritz, with more unique flavour. than 30 variants. Leading brands Lucky Strike continues to develop include Hollywood, Souza Cruz’s its market share through blend and oldest brand, which became Brazil’s flavour and packaging innovations. best-selling cigarette during the 1980s. Launched in 1984, Free was the first Souza Cruz brand to disclose full lists of ingredients and smoke constituents, an initiative that was subsequently adopted by all Souza Cruz brands. Carlton is the market leader in the premium segment. It was the first to launch a range of flavoured new variants in 2003. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Agrega’s volume-based purchasing power gives it a keen competitive edge in negotiations with suppliers.

Productivity Agrega’s volume-based purchasing power gives it a keen competitive edge Reducing complexity and costs in negotiations with suppliers and £6m All British American Tobacco Group today, it encompasses over 80 groups Savings on indirect purchases companies aim to reduce supply of materials and services such as IT, in 2006 chain complexity and save costs, fuel and medical services. with Souza Cruz being no exception. Other British American Tobacco In 2006, the company delivered companies have used Agrega’s success savings of £6 million on indirect as a template for establishing their purchases (anything other than own versions. In Argentina, Nobleza leaf, wrapping materials, cigarette £3m Piccardo has worked with Quilmes, making machinery and labour). Savings of over £3 million in the country’s biggest brewer, to set Souza Cruz also achieved savings supply chain management up a joint venture to reduce indirect of over £3 million in its supply costs and the business model has also chain management through been rolled out to Cigarrera Bigott in closer alignment of leaf purchasing, Venezuela. In 2006, Agrega moved procurement negotiation, into Canada and Mexico. manufacturing and waste reduction. Efficient distribution Agrega The comprehensive Souza Cruz Souza Cruz has pioneered an distribution network directly services innovative and collaborative approach more than 200,000 points of sale. At to delivering competitive advantage the heart of the system is the São Paulo through reducing the cost of indirects. facility, the largest and most modern In 2001, the company formed a joint cigarette distribution hub in Latin venture called Agrega, with leading America. With around 1,000 vehicles brewer AmBev, to identify potential and some 2,000 sales and delivery staff, reductions in spending on 44 common Souza Cruz guarantees delivery periods product groups in areas such as office of no more than 24 hours between materials and travel. Using economies ordering and receipt of the product of scale and mainly in-house expertise, almost everywhere in Brazil. Souza Cruz Agrega soon became a benchmark has been acknowledged as a model for procurement practice in Brazil, supplier and an international benchmark attracting major clients including for FMCG logistical operations. Nestlé, Pfizer and Unibanco. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Distribution Centre, São Paulo

Distribution Centre, São Paulo WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Tobacco field, Santa Cruz do Sul

‘Available Here’ campaign at Varanda das Frutas, São Paulo WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Souza Cruz remains committed to reducing its environmental impacts and preserving the biodiversity of native forests.

Responsibility has been recognised by the RainForest Alliance for managing these areas Responsibility takes many forms in line with the stringent standards at Souza Cruz, from youth smoking defined by the Forest Stewardship prevention programmes to extensive Council and for its efforts to preserve environmental commitment and the environment. efforts to tackle illicit trade. Tackling illicit trade Examples include the ‘Available Here’ Illicit trade is a major problem in Social Responsibility Programme, Brazil, negatively affecting many which aims to ensure that retailers sectors of industry. Only recently it comply with national legislation accounted for around a third of the and do not sell tobacco products total cigarette market. Souza Cruz to people under 18 years of age. has been working with the authorities The initiative encourages retailers and other industries faced with similar to think of the wider benefits to their problems to tackle the issue and own communities, rather than profit these combined endeavours are from tobacco sales to the underaged. beginning to achieve results. During In 2006, more than 210,000 retailers 2006, smuggling was down 7 per cent took part in the programme and and counterfeit dropped 45 per cent, activities are set to expand in 2007. bringing the share of the total market attributable to illicit trade below the Environment 30 per cent level. Souza Cruz remains committed to reducing its environmental impacts and preserving the biodiversity of native forests. In southern Brazil, it owns two reforestation areas that together cover over 5,000 hectares and enable the company to be self-sufficient in wood fuel, a source of cleaner renewable energy for its factories and leaf processing plants. The company

210,000 5,000 Retailers in the ‘Available Here’ youth Hectares of forest land enabling Souza smoking prevention programme Cruz to be self-sufficient in wood fuel WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da The programme recognises projects that represent good examples of leadership and adding value to the business.

Winning Organisation plant are regularly updated to respond to the needs of the new recruits and Recruiting and developing talented the campaign has involved raising managers at all levels remains central extensive awareness among employees to the continuing success of Souza Cruz. of the relevance of a socially inclusive The company runs a development working environment. programme involving academic Staff welfare is of key importance centres of excellence in Brazil and at Souza Cruz and the company Andrew Gray – General Manager, Souza Cruz also places staff on secondment was one of the first in Brazil to offer in other British American Tobacco supplementary pension funds before companies, with around 40 managers national private pension legislation working abroad at any one time. came into place. The Albino Souza Initiatives such as the Souza Cruz Cruz Pension Foundation has continued Golden Leaf Acknowledgement to evolve to offer greater security and Programme aim to motivate employees better benefits to its members, making and create a working environment a real contribution to employee that fosters and encourages high satisfaction in the process. performance by teams. The programme Corporate social investment recognises projects that represent Many community-based projects are good examples of leadership run by the Institute of Souza Cruz, set and adding value to the business, up in 2000, with a particular focus replicating a similar awards scheme on education and training for young held for senior management across people in rural areas. Its core activity British American Tobacco. is the Rural Youth Entrepreneurship Souza Cruz is committed to building Programme, which operates in the a diverse workforce. For example, the three southernmost states of Brazil leaf processing plant at Santa Cruz do and trains young people to manage Sul launched a pioneering campaign their own lives and businesses. in 2005 to further the recruitment of people with special needs who apply for seasonal work. All facilities at the

Staff welfare is of key importance at 40 Souza Cruz Managers working outside Brazil, sharing their

knowledge and experience WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Distribution in action in São Paulo

Visitors to the sense garden for the

visually impaired at Cachoeirnha WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Souza Cruz is one of the most successful companies within the British American Tobacco Group and the following awards and achievements reflect some of the passion, talent and commitment of its employees.

2006 awards 2006 achievements • In its tenth year, the corporate category • For the second year in succession, Souza of the Hummingbird (Beija-Flor) Trophy, Cruz was rated the best company in the was awarded to Souza Cruz. The award Foods, Beverages and Tobacco sector was presented by the RioVoluntário by the latest Biggest and Best Yearbook, non-governmental organisation in which offers the most wide-ranging and recognition of the Souza Cruz Volunteers accurate analysis of business in Brazil. Programme, which involved most of the • Souza Cruz was rated the best company company’s members of staff and benefited in the Foods, Beverages and Tobacco more than 5,000 people across Brazil. segment by the Agri-Business Yearbook. • Souza Cruz was awarded the Sustainable • Souza Cruz was voted the Best Company Enterprise Prize by Meio-Ambiente in Brazil’s leaf sector by the editors of Industrial magazine. The criteria for Global Finance magazine. entry included meeting standards such as ISO 14001 (Environment), SA 8000 (Social Responsibility) and OHSAS 18001 (Occupational Health and Safety), as well as carrying out environmental and social reporting audits. • For the fifth year, Souza Cruz won the Prize for Excellence in Customer Services, awarded by Consumidor Moderno magazine. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Annual Review 2006 British American Tobacco 25 Operating and financial review

growth accelerated during the second half of the year 3 Latin America with strong performances from Kent and Kool. Profit like-for-like information rose significantly due to the increased volumes, the 1,791 benefit of the manufacturers’ price increase and the 1,555 absence of one-off costs, which more than offset the 149 153 impact of exchange. 530 611 REVIEW FINANCIAL AND REGIONAL 5 See chart 2005 2006 Unallocated costs Volume Revenue Operating profit (billions) (£ million) (£ million) Unallocated costs, which are net corporate costs not directly attributable to individual regions, were £7 million 4 Africa and Middle East higher at £103 million, mainly as a result of increased like-for-like information pension costs. 1,405 1,489 The above regional profits were achieved before accounting for restructuring costs and losses/gains on disposal of a 103 103 business, brands and joint venture, as explained on page 26. 434 468 2005 Results of associates 2006 Volume Revenue Operating profit The Group’s share of the post-tax results of associates (billions) (£ million) (£ million) increased by £39 million to £431 million. Excluding the exceptional items explained on page 26, the Group’s 5 America-Pacific share of the post-tax results of associates increased by like-for-like information £38 million to £427 million. 1,110 1,098 The contribution from Reynolds American, excluding brand impairment charges and the benefit from the 436 424 favourable resolution of certain tax matters in both 45 44 2005 years, as well as other exceptional charges in 2005, 2006 Volume Revenue Operating profit was £18 million higher at £285 million. This was mainly (billions) (£ million) (£ million) due to improved pricing and cost reductions, partially offset by lower volumes. As explained on page 29, REVIEW REGIONAL Reynolds American acquired Conwood on 31 May 2006. Reynolds American reported that on a US GAAP pro forma basis, as if it had been owned since the beginning of 2005, Conwood increased margins and profits for the year to December 2006. The Group’s associate in India, ITC, continued its strong growth and, excluding the one-off items in 2005, its contribution to Group profit rose by £11 million to £91 million. Associates’ volumes increased by 4 per cent to 241 billion, and with the inclusion of these, total Group volumes were 930 billion (2005: 910 billion). WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 26 British American Tobacco Annual Review 2006 Operating and financial review

FINANCIAL REVIEW

From 1 January 2005, the Group is reporting under In 2006, the Group sold its Muratti Ambassador brand International Financial Reporting Standards (IFRS). The in certain markets, as well as the L&M and Chesterfield move to IFRS has made the reporting of performance trademarks in Hong Kong and Macao, while acquiring the more complex. Benson & Hedges trademark in certain African countries. The transactions resulted in a gain of £60 million. However, the changes in IFRS during 2006 have not

EINLADFNNILREVIEW FINANCIAL AND REGIONAL had a material impact on the Group’s results. The only Profit from operations in 2005 benefited from a change to impact the income statement is an amendment £72 million gain, principally in respect of the disposal to IFRS in respect of foreign exchange. This required a of certain trademarks in Malta, Cyprus and Lithuania. restatement of the 2005 results to increase net finance Below profit from operations, net finance costs at costs by £4 million, with a compensating adjustment £289 million were £61 million higher than last year, reflected directly in changes in total equity. principally reflecting the impact of higher interest Profit from operations like-for-like rates as well as derivatives. The reported Group profit from operations was 8 per cent Interest cover higher at £2,622 million. The table below shows like-for-like The Group assesses its financial capacity by reference to operating profit after excluding exceptional items and the cash flow and interest cover. Interest cover is distorted impact arising from the change in terms of trade in Italy by the pre-tax impact of the exceptional items and net following the sale of Etinera in December 2004. finance cost distortions reflected in the adjusted earnings 2006 2005 £m £m per share as explained below. The chart shows the cover, adjusting for these items, on the basis of profit before As reported (page 42) 2,622 2,420 interest payable over interest payable. The interest cover Restructuring costs (page 42) 216 271 remains strong at 8.1x (2005: 8.8x), with the lower cover Losses/(gains) on impairment of a reflecting higher interest costs. business and disposal of brands and joint venture (page 42) (41) (72) See chart 2 2,7972,619 At 31 December 2006, the ratio of floating to fixed rate Etinera – change in terms of trade (12) financial liabilities was 58:42 (2005: 55:45). Like-for-like 2,797 2,607 As explained on page 25, the Group’s share of the

IACA REVIEW FINANCIAL post-tax results of associates, included at the pre-tax level On this basis, the operating profit for 2006 of £2,797 million under IFRS, increased by £39 million to £431 million, after would represent growth of 7 per cent. The overall impact of exceptional net income of £4 million (2005: £3 million). foreign exchange for the year as a whole was not material. The exceptional items are shown as memorandum See chart 1 information on the Group Income Statement (page 42). Details of the Group’s operating performance excluding Profit before tax was up £180 million at £2,764 million, exceptional items can be found on pages 20 to 25. principally reflecting the higher profit from operations. The Group continued its review of manufacturing Effective tax rate – subsidiaries operations and organisational structure, including the The tax rates in the income statement of 25.9 per cent initiative to reduce overheads and indirect costs. Further in 2006 and 26.7 per cent in 2005 are affected by the restructurings continued in 2006 and on 22 September inclusion of the share of associates’ post-tax profit in agreement was reached on the closure of the plant at the Group’s pre-tax results. Zevenaar in the Netherlands. The plant will close by the The underlying tax rate for subsidiaries, adjusted to end of 2008 with the production being transferred to remove the distortions as reflected in the adjusted Bayreuth in Germany and Augustow in Poland. The total earnings per share below, was 29.6 per cent in 2006 restructuring costs of £216 million for 2006 principally and 31.4 per cent in 2005; the decrease reflects the comprise costs in respect of Zevenaar and further costs for inclusion of a tax credit in Canada in respect of prior the UK and Canadian restructurings announced in 2005. years and changes in the mix of profits. The agreement to sell the Italian cigar business described on See chart 3 page 29 resulted in the recognition of a loss of £19 million, including an impairment charge of £15 million. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Annual Review 2006 British American Tobacco 27 Operating and financial review

Adjusted diluted earnings per share 1 Profit from operations like-for-like Basic earnings per share for 2006 were 92.08p (2005: 84.34p). £ million 2,797 With the distortions that can occur in profit over the 2,607 years, as well as the potential dilutive effect of employee share schemes, earnings per share is best viewed on +7% the basis of adjusted diluted earnings per share. This REVIEW FINANCIAL AND REGIONAL removes the impact of exceptional items which are shown as memorandum information in the Group 2005 2006 Income Statement on page 42. The main items are restructuring costs, loss on impairment of a business 2 Interest cover and gains on disposal of brands and a joint venture. times In addition, the calculation adjusts for certain distortions 8.8x 8.1x in net finance costs arising under IFRS in 2005, as well as reflecting the impact of the potential conversion of shares. 8.1x On this basis, the earnings per share are 98.12p, a 10 per cent increase over 2005, as the higher net

finance costs and minority interests were more than 2005 2006 offset by the improvement in profit from operations, the share of associates’ post-tax results, a lower tax rate 3 Underlying tax rate – subsidiaries and the benefit from the share buy-back programme. percentage 31.4 29.6 See chart 4 Dividends per share declared 29.6% With the recommended final dividend of 40.2p, the total dividends per share declared for 2006 are 55.9p, up 19 per cent on the prior year. Under IFRS, 2005 2006 the recommended final dividend in respect of a year is only provided in the accounts of the following year. 4 Adjusted diluted earnings per share

Therefore, the 2006 accounts reflect the 2005 final dividend pence REVIEW FINANCIAL and the 2006 interim dividend amounting to 48.7p 98.12 (£1,008 million) in total (2005: 43.2p – £910 million). 89.34 The table on page 28 shows the dividends declared in +10% respect of 2006 and 2005. As explained in the Chairman’s Statement, the previous policy was to pay out as dividends at least 50 per cent of 2005 2006 long term sustainable earnings but the Board has decided to raise the ratio to 65 per cent by 2008 in progressive 5 Dividends per share declared steps. Dividends per share declared for 2006 represent pence 57.0 per cent of adjusted fully diluted earnings per share 55.9 (2005: 52.6 per cent). 47.0 +19% See charts4 and 5 Total equity was £189 million lower at £6,688 million. The profit retained after payment of dividends exceeded 2005 2006 the impact of the share buy-back by £388 million. However, this was more than offset by a £580 million adverse impact from exchange movements, reflecting the general strength of sterling. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 28 British American Tobacco Annual Review 2006 Operating and financial review

FINANCIAL REVIEW CONTINUED

Cash flow The other net flows in 2006 principally reflect the purchase 2006 2005 £m £m of minority interests in Chile and shares for the Group’s share-based compensation plans, largely offset by the sale Net cash from operating activities of Toscano in Italy and the sale of brands. The other net before restructuring costs and taxation 3,295 3,229 flows in 2005 mainly arise from the acquisition of further Restructuring costs (220) (143) shares in the Group’s Danish associate and the acquisition EINLADFNNILREVIEW FINANCIAL AND REGIONAL Taxation (713) (762) of Restomat AG in Switzerland, partly offset by the Net cash from operating activities 2,362 2,324 proceeds of the brand sale to Gallaher. Net interest (263) (231) Net capital expenditure (419) (378) The above flows resulted in net cash inflows of £28 million Dividends to minority interests (139) (133) compared to £122 million in 2005. After taking account of transactions related to borrowings, especially the net Free cash flow 1,541 1,582 repayment of borrowings, the above flows resulted in a Dividends paid to shareholders (1,008) (910) net decrease of cash and cash equivalents of £292 million Share buy-back (500) (501) compared to a net decrease of £115 million in 2005, as Other net flows (5) (49) shown in the IFRS cash flow above. Net cash flows 28 122 These cash flows, after an adverse exchange impact IFRS cash flow of £96 million, resulted in cash and cash equivalents, Net cash from operating activities 2,362 2,324 net of overdrafts, decreasing by £388 million in 2006 Net cash from investing activities (315) (292) (2005: £66 million). Net cash from financing activities (2,339) (2,147) Borrowings, excluding overdrafts but taking into account Net cash flows (292) (115) derivatives relating to borrowings, were £6,401 million compared to £7,117 million as at 31 December 2005. The IFRS cash flow includes all transactions affecting cash The decrease in this figure principally reflected the net and cash equivalents, including financing. The alternative repayment of borrowings and the impact of exchange cash flow above is presented to illustrate the cash flows movements. before transactions relating to borrowings. Current available-for-sale investments at 31 December 2006 The Group’s net cash flow from operating activities at were £128 million (31 December 2005: £96 million).

IACA REVIEW FINANCIAL £2,362 million was £38 million higher. The growth in As a result of the above borrowings, net of cash, cash underlying operating performance was offset by the equivalents and current available-for-sale investments, timing of working capital movements. However, a were £4,996 million (31 December 2005: £5,357 million). £49 million fall in tax outflows, reflecting the timing of payments, as well as £66 million higher dividends from Treasury operations associates more than offset the higher restructuring flows. Treasury is tasked with raising finance for the Group, managing the financial risks arising from underlying After higher net capital expenditure and net interest operations and managing the Group's cash resources. flows, with similar levels of dividends to minority interests, All these activities are carried out under defined policies, the free cash flow is £41 million lower than in 2005 at procedures and limits. £1,541 million. This inflow exceeds the total cash outlay on dividends to shareholders and share buy-back by The Board reviews and agrees the overall treasury policies £33 million. and procedures, delegating appropriate authority to the

Dividends declared 2006 2005 Pence Pence per share £m per share £m Ordinary shares Interim 2006 paid 13 September 2006 (see page 45) 15.7 323 14.0 293 Final 2006 payable 3 May 2007 40.2 821 33.0 685 55.9 1,144 47.0 978 WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Annual Review 2006 British American Tobacco 29 Operating and financial review

Finance Director, the Treasury function and the boards of formed joint venture between British American Tobacco the central finance companies. The Finance Director chairs and Honda Motor Co. Ltd, acquired the BAR business. the boards of the major central finance companies. Any On 4 October 2005, the Group announced that it had significant departure from agreed policies is subject to the agreed the sale of its 55 per cent shareholding in BARH prior approval of the Board. to Honda and the sale was completed on 20 December 2005. As a result of these transactions, a gain of £5 million Clear parameters have been established, including levels REVIEW FINANCIAL AND REGIONAL was included in profit from operations. For the period of authority, on the type and use of financial instruments 7 January 2005 to 20 December 2005, BARH was equity to manage the financial risks facing the Group. Such accounted reflecting shared control with Honda. instruments are only used if they relate to an underlying exposure; speculative transactions are expressly forbidden On 21 October 2005, the Group announced the exercise under the Group’s treasury policy. The Group’s treasury of its pre-emption rights over shares in Skandinavisk position is monitored by the Group Treasury Committee, Tobakskompagni AS, its Danish associate company, and which meets seven times a year and is chaired by the the transaction was completed on 12 December 2005. Finance Director. Regular reports are provided to senior This increased the Group’s holding from 26.6 per cent management, and treasury operations are subject to periodic to 32.3 per cent at a cost of £95 million, resulting in independent reviews and audits, both internal and external. goodwill of £69 million. One of the principal responsibilities of Treasury is to On 25 November 2005, the Group acquired Restomat manage the financial risk arising from the Group’s AG, the largest operator of cigarette vending machines in underlying operations. Specifically, Treasury manages, Switzerland, at a cost of £25 million, resulting in goodwill within an overall policy framework, the Group's exposure of £7 million. to funding and liquidity, interest rate, foreign exchange On 10 March 2006, the Group’s Italian subsidiary and counterparty risks. Derivative contracts are only signed an agreement to sell its cigar business, Toscano, entered into to facilitate the management of these risks. to Maccaferri for €95 million. The sale was subject During 2005, the Group issued one further bond maturing to regulatory and governmental approval and was in 2012, which raised €750 million; the proceeds were completed on 19 July 2006. This agreement resulted in used to refinance maturing bond issues. In addition, the recognition of an impairment charge of £15 million. the Group’s central banking facility was renewed for an From August 2006, the Group purchased minority increased amount of £1.75 billion for a term of five years

interests in its subsidiary in Chile for a cost of £91 million, REVIEW FINANCIAL (with two additional one year extension options) and on raising the Group shareholding from 70.4 per cent to significantly improved terms. 96.5 per cent. The goodwill arising on these transactions During 2006, the Group issued three bonds (€525 million was £80 million and the minority interests in Group equity maturing in 2010, €600 million maturing in 2014 and were reduced by £11 million. £325 million maturing in 2016) and the proceeds were On 31 May 2006, the Group’s associate, Reynolds American, used to refinance maturing bond issues. In addition, the completed the acquisition of Conwood, the second largest Group’s central banking facility was extended on existing manufacturer of smokeless tobacco products in the US, terms under the first extension option to a term of five for US$3.5 billion. The acquisition was funded principally years (plus one remaining one year extension). with debt, and the fair value of assets acquired and liabilities The Group continues to target investment-grade credit assumed was US$4.1 billion and US$0.6 billion respectively. ratings; as at 31 December 2006 the ratings from Moody’s Changes in accounting policies and S&P were Baa1/BBB+ (end 2005: Baa1/BBB+). The In December 2005, the International Accounting Standards strength of the ratings has underpinned the debt issuance Board issued an amendment to IAS21 on foreign exchange during 2005 and 2006 and the Group continues to enjoy rates. The amendment to IAS21 allowed inter company full access to the debt capital markets. balances that form part of a reporting entity’s net investment Changes in the Group in a foreign operation to be denominated in a currency The Group ceased to be the controlling company of other than the functional currency of either the ultimate British American Racing (Holdings) Limited (BAR) on parent or the foreign operation itself. This means that 8 December 2004, when BAR went into administration. certain exchange differences previously taken to the The Group consequently ceased to consolidate BAR from income statement are instead reflected directly in changes that date. On 7 January 2005, BARH Ltd. (BARH), a newly in total equity. However, as this amendment was only WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 30 British American Tobacco Annual Review 2006 Operating and financial review

FINANCIAL REVIEW KEY GROUP RISK FACTORS CONTINUED

adopted by the EU in 2006, the interim report to 30 June Introduction 2006 contained the first published results to reflect this A description of the key risk factors that may affect the change. The previously published results have been restated British American Tobacco Group’s business is outlined accordingly, which has resulted in an increase in net finance below. Not all of these factors are within the control of costs of £4 million for the year ended 31 December 2005. British American Tobacco and other factors besides those listed below may affect the performance of its business. EINLADFNNILREVIEW FINANCIAL AND REGIONAL While this amendment was not applicable for Group This section highlights some of these particular risks but reporting until it was endorsed by the EU, as this was it is not intended to be an extensive analysis of all risks expected in 2006 it was allowed for in the adjusted affecting the Group. Some risks may be unknown at earnings per share calculations in the published results present and other risks, currently regarded as immaterial, for the year ended 31 December 2005. could turn out to be material in the future. All of these The International Accounting Standards Board issued IFRIC risks have the potential to have an adverse impact on the Interpretation 4 which is applicable for annual reporting Group’s business; its revenues, profits, assets, liquidity and periods beginning on or after 1 January 2006. This capital resources. These risks should be considered with interpretation is to determine whether an arrangement, reference to the statement on internal control on page 71 which is not in the legal form of a lease, is in substance of the Annual Report and Accounts (the main aspects of a lease and should be accounted for in accordance with which are summarised below) and the cautionary statement IAS17 (Leases). This has resulted in the recognition of regarding forward-looking statements on page 32. certain arrangements as leases. The previously published Risk management in summary balance sheet for 2005 has been restated in respect of The Company maintains a sound system of internal finance leases to increase property, plant and equipment control with a view to safeguarding shareholders’ by £4 million and borrowings by a similar amount but investment and the Company’s assets. It is designed to there was no impact on the Group’s reported profit. manage risks that may impede the achievement of the In 2005, IAS32 and IAS39 on financial instruments were Company’s business objectives rather than to eliminate applied from 1 January 2005. This resulted in a £42 million these risks and can therefore provide only reasonable, not reduction in the Group equity at that date, which is shown absolute, assurance against material misstatement or loss. as the change in accounting policy on page 44. The Group uses audit committees at both regional and Share buy-back programme end market levels to support the Audit Committee (see

IACA EIW/KYGOPRS FACTORS RISK GROUP KEY / REVIEW FINANCIAL The Group initiated an on-market share buy-back page 33) in monitoring risks and control. This framework programme at the end of February 2003. By the close of provides a continuing process for identifying, evaluating business on 1 March 2007, we expect that some 35 million and managing the significant risks faced by the Company shares will have been bought back since 1 January 2006 and its subsidiaries. The Group’s regional audit committees at a cost of £500 million (see page 45). During 2005, (which are all chaired by an Executive Director) focus 45 million shares were bought at a cost of £501 million. on risks and the control environment within each region and are in turn supported by end market or area audit committees. The regional audit committees’ reviews include consideration of the effectiveness of the process for identifying, evaluating and managing the risks of the business and the assessments of internal control and business risks completed by operating companies. In addition, the Corporate Social Responsibility (CSR) Committee (see page 33) is responsible for identifying and assessing, in conjunction with management, the significant social, environmental and reputational risks facing the Group’s business and for evaluating management’s handling of such risks. In this, it is similarly supported by a framework of regional and end market CSR committees. Litigation The Group is involved in a number of legal and regulatory court proceedings in a number of countries. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Annual Review 2006 British American Tobacco 31 Operating and financial review

These proceedings may be characterised as covering Further, taking into account the significant number of smoking and health issues and include claims for personal regulations applying to the Group’s businesses across injury and claims for economic loss arising from the the world, it is possible that there may be allegations of treatment of smoking and health related diseases. Regulatory breaches of regulations. Even when such allegations are proceedings may result in a challenge to new regulations. proven untrue, there is often a reputational impact and In addition, there are legal proceedings and a governmental a financial cost in defending such allegations. EINLADFNNILREVIEW FINANCIAL AND REGIONAL investigation in Canada arising from alleged past smuggling Operations activities with consequent claims for unpaid excise tax. The Group has substantial operations in over 180 countries. A fuller analysis of current legal proceedings to which The Group’s results are influenced by the economic, the Group is subject is set out on pages 130 to 136 of regulatory and political situations in the countries and the Annual Report and Accounts and pages 45 to 47 regions in which it has operations. Some countries in of the Annual Review. which the Group operates face the threat of increasing While it is impossible to be certain of the outcome of civil unrest and can be subject to frequent changes in any particular case or of the amount of any possible regime. In others, terrorism, conflict and the threat of war adverse verdict, the Company believes that the defences may have a significant impact on the business environment. of the Group companies to all these various claims are Some countries maintain trade barriers or adopt policies meritorious both on the law and the facts. Nevertheless, that favour domestic producers, preventing or restricting it is not impossible that the results of operations or cash sales by the Group. There can be no assurance that political, flows of the Group could be materially affected by the social, legal, economic, trade or other developments, as final outcome of any particular litigation. well as theft and fraud, will not have an adverse impact on the Group’s investments and businesses or on the Regulation Group’s consolidated results of operations. The Group’s businesses operate under increasingly stringent regulatory regimes around the world. Further Severe disruption to any aspect of the Group’s supply regulation is expected, particularly as a result of the chain or suppliers’ operations could have an adverse World Health Organisation’s Framework Convention on impact on the Group’s ability to produce and deliver to Tobacco Control (FCTC) and increasingly active tobacco customer demands. In certain markets, the distribution control activities outside the FCTC. It is not possible to of Group products is through channels managed by predict where, when and in what form regulations will third parties, and often licensed by governments. In

be enacted, but regulation of the tobacco industry these instances, loss of distribution, and therefore a FACTORS RISK GROUP KEY generally covers: reduction in sales volumes and revenues, is a possibility. • Product: product design and attributes (e.g. ‘low The raw materials used in the Group’s business are ignition propensity paper’) as well as product disclosures commodities that are subject to price volatility caused by (e.g. ingredients, additives, emissions); factors such as weather conditions, growing conditions, • Packaging: pictorial warnings, rotating warnings, local planting decisions, market fluctuations and changes use of colours and size; in agricultural regulations. Commodity price changes that • Promotion: communications regarding the Group’s are beyond the Group’s control may result in unexpected products at both retail and trade levels; increases in raw materials and packaging costs for the • Purchase: the manner in which cigarettes are sold, such Group’s products. as type of outlet (e.g. supermarkets, vending machines) and how they are sold (e.g. above the counter versus The Group operates in highly competitive businesses and beneath the counter); geographical markets. To maintain a competitive advantage, • Place: regulations as to the places where adults can it must anticipate and respond to new consumer trends and cannot smoke tobacco products; through continuous innovation. The Group also seeks • Price: regulations as to the price the Group can charge to develop and market new products, packaging and for its products (e.g. by excise or minimum prices). technologies, including products with potentially reduced harm. Development of these products is an expensive and These regulations may have an impact on volumes (e.g. as lengthy process, but there are anticipated advantages for a result of restrictions on where cigarettes may be smoked) any manufacturer who introduces these products to the and profits (e.g. as a result of diminution of brand equity market first. Competitors’ speed-to-market in branding leading consumers away from premium brands, through changes, new product launches, or changes in product excise increases and/or through increased cost of complying mix, could have an adverse effect on the Group’s operations. with product design, disclosure or packaging requirements). WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 32 British American Tobacco Annual Review 2006 Operating and financial review

KEY GROUP RISK FACTORS CONTINUED

In tough competitive environments, where the price burden Financial on consumers is high because of taxation or limited The Group’s subsidiary undertakings operate over purchasing power, the Group is vulnerable to competitors 120 active retirement benefit arrangements worldwide. aggressively taking market share through price repositioning, These arrangements have been developed in accordance which generally has the impact of reducing the overall with local practices in the countries concerned. The profit pool of the market and, ultimately, Group profits. majority of employees belong to defined benefit schemes, EINLADFNNILREVIEW FINANCIAL AND REGIONAL most of which are funded externally, although the Group Excise and sales tax operates a number of defined contribution schemes. The Tobacco products are subject to substantial excise and contributions to the Group’s defined benefit schemes and sales taxes in most countries in which the Group operates. their valuations are determined in accordance with the In many of these countries, taxes are generally increasing advice of independent, professionally qualified actuaries. but the rate of increase varies between countries and Changes in asset returns, salary increases, inflation, long between different types of tobacco products. Increased term interest rates and other actuarial assumptions could tobacco taxes, or changes in relative tax rates for different have an adverse impact on the Group. tobacco products, or adjustments to excise structures, may result in a decline in overall sales volume for the Funding and liquidity risks expose the Group to shortages of Group’s products or may alter the Group’s sales mix in cash and cash equivalents needed in the Group’s operations favour of Value-for-Money brands. Increases in tobacco and for refinancing of existing debt. The Group cannot be taxes can also lead to consumers rejecting the Group’s certain that it will at all times have access to the bank and legitimate tax-paid products for products from illicit sources. capital markets and that the failure to achieve such access will not have an adverse effect on the Group’s funding Illicit trade and intellectual property and liquidity position and on its credit ratings. Illicit trade in the form of counterfeit products, smuggled genuine products and locally manufactured product on The Group is exposed to changes in currency rates on which applicable taxes are evaded, represents a significant the translation of the net assets of overseas subsidiaries into and growing threat to the legitimate tobacco industry. the Group’s reporting currency, sterling. The Group is also Increasing excise rates are encouraging more consumers exposed to currency changes from the translation of profits to switch to illegal cheaper tobacco products and providing earned in overseas subsidiaries; these exposures are not greater rewards for smugglers. Illicit trade can have an normally hedged. Exposures also arise from the foreign adverse effect on Group volumes, restrict the ability to currency denominated trading transactions undertaken

E RU IKFACTORS RISK GROUP KEY increase selling prices and damage brand equity. by subsidiaries and dividend flows. The Group maintains both floating and fixed rate debt. Where appropriate, the The brand names under which the Group’s products Group also uses derivatives, primarily interest rate swaps, are sold are key assets. Investments over a period of time to vary the fixed to floating mix. Changes in currency have led to many of the Group’s brands having significant values and interest rates could have an adverse impact brand equity and global appeal to consumers, essential on the financial condition or operations of the Group. for delivering sustainable profit growth into the future. The protection and maintenance of the reputation of Cash deposits and other financial instruments give rise these brands is important to the success of the Group. to credit risk on the amounts due from counterparties. In a number of countries around the world, the risk of The failure of any counterparty to meet its obligations to intellectual property rights’ infringement remains high the Group could have an adverse effect on the financial as a result of limitations in judicial protection and/or condition or operations of the Group. inadequate enforceability. Any substantial erosion in Further details on the Group’s financial management the value of the brands could have an adverse effect and treasury operations are on page 28. on the Group. Information Technology The Group is increasingly reliant on information Cautionary Statement: the Operating and Financial Review and certain technology systems for its internal communications, other sections of this document contain forward looking statements controls, reporting and relations with customers and which are subject to risk factors associated with, among other things, suppliers. A significant disruption due to computer the economic and business circumstances occurring from time to time in the countries and markets in which the Group operates. It is believed viruses, malicious intrusions, the setting up of shared that the expectations reflected in these statements are reasonable but services centres or the installation of new systems could they may be affected by a wide range of variables which could cause affect the Group’s communications and operations. actual results to differ materially from those currently anticipated. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Annual Review 2006 British American Tobacco 33 Summary Corporate Governance and Summary Financial Statement

SUMMARY CORPORATE GOVERNANCE

Corporate governance Company’s business objectives rather than to eliminate British American Tobacco is committed to maintaining these risks. The internal control system can therefore high standards of corporate governance. Our corporate only provide reasonable, not absolute, assurance against governance framework is directed towards achieving material misstatement or loss. our business objectives in a manner which is responsible

The Audit Committee is chaired by Robert Lerwill. Its GOVERNANCE CORPORATE SUMMARY and in accordance with high standards of honesty, role is to monitor the integrity of the financial statements transparency and accountability. These principles are of the Company, review and, where appropriate, make reflected in our Standards of Business Conduct, which representations to the Board on business risks, internal have been in place for many years and are kept under control and compliance. continual review in order to ensure that they remain at the forefront of best business practice. Every Group The Corporate Social Responsibility Committee is chaired company and every employee worldwide is expected by Kenneth Clarke and its role is to help identify and assess, to live up to them. In addition, the principles set out with management, those significant social, environmental within our Statement of Business Principles are designed and reputational risks that might impair the Company’s to help meet the expectations placed on us by our various strategic objective to be recognised as a responsible stakeholders. Both documents are available from the company in a controversial industry. The Committee Company Secretary and through our bat.com website. also evaluates the adequacy of the Company’s policies in this area and makes recommendations for change. The principal governance rules applying to UK companies listed on the London Stock Exchange are contained in the The Nominations Committee is chaired by Jan du Plessis. Combined Code on Corporate Governance adopted by the Its role is to make recommendations to the Board on Financial Reporting Council in July 2003 (the Code). The suitable candidates for appointment to the Board and Company has either complied with the Provisions of the Management Board, ensuring that both boards have an Code throughout the year or else a full explanation (in the appropriate balance of expertise and ability. In addition, case of the continuing appointment of Rupert Pennant-Rea) it is responsible for reviewing the succession plans for the has been provided in the Corporate Governance Statement Executive Directors and members of the Management Board. at pages 67 to 72 of the Annual Report and Accounts The Remuneration Committee is chaired by Kenneth where it has not. The Board therefore considers that the Clarke and the summary remuneration report below Company has satisfied its obligations under the Code. sets out its role, responsibilities and policies during 2006.

The Board and its Committees GOVERNANCE CORPORATE SUMMARY The Board is responsible to the Company’s shareholders for the success of the Group and for its overall strategic direction, its values and its governance. Among the key matters on which the Board alone may make decisions are the Group’s business strategy, its annual budget, dividends and major corporate activities. It is also responsible for reviewing the Company’s internal control and governance system and for approving our Standards of Business Conduct. It held seven scheduled meetings in 2006. Responsibility for implementing the Group’s strategy and for creating the conditions for the Group’s successful day-to-day operation is delegated to the Management Board, which met nine times in 2006. The Board is also responsible for the overall system of internal control for the Company and its subsidiaries and for reviewing the effectiveness of the system. It carries out such a review at least annually, covering all material controls including financial, operational and compliance controls and risk management systems, and reports to shareholders that it has done so. The system is designed to manage risk that may impede the achievement of the WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 34 British American Tobacco Annual Review 2006 Summary Corporate Governance and Summary Financial Statement

BOARD OF DIRECTORS UMR OPRT GOVERNANCE CORPORATE SUMMARY

Jan du Plessis (British/South African) The Rt. Hon. Kenneth Clarke QC MP Paul Adams (British) Paul Rayner (Australian) Chairman ▲ (British) Chief Executive Finance Director Appointed Chairman in July 2004, Deputy Chairman and Senior Appointed a Director in March 2001 Joined Rothmans Holdings Limited having been a Non-Executive Director Independent Non-Executive Director and Chief Executive in January 2004. in Australia in 1991. He held senior since his appointment to the Board in ▲■● ◆ He joined British American Tobacco executive positions with Rothmans 1999. He was previously Group Finance Appointed a Director in 1998. in July 1991 and held senior before becoming Chief Operating Director of Richemont. He is Chairman He is Chairman of the Remuneration appointments as Regional Director, Officer of British American Tobacco of the Nominations Committee. and Corporate Social Responsibility Asia-Pacific and Regional Director, Australasia Limited in September 1999. He is Chairman of RHM plc and a Committees. He is Non-Executive Europe prior to becoming Deputy He became Finance Director in January Non-Executive Director of Lloyds TSB Director of Foreign & Colonial Managing Director in June 2001 and 2002. He has been a Non-Executive Group plc. (53) Investment Trust PLC and Independent Managing Director in January 2002. (53) Director of Centrica plc since News & Media (UK) Limited. (66) September 2004. (52)

Antonio Monteiro de Castro (Brazilian) Piet Beyers (South African) Robert Lerwill (British) Dr Ana Maria Llopis (Spanish) Chief Operating Officer and Director, Non-Executive Director▲ ◆ Non-Executive Director ▲■● ◆ Non-Executive Director ▲■● ◆ America-Pacific Appointed a Director in June 2004. He Appointed a Director in 2005, he is Appointed a Director in 2003. She Appointed a Director in March is an Executive Director of Richemont Chairman of the Audit Committee. is Executive Deputy Chairman of the 2002 and Chief Operating Officer and a Non-Executive Director of Distell He has been Chief Executive of Aegis J F Llopis Foundation and a member in January 2004. He is President of Group Limited and Remgro Limited Group plc since 2005 and was formerly of the Good Governance Working the administrative council of Souza where he was previously Marketing a Director of Cable & Wireless plc and Group for Spanish listed companies. CruzSAandamemberoftheboard Strategy Director. (57) WPP Group PLC. He is Non-Executive Previously she was Executive Vice-

OR FDIRECTORS OF BOARD of the Getulio Vargas Foundation. Director of Synergy Healthcare plc President at Indra and Chief Executive He has been a Director of Reynolds and a Director of The Anthony Nolan of Openbank, the Santander Group American Inc. since July 2004. (61) Trust. (55) online bank. (56)

Rupert Pennant-Rea (British) Anthony Ruys (Dutch) Sir Nicholas Scheele (British/US) Thys Visser (South African) Non-Executive Director ▲■● ◆ Non-Executive Director ▲■● ◆ Non-Executive Director ▲■● ◆ Non-Executive Director ▲ ◆ Appointed Non-Executive Director of A Director from March 2006. He joined Appointed a Director in 2005. A Director since 2001. He is CEO of B.A.T Industries p.l.c. in 1995, Heineken N.V. in 1993 becoming Formerly President and Chief Operating Remgro Limited, having held senior becoming a Director of British Chairman in 2002. He is a member of Officer of Ford Motor Company. He is management positions with Rembrandt American Tobacco in 1998. He will the Supervisory Boards of ABN AMRO Chancellor of the University of Warwick. Group since 1980. He is Chairman of retire at the conclusion of this year’s Bank and Sara Lee International B.V. He is Chairman of The Cambridge-MIT Rainbow Chicken Ltd and is a Non- Annual General Meeting. Formerly and a director of Lottomatica S.p.A. Institute and Director of Pegasus Executive Director of Medi-Clinic Editor of The Economist and Deputy (Italy). He was appointed an Officer Holdings Group (USA), Grupo Proeza Corporation Limited, Nampak Limited Governor of the Bank of England. He is in the Order of Orange-Nassau in (Mexico) and Caparo plc. (63) and Distell Group Limited. (52) Chairman of Henderson Group plc and 2005. (59) Electra Kingsway VCT plc. (59) WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Annual Review 2006 British American Tobacco 35 Summary Corporate Governance and Summary Financial Statement

MANAGEMENT BOARD UMR OPRT GOVERNANCE CORPORATE SUMMARY

Flavio de Andrade (Brazilian) John Daly (Irish) Nicandro Durante (Italian) Rudi Kindts (Belgian) Director, Latin America and Caribbean Director, Asia-Pacific Director, Africa and Middle East Director, Human Resources Joined the Management Board as Joined the Management Board as Appointed Regional Director for Africa Joined British American Tobacco in Regional Director for Latin America and Regional Director for Asia-Pacific in and Middle East and appointed to the 1988. He has held a number of senior Caribbean in January 2004, following a October 2004. He held a number of Management Board in March 2006. human resources roles across the long career in Brazil with Souza Cruz senior management roles for Rothmans He previously held senior financial and Group (including Europe, Africa, the SA, assuming a variety of senior International in Europe and the Far East general management roles in Brazil Middle East and Central and South management roles (including President before becoming Area Director for (including President of Souza Cruz) and Asia). He has been Director, Human of Souza Cruz) before being appointed the Middle East and North Africa in also in the UK and Hong Kong. (50) Resources since July 2004. (49) to his current position. (58) 2001. (50)

Michael Prideaux (British) Jimmi Rembiszewski (German) Ben Stevens (British) Peter Taylor (British) Director, Corporate and Director, Marketing Director, Europe Director, Operations and IT Regulatory Affairs Joined the Group as a Marketing Appointed Director, Europe in January Joined British American Tobacco in Appointed Director, Corporate and Director and as a Territorial Director in 2004 having previously joined the 1980 and worked in a variety of Regulatory Affairs in 1998 following the 1991, having had various senior Management Board in 2001 as operational and general management demerger of B.A.T Industries. He had marketing and business appointments Development Director. Since joining roles across the Group. He was previously joined B.A.T Industries in in Procter & Gamble and Jacobs British American Tobacco in 1989, he appointed Global Operations Director 1989 from Charles Barker, a leading Suchard. He has been a member of the has covered a number of senior in 2003. (54)

financial and corporate public relations, Management Board since 1996. (56) marketing, finance and management BOARD MANAGEMENT advertising and design agency, where roles particularly in Europe, South Asia he was Chief Executive. (56) and Russia. (47)

The role of the Management Board The Management Board, chaired by the Chief Executive, comprises the Executive Directors of British American Tobacco p.l.c. together with the executives shown on this page. The Management Board has delegated responsibility for overseeing the implementation by the Group’s operating subsidiaries of the policies and Neil Withington (British) Director, Legal and General Counsel strategy set by the Board of Directors, and for creating Appointed Director, Legal and Security the conditions for their successful day-to-day operation. and General Counsel of British American Tobacco in 2000, having previously been the Group’s Deputy General Counsel. He joined the Group Board Committees in 1993 after a career at the Bar and Committee membership is indicated by the following symbols: in the chemical and pharmaceutical ▲ Nominations Committee industries. He has been a Director ■ Audit Committee of Reynolds American Inc. since July ● Remuneration Committee 2004. (50) ◆ Corporate Social Responsibility Committee WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 36 British American Tobacco Annual Review 2006 Summary Corporate Governance and Summary Financial Statement

SUMMARY REMUNERATION REPORT

This report is extracted from the full Remuneration Remuneration – key components Report set out in the Directors’ Report and Accounts Table 1 Executive Directors’ remuneration policy summary 2006 (a copy of which is available on request and can Table 2 Directors’ remuneration be found on our website, bat.com). Table 3 Summary of share interests including long term incentives

UMR OPRT GOVERNANCE CORPORATE SUMMARY The role of the Remuneration Committee and Executive remuneration policy Review of incentive arrangements and proposed The Remuneration Committee determines the new Long Term Incentive Plan framework and policy on the terms of engagement The Company’s current LTIP (the Current LTIP) will (including remuneration) for the Chairman, the Executive expire in April 2008. The Remuneration Committee Directors and the members of the Management Board. undertook a comprehensive review of the current The Remuneration Committee also decides their specific incentive arrangements for the senior executive remuneration, including awards under the share incentive team with a view to advising the Board on possible schemes and pension schemes. replacement incentive arrangements to support the executive remuneration policy and its embedded The overriding objective of the British American Tobacco link with the Group strategy (the Review). remuneration policy is to reward the achievement of corporate and individual goals by linking success in As a result of the Review, shareholder approval is those areas to the Group strategy: a balanced approach being sought for a new Long Term Incentive Plan to achieving growth, improving productivity, managing (the New LTIP). Details of the New LTIP will be set the business in a responsible manner and developing a out in the notice for the 2007 Annual General Meeting winning organisation. The delivery of strategy is measured and its accompanying letter from the Chairman of the by the Key Performance Indicators (KPIs) and Business Remuneration Committee. Measures set out and described on pages 6 to 9 of this The proposed new plan, in which all Executive Directors Annual Review. The continued focus by the Executive and members of the Management Board would Directors of British American Tobacco and the members participate, is, in many respects, very similar to the of its Management Board in driving all four elements of existing arrangements and the key points and differences the strategy will continue to build a sustainable business. (including proposed award levels) are noted in Table 1 on This methodology is supported by a competitively page 38. Awards under the New LTIP would deliver shares positioned and integrated pay and benefits structure subject to stretching performance conditions over three

UMR EUEAINREPORT REMUNERATION SUMMARY which reflects the nature of the Group’s worldwide years. These performance conditions for the awards would operations and the need to attract, motivate and retain continue to be based on Total Shareholder Return (TSR) high-quality executives. and earnings per share (EPS) measures. Participants would In order to strengthen the alignment of executive continue to receive the LTIP Dividend Equivalent. In order remuneration to the generation of shareholder value, to provide flexibility and sufficient capacity for future a balance is maintained between the short and the long awards over the life of the Plan, the individual limit would term elements of the structure. The application of this be increased to 300 per cent of salary. The Remuneration policy will continue during 2007, with performance based Committee does not anticipate that awards will be made variable rewards (cash and share-based performance up to this limit in normal circumstances and there is no related annual bonus plans; and a Long Term Incentive current intention to utilise this limit by making awards Plan – the LTIP) comprising about 56 per cent of total in excess of the proposed levels referred to in Table 1 remuneration with the balance of core fixed elements on page 38. The Remuneration Committee will advise covering base salary, pension and other benefits. shareholders in advance of any change in the current proposed award levels, and any such change will be disclosed in the Remuneration Report. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Annual Review 2006 British American Tobacco 37 Summary Corporate Governance and Summary Financial Statement

Long Term Incentive Plan: vesting of 2004 award Historical TSR performance As reported last year, 77.1 per cent of the 2003 LTIP award growth in the value of a hypothetical £100 holding over five years vested on 19 March 2006. The sixth LTIP award was made 350 in 2004, with the performance period being completed 300 British American Tobacco at 31 December 2006. The Remuneration Committee FTSE 100 has assessed the performance of British American Tobacco 250 GOVERNANCE CORPORATE SUMMARY against the two performance conditions outlined in Table 1 200 and has determined that 100 per cent of the award will 150 vest. On the TSR measure, the Company ranked tenth 100 out of the FTSE 100 group of companies, giving a vesting 50 of 25 per cent for performance at the upper quartile. Dec Dec Dec Dec Dec Dec A vesting of 25 per cent was achieved for ranking second 2001 2002 2003 2004 2005 2006 out of the peer group of international FMCG companies, FTSE 100 comparison based on 30 trading day average values. this being upper quartile. Earnings per share growth was Total shareholder return (annual %) 8.98 per cent per annum in excess of inflation, resulting (1 January 2004 – 31 December 2006) FMCG group in a vesting of 50 per cent. Upper Quartile Median – 15.3% BAT – 32.2% 35 Lower Quartile The members of the FMCG group for the 2004 award 30 vesting in March 2007 were: 25 Altadis Imperial Tobacco Group 20 Altria Group InBev 15 Anheuser-Busch Johnson & Johnson 10

Cadbury Schweppes Kellogg 5 Campbell Soup Kimberly-Clark 0 Carlsberg LVMH Moët Hennessy Coca-Cola Nestlé –5 Colgate-Palmolive Pepsico The FMCG comparison is based on three months’ average values. Danone Procter & Gamble Total shareholder return (annual %) Diageo Reckitt Benckiser (1 January 2004 – 31 December 2006) FTSE 100

Gallaher Group SABMiller REPORT REMUNERATION SUMMARY Upper Quartile Median – 19.9% BAT – 32.2% 70 Heineken Sara Lee Lower Quartile HJ Heinz Scottish & Newcastle 60 The Hershey Company Unilever 50 40 Performance graph Schedule 7A to the Companies Act requires that the 30 Company must provide a graph comparing the TSR 20 performance of a hypothetical holding of shares in the 10

Company with a broad equity market index over a five 0 year period – the performance graph. This illustrates the –10 performance of TSR against the FTSE 100 Index over a five year period commencing on 1 January 2002. In the The FTSE 100 comparison is based on three months’ average values. opinion of the Directors, the FTSE 100 Index is the most appropriate index against which TSR should be measured because it is a widely used and understood index of broadly similar-sized UK companies to the Company. In addition to the performance graph, illustrative graphs show the relative position on the TSR measures for the LTIP award vesting in March 2007. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 38 British American Tobacco Annual Review 2006 Summary Corporate Governance and Summary Financial Statement

SUMMARY REMUNERATION REPORT CONTINUED

Table 1. Executive Directors’ remuneration policy summary

Remuneration constituents Rationale Delivery Policy summary

UMR OPRT GOVERNANCE CORPORATE SUMMARY Base salary – competitively reward –cash – annual review with changes effective from April corporate and individual – monthly – benchmarked against a mid-market level of main board performance directors from a UK comparator group with a mainly – reflect skills and experience international consumer goods focus chosen from the FTSE 100 Index – additional reference to published salary data with reference to companies in the UK comparator group

Benefits in kind – car or car allowance – UK management level benefit – private medical and personal – Executive Directors receive the benefit of the use of a accident insurance driver

Performance related – incentivise the attainment – International Executive – five common measures: underlying operating profit, bonus of corporate targets on Incentive Scheme (IEIS) market share of key players, Global Drive Brand an annual basis – 50 per cent cash volume, net revenue and cash flow – 50 per cent shares (Deferred – for an ‘on target’ performance, the cash and Share Bonus Scheme - DSBS) shares elements of the IEIS together carry a value – DSBS shares held in trust for of 100 per cent of the base salary with an overall three years and participants maximum of 150 per cent receive cash sum equivalent to the dividend on the after tax position of all unvested shares held in the DSBS at the dividend record date

Long term incentives – alignment of executive – shares – maximum awards under the New LTIP will be increased (Long Term Incentive remuneration with the – discretionary annual award from 175 per cent of salary to 250 per cent for the Chief Plan or LTIP); new Long generation of shareholder – LTIP dividend equivalent as Executive, and from 125 per cent to 200 per cent of salary Term Incentive Plan or value cash at time of vesting for the Finance Director and Chief Operating Officer New LTIP proposed for – incentivise growth in – the proportion of shares – cash LTIP dividend equivalent to the dividends that shareholder approval at earnings per share and Total awarded under an LTIP grant participants would have received as shareholders from

UMR EUEAINREPORT REMUNERATION SUMMARY Annual General Meeting Shareholder Return (TSR) which later lapse upon the the date of the LTIP award to the award’s vesting date on 26 April 2007 over a three year period vesting of an award do not – the value of the LTIP dividend equivalent is taken into attract the LTIP dividend account when considering awards equivalent – three year performance period – TSR performance (50 per cent of the total award) combines both the share price and dividend performance during the three year performance period as against two comparator groups: (1) the constituents of the FTSE 100 Index; and (2) a peer group of FMCG companies (25 per cent for each measure) – earnings per share measure (50 per cent of the total award) relates to earnings per share growth (on an adjusted diluted basis) relative to inflation

Pension – provision of competitive – British American Tobacco UK – pension accrues at 1/40 of annual basic salary post-retirement benefits Pension Fund; defined – UK Pension Fund normal retirement age of 60 benefit plan – maximum pension payable will not exceed 2/3 of – benefit paid as on-going base salary averaged over the preceding 12 months pension – Paul Adams and Paul Rayner are both members of the UK Pension Fund – UK Pension Fund retains a scheme-specific cap following the introduction of the new UK pension regime in April 2006 – excess benefits continue to be accrued within an unfunded unapproved retirement benefits scheme (UURBS) – benefits for Antonio Monteiro de Castro are all accrued in the UURBS, offset by his entitlements under the defined benefit plan of Souza Cruz of Brazil WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Annual Review 2006 British American Tobacco 39 Summary Corporate Governance and Summary Financial Statement

Executive Directors’ service contracts Non-Executive Directors’ terms of appointment and The Remuneration Committee continues to operate a remuneration policy policy of one year rolling contracts for Executive Directors; The Non-Executive Directors do not have service contracts these contracts incorporate a provision for a termination with the Company but instead have letters of appointment. or compensation payment in lieu of notice. This will The terms of appointment provide that a new Director is comprise: (1) 12 months’ salary at his then current base appointed for a specified term, being an initial period to GOVERNANCE CORPORATE SUMMARY pay; and (2) a cash payment in respect of other benefits the next Annual General Meeting after appointment and, under the contract such as medical insurance, or the subject to reappointment at that meeting, for a further Company may at its option continue those benefits period ending at the Annual General Meeting held three for a 12 month period. In addition, the Committee also years thereafter. Subsequent reappointment is subject to maintains discretion in respect of this policy for those endorsement by the Board and the approval of shareholders. Executive Directors who may be recruited externally Fees for Non-Executive Directors are determined by the or from overseas, when it may be appropriate to offer Board with reference to the time commitment and a contract with an initial period of longer than one year, responsibilities associated with the roles. Under the terms reducing to a one year rolling contract after the expiry of their letters of appointment, on termination (at any time), of the initial period. a Non-Executive Director is entitled to any accrued but unpaid Director’s fees but not to any other compensation.

Table 2. Directors’ remuneration Performance- Performance- related pay: related pay: annual cash deferred share Benefits 2006 2005 Salary/fees bonus2 bonus2, 3 in kind4 Total Total ££££££ J P du Plessis 520,000 – – 68,524 588,524 533,743 K H Clarke 150,000 – – 593 150,593 154,237 PNAdams 984,896 710,000 745,425 132,397 2,572,718 2,118,457 P A Rayner5 608,646 436,650 460,512 232,642 1,738,450 1,443,800 A Monteiro de Castro6 835,956 482,800 504,779 213,176 2,036,711 1,803,123

P E Beyers 60,000 – – 9,735 69,735 60,000 REPORT REMUNERATION SUMMARY R E Lerwill 75,000 – – 403 75,403 79,664 A M Llopis 60,000 – – – 60,000 60,000 R L Pennant-Rea 60,000 – – – 60,000 68,750 A Ruys1 50,000 – – 831 50,831 – Sir Nicholas Scheele 60,000 – – 8,739 68,739 50,860 M H Visser 60,000 – – 6,584 66,584 82,588 Former Director K S Wong (deceased)1 –––––10,000 Total remuneration 3,524,498 1,629,450 1,710,716 673,624 7,538,288 6,465,222 Notes: 1 K S Wong died on 16 February 2005; Anthony Ruys was appointed a Director on 1 March 2006. 2 The Remuneration Committee, following its usual procedures, agreed that the performance targets for the year ended 31 December 2006 have been met (subject to confirmation of a figure yet to be published). The Committee agreed that the performance-related bonus payments shown above could, as a consequence, increase or decrease by approximately 1.5 per cent following the publication of the outstanding information which would enable the relevant calculations to be finalised after 1 March 2007. Such changes, if any, will be reported in the Remuneration Report for the year ending 31 December 2007. 3 The deferred share bonus payments include cash sums equivalent to the dividend on the after tax position on all unvested ordinary shares comprised in theawardsheldby participants (including Executive Directors) in the Deferred Share Bonus Scheme at each dividend record date. For the year ended 31 December 2006, these payments for Executive Directors were as follows: Paul Adams £35,425 (2005: £29,374); Paul Rayner £23,862 (2005: £19,750); and Antonio Monteiro de Castro £21,979 (2005: £18,376). 4 Benefits in kind include: (a) a car or a car allowance; (b) use of a driver; (c) spouse travel and associated expenses for business-related purposes. For Non-Executive Directors these benefits relate to spouse travel only. 5 Paul Rayner’s benefits in kind included payments in respect of family education (£56,344) which followed his relocation to the UK from Australia. 6 Antonio Monteiro de Castro’s benefits in kind included tax advice of £65,424 in respect of his former contractual arrangements up to 1 January 2004 prior to which date he derived his emoluments in both the UK and Brazil. 7 The Directors’ remuneration shown above does not include the illustrative value (as at 23 February 2007) of the Executive Directors’ Long Term Incentive Plan awards made in March 2004 which will vest on 17 March 2007. Reference should be made to Table 3 on page 40 note 5. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 40 British American Tobacco Annual Review 2006 Summary Corporate Governance and Summary Financial Statement

SUMMARY REMUNERATION REPORT CONTINUED

Chairman’s terms of appointment and remuneration relevant notice period as the Board does not require the Jan du Plessis’s terms of appointment provide that he will Chairman to perform his duties. The Chairman is subject hold the office of Chairman with effect from 1 July 2004 to the reappointment of Directors’ provisions contained in for a period of three years unless terminated earlier by: the Company’s articles of association; he will therefore not (1) the Company giving three months’ notice or a ordinarily serve as a Director for more than two years UMR OPRT GOVERNANCE CORPORATE SUMMARY discretionary compensation payment in lieu of notice; before seeking reappointment. In common with the or (2) by the Chairman giving one month’s written Non-Executive Directors, he does not participate in the notice with the Company having discretion to make a Company’s share schemes, bonus schemes or incentive compensation payment in lieu of such notice. This is plans and is not a member of any Group pension plan. limited to any fees which are payable for such part of the

Table 3. Summary of share interests including long term incentives

Ordinary shares Options and Options and Share options at 1 Jan 2006 Ordinary shares Ordinary shares awards over awards over exercisable from/to or date of Ordinary shares (Deferred Scheme) (Deferred Scheme) ordinary shares ordinary shares LTIP awards initial appointment at 31 Dec 2006 at 1 Jan 2006 at 31 Dec 2006 at 1 Jan 2006 at 31 Dec 2006 vesting date P N Adams 143,051 143,394 125,517 118,611 – – – Sharesave Scheme – – – – 2,492 2,492 Jan 10-Jun 10 LTIP – – – – 341,383 362,067 Mar 07-Mar 09 P A Rayner 83,228 83,558 83,155 82,821 – – – Share Option and Sharesave Schemes – – – – 6,777 6,266 Sep 02-Jun 12 LTIP – – – – 200,511 177,490 Mar 07-Mar 09 A Monteiro de Castro 179,564 179,844 76,784 75,889 – – – Sharesave Scheme – – – – 957 957 Jan 09-Jun 09 LTIP – – – – 229,480 266,273 Mar 06-Mar 09 J P du Plessis 50,000 50,000 – – – – – KHClarke 4,459 4,611 – – – – – UMR EUEAINREPORT REMUNERATION SUMMARY P E Beyers –– – ––– – R E Lerwill 3,000 3,000 – – – – – A M Llopis 2,200 2,200 – – – – – R L Pennant-Rea 3,295 3,407 – – – – – A Ruys1 – 3,000 – – – – – Sir Nicholas Scheele –– – ––– – MHVisser –– – ––– – Notes: 1 Anthony Ruys was appointed a Director on 1 March 2006. 2 No Director had a non-beneficial interest in the shares of the Company at the dates stated above. 3 Share options granted under the Share Option Scheme are not normally granted in any year to Executive Directors who receive an award under the LTIP; no options were granted in the year ended 31 December 2006. The aggregate gains on share options exercised by Executive Directors during the year ended 31 December 2006 were £17,562 (2005: £423,516). Options granted under the Share Option Scheme are exercisable subject to a performance condition based on earnings per share growth; the Company’s published adjusted earnings per share growth has to exceed inflation by an average of 3 per cent per annum over any consecutive three year period during the 10 year life of the options. 4 The value of LTIP awards which vested to Executive Directors during the year ended 31 December 2006 was £2,783,533 (2005: £1,300,628). 5 The March 2004 LTIP award will vest on 17 March 2007 at 100 per cent in the manner described on page 37. For illustrative purposes only, the aggregate value of the vesting awards for the Executive Directors was £3,820,370 based on a share price on 23 February 2007 (being the latest practicable date prior to publication) of 1,584p per ordinary share. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Annual Review 2006 British American Tobacco 41 Summary Corporate Governance and Summary Financial Statement

INDEPENDENT AUDITORS’ STATEMENT TO THE MEMBERS OF BRITISH AMERICAN TOBACCO P.L.C.

We have examined the Summary Financial Statement on pages 42 to 47, including the Summary Remuneration Report (pages 36 to 40) of British American Tobacco p.l.c. for the year ended 31 December 2006. Respective responsibilities of Directors and auditors

The Directors are responsible for preparing the Summary STATEMENT FINANCIAL SUMMARY Corporate Governance and Summary Financial Statement in accordance with United Kingdom law. Our responsibility is to report to you our opinion on the consistency of the Summary Financial Statement (including the Summary Remuneration Report) within the Summary Corporate Governance and Summary Financial Statement with the full annual financial statements, the Directors’ Report and the Remuneration Report and its compliance with the relevant requirements of Section 251 of the Companies Act 1985 and the regulations made thereunder. We also read the other information contained in the Annual Review and consider the implications for our report if we become aware of any apparent misstatements or material inconsistencies with the Summary Financial Statement. This statement, including the opinion, has been prepared for and only for the Company’s members as a body in accordance with Section 251 of the Companies Act 1985 and for no other purpose. We do not, in giving this opinion, accept or assume responsibility for any other purpose or to any other person to whom this statement is shown or into whose hands it may come save where expressly agreed by our prior consent in writing.

Basis of opinion STATEMENT AUDITORS’ INDEPENDENT We conducted our work in accordance with Bulletin 1999/6, ‘The Auditors’ Statement on The Summary Financial Statement’ issued by the Auditing Practices Board. Our reports on the Company’s full annual financial statements describe the basis for our audit opinions on those financial statements and the Directors’ Report and the Remuneration Report. Opinion In our opinion the Summary Financial Statement is consistent with the full annual financial statements, the Directors’ Report and the Remuneration Report of British American Tobacco p.l.c. for the year ended 31 December 2006 and complies with the applicable requirements of Section 251 of the Companies Act 1985, and the regulations made thereunder. PricewaterhouseCoopers LLP Chartered Accountants and Registered Auditors 1 Embankment Place, London 1 March 2007 WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 42 British American Tobacco Annual Review 2006 Summary Corporate Governance and Summary Financial Statement

GROUP INCOME STATEMENT FOR THE YEAR ENDED 31 DECEMBER

2006 2005 Restated £m £m Gross turnover (including duty, excise and other taxes of £15,427m (2005: £14,659m)) 25,189 23,984

Revenue 9,762 9,325 Raw materials and consumables used (2,861) (2,760) UMR IACA STATEMENT FINANCIAL SUMMARY Changes in inventories of finished goods and work in progress (11) (2) Employee benefit costs (1,554) (1,557) Depreciation and amortisation costs (401) (383) Other operating income 181 179 Other operating expenses (2,494) (2,382) Profit from operations 2,622 2,420 after (charging)/crediting – restructuring costs (216) (271) – (losses)/gains on disposal of a business, brands and joint venture 41 72 Finance income 110 118 Finance costs (399) (346) Net finance costs (289) (228) Share of post-tax results of associates and joint ventures 431 392 after (charging)/crediting – restructuring costs (13) – US Federal tobacco buy-out (12) – brand impairments (13) (29) – exceptional tax credits and other impairments 17 57 Profit before taxation 2,764 2,584 Taxation on ordinary activities (716) (690)

RU NOESTATEMENT INCOME GROUP Profit for the year 2,048 1,894

Attributable to: Shareholders’ equity 1,896 1,767

Minority interests 152 127

Earnings per share Basic 92.08p 84.34p

Diluted 91.33p 83.66p WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Annual Review 2006 British American Tobacco 43 Summary Corporate Governance and Summary Financial Statement

GROUP BALANCE SHEET AT 31 DECEMBER

2006 2005 Restated £m £m Assets Non-current assets Intangible assets 7,476 7,987

Property, plant and equipment 2,207 2,331 STATEMENT FINANCIAL SUMMARY Investments in associates and joint ventures 2,108 2,193 Retirement benefit assets 29 35 Deferred tax assets 273 290 Trade and other receivables 192 197 Available-for-sale investments 24 27 Derivative financial instruments 76 87 Total non-current assets 12,385 13,147 Current assets Inventories 2,056 2,274 Income tax receivable 59 81 Trade and other receivables 1,568 1,577 Available-for-sale investments 128 96 Derivative financial instruments 124 86 Cash and cash equivalents 1,456 1,790 Total current assets 5,391 5,904 Total assets 17,776 19,051

Equity Total equity 6,688 6,877 Liabilities Non-current liabilities

Borrowings 5,568 5,058 SHEET BALANCE GROUP Retirement benefit liabilities 435 543 Deferred tax liabilities 296 277 Other provisions for liabilities and charges 161 261 Trade and other payables 146 180 Derivative financial instruments 29 19 Total non-current liabilities 6,635 6,338 Current liabilities Borrowings 1,058 2,202 Income tax payable 292 374 Other provisions for liabilities and charges 253 234 Trade and other payables 2,766 2,883 Derivative financial instruments 84 143 Total current liabilities 4,453 5,836 Total equity and liabilities 17,776 19,051

This Summary Financial Statement was approved by the Board of Directors on 1 March 2007 and signed on its behalf by Jan du Plessis, Chairman. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 44 British American Tobacco Annual Review 2006 Summary Corporate Governance and Summary Financial Statement

GROUP STATEMENT OF CHANGES IN TOTAL EQUITY FOR THE YEAR ENDED 31 DECEMBER

2006 2005 Restated £m £m Differences on exchange (685) 425 Cash flow hedges (2) 58 Available-for-sale investments (2) Net investment hedges 117 (52) UMR IACA STATEMENT FINANCIAL SUMMARY Tax on items recognised directly in equity (12) (41) Net (losses)/gains recognised directly in equity (584) 390 Profit for the year page 42 2,048 1,894 Total recognised income for the year 1,464 2,284 – shareholders’ equity 1,334 2,128 – minority interests 130 156 Employee share options 69 72 Dividends and other appropriations – to British American Tobacco shareholders (1,008) (910) – to minority interests (137) (112) Purchase of own shares – held in Employee Share Ownership Trusts (77) (48) – share buy-back programme (500) (501) Other movements 17 (189) 802 Balance 1 January page 43 6,877 6,117 Change in accounting policy page 29 (42) Balance 31 December 6,688 6,877

Total equity comprised £6,461 million of shareholders’ funds (2005: £6,630 million), after deducting cost of own shares held in Employee Share Ownership Trusts of £197 million (2005: £182 million), and minority interests of £227 million

RU TTMN FCAGSI OA EQUITY TOTAL IN CHANGES OF STATEMENT GROUP (2005: £247 million). WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Annual Review 2006 British American Tobacco 45 Summary Corporate Governance and Summary Financial Statement

SUMMARY FINANCIAL STATEMENT AND NOTES

The Summary Financial Statement on pages 42 to 47 However, as a result of the technical infringement of the is a summary of information in the Annual Report and Companies Act 1985, the repurchase and cancellation Accounts and should be read with the reviews on pages of these shares was invalid and accordingly, their nominal 1 to 32. Reference should also be made to the Summary value is included within the Company's share capital as at Remuneration Report on pages 36 to 40. 31 December 2006. These shares will be repurchased on The Annual Review and Summary Financial Statement 1 March 2007 from their present holders, the Company's UMR IACA STATEMENT FINANCIAL SUMMARY does not contain sufficient information to allow for as brokers, at the same prices agreed between 22 September full an understanding of the results of the Group and 2006 and 4 December 2006. the state of affairs of the Company, or of the Group, and Contingent liabilities their policies and arrangements concerning Directors’ There are contingent liabilities in respect of litigation, remuneration, as would be provided by the full Annual overseas taxes and guarantees in various countries. Report and Accounts. Shareholders requiring more detailed information have the right to obtain, free of Product liability litigation charge, a copy of the full Annual Report and Accounts for Group companies, notably Brown & Williamson Holdings, 2006, or for future years, by contacting British American Inc. (B&W), as well as other leading cigarette manufacturers, Tobacco Publications as set out on the inside back cover. are defendants, principally in the US, in a number of product liability cases. In a number of these cases, the amounts of Report of the auditors compensatory and punitive damages sought are significant. The auditors’ report on the full annual accounts of the Group for the year ended 31 December 2006 is unqualified and Indemnity does not contain any statement concerning accounting records On 30 July 2004, B&W completed transactions combining or failure to obtain necessary information and explanations. its US tobacco business assets, liabilities and operations with R.J. Reynolds Tobacco Company. A new company Going concern called R.J. Reynolds Tobacco Company (RJRT) was created After reviewing the Group’s annual budget and plans, the as a result of the combination transactions. As a result of Directors consider that the Group has adequate resources these transactions: (a) B&W discontinued the active conduct to continue in operational existence for the foreseeable of any tobacco business in the US; (b) B&W contributed future and that it is therefore appropriate to continue to to RJRT all of its assets other than the capital stock of adopt the going concern basis in preparing the accounts. certain subsidiaries engaged in non-US businesses and Accounting policies other limited categories of assets; (c) RJRT assumed all From 1 January 2005, the Group has prepared its annual liabilities of B&W (except liabilities to the extent relating NOTES AND STATEMENT FINANCIAL SUMMARY consolidated financial statements in accordance with to businesses and assets not contributed by B&W to RJRT International Financial Reporting Standards (IFRS) as adopted and other limited categories of liabilities) and contributed by the European Union and implemented in the UK. subsidiaries or otherwise to the extent related to B&W’s tobacco business as conducted in the US on or prior to Changes in accounting policies are as described on page 29. 30 July 2004; and, (d) RJRT agreed to indemnify B&W and Dividends and share buy-back each of its affiliates (other than Reynolds American Inc. The dividends are as described on pages 27 and 28. and its subsidiaries) against, among other matters, all losses, liabilities, damages, expenses, judgments, attorneys’ For the first time the Company needed to file interim fees, etc, to the extent relating to or arising from such accounts which were prepared to recognise additional assumed liabilities or the assets contributed by B&W to dividend income during 2006. As a result of the Company RJRT (the RJRT Indemnification). The scope of the RJRT not doing so, the interim dividend of £323 million paid Indemnification includes all expenses and contingent on 13 September 2006 did not comply with the technical liabilities in connection with litigation to the extent relating requirements of the Companies Act 1985. It is proposed to or arising from B&W’s US tobacco business as conducted that the appropriation of distributable profits to the payment on or prior to 30 July 2004, including smoking and health of the interim dividend will be ratified by shareholders by tobacco litigation, whether the litigation is commenced way of a special resolution at the Annual General Meeting. before or after 30 July 2004 (the tobacco litigation). Accordingly, the payment has been presented as a dividend payment on page 44. Pursuant to the terms of the RJRT Indemnification, RJRT is liable for any possible judgments, the posting of appeal Between 22 September 2006 and 4 December 2006, bonds or security, and all other expenses of and responsibility the Company sought to repurchase 6,927,790 shares for managing the defence of the tobacco litigation. RJRT for an aggregate consideration of £100 million, which has assumed control of the defence of the tobacco litigation are included in the purchase of own shares on page 44. involving B&W. Affiliates of B&W have retained control of WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 46 British American Tobacco Annual Review 2006 Summary Corporate Governance and Summary Financial Statement

SUMMARY FINANCIAL STATEMENT AND NOTES CONTINUED

the defence in certain tobacco litigation cases with respect as B.A.T Industries p.l.c. was previously a defendant to which such affiliates are entitled to indemnification. in around 1,000 consolidated individual cases in West Virginia. British American Tobacco (Investments) Limited US litigation has been dismissed from those West Virginia consolidated 1. Medical reimbursement cases smoking and health cases in which it was a defendant. These civil actions seek to recover amounts spent by government entities and other third party providers 5. Conduct-based claims UMR IACA STATEMENT FINANCIAL SUMMARY on healthcare and welfare costs claimed to result from In 1999, the US Department of Justice brought an action illnesses associated with smoking. As at 31 December against various industry members, including RJRT and 2006, a reimbursement suit brought by an Indian tribe B&W. British American Tobacco (Investments) Limited and two non-governmental reimbursement suits were is a co-defendant in the action. The trial of this claim pending against B&W. The vast majority of other such was completed in June 2005. In August 2006, the District claims have been dismissed on legal grounds. Court issued its final judgment, finding in favour of the Government, and against certain defendants, including As at 31 December 2006, B&W was named as defendant B&W and British American Tobacco (Investments) Limited. in two US cases brought by foreign government entities The court also ordered a wide array of injunctive relief, (São Paulo and Panama) seeking reimbursement of medical including a ban on the use of ‘lights’ and other similar costs. In July 2006, the Delaware Superior Court granted descriptors. Defendants filed a motion to stay enforcement defendants’ motion to dismiss these cases. Plaintiffs of the judgment shortly after the judgment was issued. appealed to the Supreme Court of Delaware, which heard The court denied the stay motion, but defendants filed oral argument in December 2006 and reserved decision. a notice of appeal and an emergency motion to stay the 2. Class actions judgment before the Washington DC Circuit Court of As at 31 December 2006, B&W was named as a defendant Appeals in September 2006. In October 2006, the Court in some 15 separate actions attempting to assert claims on of Appeals granted defendants’ motion to stay enforcement behalf of classes of persons allegedly injured by smoking. of the judgment pending the outcome of the appeal. In the Engle case (Florida), one jury awarded compensatory 6. Settlement of State Health Care Reimbursement Cases damages totalling US$12.7 million and assessed After an Independent Auditor found that the terms of the US$17.6 billion in punitive damages against B&W. The Master Settlement Agreement (MSA) were a ‘significant intermediate appellate court reversed the trial court’s factor’ in market share losses experienced by signatories judgment. In July 2006, the Florida Supreme Court upheld to the MSA in 2003, several US tobacco companies

UMR IACA TTMN N NOTES AND STATEMENT FINANCIAL SUMMARY the intermediate appellate court’s decision to decertify asserted their rights under the MSA to recover a payment the class, and vacated the jury’s punitive damages award. credit or offset for MSA payments made in April 2004. In Scott, the jury returned a verdict of US$591 million The amount at stake exceeds US$1 billion. The settling on the class’s claim for a smoking cessation programme. states have filed motions seeking enforcement of certain Defendants’ appeal to the Louisiana Fourth Circuit Court MSA provisions and defendants have opposed these of Appeal resulted in the reduction of the award by motions, arguing instead for arbitration. US$312 million. In the Schwab class action complaint, the court granted plaintiffs’ motion for class certification. 7. Other claims By order in November 2006, the Second Circuit Court of The Flintkote Company (Flintkote), a US asbestos production Appeals granted defendants’ motion to stay proceedings and sales company, was included in the acquisition of in this case, and further granted defendants’ petition for Genstar Corporation by Imasco Limited (now Imperial leave to appeal the class certification order. Tobacco Canada Limited (Imperial)) in 1986 and became a Group subsidiary following the restructuring of Imasco 3. Individual cases in 2000. In 2003, Imperial divested Flintkote and then, Approximately 3,471 cases were pending against B&W in 2004, Flintkote filed for bankruptcy in the US. In 2006, at 31 December 2006, filed by or on behalf of individuals Flintkote, certain representatives of both the present and in which it is contended that diseases or deaths have been future asbestos claimants as well as certain individual caused by cigarette smoking or by exposure to environmental asbestos claimants were permitted by the bankruptcy court tobacco smoke (ETS). to file a complaint against Imperial and other defendants 4. Consolidated claims for the recovery of dividends paid and other compensation In the West Virginia consolidated smoking and health cases, under various legal theories. The parties are presently the court so-ordered the parties' stipulation dismissing engaged in case management discussions to establish the B.A.T Industries p.l.c. from the action, with prejudice, scope and manner of discovery in this case. This litigation on 12 December 2006. This is a significant decision is expected to take several years to proceed to trial. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Annual Review 2006 British American Tobacco 47 Summary Corporate Governance and Summary Financial Statement

In Wisconsin, the Authorities have identified potentially the certification of the class but limited any liability, if responsible parties to fund the clean up of the Fox River proved, to the period from 1997. In Quebec, in February after pollution from paper mills operating nearby, a task 2005, two smoking and health class actions were certified. currently estimated to cost in the order of US$600m. There is no right of appeal against class certification. Among the potentially liable parties are NCR Corporation Imperial is currently being investigated by the Royal Canadian and Appleton Papers Inc. B.A.T Industries p.l.c. purchased Mounted Police relating to its business records and sales of what was then NCR’s Appleton Papers Division from NCR STATEMENT FINANCIAL SUMMARY products exported from Canada between 1989 and 1994. Corporation, and B.A.T Industries p.l.c. spun off the No action has been commenced against Imperial. Imperial Appleton Paper business in 1990 having obtained full believes that it has conducted itself appropriately at all times, indemnities from Appleton Papers Inc. for past and future but cannot predict the outcome of any such investigation, environmental claims. Disputes have arisen between NCR or whether additional investigations will occur. Corporation and B.A.T Industries p.l.c. as to the indemnities given and received under the purchase agreement in Two actions have been started in Russia by a minority 1978 which disputes have been the subject of arbitration shareholder in OJSC Company British American Tobacco- in 1998 and 2006. Under the terms of the arbitration Yava (BAT-Yava), a Russian incorporated subsidiary of awards B.A.T Industries p.l.c. has an obligation to share British American Tobacco Holdings (Russia) B.V. The the costs of environmental claims with NCR Corporation, minority shareholder, Branston Holdings, issued a claim although it has never been required to do this because in Moscow seeking to have a contract between BAT-Yava Appleton Papers Inc. has paid any sums demanded. and its sister company invalidated, and issued another It is our belief that all future environmental liabilities claim in the Stavropol region alleging that certain of will continue to be met directly by Appleton Papers Inc. the directors of BAT-Yava, and other parties, took various by self funding or insurance cover and no demand will unlawful steps. The Moscow Court has dismissed the claim be made upon B.A.T Industries p.l.c. by NCR Corporation. and the Stavropol Court has ordered the transfer of the case filed there to Moscow. An appeal of the dismissed Other foreign litigation Moscow case has been sent to the Moscow Appellate At 31 December 2006, active claims against Group Court. Branston has also threatened actions in the companies existed in 18 countries outside the United States Netherlands and England but has not yet commenced but the only countries with more than five active claims were these. The Company considers these actions to be Argentina, Brazil, Canada, Chile, Italy and the Republic of without merit and will defend the claims strenuously. Ireland. As at 31 December 2006, there were some 1,142

pending individual cases in Italy. 1,113 cases are pending Conclusion NOTES AND STATEMENT FINANCIAL SUMMARY before the Justice of the Peace Courts, the majority of While it is impossible to be certain of the outcome of any which relate to claims of alleged fraud in connection with particular case or of the amount of any possible adverse ‘light’ cigarettes. Because of the type of court involved, verdict, the Company believes that the defences of the the most an individual plaintiff can recover is €1,033. Group companies to all these various claims are meritorious There are around 27 smoking and health cases filed by both on the law and the facts, and a vigorous defence is or on behalf of individuals. There are also two labour being made everywhere. If an adverse judgment were cases for alleged occupational exposure pending in Italy. entered against any of the Group companies in any case, an appeal will be made. Such appeals could require the The Supreme Court of Canada has upheld the constitutionality appellants to post appeal bonds or substitute security of the British Columbian Tobacco Damages and Health Care in amounts which could in some cases equal or exceed Costs Recovery Act. Non-Canadian defendants challenged the amount of the judgment. In any event, with regard the personal jurisdiction of the British Columbia Court but to US litigation, the Group has the benefit of the RJRT these motions were dismissed. The Court found a ‘real and Indemnification. At least in the aggregate and despite substantial connection’ between British Columbia and the the quality of defences available to the Group, it is not foreign defendants. Defendants’ appeal to this decision impossible that the results of operations or cash flows of was dismissed in September 2006. Defendants then filed the Group in particular quarterly or annual periods could leave to appeal to the Supreme Court in November 2006. be materially affected by this and by the final outcome of In addition, there are five class actions and four individual any particular litigation. cases in Canada. In the Knight class action, the Supreme Having regard to these matters, the Directors (i) do not Court of British Columbia certified a class of all consumers consider it appropriate to make any provision in respect of Imperial manufactured cigarettes in British Columbia, not of any pending litigation and (ii) do not believe that the just British Columbia residents. Defendant’s appeal was ultimate outcome of all this litigation will significantly heard in February 2006, and the Appeal Court confirmed impair the financial condition of the Group. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 48 British American Tobacco Annual Review 2006 Summary Corporate Governance and Summary Financial Statement

SHAREHOLDER INFORMATION

Registrar Church Street Station, New York, NY 10286-1258, USA, Enquiries concerning your shareholding, mandating your tel: +1 888 BNY ADRS (toll-free) or +1 212 815 3700, dividends (including consolidated dividend tax vouchers) e-mail: [email protected] and notifying changes in your personal details should be website: www.adrbny.com directed to Computershare Investor Services PLC, PO Box 82, Individual Savings Accounts (ISAs) The Pavilions, Bridgwater Road, Bristol BS99 7NH, A British American Tobacco sponsored ISA; contact The tel: 0800 408 0094 (UK); +44 870 889 3159 Share Centre, PO Box 2000, Aylesbury, Bucks, HP21 8ZB, Online tel: 0800 800 008 (UK); +44 (0)1296 414 141, DIINLINFORMATION ADDITIONAL www.bat.com e-mail: [email protected]; website: www.share.co.uk Access comprehensive information about British American Capital gains tax Tobacco and download shareholder publications at the Fact sheet for British American Tobacco historical corporate website; visit the Investor Centre for valuation capital gains tax information; contact the British and charting tools and dividend and share price data; and American Tobacco Company Secretarial Department, subscribe to the e-mail and SMS alert services for key financial tel: +44 (0)20 7845 1000 or access the Investor Centre events in the British American Tobacco financial calendar at www.bat.com/investorcentre/cgt www.computershare.com/uk/investor/bri Final dividend 2006 Access the web-based enquiry service for shareholders Ex-dividend date – 7 March 2007 operated by Computershare Investor Services; view details Record date – 9 March 2007 of your British American Tobacco shareholding and recent Payment date – 3 May 2007 dividend payments and register for shareholder electronic communications to receive notification of British American Annual General Meeting Tobacco shareholder mailings by e-mail Thursday, 26 April 2007 at 11.30am, The Mermaid Conference & Events Centre, Puddle Dock, Blackfriars, www.computershare.com/dealing/UK London EC4V 3DB Go online or telephone 0870 703 0084 (UK) to buy or sell British American Tobacco shares Financial results 2007 First quarter – 3 May [email protected] Interim – 26 July Contact Computershare Investor Services by e-mail Third quarter – 1 November HRHLE INFORMATION SHAREHOLDER Publications Analyses of shareholders Copies of current and past Annual Report and Accounts At 31 December 2006, there were 2,068,803,944 and Annual Reviews are available on request. Copies ordinary shares in issue held by 60,226 shareholders. of the Group corporate descriptive booklet About Us These shareholdings are analysed as follows by category and past Quarterly Reports are also available. Highlights of shareholder and size of shareholding: from these publications can be produced in alternative Percentage formats such as Braille, audio tape and large print. Percentage of issued Contact British American Tobacco Publications, Unit 80, Category of Number of of total Number of ordinary shareholder holders holders ordinary shares share capital London Industrial Park, Roding Road, London E6 6LS Individuals 53,283 88.47 77,196,613 3.74 tel: +44 (0)20 7511 7797, facsimile: +44 (0)20 7540 4326, Financial institutions/ e-mail: [email protected] pension funds 273 0.46 5,913,028 0.29 Nominee companies 6,162 10.23 1,356,353,424 65.56 Dividend Reinvestment Plan Other corporate holders 507 0.84 25,004,252 1.21 A straightforward and economic way of utilising your R&R Holdings S.A. 1 – 604,336,627 29.20 dividends to build up your shareholding in British 60,226 100.00 2,068,803,944 100.00 American Tobacco; contact Computershare Investor Services for details Percentage of issued Size of shareholding Number of holders ordinary share capital American Depositary Receipts 1 – 1,999 48,232 1.26 British American Tobacco sponsors an American 2,000 – 9,999 9,852 1.79 Depositary Receipt (ADR) programme in the United 10,000 – 199,999 1,609 3.24 200,000 – 499,999 215 3.33 States. Enquiries regarding ADR holder accounts and 500,000 and over 318 90.38 payment of dividends should be directed to Shareholder 60,226 100.00 Relations, The Bank of New York, PO Box 11258, WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 49

DIRECTORS’ REPORT

Introduction Annual General Meeting The Directors present their report and the audited financial The Annual General Meeting will be held at The Mermaid statements for the Group for the year ended 31 December Conference & Events Centre, Puddle Dock, Blackfriars, 2006. A report from the Directors on corporate governance London EC4V 3DB at 11.30am on 26 April 2007. Details is set out on pages 67 to 72 and the Remuneration of the business to be proposed at the meeting are contained Committee report is on pages 53 to 66. in the Notice of Annual General Meeting which is sent to all GROUP TOBACCO AMERICAN BRITISH shareholders and is also published on our bat.com website. Business review Section 234ZZB of the Companies Act 1985 requires Directors British American Tobacco p.l.c. (the Company) to produce The following persons are the current Directors of the a business review. The information that has been prepared Company: to a standard which fulfils the requirements of that business Chairman review can be found in the Operating and Financial Review Jan du Plessis (OFR) on pages 1 to 32 of the Annual Review, those pages being incorporated by reference into this Directors’ Report. Deputy Chairman and Senior Independent The preparation of the OFR also took into account, where Non-Executive Director considered appropriate, the best practice set out in the Kenneth Clarke UK Accounting Standards Board’s ‘Reporting Statement: Executive Directors Operating and Financial Review’. The OFR reports on the Paul Adams (Chief Executive) Group’s development and performance during the past Paul Rayner (Finance Director) year together with its strategy and prospects, with particular Antonio Monteiro de Castro (Chief Operating Officer) reference to stated Key Performance Indicators (KPIs) and Business Measures on pages 6 to 19. The OFR also includes Non-Executive Directors information in respect of financial and other risks under Piet Beyers the heading of ‘Key Group Risk Factors’ (pages 30 to 32), Robert Lerwill research and development (page 18) and employee Dr Ana Maria Llopis involvement and employee practices (pages 18 and 19). Rupert Pennant-Rea Anthony Ruys The Annual Review is issued to all shareholders. The Directors’ Sir Nicholas Scheele Report and Accounts is issued to shareholders who have Thys Visser elected to receive it together with an Annual Review. REPORT DIRECTORS’ Anthony Ruys was appointed to the Board as a Principal activities Non-Executive Director on 1 March 2006 and he was British American Tobacco p.l.c. is a holding company reappointed by shareholders at the 2006 Annual General which owns, directly or indirectly, investments in the Meeting. In accordance with the Articles of Association, numerous companies constituting the British American the Directors named below retire from the Board at the Tobacco Group of companies. The principal subsidiaries forthcoming Annual General Meeting and, being eligible, and associates are listed on pages 140 to 142. All subsidiary offer themselves for reappointment: undertakings are involved in activities related to the manufacture, distribution or sale of tobacco products. Paul Adams Robert Lerwill Group results and dividends Sir Nicholas Scheele The Group results are dealt with fully in the Financial Thys Visser Statements (pages 74 to 139) and in the OFR (pages 1 to 32). The Board has recommended to shareholders a final Biographical and related information about the Directors dividend of 40.2p per ordinary share for the year ended is given in the Annual Review and will also be given in 31 December 2006. If approved, this dividend will be paid the Secretary’s letter in the Notice of Annual General on 3 May 2007 to shareholders on the register at the close Meeting for those Directors who are offering themselves of business on 9 March 2007. Full details of dividends in for reappointment. respect of 2006 are given on page 93 in note 8. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 50 British American Tobacco Directors’ Report and Accounts 2006

DIRECTORS’ REPORT CONTINUED

Directors’ interests and indemnities The applicable accounting standards referred to in (3) The interests of the Directors of the Company in the above are: (a) United Kingdom Generally Accepted issued share capital of the Company (including interests Accounting Principles (UK GAAP) for the Company; and in share options and deferred shares) are shown in the (b) International Financial Reporting Standards (IFRS) as Remuneration Report on pages 62 to 65. adopted by the European Union and implemented in the RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH UK for the Group. No Director had any material interest in a contract of significance (other than a service contract) with the The Directors are responsible for ensuring that the Company or any subsidiary company during the year. Company keeps sufficient accounting records to disclose Details of the Executive Directors’ service contracts and with reasonable accuracy the financial position of the the letters of appointment for the Non-Executive Directors, Company and to enable them to ensure that the financial their emoluments and share interests (including interests statements comply with the Companies Act 1985. They in share-based payments) are given in the Remuneration are also responsible for taking reasonable steps to safeguard Report on pages 60 to 65. the assets of the Company and the Group and, in that context, to have proper regard to the establishment of The Company’s practice has always been to indemnify its appropriate systems of internal control with a view to the Directors in accordance with the Company’s Articles of prevention and detection of fraud and other irregularities. Association and to the maximum extent permitted by law. As at the date of this report, indemnities are in force under The Directors are required to prepare financial statements which the Company has agreed to indemnify the Directors, and to provide the auditors with every opportunity to in accordance with the Company’s Articles of Association take whatever steps and undertake whatever inspections and to the maximum extent permitted by law, in respect the auditors consider to be appropriate for the purpose of all costs, charges, expenses or liabilities, which they of enabling them to give their audit report. may incur in or about the execution of their duties to the The Directors are responsible for the maintenance Company, or any entity which is an associated company and integrity of the Annual Report and Accounts on the (as defined in Section 309A of the Companies Act 1985) Company’s bat.com website in accordance with the UK or as a result of duties performed by the Directors on legislation governing the preparation and dissemination behalf of the Company or any such associated company. of financial statements. Access to the website is available Directors’ responsibilities in relation to from outside the UK, where comparable legislation may the financial statements be different. IETR’REPORT DIRECTORS’ The following statement sets out the responsibilities of the The Directors consider that they have pursued the Directors in relation to the financial statements of both the actions necessary to meet their responsibilities as set Group and the Company. The report of the independent out in this Statement. auditors shown on page 73, set out their responsibilities in relation to those financial statements. Directors’ declaration in relation to relevant audit information Company law requires the Directors to prepare financial Having made enquiries of fellow Directors and of the statements for each financial year which give a true and Company’s auditors, each of the Directors confirms that: fair view of the state of affairs of the Company and the (1) to the best of his or her knowledge and belief, there Group as at the end of the financial year and of the profit is no relevant audit information of which the Company’s or loss of the Group for the financial year. In preparing auditors are unaware; and (2) he or she has taken all steps those financial statements, the Directors are required to: that a Director might reasonably be expected to have (1) select appropriate accounting policies and apply taken in order to make himself or herself aware of relevant them consistently; (2) make judgements and estimates audit information and to establish that the Company’s that are reasonable and prudent; (3) state whether auditors are aware of that information. applicable accounting standards have been followed, subject to any material departures being disclosed and Going concern explained; and (4) prepare the financial statements on After reviewing the Group’s annual budget and plans, the the going concern basis, unless they consider that to Directors consider that the Group has adequate resources be inappropriate. to continue in operational existence for the foreseeable future and that it is therefore appropriate to continue to adopt the going concern basis in preparing the accounts. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 51

Auditors shareholders should therefore include this dividend in Resolutions will be proposed at the Annual General their tax returns on the basis of the information shown in Meeting to reappoint PricewaterhouseCoopers LLP as the original dividend certificates in respect of 13 September the Company’s auditors and to authorise the Directors 2006 as a dividend received on that day. HMRC has further to agree their remuneration. The Audit Committee will confirmed that, if shareholders approve the resolution recommend the appropriate level of fees to the Board. submitted for their approval, this will have no effect either GROUP TOBACCO AMERICAN BRITISH on the amount of their taxable income or on the period Substantial shareholding for which it is assessable to UK tax. UK resident shareholders At 1 March 2007, the following person had notified an need therefore take no further action. If any non-UK resident interest in the ordinary shares of the Company. shareholders have any doubt about their tax position, Number of Percentage ordinary shares of issue2 they should consult their own professional advisers. R&R Holdings S.A.1 604,336,627 29.20 Purchase of own shares Notes: From March 2006, the Board continued its on-market 1 Pursuant to the Standstill Agreement dated 11 January 1999 entered into between the Company and R&R Holdings S.A. (then named Rothmans International Holdings programme of buying back the Company’s ordinary S.A.), Compagnie Financière Richemont SA (then called Compagnie Financière shares of 25p each in order to enhance its earnings Richemont AG) and Rembrandt Group Limited (together ‘the R and R Parties’), the R and R Parties gave certain undertakings to the Company including the following: under the authority granted by shareholders in 2005. (a) that the R and R Parties and persons acting in concert with any of them will not exercise at any general meeting of the Company more than 25 per cent of the At the 2006 Annual General Meeting, the Company voting rights attached to shares of a class carrying rights to vote in all circumstances was given authority to purchase up to 209,600,000 at general meetings of the Company; and (b) the interests of the R and R Parties and persons acting in concert with any of them in the issued ordinary share capital of of its ordinary shares. the Company will not exceed 27.8 per cent except in certain specified circumstances e.g. the Company making a purchase of its own shares or otherwise having reduced During the year ended 31 December 2006, the Company its issued share capital. During the year ended 31 December 2006, the interests of the R and R Parties changed as a result of the Company continuing its share made on-market repurchases totalling 28,330,000 of its buy-back programme (see below). Further to a reorganisation of the Rembrandt own ordinary shares, representing 1.37 per cent of the Group in August 2000, the interest of Rembrandt Group Limited in R&R Holdings S.A. is now held by Remgro Limited, which company has become a party to the issued share capital, for an aggregate consideration of Standstill Agreement. £400 million. The repurchased shares were cancelled. 2 The interest of R&R Holdings S.A. is expressed as a percentage of the Company’s issued ordinary share capital before the proposed repurchase and cancellation of shares described under ‘Purchase of own shares’ below (the ‘Repurchases and Between 22 September 2006 and 4 December 2006, the Cancellations’). The interest of R&R Holdings S.A. immediately after the Repurchases Company sought to repurchase 6,927,790 shares for an and Cancellations will be 29.30 per cent. aggregate consideration of £100 million. As a result of the Interim dividend 2006 technical infringement of the Companies Act 1985 noted For the first time, the Company needed to file interim above, the repurchase and cancellation of these shares REPORT DIRECTORS’ accounts which were prepared to recognise additional was invalid. These shares will be repurchased on 1 March dividend income during 2006. As a result of the Company 2007 from their present holders, the Company’s brokers, not doing so, the interim dividend of £323 million paid at the same prices agreed between 22 September 2006 on 13 September 2006 (the 2006 Interim Dividend) and 4 December 2006. Accordingly, the payments have did not comply with the technical requirements of the been included in the cost of share buy-backs in the Companies Act 1985. It is proposed that the appropriation Financial Statements. of distributable profits to the payment of the 2006 Interim Dividend will be ratified by shareholders by way of a The present authority for the Company to purchase special resolution at the Annual General Meeting and its own shares will expire at the 2007 Annual General that, if so approved by shareholders, any liability of the Meeting. The Directors will be seeking fresh authority for Company’s shareholders or Directors relating to the the Company to purchase its ordinary shares as part of the 2006 Interim Dividend should be released. Accordingly, planned continuation of the share buy-back programme. the payment has been presented as a dividend payment It is expected that any shares purchased pursuant to the in the Financial Statements. share buy-back programme will automatically be cancelled The Company has drawn the attention of HM Revenue and the number of shares in issue reduced accordingly. & Customs (HMRC) to the circumstances surrounding However, the Company may, in appropriate circumstances, the payment of the 2006 Interim Dividend and to the wish to hold and deal with the shares purchased as treasury steps described above that are now proposed to rectify shares in connection with the operation of employee the legal position of the Company. HMRC has confirmed share schemes. that the tax position of UK shareholders is not affected Continuation of the Company’s share buy-back programme by any irregularity in the original dividend and that UK may result in the shareholding of R&R Holdings S.A. (the WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 52 British American Tobacco Directors’ Report and Accounts 2006

DIRECTORS’ REPORT CONTINUED

Company’s largest shareholder – see above) increasing arrangements are adhered to provided that suppliers meet to over 30 per cent. This would trigger an obligation their contractual commitments. on the part of R&R Holdings S.A. to make a general offer Creditor days have not been calculated for the Company for the remainder of the entire issued share capital of the as it is an investment holding Company and had no trade Company under the City Code on Takeovers and Mergers.

RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH creditors at 31 December 2006. Approval of shareholders will therefore be sought, by means of an ordinary resolution at the Annual General OECD Guidelines Meeting, for a waiver of this offer obligation. The Panel The Group recognises its responsibilities to the countries on Takeovers and Mergers has indicated, subject to final in which it operates and in this context, notes the OECD approval, that it is prepared to waive this requirement, Guidelines for Multinational Enterprises in their current form. if the independent shareholders approve such a waiver Intra-group pricing at the Annual General Meeting. Full details of the waiver The prices agreed between Group companies for will be set out in a circular to shareholders which will intra-group sales of materials, manufactured goods, accompany the Notice of Annual General Meeting. charges for royalties, commissions, services and fees Stock market listings are based on normal commercial practices which The Company’s ordinary shares are listed on the London would apply between independent businesses. Stock Exchange. They are also traded on the American On behalf of the Board Stock Exchange, New York, in the form of American Depositary Receipts for which the Company has unlisted Nicola Snook trading privileges. None of its securities are listed on any Secretary United States securities exchange or registered pursuant 1 March 2007 to the securities laws of the United States. Charitable and political contributions Payments for charitable purposes in 2006 amounted to £17.6 million (2005: £15.2 million), £3 million of which was paid in the UK (2005: £3.5 million). No donation was made to any political party registered in the UK under the Political Parties, Elections and Referendums Act

IETR’REPORT DIRECTORS’ 2000. Subsidiaries of the Company in Canada, Australia, the Solomon Islands and Fiji made contributions to non-EU political parties in their respective countries of incorporation totalling £87,570 (2005: £148,782). Creditor payment policy Given the international nature of the Group’s operations, there is not a global standard code for the Group in respect of payments to suppliers. In the UK, the operating subsidiaries have signed up to the Better Payment Practice Code under which each company undertakes to: (1) seek agreement on payment terms with its suppliers at the outset of each transaction; (2) explain its payment procedures to its suppliers; (3) pay bills in accordance with the agreed terms and all legal requirements; and (4) inform suppliers without delay when contesting an invoice and settle disputes quickly. Details of the Code are available on the website, payontime.co.uk Non-UK operating subsidiaries are responsible for agreeing terms and conditions for their business transactions when orders for goods and services are placed, ensuring that suppliers are aware of the terms of payment and including the relevant terms in contracts where appropriate. These WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 53

REMUNERATION REPORT

Executive remuneration policy Review of incentive arrangements and proposed Policy: introduction new Long Term Incentive Plan The overriding objective of the British American Tobacco Background: strategy remuneration policy is to reward the achievement of The Company’s current Long Term Incentive Plan (the corporate and individual goals by linking success in Current LTIP) will expire in April 2008 and in anticipation those areas to the Group strategy: a balanced approach of that event, the Remuneration Committee appointed GROUP TOBACCO AMERICAN BRITISH to achieving growth, improving productivity, managing Deloitte & Touche LLP to undertake a comprehensive review the business in a responsible manner and developing a of the current incentive arrangements for the senior executive winning organisation. The delivery of strategy is measured team and to advise on possible replacement incentive by the Key Performance Indicators (KPIs) and Business arrangements to support the executive remuneration Measures set out and described on pages 6 to 19 of the policy and its embedded link with the Group strategy. Annual Review. The continued focus by the Executive This review also assimilated data from Towers Perrin, the Directors of British American Tobacco and the members of remuneration consultants to the Committee (the Review). its Management Board on driving all four elements of the strategy, will continue to build a sustainable business. This The following key principles were confirmed by the methodology is supported by a competitively positioned Committee during the Review: (1) there should continue and integrated pay and benefits structure which reflects to be a single global incentive plan for all participants, the nature of the Group’s worldwide operations and the thereby supporting British American Tobacco’s global need to attract, motivate and retain high-quality executives. strategy and culture; (2) a performance-based share plan structure continues to be right for the business, and should In order to strengthen the alignment of executive continue to be the only long term performance-based remuneration to the generation of shareholder value, a plan operated by the Company; (3) Total Shareholder balance is maintained between the short and long term Return (TSR) and earnings per share (EPS) continue to elements of the structure. This policy will continue to be be the most appropriate measures of British American applied during 2007. Tobacco’s performance on the basis that these measures Policy: remuneration balance are aligned with shareholders’ interests and with British The role of the Remuneration Committee is to determine American Tobacco’s key goal of achieving (on average) the framework and policy on terms of engagement high single digit earnings growth. (including remuneration) of the Chairman (Jan du Plessis), As a result of the Review, shareholder approval is being the Executive Directors (Paul Adams, Antonio Monteiro sought for a new Long Term Incentive Plan (the New de Castro and Paul Rayner) and the members of the REPORT REMUNERATION LTIP). Details of the New LTIP will be set out in the notice Management Board. It also determines the specific for the 2007 Annual General Meeting and its accompanying remuneration of each of them (including awards under letter from the Chairman of the Remuneration Committee, share incentive schemes and pension schemes) and any compensation payments. In developing and applying the the key points of which are summarised below. framework and policy, the Committee has a guideline that Background: Current LTIP approximately 50 per cent of the remuneration (assuming The Current LTIP provides for awards of free ordinary ‘on target’ performance) should be of a performance- shares to the Executive Directors and senior employees, related or variable nature. The remuneration package provided certain demanding performance conditions are comprises both performance-based variable rewards (cash met. The Current LTIP is operated each year by the and share incentive annual bonus plans; Long Term Remuneration Committee in relation to awards to the Incentive Plan) and core fixed elements (base salary; Executive Directors and members of the Management pension and other benefits). The composition in the case Board. Awards under the Current LTIP have been made of Executive Directors for 2006 and 2007 is as follows: at a level of 175 per cent of salary for the Chief Executive Variable element per cent and 125 per cent of salary for the other Executive Fixed element per cent (on target performance) Directors and members of the Management Board. 2006 2007 2006 2007 P N Adams 44 40 56 60 For awards made since 2005, participants have been P A Rayner 47 43 53 57 entitled to receive a cash payment equivalent to the A Monteiro de Castro 52 48 48 52 value of the dividends that they would have received as Notes: shareholders on their vesting awards (the LTIP Dividend 1 The variable elements shown for 2007 take into account awards to be made under Equivalent). The value of the LTIP Dividend Equivalent has the proposed new Long Term Incentive Plan which is summarised below. 2 For members of the Management Board, this policy typically translates for 2007 into a been taken into account when considering awards under fixed element at 52 per cent (2006: 53 per cent) and a variable element at 48 per cent the Plan. (2006: 47 per cent). WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 54 British American Tobacco Directors’ Report and Accounts 2006

REMUNERATION REPORT CONTINUED

Awards are based on a combination of TSR and EPS three year performance period. The opening and closing performance conditions measured over three years. The indices for this calculation are respectively the average Remuneration Committee considers that both of these of the index numbers for the last quarter preceding the measures are widely accepted and understood benchmarks performance period and for the last quarter of the final of a company’s performance, and that together they provide year of that performance period – this methodology is RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH a good spread of measures relevant to the Group’s business employed to reflect movements of the indices over that and market conditions. These are outlined in the following time as accurately as possible. long term incentive proposals. The constituent companies for the proposed FMCG group Summary of proposed Plan for the first awards under the New LTIP are identified on Shareholder approval is being sought for the introduction page 65 in Table 7. of the New LTIP to replace the Current LTIP which expires TSR will continue to be measured on a local currency basis. in 2008. The proposed new Plan, in which all Executive This approach is considered to have the benefits of simplicity Directors and members of the Management Board would and directness of comparison with the performance of the participate, is, in many respects, very similar to the existing comparator companies, and is in line with the approach arrangements, although there are some differences which currently taken for the purposes of TSR measurement. are identified and described below. Awards under the New LTIP would continue to deliver shares subject to EPS performance condition stretching performance conditions over three years. 50 per cent of an award under the Current LTIP and the Participants would also continue to receive the LTIP New LTIP will be based on EPS growth relative to inflation. Dividend Equivalent. This element of the award will vest fully if EPS growth over the three year performance period is an average of at least The performance conditions for the awards would 8 per cent per annum in excess of inflation; 10 per cent of continue to be based on TSR and EPS measures as follows: this element will vest if the same figure is at least 3 per cent TSR performance condition in excess of inflation, and an award will vest on a pro rata In line with the approach taken under the Current basis between these two points. The EPS portion of an LTIP, a total of 50 per cent of the total award will be award would not vest below these points. based on the Company’s TSR performance against two Growth in EPS for these purposes is calculated on comparator groups (25 per cent for each measure): an adjusted diluted EPS basis using a formula which (1) the constituents of the London Stock Exchange’s

EUEAINREPORT REMUNERATION incorporates: (1) the adjusted diluted EPS for the year FTSE 100 Index at the beginning of the performance prior to the start of the first performance period and then period; and (2) a peer group of international fast-moving for the first, second and third years of that performance consumer goods (FMCG) companies. 25 per cent of period; and (2) retail price index (RPI) for the last month the total award vests in full in the event of upper quartile of the year immediately preceding the performance performance by the Company relative to one of the period, and then the RPI for the respective first, second comparator groups above, 7.5 per cent of the total and third years of that performance period. award will vest in the event of median performance, and with pro rata vesting between these two points. The proposed targets are in line with and support The TSR portions of an LTIP award would not vest for British American Tobacco’s strategy to deliver high single below median performance. digit (nominal) EPS growth. The maximum target would require 8 per cent per annum growth in earnings ahead These comparator groups, which will be kept under of inflation and is considered to be very demanding. review to ensure that they will remain both relevant and The Remuneration Committee will keep these targets representative, are chosen to reflect, as far as possible, the under review to ensure that they continue to be Company’s financial and business trading environments. appropriately stretching. TSR will continue to be measured according to the Award levels return index calculated by Datastream and reviewed The Remuneration Committee continues to maintain by the Company’s independent advisers. It is measured a responsible approach to benchmarking and aims to on the basis that all companies’ dividends are reinvested set the total compensation opportunity for Executive in the shares of those companies. The return is the Directors within the market competitive range, but with percentage increase in each company’s index over the a conservative overall positioning. As part of the Review, WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 55

the Committee decided to maintain a simple, focused Salary incentive structure with only two elements of variable pay. Salaries for the Executive Directors and members of This methodology is in contrast to a number of FTSE 100 the Management Board are reviewed annually or on companies which may operate two or, in a few cases, a significant change of responsibilities. In deciding three different long term incentive plans in the same year. appropriate salary levels, and to ensure competitive The Remuneration Committee believes that the Company’s positioning, Executive Directors’ salaries are benchmarked GROUP TOBACCO AMERICAN BRITISH approach will provide a clear message to participants of against a mid-market level of main board directors from what is required and will be transparent to shareholders. the Salary Comparator Group described above. Where necessary, additional reference is also made to published The Remuneration Committee has an established peer salary data, including that for positions for companies in group for benchmarking purposes, made up of FTSE 100 the Salary Comparator Group. companies with a consumer goods focus, an international spread of operations and competitors for top management Matched salary positions are identified and compared talent. This group of UK listed companies (the Salary using factors chosen to cover comparative reporting levels, Comparator Group) has been used for a number of revenue, international responsibilities and main board years to ensure that base salaries and total compensation membership. This enables a mid-market assessment and continue to be market competitive and is subject to a ‘competitive range’ (typically 15 to 20 per cent either annual review. The companies in the Salary Comparator side of the assessment) to be reported to the Committee, Group as at 31 December 2006 are set out on page 65 which will then make judgements within this range in Table 6. depending on individual performance and experience. The opportunity provided by the total package was Salaries of members of the Management Board are compared against the Salary Comparator Group on reviewed on the basis of a mid-market comparison for both an expected and projected value basis, taking equivalent management board roles. Similar principles into account the value of the LTIP Dividend Equivalent. are applied to the salaries of senior managers and, below Under both these approaches, the total compensation this level in the organisation, salary scales are graded with opportunity for the Executive Directors, and in particular reference to market conditions whilst individual salary the Chief Executive, was positioned appreciably below increases are linked to performance. the mid-market. During 2006, the Committee continued to recognise To ensure that remuneration levels remain competitive that the requirements of recruitment or retention may (subject to the approval of shareholders), awards under on occasion justify the payment of a salary outside the REPORT REMUNERATION the New LTIP will therefore be increased from 175 per cent range regarded as appropriate for a particular position. to 250 per cent of base salary for the Chief Executive, In addition to basic salary, the Executive Directors and and from 125 per cent to 200 per cent of base salary members of the Management Board receive certain benefits for the Finance Director and the Chief Operating Officer. in kind, principally a car or car allowance and private In this way, the total package continues to be positioned medical and personal accident insurance. The Executive appropriately against the market. Directors also receive the benefit of the use of a driver. The level of award for members of the Management Executive Directors’ performance-related bonus plans Board will also be increased from 125 per cent of salary With effect from 1 January 2006, the Executive Incentive to 150 per cent of salary. Scheme (annual cash bonus) and the Deferred Share In order to provide flexibility and sufficient capacity for Bonus Scheme were combined under one vehicle to future awards over the life of the Plan, the individual limit create a higher impact, more focused and simpler will be increased to 300 per cent of salary. The Remuneration annual incentive arrangement called the International Committee does not anticipate that awards will be made Executive Incentive Scheme (IEIS). The Executive Directors up to this limit in normal circumstances, and there is no participate in the IEIS, which is an annual bonus scheme current intention to utilise this limit by making awards for senior managers, comprising both a cash and deferred in excess of the proposed levels. The Remuneration shares element. The deferred shares element is delivered Committee will advise shareholders in advance of any through the Deferred Share Bonus Scheme (the Deferred change in the current proposed award levels, and any Scheme). The IEIS aims to reward short term performance such change will be disclosed in the Remuneration Report. within the context of longer term sustainability. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 56 British American Tobacco Directors’ Report and Accounts 2006

REMUNERATION REPORT CONTINUED

The role of the IEIS was also considered during the carry a value of 67 per cent of base salary for ‘on target’ long term incentive review referred to above; there performance, with an overall maximum of 100 per cent. are no changes currently planned or proposed to the The Committee, following its usual procedures, agreed annual bonus arrangements. that the performance targets for the year ended 31 December 2006 have been met (subject to

RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH Bonus entitlements and awards to the Executive confirmation of a figure yet to be published). These Directors and members of the Management Board performance-related bonus payments are included on under the IEIS depend upon the performance of the page 62 in Table 1, in the year to which they relate. business. Demanding targets are set by the Remuneration Committee at the beginning of each year, and are Directors’ interests in shares measured in terms of both financial and business The interests of the Directors of the Company in the performance. Since the beginning of 2006, the targets issued share capital of the Company, according to the for the IEIS reflect five common measures: underlying register maintained under Section 325 of the Companies operating profit, market share of key player volume, Act 1985 (which is open to inspection at the registered Global Drive Brand volume, net revenue and cash flow. office), together with their interests in share options, are These measures, identified as being key to sustained shown on page 62 in Table 2. performance, have an equal weighting of 20 per cent The Remuneration Committee continues to promote each. Payouts for each target are determined on a its shareholding guidelines under which Executive sliding scale with three performance points: threshold Directors and members of the Management Board are (which must be exceeded to attract a bonus); target; encouraged to work towards holding ordinary shares in and maximum amount (the level at which the bonus the Company to the values of one times and 0.75 times is capped). The specific targets are not disclosed as base salary respectively. they are considered to be commercially sensitive. Share options and share incentive schemes The performance points are calculated at the start of The Executive Directors are eligible to participate in the the year by reference to the type of target and projected following employee share schemes which are designed performance in the context of the Group’s annual budget. to incentivise employees of the Group by giving them The Committee receives reports from internal functions opportunities to build a shareholding in the Company: to allow it to determine the extent to which performance the British American Tobacco Sharesave Scheme measures have been achieved. No elements of the bonuses (Sharesave Scheme), the Employee Share Ownership

EUEAINREPORT REMUNERATION are guaranteed. Bonuses will be equally delivered in cash Plan and the Current LTIP. Executive Directors have and shares. also participated in the British American Tobacco Share Awards made under the Deferred Scheme are in the Option Scheme (Share Option Scheme) and in line with form of free ordinary shares in the Company which current policy, no options have been granted to Executive are normally held in trust for three years and no further Directors or other participants under the Share Option performance conditions apply in that period. In certain Scheme since March 2004. The Share Option Scheme will circumstances, participants may forfeit the shares if expire in April 2008 and there is no intention to renew it. they resign before the end of the three year period. All benefits under the employee share schemes are The Remuneration Committee is keen to encourage non-transferable and non-pensionable. a culture of ‘ownership’ of these awarded shares and, since April 2004, participants have received a cash sum Sharesave Scheme equivalent to the dividend on the after tax position of all Eligible employees, including the Executive Directors, unvested ordinary shares held in the Deferred Scheme have been granted employee savings-related share at the dividend record date. options to subscribe for ordinary shares in the Company. In November 2006, the Company made a further grant For the Executive Directors, the cash and shares elements of options under the Sharesave Scheme which allows of the IEIS taken together carry a value of 100 per cent for options granted to be exercisable in conjunction of base salary for ‘on target’ performance, with an overall with either a three year or five year savings contract up maximum of 150 per cent. For the members of the to a monthly limit of £250. Options are normally granted Management Board, both elements taken together WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 57

at a discount of 20 per cent to the market price at the each year in which the Scheme operates in respect of time of the invitation, as permitted under the rules of performance in the previous financial year. In this way, an the Sharesave Scheme. At 31 December 2006, all the award will be made on 2 April 2007 in respect of the year Executive Directors participated in the Sharesave ended 31 December 2006, subject to the performance Scheme, each saving the maximum monthly amount. conditions being met. For the Executive Directors, the performance conditions were aligned to those set for GROUP TOBACCO AMERICAN BRITISH The Sharesave Scheme in its current form, which was the IEIS in respect of the same performance period. The initially approved by shareholders in 1998, will expire in shares are held in a UK-based trust for a minimum period April 2008. The Remuneration Committee has recommended of three years. The maximum individual award under the that the Company continue to operate a Sharesave Scheme Share Reward Scheme is £3,000. and that shareholders’ approval to renew the Sharesave Scheme for a further 10 years will be sought at the 2007 Share Option Scheme Annual General Meeting. It is the policy of the Remuneration Committee not normally to grant options in any year to individuals The rules of the renewed Sharesave Scheme will who receive an award under the LTIP. No options have be substantially unchanged, although there is some been granted under the Share Option Scheme since updating of statutory references and the inclusion of March 2004, with no options having been granted to provisions allowing for electronic communications. In the current Executive Directors since September 1999. order to bring the limits on the number of new shares As mentioned above, the Share Option Scheme expires which may be issued pursuant to the exercise of options in April 2008 and there is no intention to renew it. granted under the Sharesave Scheme in line with current One Executive Director, Paul Rayner, holds outstanding ABI guidelines and market practice, the Sharesave Scheme options under the Share Option Scheme; these options will be amended to provide for a single limit on the were granted to Mr Rayner prior to his appointment as number of shares which may be issued under the scheme a Director in 2002. in any 10-year period of 10 per cent of the Company’s issued share capital. The Sharesave Scheme will continue Options already granted under the Share Option Scheme to be approved by HM Revenue & Customs (HMRC), who were not issued at a discount to the market price at the have given their preliminary approval to the extension of time of grant, with the value of options for that grant being the scheme in its amended form. limited to 50 per cent of a participant’s base salary. Options are normally exercisable after the third anniversary of the Employee Share Ownership Plan

date of the grant and lapse 10 years after the date of REPORT REMUNERATION The Employee Share Ownership Plan is an HMRC their original grant, subject to a performance condition approved share incentive plan. The Company continues based on EPS growth. For options to be exercisable, the to operate its Partnership Share Scheme as a key Company’s published adjusted diluted EPS growth has to constituent part of this Plan. The Partnership Share exceed inflation by an average of 3 per cent per annum Scheme is open to all eligible employees, including over any consecutive three year period during the 10 year Executive Directors. Employees can allocate part of their life of the options. pre-tax salary to purchase shares in British American Tobacco. The maximum amount that can be allocated Current LTIP in this way is £1,500 in any year. Shares purchased are Details of the framework and general operating held in a UK-based trust, normally capable of transfer parameters of the Current LTIP have been included as to participants tax free after a five year holding period. part of the summary of the Review and the proposed At 31 December 2006, all the Executive Directors New LTIP referred to above, in which it is noted that the participated in the Partnership Share Scheme, each Current LTIP will expire in April 2008 and, subject to the investing the maximum monthly contribution. required shareholders’ approval, the first awards under the New LTIP will be made in May 2007. Therefore, no The Company also operates the Free Shares element further awards will be made to the Executive Directors of the Plan, known as the Share Reward Scheme. Under and the members of the Management Board under the this Scheme, eligible employees (including Executive Current LTIP. Directors) receive an appropriation of shares in April of WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 58 British American Tobacco Directors’ Report and Accounts 2006

REMUNERATION REPORT CONTINUED

Performance Performance graph To the extent that the performance conditions have Schedule 7A to the Companies Act 1985 requires that been satisfied following assessment by the Remuneration the Company must provide a graph comparing the TSR Committee, awards are normally exercisable between performance of a hypothetical holding of shares in the three and 10 years after they have been made. An award Company, with a broad equity market index over a five RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH of shares lapses to the extent that the performance year period. In this context, the Directors have again conditions are not satisfied in accordance with the chosen to illustrate the performance of TSR against the measures set out above at the end of the three year FTSE 100 Index over a five year period, commencing performance period. The Remuneration Committee on 1 January 2002. In the opinion of the Directors, the considers that a three year performance period for the FTSE 100 Index is the most appropriate index against Current LTIP gives a balance between the aspirations of which TSR should be measured, because it is a widely the Executive Directors, the members of the Management used and understood index of broadly similar-sized UK Board and shareholders. companies to the Company. The performance graph is shownonpage66. As stated last year, the transition to International Financial Reporting Standards (IFRS) for financial years beginning In addition to the performance graph, illustrative graphs on or after 1 January 2005 has impacted profits-based that show the relative position on the TSR measures for the measures such as EPS. The Committee has noted that LTIP award vesting in March 2007 are shown on page 66. IFRS is still changing and that the concepts of what Options and awards outstanding: employee share should be income, and consequently the basis for EPS ownership trust measures, may well undergo fundamental change To satisfy the future exercise of options or awards under as future standards are developed. The Committee, the Group’s employee share schemes, ordinary shares however, continues to be committed to ensuring a are acquired in the market by an existing employee share consistent approach to measurement of performance ownership trust – the British American Tobacco Group for the vesting of LTIP awards. Employee Trust (BATGET). During the year, new ordinary Vesting of 2004 LTIP award shares were issued by the Company in relation to the As reported last year, 77.1 per cent of the 2003 LTIP Sharesave Scheme and to certain participants in the award vested on 19 March 2006. The sixth LTIP award Share Option Scheme resident outside the UK. was made in 2004, with the performance period being Under the Sharesave Scheme, a total of 2,507,461 options

EUEAINREPORT REMUNERATION completed at 31 December 2006. The Remuneration over ordinary shares in the Company were outstanding Committee has assessed the performance of British at 31 December 2006. The options outstanding under American Tobacco against the two performance the Sharesave Scheme are exercisable until June 2012 conditions outlined on page 54 and has determined at option prices ranging from 480p to 1,152p. that: (1) the effects of the transition to IFRS stated above have not had a material impact on the measurement BATGET is used to satisfy the future exercise of options of EPS growth used for the LTIP; and (2) 100 per cent of under the Share Option Scheme and the vesting and the award will vest. On the TSR measure, the Company exercise of awards of ordinary shares made under the ranked 10th out of the FTSE 100 group of companies, Deferred Scheme and the LTIP respectively. BATGET is giving a vesting of 25 per cent for performance at the funded by interest-free loan facilities from the Company upper quartile. A vesting of 25 per cent was achieved totalling £300 million, enabling the Trust to facilitate the for ranking second out of the peer group of international purchase of ordinary shares to satisfy the future vesting FMCG companies, this being upper quartile. EPS growth or exercise of options and awards. The loan to BATGET was 8.98 per cent per annum in excess of inflation, amounted to £248 million at 31 December 2006 resulting in a vesting of 50 per cent. Members of the (2005: £198 million). The loan will be repaid from the FMCG group for the 2004 award vesting in March 2007 proceeds of the exercise of options or, if the options lapse, are set out on page 65 in Table 7. ordinary shares may be sold by BATGET to cover the loan WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 59

repayment or, in the case of ordinary shares acquired by the Pension Fund. This is provided through membership BATGET to satisfy the vesting and exercise of awards, the of an unfunded unapproved retirement benefit scheme. Company will subsequently waive the loan provided over However, following the changes in pensions legislation in the life of the awards. 2006, it was agreed that benefits up to £75,000 per annum

BATGET currently waives dividends on the ordinary (targeting the Lifetime Allowance) would be provided GROUP TOBACCO AMERICAN BRITISH shares held by it as an employee share ownership trust. through the Pension Fund, with the remainder of benefits As at 31 December 2006, BATGET held 19,252,345 being provided through the unfunded arrangement. ordinary shares with a market value of £275.1 million As a result, the Company paid an additional amount to (1 January 2006: 22,751,064 ordinary shares; £295.8 million). the Pension Fund in 2006 to fund the additional benefits BATGET waived payment of the final dividend for 2005 up to a maximum of £75,000 per annum. The overall of £7.2 million in May 2006 and the interim dividend for pension entitlement for each of the Executive Directors 2006 of £3.2 million in September 2006. remained unchanged. Paul Adams and Paul Rayner, being members of the Pension Fund, are entitled to Executive Directors’ pensions benefits receive increases in their pensions in line with price The Executive Directors (with the exception of Antonio inflation up to 6 per cent per annum. Monteiro de Castro) are, like other employees, eligible for membership of the British American Tobacco UK Pension These unfunded commitments are included in the provisions Fund (Pension Fund). referred to on page 99 in note 12 to the accounts. The Pension Fund is a non-contributory defined benefit Paul Rayner has an accumulated defined contribution scheme and includes provision for spouses’ benefits entitlement from Division A of the British American on death in service or after retirement. In the event of Tobacco Australia Superannuation Fund. No contributions death in service, a spouse’s pension equal to half of the were paid to this arrangement on behalf of Paul Rayner member’s prospective pension at normal retirement during 2006. age, would be payable. A spouse’s pension payable in Antonio Monteiro de Castro is in receipt of a pension the event of death after retirement is equal to half of based on an accrual rate of 1.85 per cent for each year the member’s full pension, irrespective of any decision of service from the Fundaçao Albino Souza Cruz, having to exchange part of the benefit for a lump sum. The early retired from this scheme in accordance with its rules in retirement rules in the Pension Fund permit a member May 2005 upon attaining his 60th birthday. This pension to draw the accrued retirement pension within five years

will be increased annually by the lesser of the same index REPORT REMUNERATION of normal retirement age without actuarial reduction, subject Souza Cruz S.A. (Souza Cruz) applies to general salary to the employing company’s agreement. Alternatively, increases and the General Price Index. In respect of an Executive Director may choose to retire at any time on service with Souza Cruz, Antonio Monteiro de Castro or after his or her 50th birthday without the employing is also entitled to a pension equivalent to 0.65 per cent company’s agreement, subject to a reduction as determined of pensionable salary for each year of service to his 60th by the Pension Fund trustee in conjunction with the birthday as an unfunded pension promise, increasing his Pension Fund actuary. Accrual rates differ according to total pension entitlement to 2.5 per cent, the value of individual circumstances but do not exceed one-fortieth which will be paid to him upon his retirement from the of pensionable salary for each year of pensionable service. Group. With effect from June 2005, Antonio Monteiro de Pensionable pay covers basic salary only. Castro participates in an unfunded unapproved retirement Paul Adams and Paul Rayner both joined the Pension benefit scheme accruing benefits at the rate of 2.5 per cent Fund after 1989. As a result, prior to 6 April 2006, per annum. At retirement, Antonio Monteiro de Castro both individuals were subject to the HMRC cap on will be entitled to a total pension based on his service pensionable earnings (£108,600 for the tax year with the Group, calculated using the 12 month average 2006/07). In addition, each has an unfunded pension of his basic salary prior to retirement. This benefit will be promise from the Company in respect of earnings above reduced by the benefits paid and payable by Souza Cruz the cap on an equivalent basis to the benefits provided by as assessed by independent actuaries. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 60 British American Tobacco Directors’ Report and Accounts 2006

REMUNERATION REPORT CONTINUED

Executive Directors’ service contracts and expertise required for non-executive roles. Paul Rayner The Remuneration Committee continues to operate a is currently a Non-Executive Director of Centrica p.l.c. policy of one year rolling contracts for Executive Directors. and the fees from this appointment for the year ended Each Executive Director has such a contract, executed 31 December 2006 totalled £65,000. at the time of his original appointment. The contract

RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH Non-Executive Directors’ terms of appointment may be re-executed during the term of his employment The Non-Executive Directors do not have service contracts to take account of variations in terms and conditions, as with the Company but instead have letters of appointment. well as changes in best practice; the contractual term will The terms of appointment of each Non-Executive Director continue to be of a one year rolling period. In addition, provide that a new Director is appointed for a specified the Remuneration Committee maintains discretion in term, being an initial period to the next Annual General respect of this policy for those future Executive Directors Meeting after appointment and, subject to reappointment who may be recruited externally or from overseas, when at that meeting, for a further period ending at the Annual it may be appropriate to offer a contract with an initial General Meeting held three years thereafter. Subsequent period of longer than one year, reducing to a one year reappointment is subject to endorsement by the Board and rolling contract after the expiry of the initial period. It is the approval of shareholders. The date of appointment the policy that an Executive Director’s one year rolling and most recent reappointment is shown below for each contract incorporates a provision for a termination or Non-Executive Director: compensation payment in lieu of notice. Date of last reappointment An Executive Director’s compensation payment, in lieu Date of appointment at Annual General Meeting of notice, would comprise: (1) 12 months’ salary at his K H Clarke 28 April 1998 28 April 2005 then current base pay; and (2) a cash payment in respect P E Beyers 22 June 2004 28 April 2005 R E Lerwill 1 January 2005 28 April 2005 of other benefits under the contract such as medical A M Llopis 24 February 2003 27 April 2006 insurance, or the Company may at its option continue RLPennant-Rea1 28 April 1998 27 April 2006 those benefits for a 12 month period. The Committee A Ruys 1 March 2006 27 April 2006 maintains discretion as to how to deal with any grants or Sir Nicholas Scheele 28 February 2005 28 April 2005 awards made prior to termination under the Share Option M H Visser 1 April 2001 28 April 2005 Note: Scheme, the Deferred Scheme and the LTIP. Pension 1 Rupert Pennant-Rea was a Non-Executive Director of B.A.T Industries p.l.c. from entitlements are dealt with in accordance with the terms 1 November 1995 until 7 September 1998. He is scheduled to retire at the conclusion and conditions of the applicable pension scheme and do of the 2007 Annual General Meeting. EUEAINREPORT REMUNERATION not form part of the contractual compensation payment. On termination, at any time, a Non-Executive Director is entitled to any accrued but unpaid Director’s fees but not The compensation payment is payable where the requisite to any other compensation. 12 months’ notice is not given to the Executive Director or when he terminates by giving 12 months’ notice and Non-Executive Directors’ remuneration policy the Company does not wish him to serve his notice. If a The fees for the Non-Executive Directors are determined period of notice is served, the compensation payment is by the Board, on the recommendation of the Chairman reduced pro rata. In the unlikely event that the contract and the Chief Executive, within the overall aggregate is terminated for cause (such as gross misconduct), the limit of £2,000,000 authorised by shareholders with Company may terminate the contract with immediate reference to the Company’s Articles of Association. The effect and therefore no compensation payment would Non-Executive Directors do not participate in discussions be payable. with the Board about their own remuneration. External appointments The fees paid to the Non-Executive Directors are Executive Directors and members of the Management determined in light of market best practice and with Board are able to accept one substantive external board reference to the time commitment and responsibilities appointment, provided that permission is respectively associated with the roles. In order to recognise the sought from the Board or Chairman. With effect from increased focus on the roles and responsibilities of the 1 January 2006, the fees from such appointments have Non-Executive Directors, and the need to ensure that the been retained for a Director’s own account, thereby Company is able to continue to attract and retain high recognising the increasing level of personal commitment calibre individuals to such non-executive roles, the fees WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 61

for the Non-Executive Directors have been revised by Appendices to the Remuneration Report the Board with effect from 1 January 2007 as follows: The Remuneration Committee Deputy Chairman £165,000; Non-Executive Directors Terms of reference £75,000, with an additional £20,000 being payable to The terms of reference of the Remuneration Committee, the Chairman of the Audit Committee.

together with an explanation of its role and the authorities GROUP TOBACCO AMERICAN BRITISH Non-Executive Directors receive no other material pay or delegated to it by the Board, are available from the benefits (with the exception of reimbursement of expenses Company Secretary on request and can be accessed on incurred in respect of their duties as Directors of the the corporate governance section of the Company’s Company). It is the policy of the Board that the spouses website at bat.com of the Executive Directors and Non-Executive Directors Membership may accompany the Directors for business purposes At the date of this report, the Committee comprises on designated trips and functions during the year. the following independent Non-Executive Directors Chairman’s terms of appointment and remuneration of the Company: Kenneth Clarke (Chairman of the The Remuneration Committee is responsible for Remuneration Committee); Robert Lerwill; Ana Maria determining the terms of engagement and fees payable Llopis; Rupert Pennant-Rea; Anthony Ruys (appointed to the Chairman. This process takes into account the 1 March 2006) and Sir Nicholas Scheele. The Secretary to breadth of that role coupled with its associated levels the Committee is Nicola Snook, the Company Secretary. of commitment and expertise. Jan du Plessis’s terms No Executive Director or other member of the Management of appointment provide that he holds the office of Board plays any part in determining his or her remuneration. Chairman of the Company with effect from 1 July 2004 During the year ended 31 December 2006, the Chief for a period of three years unless terminated earlier by: Executive was consulted and invited to attend meetings (1) the Company giving three months’ notice or a of the Committee, except when his own remuneration discretionary compensation payment in lieu of notice; was under consideration. In determining remuneration or (2) by the Chairman giving one month’s written for the year, the Committee consulted the Chief Executive, notice with the Company having discretion to make the Director, Human Resources and the Head of Reward. a compensation payment in lieu of such notice. The The Chairman, Jan du Plessis, was also consulted and compensation payment is limited to any fees which are invited to attend meetings of the Committee. The payable for such part of the relevant notice period as the Committee appointed Towers Perrin as remuneration

Board does not require the Chairman to perform his duties. REPORT REMUNERATION consultants, to provide remuneration services and advice As a Director of the Company, the Chairman is subject to the Company for 2006, with specific reference to the to the reappointment of Directors provisions contained needs of the Remuneration Committee. Towers Perrin is in the Company’s Articles of Association. The date of a leading international firm of remuneration and benefits his last reappointment as a Director was at the Annual consultants. It also provides general consultancy services General Meeting held on 27 April 2006. The terms of and advice to British American Tobacco Group companies Jan du Plessis’s appointment provide for: (1) an annual around the world on pay, pensions and other human fee of £535,000; (2) the use of a driver; and (3) private resources related issues. As referred to above, Deloitte & medical and personal accident insurance. In common Touche LLP were appointed to undertake a comprehensive with the Non-Executive Directors, the Chairman does review of the current incentive arrangements for the senior not participate in the British American Tobacco share executive team. Herbert Smith LLP have also been retained schemes, bonus schemes or incentive plans and is not by the Company to provide legal advice in respect of the a member of any Group pension plan. Company’s share schemes, as well as providing other legal services to British American Tobacco as a whole. Copies of the Executive Directors’ service contracts and the details of the terms of appointment of each Non-Executive Director and the Chairman are available for inspection during normal business hours at the Company’s registered office and will also be available for inspection at the Annual General Meeting on 26 April 2007. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 62 British American Tobacco Directors’ Report and Accounts 2006

REMUNERATION REPORT CONTINUED

Table 1. Directors’ remuneration – audited Performance- Performance- related pay: related pay: annual deferred Benefits 2006 2005 Salary/fees cash bonus2 share bonus2, 3 in kind4 Total Total ££££££ J P du Plessis 520,000 – – 68,524 588,524 533,743 RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH K H Clarke 150,000 – – 593 150,593 154,237 P N Adams 984,896 710,000 745,425 132,397 2,572,718 2,118,457 P A Rayner5 608,646 436,650 460,512 232,642 1,738,450 1,443,800 A Monteiro de Castro6 835,956 482,800 504,779 213,176 2,036,711 1,803,123 P E Beyers 60,000 – – 9,735 69,735 60,000 R E Lerwill 75,000 – – 403 75,403 79,664 A M Llopis 60,000 – – – 60,000 60,000 R L Pennant-Rea 60,000 – – – 60,000 68,750 A Ruys1 50,000 – – 831 50,831 – Sir Nicholas Scheele 60,000 – – 8,739 68,739 50,860 M H Visser 60,000 – – 6,584 66,584 82,588 Former Director KSWong(deceased)1 –––––10,000 Total remuneration 3,524,498 1,629,450 1,710,716 673,624 7,538,288 6,465,222 Notes: 1 K S Wong died on 16 February 2005; Anthony Ruys was appointed a Director on 1 March 2006. 2 The Remuneration Committee, following its usual procedures, agreed that the performance targets for the year ended 31 December 2006 have been met (subject to confirmation of a figure yet to be published). The Committee agreed that the performance-related bonus payments shown above could, as a consequence, increase or decrease by approximately 1.5 per cent following the publication of the outstanding information which would enable the relevant calculations to be finalised after 1 March 2007. Such changes, if any, will be reported in the Remuneration Report for the year ending 31 December 2007. 3 The deferred share bonus payments include cash sums equivalent to the dividend on the after tax position on all unvested ordinary shares comprised in the awards held by participants (including Executive Directors) in the Deferred Share Bonus Scheme at each dividend record date. For the year ended 31 December 2006, these payments for Executive Directors were as follows: Paul Adams £35,425 (2005: £29,734); Paul Rayner £23,862 (2005: £19,570); and Antonio Monteiro de Castro £21,979 (2005: £18,376). 4 Benefits in kind include: (a) a car or a car allowance; (b) use of a driver; and (c) travel and other expenses incurred in connection with accompanied attendance at business functions. Non-Executive Directors receive benefits under (c) only. 5 Paul Rayner’s benefits in kind included payments in respect of family education (£56,344) which followed his relocation to the UK from Australia. 6 Antonio Monteiro de Castro’s benefits in kind included tax advice of £65,424 in respect of his former contractual arrangements up to 1 January 2004, prior to which date he derived his emoluments in both the UK and Brazil. 7 The Directors’ remuneration shown above does not include the illustrative value (as at 23 February 2007) of the Executive Directors’ Long Term Incentive Plan awards made in March 2004 which will vest on 17 March 2007. Reference should be made to page 65, note 3 to Table 5. EUEAINREPORT REMUNERATION Table 2. Directors’ interests in British American Tobacco p.l.c. ordinary shares of 25p

At 1 Jan 2006 Changes or date of At from At appointment 31 Dec 2006 31 Dec 20062 1 Mar 2007 J P du Plessis 50,000 50,000 – 50,000 K H Clarke 4,459 4,611 – 4,611 P N Adams 143,051 143,394 16 143,410 P A Rayner 83,228 83,558 17 83,575 A Monteiro de Castro3 179,564 179,844 17 179,861 P E Beyers –––– R E Lerwill 3,000 3,000 – 3,000 A M Llopis 2,200 2,200 – 2,200 R L Pennant-Rea 3,295 3,407 – 3,407 A Ruys1 –3,000–3,000 Sir Nicholas Scheele –––– M H Visser –––– Notes: 1 Anthony Ruys was appointed a Director on 1 March 2006. 2 The changes in Directors’ interests since 31 December 2006 relate to the purchase of shares pursuant to the Company’s Partnership Share Scheme. No Director had a non-beneficial interest in the shares of the Company at the dates stated in Table 2 above. 3 At 31 December 2006, Antonio Monteiro de Castro also had an interest in 100,000 shares of no par value (1 January 2006: 97,600 shares) in the Common Stock of Souza Cruz S.A. of Brazil, the listed company in which British American Tobacco has a 75 per cent interest. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 63

4 In addition to the shares shown above, the Executive Directors have the following interests in the ordinary shares of the Company which are held in trust pursuant to the British American Tobacco Deferred Share Bonus Scheme: Awarded Released At At 1 Jan 2006 15 Mar 20065 20 Mar 2006 31 Dec 2006 P N Adams 125,517 34,858 41,764 118,611 P A Rayner 83,155 21,739 22,073 82,821 A Monteiro de Castro 76,784 23,988 24,883 75,889 GROUP TOBACCO AMERICAN BRITISH 5 The cost of these shares has been included as Directors’ emoluments in the prior year. Details of the Deferred Share Bonus Scheme are given on page 55. 6 Based on the performance for 2006, the Executive Directors will each be awarded a number of ordinary shares to the value of £2,700 pursuant to an appropriation of shares under the Share Reward Scheme on 2 April 2007. 7 On 31 December 2006, the Group’s employee share ownership trust referred to on page 58 held a total of 19,252,345 ordinary shares in the Company. All participating employees, including the Executive Directors, are deemed to have a beneficial interest in these shares. Table 3. Executive Directors’ share options over British American Tobacco p.l.c. ordinary shares of 25p – audited

At 1 Jan 2006 Granted in 2006 Exercised in 20063 At 31 Dec 2006 Dates from Latest number of shares Grant price number of shares number of shares number of shares which exercisable expiry date P N Adams Sharesave Scheme1 2,492 663.0p – – 2,492 Jan 2010 Jun 2010

P A Rayner Sharesave Scheme1 3,447 480.0p – – 3,447 Jan 2007 Jun 2007 – 1,152.0p 1,421 – 1,421 Jan 2012 Jun 2012 Total 3,447 1,421 – 4,868 Share Option Scheme2 3,330 500.0p – 1,932 1,398 Sep 2002 Sep 2009

A Monteiro de Castro Sharesave Scheme1 957 997.0p – – 957 Jan 2009 Jun 2009 Notes: 1 Sharesave Scheme: in respect of the Executive Directors, no options lapsed during the year ended 31 December 2006. There have been no variations in the terms and conditions of these interests in share options during the year. Options granted under the Sharesave Scheme are exercisable in conjunction with a three year or five year savings contract up to a monthly limit of £250. Options are normally granted at a discount of 20 per cent to the market price at the time of the invitation, as permitted under the rules of the Sharesave Scheme. 2 Share Option Scheme: in respect of the Executive Directors, no options lapsed or were granted during the year ended 31 December 2006. There have been no variations in the terms and conditions of these interests in share options during the year. No consideration is payable for the grant of an option. 3 Aggregate gains on share options exercised by Executive Directors during the year ended 31 December 2006 were as follows: Number of Gain

Date of exercise Exercise price Market price options exercised £ REPORT REMUNERATION P A Rayner Share Option Scheme 27 July 2006 500.0p 1,409.0p 1,932 17,562

Aggregate gains on the exercise of share options in 2006 17,562 Aggregate gains on the exercise of share options in 2005 (two directors) 423,516 4 Performance conditions are applicable in respect of the options granted under the Share Option Scheme. For options to be exercisable, the Company’s published adjusted diluted earnings per share growth has to exceed inflation by 3 per cent per annum over any consecutive three year period during the 10 year life of the options. 5 The closing mid-market price of ordinary shares in British American Tobacco p.l.c. on 29 December 2006 (the last day of dealing in the Company’s shares in 2006) was 1,429.0p and the range during the year was 1,242.0p to 1,510.0p. The market price on 29 December 2006 exceeded the grant price of all the options detailed in Table 3 above. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 64 British American Tobacco Directors’ Report and Accounts 2006

REMUNERATION REPORT CONTINUED

Table 4. Executive Directors’ pension entitlements – audited The following Directors were members of defined benefit schemes provided by the Group during the year. Pension entitlements and corresponding transfer values increased as follows during the year:

Total Gross Increase Transfer value Transfer value Transfer value UK Pension accrued increase in in accrued of net increase of accrued of accrued Total change in Fund pension at accrued pension net in accrual pension at pension at transfer value RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH normal 31 Dec 20061 pension of inflation2 over period3 31 Dec 20053 31 Dec 20063 during period retirement age £££££££ P N Adams 60 378,878 50,693 36,252 702,820 4,820,971 7,345,334 2,524,363 P A Rayner 60 75,729 18,768 16,262 305,892 802,161 1,424,481 622,320 A Monteiro de Castro5 60 294,225 33,541 27,806 611,728 5,638,863 6,472,957 834,094 Notes: 1 The amount of total accrued pension is the pension that would be paid annually on retirement based on service to the end of the year, excluding any increases granted under statute before retirement. 2 The value of net increase in accrued pension represents the incremental value to the Executive Director of his service during the year, calculated on the assumption service terminated at the year end. 3 Changes in the transfer values reflect both individual Executive Director’s circumstances such as the date of joining the Pension Fund and changes in salary during the year, together with the application of market value adjustments in accordance with actuarial and legislative requirements. During 2006, the Trustee of the Pension Fund revised the method and assumptions used to calculate transfer values. Previously, transfer values were calculated in accordance with section 1.5 of version 9.2 of Actuarial Guidance Note GN11 issued by the actuarial profession. Following a review of the transfer value basis, the Trustee agreed to increase the transfer value offered to members, and these are now provided on the same basis used for the ongoing funding of the Pension Fund. The transfer values of the accrued entitlement represent the value of assets that the Pension Fund would need to transfer to another pension provider on transferring the Pension Fund’s liability in respect of Executive Director’s pension benefits. They do not represent sums payable to individual Executive Directors and, therefore, cannot be added meaningfully to annual remuneration. Further, although Antonio MonteirodeCastroisnotamember of the Pension Fund, the transfer values calculated above have been calculated in accordance with the method used for the Pension Fund. Although Paul Adams and Paul Rayner receive a significant element of their overall entitlement from an unfunded unapproved retirement benefit scheme, the transfer values calculated above have been calculated in accordance with the method used for the Pension Fund. 4 The Pension Fund is non-contributory; voluntary contributions paid by the Executive Directors and resulting benefits are not shown. No excess retirement benefits have been paid to or are receivable by any Executive Director or past Executive Director of the Company. 5 Antonio Monteiro de Castro attained his normal retirement age of 60 on 24 May 2005 and became entitled to a pension in accordance with the rules of the Souza Cruz Plan. He commenced immediate receipt of a pension of £81,396 per annum in respect of his service up to age 60. In addition, he is entitled to a top-up benefit to increase his overall accrual rate over this period to 2.5 per cent per annum. This benefit will be provided through an unfunded unapproved retirement benefit scheme when he retires. He has remained a Director and continues to accrue pension at 2.5 per cent. The accrued pension figures in the table above reflect Antonio Monteiro de Castro’s full entitlement to an accrual rate of 2.5 per cent per annum and assume immediate retirement at the year ended 31 December 2006. Table 5. Executive Directors’ Long Term Incentive Plan awards over British American Tobacco p.l.c. ordinary shares of 25p – audited

At 1 Jan 2006 Awarded in 2006 Vested in 2006 Lapsed in 2006 At 31 Dec 2006 Value vested Performance number of number of number of number of number of 20062 period ending Award date shares shares shares shares shares £ Vesting date EUEAINREPORT REMUNERATION P N Adams 2005 19 Mar 2003 92,809 – 71,555 21,254 – 1,036,116 19 Mar 2006 2006 17 Mar 2004 105,132 – – – 105,132 – 17 Mar 2007 2007 17 May 2005 143,442 – – – 143,442 – 17 May 2008 2008 15 Mar 2006 – 113,493 – – 113,493 – 15 Mar 2009 Total 341,383 362,067

P A Rayner 2005 19 Mar 2003 73,578 – 56,728 16,850 – 821,421 19 Mar 2006 2006 17 Mar 2004 61,842 – – – 61,842 – 17 Mar 2007 2007 17 May 2005 65,091 – – – 65,091 – 17 May 2008 2008 15 Mar 2006 – 50,557 – – 50,557 – 15 Mar 2009 Total 200,511 177,490

A Monteiro de Castro 2005 19 Mar 2003 82,945 – 63,950 18,995 63,9502 925,996 19 Mar 2006 2006 17 Mar 2004 74,211 – – – 74,211 – 17 Mar 2007 2007 17 May 2005 72,324 – – – 72,324 – 17 May 2008 2008 15 Mar 2006 – 55,788 – – 55,788 – 15 Mar 2009 Total 229,480 266,273

Total of awards vested in 2006 192,233 2,783,533 Notes: 1 The closing mid-market price of ordinary shares in British American Tobacco p.l.c. on 19 March 2003 was 595.0p, 17 March 2004 was 810.5p, 17 May 2005 was 1,030.0p, 15 March 2006 was 1,435.0p and 20 March 2006 was 1,448.0p (the vesting date of 19 March 2006 not being a business day). 2 The vesting of the awards on 19 March 2006 was reported in the Company’s Directors’ Report & Accounts 2005 showing illustrative vesting values based on the mid-market price of ordinary shares of 1,328.0p at 23 February 2006, being the latest practicable date prior to publication of that Report. At the date of this Report, each of the Executive Directors, with the exception of Antonio Monteiro de Castro, had exercised the awards shown above. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 65

3 The March 2004 award will vest on 17 March 2007 at 100 per cent in the manner described on page 58. For illustrative purposes only, the share price on 23 February 2007, being the latest practicable date prior to publication, was 1,584.0p, valuing the vesting awards as follows: Award Award Award vesting granted vesting illustrative number number value of shares of shares £

P N Adams 105,132 105,132 1,665,291 GROUP TOBACCO AMERICAN BRITISH P A Rayner 61,842 61,842 979,577 A Monteiro de Castro 74,211 74,211 1,175,502 Total 241,185 241,185 3,820,370 4 The performance conditions applicable to the awards that vested on 19 March 2006 and will vest on 17 March 2007 relate to an apportionment between measures relating to Total Shareholder Return (TSR) and earnings per share-based criteria with reference to a three year performance period. TSR combines both the share price and dividend performance of the Company as set against two comparator groups: (a) the FTSE 100 Index at the beginning of the performance period; and (b) a peer group of FMCG companies. A total of 50 per cent of the total award is based upon each of two separate measures (25 per cent for each measure). 25 per cent of the total award vests in full in the event of upper quartile performance by the Company relative to one of the comparator groups, 7.5 per cent of the total award will vest in the event of median performance, and then pro rata between these two points. The earnings per share measure applies to 50 per cent of the award. 50 per cent of the award will vest if earnings per share growth over the three year performance period is an average of at least 8 per cent per annum in excess of inflation; 10 per cent will vest if the same figure is at least3percentinexcess of inflation, and an award will vest pro rata between these two points. Similar criteria attach to the awards made on 17 May 2005 and 15 March 2006. 5 There have been no variations in the terms and conditions of the LTIP interests during the year. 6 The awards made in May 2005 and March 2006 are due to vest in May 2008 and March 2009 respectively. At 31 December 2006, the performance percentage reflecting performance to date, was 100 per cent for the May 2005 award and 48.3 per cent for the March 2006 award. Table 6. Salary comparator group AstraZeneca Imperial Tobacco Group SABMiller BP InterContinental Hotels Group J Sainsbury BT Group Marks & Spencer Scottish & Newcastle Cadbury Schweppes Reckitt Benckiser Tesco Diageo Reed Elsevier Unilever Gallaher Group Rio Tinto Vodafone GlaxoSmithKline Royal Dutch Shell WPP Group Table 7. FMCG group (a) For the 2004 award vesting in March 2007 Altadis Gallaher Group Nestlé Altria Group Heineken Pepsico Anheuser-Busch HJ Heinz Procter & Gamble REPORT REMUNERATION Cadbury Schweppes The Hershey Company Reckitt Benckiser Campbell Soup Imperial Tobacco Group SABMiller Carlsberg InBev Sara Lee Coca-Cola Johnson & Johnson Scottish & Newcastle Colgate-Palmolive Kellogg Unilever Danone Kimberly-Clark Diageo LVMH Moët Hennessy (b) For the proposed New LTIP Altadis Heineken Pepsico Altria Group HJ Heinz Pernod Ricard Anheuser-Busch Imperial Tobacco Group Procter & Gamble Cadbury Schweppes InBev Reckitt Benckiser Campbell Soup Japan Tobacco SABMiller Carlsberg Johnson & Johnson Sara Lee Coca-Cola Kellogg Scottish & Newcastle Colgate-Palmolive Kimberly-Clark Unilever Danone LVMH Moët Hennessy Wrigley Diageo Nestlé WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 66 British American Tobacco Directors’ Report and Accounts 2006

REMUNERATION REPORT CONTINUED

Status of Remuneration Report Historical TSR performance growth in the value of a hypothetical £100 holding over five years This Report has been prepared in accordance with Schedule 7A to the Companies Act 1985. The Report 350 also meets the relevant requirements of the Listing Rules 300 British American Tobacco FTSE 100 of the UK Listing Authority and describes how the Board RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH 250 has applied the Principles of Good Governance relating to 200 Directors’ remuneration as set out in the Combined Code

150 on Corporate Governance referred to in the Corporate

100 Governance Statement on page 67. As required by the Companies Act 1985, a resolution to approve the Directors’ 50 Dec Dec Dec Dec Dec Dec Remuneration Report (Report) will be proposed at the 2001 2002 2003 2004 2005 2006 Annual General Meeting of the Company on 26 April 2007, at which the Financial Statements will be presented for FTSE 100 comparison based on 30 trading day average values. approval. The vote will have advisory status, will be in Total shareholder return (annual %) respect of the remuneration policy and overall remuneration (1 January 2004 – 31 December 2006) FMCG group packages and will not be specific to individual levels of remuneration. Upper Quartile Median – 15.3% BAT – 32.2% 35 Lower Quartile 30 The Companies Act 1985 requires the auditors to

25 report to the Company’s shareholders on the ‘audited

20 information’ within the Report and to state whether, in their opinion, those parts of the Report have been 15 prepared in accordance with the Companies Act 1985. 10 The Auditors’ Report is set out on page 73 and those 5 aspects of the Report which have been subject to audit 0 have been clearly marked: Table 1, Table 3, Table 4 and

–5 Table 5 on pages 62 to 65. The FMCG comparison is based on three months’ average values. On behalf of the Board Total shareholder return (annual %) Kenneth Clarke EUEAINREPORT REMUNERATION (1 January 2004 – 31 December 2006) FTSE 100 Chairman of the Remuneration Committee

Upper Quartile Median – 19.9% BAT – 32.2% 70 Lower Quartile 1 March 2007 60

50

40

30

20

10

0

–10

The FTSE 100 comparison is based on three months’ average values. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 67

CORPORATE GOVERNANCE STATEMENT

British American Tobacco is committed to maintaining Meetings of the Board high standards of corporate governance. Our corporate The Board held seven scheduled meetings in 2006 and is governance framework is directed towards achieving our scheduled to hold the same number of meetings in 2007. business objectives in a manner which is responsible and Among the key matters on which the Board alone may in accordance with high standards of honesty, transparency

make decisions are the Group’s business strategy, its annual GROUP TOBACCO AMERICAN BRITISH and accountability. These principles are reflected in our budget, dividends and major corporate activities. It is also Standards of Business Conduct, which have been in place responsible for reviewing the Company’s internal controls for many years and are kept under continual review in and governance system and for approving our Standards order to ensure that they remain at the forefront of best of Business Conduct. In addition, the Board annually: business practice. Every Group company and every employee worldwide is expected to live up to them. In addition, • approves the Annual Report and Accounts, recommends the principles set out within our Statement of Business the final dividend and agrees the agenda for the Annual Principles are designed to help meet the expectations General Meeting; placed on us by our various stakeholders. Both documents • reviews the quarterly and interim results and declares are available from the Company Secretary and through an interim dividend; our bat.com website. • agrees succession plans and evaluates the Board’s The principal governance rules applying to UK companies performance over the preceding year; and listed on the London Stock Exchange are contained in the Combined Code on Corporate Governance adopted by • agrees the two year Company budget. the Financial Reporting Council in July 2003 (the Code). The agenda for Board meetings is set by the Chairman in An updated version of the Code was published in June consultation with the Deputy Chairman, the Chief Executive 2006 and applies to reporting years beginning on or and the Company Secretary. In addition to the Company after 1 November 2006. While in preparing this Statement Secretary, the General Counsel to the Company ordinarily we have taken account of the updated Code, our formal attends all meetings of the Board. obligation for 2006 is to report by reference to the July 2003 version of the Code. Accordingly, references in this Non-Executive Directors, led by the Chairman, meet, Statement to the Code are, unless otherwise stated, to if required, prior to meetings of the Board without the that version of the Code. Executive Directors present and also meet annually, led by the Deputy Chairman, without the Chairman present.

As required by the Code, this Statement reports on how the STATEMENT GOVERNANCE CORPORATE Code’s principles are applied by the Company and provides All Directors are aware of their responsibility to take our formal report on compliance with the Code’s provisions. decisions objectively in the interests of the Company. The Chairman will always seek to obtain consensus at Board The Board meetings but, in exceptional circumstances, decisions will The Board is responsible to the Company’s shareholders for be taken by majority. If any Director has concerns about the success of the Group and for its overall strategic direction, the running of the Company or a proposed action which its values and its governance. It provides the leadership cannot be resolved, such concerns will be recorded in necessary to enable the Group’s business objectives to be the Board minutes. No such concerns arose in 2006. met within the framework of the internal controls described below, while also ensuring that the Company’s obligations Management Board to its shareholders and others are met. The Board delegates to the Management Board responsibility for overseeing the implementation by the Directors Group’s operating subsidiaries of the policies and strategy The Company currently has a Board of 12 Directors: which it sets, and for creating the conditions for their the Chairman, three Executive Directors – the Chief successful day-to-day operation. The Management Board Executive, the Chief Operating Officer and the Finance is chaired by the Chief Executive and its other members Director – and eight Non-Executive Directors. They are are the Finance Director, the Chief Operating Officer and listed in the Directors’ Report on page 49 and their details nine senior Group executives, whose names appear in appear in the Annual Review on page 34. the Annual Review on page 35. It held nine scheduled Anthony Ruys was appointed as a Non-Executive Director meetings in 2006 and is scheduled to hold the same on 1 March 2006. His appointment was confirmed at the number of meetings in 2007. Members of the Management Company’s Annual General Meeting on 27 April 2006. Board are also invited to attend meetings of the Board WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 68 British American Tobacco Directors’ Report and Accounts 2006

CORPORATE GOVERNANCE STATEMENT CONTINUED

from time to time, in particular when the Group’s future of the Group’s assets and, jointly with the Chairman, strategy and annual budgets are under discussion. representation of the Group externally. Board Committees Board balance and independence The Board has established four principal Board The Board considers that six of the eight Non-Executive

RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH Committees, to which it has delegated certain of its Directors are independent. Thys Visser and Piet Beyers responsibilities. They are the Audit Committee, the are presumed not to be independent because of the Nominations Committee, the Remuneration Committee shareholdings that they represent. Accordingly, they do and the Corporate Social Responsibility Committee. Each not sit on the Audit or Remuneration Committees, both of has its own clear terms of reference, which are available which comprise solely independent Non-Executive Directors. from the Company Secretary and through our bat.com Rupert Pennant-Rea has served on the Board for just website. The roles and membership of these Committees under nine years but, including his tenure on the Board are described in more detail where appropriate below. of B.A.T Industries p.l.c., he has served on the Board of Scheduled Board and Committee meetings held in 2006 the Group’s ultimate holding company for slightly in The following table shows the number of scheduled Board excess of 11 years. It had originally been envisaged that and Committee meetings held in 2006 and the number he would retire in 2006. However, in order to provide attended by their respective members. ongoing continuity and stability in 2006 following a two

Board Audit Nominations Remuneration CSR year period in which there had been a number of changes Number held 7 5 2 3 2 in the Board’s membership, it was agreed that he would remain a Non-Executive Director during the year. The Number attended J P du Plessis 7 – 2 – – extension of his tenure was approved at the Annual K H Clarke 7 5 1 2 2 General Meeting in April 2006. The Board recognises P N Adams 7 – – – – that length of service can impact on the independence P A Rayner 7 – – – – of a Non-Executive Director and has therefore kept his A Monteiro de Castro 7 – – – – position under careful review. It is satisfied, in light P E Beyers 5 – 1 – 2 R E Lerwill 6 5 2 3 2 of his continuing valuable contributions to the Board A M Llopis 7 5 2 3 2 and its Committees, that he has remained independent Sir Nicholas Scheele 7 5 2 3 2 throughout the period under review. Rupert Pennant-Rea R L Pennant-Rea 7 5 2 3 2 will retire from the Board at the conclusion of the Company’s A Ruys1 64122

OPRT OENNESTATEMENT GOVERNANCE CORPORATE Annual General Meeting on 26 April 2007. M H Visser 7 – 2 – 2 – Indicates not a member of that Committee. The Non-Executive Deputy Chairman, Kenneth Clarke, Notes: is the Senior Independent Director. He is available should 1 Anthony Ruys was appointed to the Board and to its four Committees with effect from 1 March 2006. occasion arise where there is a need to convey concerns 2 Every Director withdrew from any meeting at which his or her own position was to the Main Board other than through the Chairman or being considered. Chief Executive. He and the other Non-Executive Directors 3 All Directors attended the Annual General Meeting in April 2006 with the exception of Anthony Ruys, who was unable to attend due to a conflicting engagement which remain available to meet with major investors in order to had been arranged prior to his appointment to the Board. understand their views and concerns. Chairman and Chief Executive Appointments to the Board The roles of Chairman and Chief Executive are separate, The Board has established the Nominations Committee with each having distinct and clearly defined responsibilities. to make recommendations on suitable candidates for The Chairman is responsible for leadership of the Board, appointment to the Board and for promotion to the ensuring its effectiveness and setting its agenda, and for Management Board, ensuring that both Boards have the ensuring that a clear business and financial strategy for the appropriate balance of expertise and ability. It is chaired Group is formulated for recommendation to the Board. by Jan du Plessis and its remaining membership comprises An important aspect of this function is to ensure effective all of the Non-Executive Directors. communication with the Company’s shareholders, and The Nominations Committee is responsible for ensuring facilitate the productive contribution of the Non-Executive that the procedure for appointing new Directors is rigorous Directors in particular. and transparent and that appointments are made on Once agreed by the Board as a whole, it is the Chief merit and against objective criteria for the purpose. The Executive’s responsibility to ensure delivery of the strategic selection process will generally involve benchmarking and financial objectives. He is also responsible for stewardship and interviews with a selection of candidates, using the WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 69

services of executive search firms specialising in board Non-Executive Directors and senior management. She is also level recruitment. This process was followed in connection responsible for advising the Board, through the Chairman, with the appointment of Anthony Ruys to the Board. on all governance matters. The appointment and removal of the Company Secretary is a matter for the Board. Directors are submitted for reappointment at regular

intervals by application of the Company’s Articles of All Directors have access to the advice and services of GROUP TOBACCO AMERICAN BRITISH Association. These require that at each Annual General the Company Secretary, and a procedure is in place Meeting: (1) not less than one-third of the Directors for them to take independent professional advice at who are subject to retirement by rotation must retire, the Company’s expense should this be required. The and (2) any Director has to retire who was not appointed Company has arranged appropriate insurance to provide at either of the two previous Annual General Meetings cover in the event of legal action against its Directors. and who has served as a Director for more than two Evaluation of Board performance years since appointment or last reappointment. The Board conducts a critical evaluation of its activities Non-Executive Directors are appointed for a specified on an annual basis. The Company Secretary conducts term, being an initial period to the next Annual General private interviews with all Directors individually (both Meeting after appointment and, subject to reappointment Executive and Non-Executive) to ascertain their views at that meeting, for a further period ending with the Annual on the performance of the Board and its Committees General Meeting no more than three years thereafter. and then compiles a report for the Deputy Chairman. Subsequent appointment will be subject to endorsement The report is presented to the Non-Executive Directors by the Board and the approval of shareholders. There and then to the entire Board. In addition, the Company is a general assumption on the part of the Board that Secretary collates the views of each Director on the individual Non-Executive Directors will not normally be invited to performance of the other Directors and presents these stand for reappointment after serving nine years. The to the Chairman, who then uses them in any discussions Committee reviews forthcoming retirements at least once which he holds with any individual Director regarding a year and considers the need to identify candidates to fill his or her effectiveness. The Chairman also discusses the vacancies for non-executive positions on the Board. This effectiveness and performance of Directors immediately process includes an evaluation of the skills and experience before they make themselves available for reappointment. to be looked for in those candidates to ensure continuing The Remuneration Committee evaluates the effectiveness Board balance. In light of Rupert Pennant-Rea’s forthcoming of the Chairman and the Chief Executive annually and the

retirement, the process is in hand. Chairman’s performance is also appraised annually at a STATEMENT GOVERNANCE CORPORATE meeting of the Non-Executive Directors, led by the Senior The Nominations Committee has made recommendations Independent Director, without the Chairman present. to the Board as to the Directors who are retiring and being put forward for reappointment at the Annual General The process in 2006 confirmed that all Directors continue Meeting on 26 April 2007. to make an effective contribution to the Board and that the Board and its Committees continue to operate effectively in Information and professional development discharging their obligations and meeting defined objectives. Directors receive induction on joining the Board, which The Notice for this year’s Annual General Meeting confirms consists of at least two days’ briefings on all areas of the that the performance of the Directors being proposed for Company’s business. After a period on the Board, they are reappointment continues to be effective and that they given an opportunity to review the induction programme continue to show commitment to their role. and raise questions on any areas in respect of which they would like further information. In addition, they have the The performance and commitment of any Non-Executive opportunity to update their skills and knowledge on a Director being proposed for appointment for a third term regular basis, for example through further briefings on the of three years should be subject to a particularly rigorous business and by visits to Company sites. They also make review. This was done in the case of Thys Visser, who will use of the opportunity to attend meetings of the Group’s be proposed for reappointment at the Annual General regional audit committees. Meeting on 26 April 2007. The Board and its Committees receive high-quality, Remuneration up-to-date information for review in good time ahead It is the role of the Remuneration Committee to determine of each meeting, and the Company Secretary, under the the framework and policy on terms of engagement direction of the Chairman, ensures good information flows (including remuneration) of the Chairman, Executive within the Board and its Committees and between the Directors and members of the Management Board, and WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 70 British American Tobacco Directors’ Report and Accounts 2006

CORPORATE GOVERNANCE STATEMENT CONTINUED

the specific remuneration of each Executive Director and at the Company’s expense, outside legal or other Management Board member (including entitlements independent professional advice and secure the under share incentive schemes and pension schemes) attendance of outsiders with relevant experience and any compensation payments. Fees payable to and expertise if it considers this necessary. Non-Executive Directors are determined by the Board on

RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH Activities of the Audit Committee in 2006 the recommendation of the Chairman and Chief Executive. The Audit Committee met five times during 2006, including The Remuneration Committee is chaired by Kenneth Clarke immediately before the Company’s full year results were and its members are Robert Lerwill, Ana Maria Llopis, Rupert published. It reviewed the Company’s Financial Statements, Pennant-Rea, Anthony Ruys and Sir Nicholas Scheele. including the full and half year results. Details of the Directors’ remuneration are set out in the During the course of the year, the Committee met Remuneration Report on page 62. regularly with management and with the internal and Accountability and audit external auditors to review the effectiveness of internal Financial reporting controls and business risk management, and received The Board is satisfied that it has met its obligation to reports from the Group’s regional audit committees. present a balanced and understandable assessment of the It reviewed compliance with the Standards of Business Company’s position and prospects in the Directors’ Report Conduct and the procedures in place within the Group for and Accounts, the Annual Review (including the Operating the management of its business records. It gave detailed and Financial Review) and Summary Financial Statement, consideration to business risks arising in the context of the interim reports, reports to regulators and price-sensitive Group’s treasury operations, its information technology announcements. A summary of the Directors’ responsibilities systems and the threat to the Group’s business posed by for the financial statements and their statement concerning illicit trade, and reviewed the specific controls in place relevant audit information is included in the Directors’ within the Group to address such risks. It has satisfied Report on page 50. The Directors’ statement that it is itself by means of these steps that proper and satisfactory appropriate to continue to adopt the going concern basis internal control systems remain in place to identify and in preparing the accounts is set out in the Directors’ Report, contain business risks, and that the Company’s business, also on page 50. and that of its subsidiaries, is being conducted in a proper and economically sound manner. Audit Committee The Board’s obligation to establish formal and transparent The Audit Committee made recommendations to the OPRT OENNESTATEMENT GOVERNANCE CORPORATE arrangements for considering how it should apply Board on the reappointment, for approval by shareholders, financial reporting and internal control principles, and of the Company’s external auditors and approved their fees for maintaining an appropriate relationship with the and terms of engagement. It continued to keep under Company’s external auditors, PricewaterhouseCoopers LLP, review the consistency of accounting policies applied is met through the Audit Committee. across the Group. The Committee has established a policy on the appointment of the auditors to perform non-audit The Audit Committee is chaired by Robert Lerwill and services for the Group over and above the external audit comprises five other independent Non-Executive Directors and keeps this issue under continual review. It remains – Kenneth Clarke, Ana Maria Llopis, Rupert Pennant-Rea, confident that the objectivity and independence of the Anthony Ruys and Sir Nicholas Scheele. Robert Lerwill auditors are not in any way impaired by reason of this has recent and relevant financial experience. The Chief further work. Moreover, the Committee is satisfied that Operating Officer, Finance Director, Head of Audit and such work is best handled by them, either because of Business Risk and a representative of the external auditors their knowledge of the Group or because they have been regularly attend meetings of the Committee. As a matter awarded it through a competitive tendering process. of best practice, the Committee meets alone with the A breakdown of non-audit fees charged by the auditors external auditors at the end of its meetings. is disclosed on page 88 in note 3(d). The Committee is authorised by the Board to review any The Group’s whistleblowing policy and procedures enable activity within the business. It is authorised to seek any staff, in confidence, to raise concerns about possible information it requires from, and require the attendance improprieties in financial and other matters and to do so at any of its meetings of, any Director or member of without fear of reprisal, provided that such concerns are management, and all employees are expected to not raised in bad faith. Details of this policy are set out cooperate with any request made by the Committee. in the Company’s Standards of Business Conduct. The The Committee is authorised by the Board to obtain, WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 71

policy is supplemented by local procedures in a number management, along with internal audit, supports the of markets and in the Group’s London headquarters, Board in its role of ensuring a sound control environment. which provide staff with additional guidance and enable Annually, at the year end, each operating company them to report matters in a language with which they within the Group is required to review its system of are comfortable. The Audit Committee remains satisfied

internal control, confirm whether it remains effective GROUP TOBACCO AMERICAN BRITISH that the policy and the procedures in place incorporate and report on any material issues arising in this regard. arrangements for the proportionate and independent In addition, each operating company and all functions investigation of matters raised and for appropriate within the Group’s UK headquarters are required to follow-up action. review and confirm compliance with the Standards of Internal control Business Conduct and identify any material instances of The Board is responsible for the overall system of internal non-compliance or conflicts of interest identified. The control for the Company and its subsidiaries and for results of these reviews are reported to the relevant regional reviewing the effectiveness of the system. It carries out audit committee and, where appropriate, to the Board’s such a review at least annually, covering all material Audit Committee to ensure that appropriate remedial controls including financial, operational and compliance action has been, or will be, taken where necessary. controls and risk management systems, and reports to The Turnbull Guidance sets out best practice on internal shareholders that it has done so. control for UK listed companies to assist them in assessing The Company maintains a sound system of internal control the application of the Code’s principles and compliance with a view to safeguarding shareholders’ investment and with the Code’s provisions with regard to internal control. the Company’s assets. It is designed to manage risks that This Guidance was updated by the Financial Reporting may impede the achievement of the Company’s business Council in October 2005, and the updated Guidance objectives rather than to eliminate these risks and can applies to listed companies for financial years beginning therefore provide only reasonable, not absolute, assurance on or after 1 January 2006. The Board, with advice from against material misstatement or loss. A description of its Audit Committee, has completed its annual review of the key risk factors that may affect the Group’s business the effectiveness of the system of internal control for the is provided in the Operating and Financial Review on period since 1 January 2006 in accordance with the updated pages 30 to 32 of the Annual Review. Turnbull Guidance, and is satisfied that this system is in accordance with that Guidance and that it has been in The Group uses audit committees at regional, area and end

place throughout the year under review and up to date. STATEMENT GOVERNANCE CORPORATE market levels to support the Audit Committee in monitoring risks and control. This framework provides a continuing Relations with shareholders process for identifying, evaluating and managing the The Board maintains a dialogue with shareholders significant risks faced by the Company and its subsidiaries. directed towards ensuring a mutual understanding The framework is designed to capture and evaluate failings of objectives. Its primary contact with shareholders is and weaknesses and, in the case of any categorised by the through the Chief Executive and Finance Director, but Board as significant, procedures are in place to ensure that the Chairman and Chief Operating Officer also maintain appropriate remedial action is taken. It does not apply in contact with major shareholders in order to understand respect of the Group’s associate undertakings. The process their issues and concerns. Where appropriate, major is regularly reviewed by the Board. The Group’s regional institutional shareholders are consulted on significant audit committees (which are all chaired by an Executive changes to the structure of the Directors’ remuneration. Director) focus on risks and the control environment within For example, in 2006, the Remuneration Committee’s each region and are in turn supported by end market or proposals to introduce a new long term incentive plan area audit committees. The regional audit committees’ were the subject of detailed consultation with a number reviews include consideration of the effectiveness of the of institutional investors. process for identifying, evaluating and managing the risks At least twice a year, the Head of Investor Relations of the business and the assessments of internal control presents a report to the Board on the issues considered and business risks completed by operating companies. at meetings between the Company and institutional The relevant external and internal auditors regularly shareholders. In addition, the Board receives regular attend meetings of all audit committees and have private reports on developments concerning the holdings of the audiences with members of the audit committees at least Company’s main institutional shareholders. once each year. In addition, regional and end market WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 72 British American Tobacco Directors’ Report and Accounts 2006

CORPORATE GOVERNANCE STATEMENT CONTINUED

The Annual General Meeting is the principal opportunity The focus for CSR governance this year is to further for the Board to meet a wide range of investors and for integrate the structural elements of CSR into the business, the Chairman to explain the Company’s progress and and regional CSR committees will be reviewing alignment receive questions from its owners, the shareholders. At the with the CSR key control checklist, first used in 2006. Annual General Meeting on 26 April 2007, the Company

RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH The Company was selected for the 2007 Dow Jones will again, in accordance with the Myners Report and best Sustainability World Index (DJSI World) and its European practice, provide for the vote on each resolution to be equivalent, DJSI STOXX, our fifth year of inclusion. British by poll, using its Registrar’s electronic voting system, American Tobacco (Malaysia) Berhad was also reselected rather than by show of hands. This provides for greater for the 2007 DJSI World. British American Tobacco was transparency and allows the votes of all shareholders to be ranked among the UK’s top 40 most responsible companies counted, including those cast by proxy. The voting results in the 2006 Corporate Responsibility Index run by Business are announced on the same day through the Regulatory in the Community (BiTC), the 700 member organisation News Service and on the Company’s bat.com website. established in the UK to help business improve its positive Corporate Social Responsibility impact on society. The Company was rated first in its The Corporate Social Responsibility (CSR) Committee sector and included in the BiTC’s ‘premier league’ for supports the Company’s commitment to social and environmental performance. environmental issues. It is chaired by Kenneth Clarke, its American Depositary Receipts other members being all of the Non-Executive Directors. The Company has unlisted trading privileges for its The Executive Directors attend meetings by invitation but American Depositary Receipts (ADRs) on the American are not members. The Committee’s role is to help identify Stock Exchange. None of its securities are listed on any and assess, with management, those significant social, United States securities exchange or registered pursuant environmental and reputational risks that might impair to the securities laws of the United States. As a result, the the Company’s strategic objective to be recognised as Company is subject to neither the American Stock Exchange a responsible company in a controversial industry. The listing standards nor the corporate governance rules under Committee also evaluates the adequacy of the Company’s the Sarbanes-Oxley Act of 2002. Nevertheless, the Board policies in this area and makes recommendations for change. has chosen, in the interests of good governance, to make The Company’s Social Report issued in July 2006 a voluntary statement explaining the principal differences details the Company’s social, ethical and environmental and common areas between the Company’s corporate

OPRT OENNESTATEMENT GOVERNANCE CORPORATE performance in 2005, and also provides a retrospective governance practices (as explained above) and those analysis of performance against all commitments made that would be required if the Company were subject in social reports since the first report was published in to those rules. The updated statement will be available 2002. Copies of the report are available on request and on the corporate governance section of our website at through the Company’s bat.com website. A summary bat.com from the date of publication of the Directors’ report of social, ethical and environmental performance Report and Accounts. against actions identified for 2006 will be issued later Compliance this year. Group companies in 32 countries are engaged The Board considers that this Statement on governance in social reporting and others covering 10 countries provides the information necessary to enable shareholders are holding dialogue and reporting on a key issue. All to evaluate how the Principles of the Code have been of the Group’s Social Reports continue to be measured, applied. The Company has either complied with the through rigorous independent review, against the AA1000 Provisions of the Code throughout the year or else a full Standard and the latest AA1000 Assurance Standard is explanation (in the case of the continuing appointment of being incrementally applied. Rupert Pennant-Rea) has been provided in this Statement The principles of CSR continue to be strongly embedded where it has not. The Board therefore considers that the in the Group, with the governance dimension being Company has satisfied its obligations under the Code. provided by local and regional CSR committees, overseen In the interests of further transparency, we have also by the CSR Committee. Stakeholder engagement continues prepared a report which summarises the matters to be very active. As an example, a dialogue on responsible addressed in this Statement, as appropriate, by reference product stewardship and harm reduction was held under to each Principle and Provision of the Code. The updated the auspices of the University of Stellenbosch in South Africa report will be available on the corporate governance in March 2006. The Company has also initiated social section of our bat.com website from the date of reporting dialogue with European Union stakeholders and a publication of the Directors’ Report and Accounts. report reflecting the dialogue will be published in due course. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 73

REPORT OF THE INDEPENDENT AUDITORS TO THE MEMBERS OF BRITISH AMERICAN TOBACCO P.L.C.

We have audited the Group Financial Statements of British of the Combined Code 2003 specified for our review by American Tobacco p.l.c. for the year ended 31 December the Listing Rules of the Financial Services Authority, and 2006 which comprise the Group income statement, the we report if it does not. We are not required to consider Group statement of changes in total equity, the Group whether the Board’s statements on internal control cover balance sheet, the Group cash flow statement, and the all risks and controls, or form an opinion on the effectiveness related notes including the principal subsidiary undertakings of the Group’s corporate governance procedures or its risk GROUP TOBACCO AMERICAN BRITISH and the principal associate undertakings. These Group and control procedures. financial statements have been prepared under the accounting policies set out therein. We read other information contained in the Annual Report and Accounts and consider whether it is consistent with the We have reported separately on the parent Company audited Group Financial Statements. The other information financial statements of British American Tobacco p.l.c. for comprises only the Annual Review, the Directors’ Report, the year ended 31 December 2006 and on the information the Remuneration Report, the Corporate Governance in the Remuneration Report that is described as having Statement, the five year summary, the quarterly analyses been audited. of profit and the parent company Financial Statements. Respective responsibilities of Directors and auditors We consider the implications for our report if we become The Directors’ responsibilities for preparing the Annual aware of any apparent misstatements or material Report and Accounts, including the Group financial inconsistencies with the Group Financial Statements. Our statements, in accordance with applicable law and responsibilities do not extend to any other information. International Financial Reporting Standards (IFRSs) Basis of audit opinion as adopted by the European Union, are set out in the We conducted our audit in accordance with International statement of Directors’ responsibility in relation to the Standards on Auditing (UK and Ireland) issued by the Financial Statements, included in the Directors’ Report. Auditing Practices Board. An audit includes examination, Our responsibility is to audit the Group Financial on a test basis, of evidence relevant to the amounts and Statements in accordance with relevant legal and disclosures in the Group Financial Statements. It also includes regulatory requirements and International Standards an assessment of the significant estimates and judgements on Auditing (UK and Ireland). This report, including made by the Directors in the preparation of the Group the opinion, has been prepared for and only for the Financial Statements, and of whether the accounting Company’s members as a body in accordance with policies are appropriate to the Group’s circumstances, Section 235 of the Companies Act 1985 and for no consistently applied and adequately disclosed. EOTO H NEEDN AUDITORS INDEPENDENT THE OF REPORT other purpose. We do not, in giving this opinion, accept We planned and performed our audit so as to obtain all or assume responsibility for any other purpose or to any the information and explanations which we considered other person to whom this report is shown or into whose necessary in order to provide us with sufficient evidence hands it may come, save where expressly agreed by our to give reasonable assurance that the Group Financial prior consent in writing. Statements are free from material misstatement, whether caused by fraud or other irregularity or error. In forming We report to you our opinion as to whether the Group our opinion, we also evaluated the overall adequacy of the Financial Statements give a true and fair view and whether presentation of information in the Group Financial Statements. the Group Financial Statements have been properly prepared in accordance with the Companies Act 1985 and Article 4 Opinion of the IAS Regulation. We also report to you whether, in In our opinion our opinion, the information given in the Directors’ Report • the Group Financial Statements give a true and fair view, in is consistent with the Group Financial Statements. The accordance with IFRSs as adopted by the European Union, information given in the Directors’ Report includes that of the state of the Group’s affairs as at 31 December 2006 specific information presented in the Operating and and of its profit and cash flows for the year then ended; Financial Review that is cross referred from the Business • the Group Financial Statements have been properly review section of the Directors’ Report. prepared in accordance with the Companies Act 1985 and Article 4 of the IAS Regulation; and In addition, we report to you if, in our opinion, we have • the information given in the Directors’ Report is consistent not received all the information and explanations we with the Group Financial Statements. require for our audit, or if information specified by law regarding Directors’ remuneration and other transactions PricewaterhouseCoopers LLP is not disclosed. Chartered Accountants and Registered Auditors 1 Embankment Place, London We review whether the Corporate Governance Statement reflects the Company’s compliance with the nine provisions 1 March 2007 WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 74 British American Tobacco Directors’ Report and Accounts 2006

GROUP INCOME STATEMENT FOR THE YEAR ENDED 31 DECEMBER

2006 2005 restated Notes £m £m Gross turnover (including duty, excise and other taxes of £15,427 million (2005: £14,659 million)) 25,189 23,984

RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH Revenue 2 9,762 9,325 Raw materials and consumables used (2,861) (2,760) Changes in inventories of finished goods and work in progress (11) (2) Employee benefit costs 3a (1,554) (1,557) Depreciation and amortisation costs 3b (401) (383) Other operating income 3c 181 179 Other operating expenses 3d (2,494) (2,382)

Profit from operations 2 2,622 2,420 after (charging)/crediting – restructuring costs 3e (216) (271) – (losses)/gains on disposal of a business, brands and joint venture 3f 41 72 Finance income 110 118 Finance costs (399) (346)

Net finance costs 4 (289) (228) Share of post-tax results of associates and joint ventures 5 431 392 after (charging)/crediting – restructuring costs 5 (13) – US Federal tobacco buy-out 5 (12) – brand impairments 5 (13) (29) – exceptional tax credits and other impairments 5 17 57 Profit before taxation 2,764 2,584 Taxation on ordinary activities 6 (716) (690) RU NOESTATEMENT INCOME GROUP Profit for the year 2,048 1,894

Attributable to: Shareholders’ equity 1,896 1,767

Minority interests 152 127

Earnings per share Basic 7 92.08p 84.34p

Diluted 7 91.33p 83.66p

All of the activities during both years are in respect of continuing operations. The effect of changes in the Group is given in note 26. Prior year results have been restated in accordance with the amendment to IAS21 as detailed in note 4. Notes are shown on pages 78 to 136 and pages 140 to 142. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 75

GROUP STATEMENT OF CHANGES IN TOTAL EQUITY FOR THE YEAR ENDED 31 DECEMBER

2006 2005 restated Notes £m £m Differences on exchange (685) 425 Cash flow hedges

– net fair value gains 13 17 GROUP TOBACCO AMERICAN BRITISH – reclassified and reported in net profit (15) 38 – reclassified as basis adjustments 3 Available-for-sale investments – net fair value losses (2) (1) – reclassified and reported in net profit 1 Net investment hedges – net fair value gains/(losses) 117 (52) Tax on items recognised directly in equity 6c (12) (41) Net (losses)/gains recognised directly in equity (584) 390 Profit for the year page 74 2,048 1,894 Total recognised income for the year 1,464 2,284 – shareholders’ equity 1,334 2,128 – minority interests 130 156 Employee share options – value of employee services 27 41 42 – proceeds from shares issued 28 30 Dividends and other appropriations – ordinary shares 8 (1,008) (910) – to minority interests (137) (112) Purchase of own shares – held in employee share ownership trusts (77) (48) – share buy-back programme (500) (501)

Acquisition of minority interests (13) EQUITY TOTAL IN CHANGES OF STATEMENT GROUP Other movements 13 17 (189) 802

Balance 1 January 20 6,877 6,117 Change in accounting policy 24 (42) 6,877 6,075

Balance 31 December 20 6,688 6,877

The decrease in total equity of £189 million (2005: £802 million increase) comprised £169 million decrease (2005: £754 million increase) in respect of shareholders’ funds and £20 million decrease (2005: £48 million increase) in respect of minority interests. The £42 million charge in the prior year for the change in accounting policy (page 120 note 24) comprised £44 million for the retained earnings and £26 million for hedging reserves less £16 million for available-for-sale reserves, £1 million of which is in respect of minority interests, and £12 million for translation reserves. The change to the translation reserve and to retained earnings (page 112 note 20) due to the amendment to IAS21 as detailed in note 4 was £3 million at 31 December 2005. Differences on exchange for 2005 have been restated by £4 million, with a corresponding change in net finance costs and consequently profit for the year as shown above. Notes are shown on pages 78 to 136 and pages 140 to 142. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 76 British American Tobacco Directors’ Report and Accounts 2006

GROUP BALANCE SHEET AT 31 DECEMBER

2006 2005 restated Notes £m £m Assets Non-current assets Intangible assets 9 7,476 7,987 RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH Property, plant and equipment 10 2,207 2,331 Investments in associates and joint ventures 11 2,108 2,193 Retirement benefit assets 12 29 35 Deferred tax assets 13 273 290 Trade and other receivables 14 192 197 Available-for-sale investments 15 24 27 Derivative financial instruments 16 76 87 Total non-current assets 12,385 13,147 Current assets Inventories 17 2,056 2,274 Income tax receivable 18 59 81 Trade and other receivables 14 1,568 1,577 Available-for-sale investments 15 128 96 Derivative financial instruments 16 124 86 Cash and cash equivalents 19 1,456 1,790 Total current assets 5,391 5,904 Total assets 17,776 19,051 Equity Capital and reserves Share capital 517 524 Share premium, capital redemption and merger reserves 3,886 3,874 Other reserves 419 981 Retained earnings 1,639 1,251 Shareholders’ funds 6,461 6,630 after deducting RU AAC SHEET BALANCE GROUP – cost of own shares held in employee share ownership trusts (197) (182) Minority interests 227 247 Total equity 20 6,688 6,877 Liabilities Non-current liabilities Borrowings 21 5,568 5,058 Retirement benefit liabilities 12 435 543 Deferred tax liabilities 13 296 277 Other provisions for liabilities and charges 22 161 261 Trade and other payables 23 146 180 Derivative financial instruments 16 29 19 Total non-current liabilities 6,635 6,338 Current liabilities Borrowings 21 1,058 2,202 Income tax payable 18 292 374 Other provisions for liabilities and charges 22 253 234 Trade and other payables 23 2,766 2,883 Derivative financial instruments 16 84 143 Total current liabilities 4,453 5,836 Total equity and liabilities 17,776 19,051 On behalf of the Board Jan du Plessis, Chairman 1 March 2007 Notes are shown on pages 78 to 136 and pages 140 to 142. The prior year balance sheet has been restated in accordance with the amendment to IAS21 as detailed in note 4 and IFRIC Interpretation 4 as detailed in note 10. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 77

GROUP CASH FLOW STATEMENT FOR THE YEAR ENDED 31 DECEMBER

2006 2005 Notes £m £m Cash flows from operating activities Cash generated from operations 25 2,816 2,893 Dividends received from associates 259 193 Tax paid (713) (762) GROUP TOBACCO AMERICAN BRITISH Net cash from operating activities 2,362 2,324 Cash flows from investing activities Interest received 119 109 Dividends received from investments 2 1 Purchases of property, plant and equipment (425) (381) Proceeds on disposal of property, plant and equipment 64 41 Purchases of intangibles (58) (38) Proceeds on disposal of intangibles 25 60 74 Purchases and disposals of investments 25 (37) 22 Purchases of subsidiaries and minority interests 25 (101) (25) Proceeds on disposal of subsidiaries 25 62 Purchases of associates 25 (1) (95) Net cash from investing activities (315) (292) Cash flows from financing activities Interest paid (389) (371) Interest element of finance lease rental payments (3) (4) Capital element of finance lease rental payments (19) (41) Proceeds from issue of shares to Group shareholders 5 6 Proceeds from the exercise of options over own shares held in employee share ownership trusts 23 24 Proceeds from increases in and new borrowings 25 1,365 742 Movements relating to derivative financial instruments 25 142 (33)

Purchases of own shares (500) (501) STATEMENT FLOW CASH GROUP Purchases of own shares to be held in employee share ownership trusts (77) (48) Reductions in and repayments of borrowings 25 (1,739) (878) Dividends paid to shareholders 8 (1,008) (910) Dividends paid to minority interests (139) (133) Net cash from financing activities (2,339) (2,147) Net cash flows from operating, investing and financing activities (292) (115) Differences on exchange (96) 49 Decrease in net cash and cash equivalents in the year (388) (66) Net cash and cash equivalents at 1 January 1,664 1,730

Net cash and cash equivalents at 31 December 19 1,276 1,664

Notes are shown on pages 78 to 136 and pages 140 to 142. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 78 British American Tobacco Directors’ Report and Accounts 2006

NOTES ON THE ACCOUNTS

1 Accounting policies the Financial Statements as the original estimates and Basis of Accounting assumptions are modified, as appropriate, in the year The Group accounts have been prepared in accordance in which the circumstances change. with International Financial Reporting Standards (IFRS) Basis of consolidation as adopted by the European Union and with those parts RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH The consolidated financial information includes the of the Companies Act 1985 applicable to companies accounts of British American Tobacco p.l.c. and its reporting under IFRS. subsidiary undertakings, together with the Group’s The 2005 Financial Statements were the Group’s first share of the results of its associates and joint ventures. consolidated Financial Statements prepared under IFRS, A subsidiary is an entity controlled by the Group, with a transition date of 1 January 2004. However, as where control is the power to govern the financial permitted under IFRS, IAS32 and IAS39 on financial and operating policies of the entity so as to obtain instruments were applied from 1 January 2005. benefit from its activities. The Financial Statements have been prepared under Associates and joint ventures comprise investments the historical cost convention except as described in in undertakings, which are not subsidiary undertakings, the accounting policy below on financial instruments. where the Group’s interest in the equity capital is long The preparation of the Group accounts requires term and over whose operating and financial policies the management to make estimates and assumptions that Group exercises a significant influence and, in the case affect the reported amounts of revenues, expenses, assets of joint ventures, has joint control. They are accounted and liabilities, and the disclosure of contingent liabilities for using the equity method. at the date of the Financial Statements. The key estimates The results of Group undertakings acquired during and assumptions are set out in the accounting policies the period are included from the date of acquisition below, together with the related notes to the accounts. of a controlling interest at which date, for the purposes The most significant items include: of consolidation, the purchase consideration is allocated between the underlying net assets acquired, including • the exemptions taken under IFRS1 on the first time intangible assets other than goodwill, on the basis of adoption of IFRS at 1 January 2004 and, in particular, their fair value. those relating to retirement benefit costs and goodwill on business combinations; The results of Group undertakings which have been sold OE NTEACCOUNTS THE ON NOTES during the year are included up to the date of disposal. The • the review of asset values, especially goodwill, and profit or loss on sale is calculated by reference to the net impairment testing; asset value at the date of disposal, adjusted for purchased • estimation of and accounting for retirement benefit costs; goodwill previously consolidated in the balance sheet. • estimation of provisions including taxation; and Where accumulated losses applicable to a minority exceed the minority’s interest in the equity of a subsidiary, • definitions of exceptional items and adjusted earnings. the excess is allocated to the Group’s interest in the Such estimates and assumptions are based on historical subsidiary, except to the extent that the minority has experience and various other factors that are believed a binding obligation and is able to make an additional to be reasonable in the circumstances and constitute investment to cover the losses. management’s best judgement at the date of the Financial Inter company balances and transactions, and any unrealised Statements. In the future, actual experience may deviate gains arising from inter company transactions, are eliminated from these estimates and assumptions, which could affect in preparing the consolidated Financial Statements. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 79

Goodwill any differences prior to that date are not included in Goodwill arising on acquisitions is capitalised and is this separate component of equity. On the disposal of an considered to have an indefinite life subject to impairment overseas undertaking, the cumulative amount of the related reviews. Goodwill represents the excess of the cost of exchange differences deferred in the separate component acquisition of a subsidiary, associate or joint venture of equity are recognised in the income statement when over the Group’s share of the fair value of identifiable the gain or loss on disposal is recognised. GROUP TOBACCO AMERICAN BRITISH net assets acquired. Goodwill is stated at cost less Foreign currency transactions are initially recorded at the accumulated impairment losses and amortisation exchange rate ruling at the date of the transaction. Foreign prior to 1 January 2004. exchange gains and losses resulting from the settlement The Group’s policy up to and including 1997 was to of such transactions and from the translation of foreign eliminate goodwill against reserves. Goodwill acquired currency assets and liabilities at year end rates of exchange from 1998 to 31 December 2003 was capitalised and are recognised in the income statement, except when amortised over its useful economic life. As permitted deferred in equity as qualifying cash flow hedges, qualifying under IFRS1, in respect of acquisitions prior to 1 January net investment hedges and on inter company quasi-equity 2004, the classification and accounting treatment of loans. Foreign exchange gains or losses recognised in the business combinations was not amended on transition income statement are included in profit from operations or to IFRS. Goodwill previously written off direct to reserves net finance costs depending on the underlying transactions is not recycled to the income statement on the disposal that gave rise to these exchange differences. of the subsidiary or associate to which it relates. Revenue Goodwill in respect of subsidiaries is included in intangible Revenue principally comprises sales of cigarettes, cigars, assets. In respect of associates, goodwill is included in the leaf and other tobacco products to external customers. carrying value of the investment in the associated company. Revenue excludes duty, excise and other taxes and is after deducting rebates, returns and other similar discounts. Foreign currencies Revenue is recognised when the significant risks and The income and cash flow statements of Group rewards of ownership are transferred to a third party. undertakings expressed in currencies other than sterling are translated to sterling at average rates of exchange in Retirement benefit costs each year, provided that the average rate approximates The Group operates both defined benefit and defined the exchange rate at the date of the underlying transactions. contribution schemes. The net deficit or surplus for Assets and liabilities of these undertakings are translated at each defined benefit pension scheme is calculated in ACCOUNTS THE ON NOTES rates of exchange at the end of each year. For high inflation accordance with IAS19, based on the present value of countries, the translation from local currencies to sterling the defined benefit obligation at the balance sheet date, makes allowance for the impact of inflation on the local less the fair value of the scheme assets. currency results. As permitted under IFRS1, all actuarial gains and losses The differences between retained profits of overseas as at 1 January 2004, the date of transition to IFRS, were subsidiary and associated undertakings translated at recognised. In respect of actuarial gains and losses that average and closing rates of exchange are taken to arise subsequent to that date, to the extent that cumulatively reserves, as are differences arising on the retranslation they exceed 10 per cent of the greater of the present to sterling (using closing rates of exchange) of overseas value of the defined benefit obligation and the fair value net assets at the beginning of the year. Any differences of the scheme assets, that portion is recognised in the that have arisen since 1 January 2004 are presented as a income statement over the expected average remaining separate component of equity. As permitted under IFRS1, working lives of the employees participating in the plan. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 80 British American Tobacco Directors’ Report and Accounts 2006

NOTES ON THE ACCOUNTS CONTINUED

1 Accounting policies continued Fair value is measured by the use of the Black-Scholes Otherwise, the accumulated actuarial gains and losses option pricing model, except where vesting is dependent are not recognised, except where there are unrecognised on market conditions, when the Monte Carlo option pricing scheme surpluses. In such instances, the actuarial gains model is used. The expected life used in the models has and losses are recognised as they occur. been adjusted, based on management’s best estimate, RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH for the effects of non-transferability, exercise restrictions Where the actuarial valuation of the scheme demonstrates and behavioural considerations. that the scheme is in surplus, the recognised asset is limited to that for which the Group expects to benefit in future, Research and development for example by refunds or a reduction in contributions. Research expenditure is charged to income in the year in which it is incurred. Development expenditure is charged Past service costs resulting from enhanced benefits are to income in the year it is incurred, unless it meets the expensed over the period to vesting and if they vest recognition criteria of IAS38 Intangible Assets. immediately, then they are recognised at that time in the income statement. Taxation Taxation is that chargeable on the profits for the period, The Group also has certain post-retirement healthcare together with deferred taxation. schemes and they are accounted for on a similar basis to the defined benefit pension schemes. Deferred taxation is provided in full using the liability method for temporary differences between the carrying For defined benefit schemes, the actuarial cost charged amount of assets and liabilities for financial reporting to profit from operations consists of current service cost, purposes and the amount used for taxation purposes. interest cost, expected return on plan assets, past service Deferred tax is provided on temporary differences arising cost and the impact of any settlements or curtailments, on investments in Group undertakings, except where as well as actuarial gains or losses to the extent they are the timing of the reversal of the temporary difference is recognised, and changes in unrecognised scheme surpluses. controlled by the Group and it is probable that it will Some benefits are provided through defined contribution not reverse in the foreseeable future. A deferred tax asset schemes and payments to these are charged as an expense is recognised only to the extent that it is probable that as they fall due. future taxable profits will be available against which the asset can be utilised. As required under IAS12, deferred Share-based payments tax assets and liabilities are not discounted.

OE NTEACCOUNTS THE ON NOTES The Group has equity-settled and cash-settled share-based compensation plans. Deferred tax is determined using the tax rates that have been enacted or substantively enacted by the balance Equity-settled share-based payments are measured at sheet date and are expected to apply when the related fair value at the date of grant. The fair value determined deferred tax asset is realised or deferred tax liability is settled. at the grant date of the equity-settled share-based payments is expensed over the vesting period, based Tax is recognised in the income statement except to the on the Group’s estimate of awards that will eventually extent that it relates to items recognised directly in equity, vest. For plans where vesting conditions are based on in which case it is recognised in equity. total shareholder returns, the fair value at date of grant Intangible assets other than goodwill reflects these conditions, whereas earnings per share These intangible assets shown on the Group balance sheet vesting conditions are reflected in the calculation of consist mainly of computer software which is carried at awards that will eventually vest over the vesting period. cost less accumulated amortisation and impairment, and For cash-settled share-based payments, a liability equal is amortised on a straight-line basis over a period ranging to the portion of the services received is recognised at its from three to five years. current fair value determined at each balance sheet date. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 81

The investments in associates shown in the Group balance Where arrangements are entered into which, while they sheet include brand names arising from the combination are not in the legal form of a lease, are in substance a lease of Brown & Williamson (B&W) and R J Reynolds (RJR) under IFRIC Interpretation 4, then they are recognised on in 2004 to form Reynolds American Inc. (RAI), as well the same basis as the leased assets above. as those arising on the acquisition of Conwood by RAI in

Impairment of assets GROUP TOBACCO AMERICAN BRITISH 2006. As the combination of B&W and RJR for the Group Assets are reviewed for impairment whenever events involved the partial disposal of B&W and an investment in indicate that the carrying amount of a cash-generating RAI, fair values were assigned to brands formerly owned by unit may not be recoverable. In addition, assets that have RJR but not to those formerly owned by B&W. Most of the indefinite useful lives are tested annually for impairment. carrying value of the brands relates to brands which are An impairment loss is recognised to the extent that the deemed to have indefinite lives and each brand is subject carrying value exceeds the higher of the asset’s fair value to an annual impairment test. Certain minor brands are less costs to sell and its value in use. being amortised over their remaining lives consistent with the pattern of economic benefits expected to be received. A cash-generating unit is the smallest identifiable group Any impairments of brands are recognised in the income of assets that generates cash flows which are largely statement but increases in brand values are not recognised. independent of the cash flows from other assets or groups of assets. At the acquisition date, any goodwill Property, plant and equipment acquired is allocated to the relevant cash-generating Property, plant and equipment is stated at cost less unit or group of cash-generating units expected to accumulated depreciation and impairment. Depreciation benefit from the acquisition for the purpose of is calculated on a straight-line basis to write off the impairment testing of goodwill. assets over their useful economic life. No depreciation is provided on freehold land. Freehold and long leasehold Inventories property are depreciated at rates between 2.5 per cent Inventories are stated at the lower of cost and net and 4 per cent per annum, and plant and equipment at realisable value. Cost is based on the average cost rates between 7 per cent and 25 per cent per annum. In incurred in acquiring inventories and bringing them accordance with the benchmark treatment under IAS23, to their existing location and condition, which will borrowing costs associated with expenditure on property, include raw materials, direct labour and overheads, plant and equipment are not capitalised. where appropriate. Net realisable value is the estimated selling price less costs to completion and sale. Tobacco

Leased assets ACCOUNTS THE ON NOTES inventories which have an operating cycle that exceeds Assets held under finance leases are included as part 12 months are classified as current assets, consistent of property, plant and equipment. Finance lease assets with recognised industry practice. are initially recognised at an amount equal to the lower of their fair value and the present value of the minimum Financial instruments lease payments at inception of the lease, then depreciated Financial assets and financial liabilities are recognised over the shorter of the lease term and their estimated useful when the Group becomes a party to the contractual lives. Leasing payments consist of capital and finance charge provisions of the relevant instrument and derecognised elements and the finance element is charged to the when it ceases to be a party to such provisions. Such income statement. assets and liabilities are classified as current if they are expected to be realised or settled within 12 months after Rental payments under operating leases are charged to the balance sheet date or if they are derivative financial the income statement on a straight-line basis over the instruments not designated as hedges in accordance lease term. with IAS39. If not, they are classified as non-current. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 82 British American Tobacco Directors’ Report and Accounts 2006

NOTES ON THE ACCOUNTS CONTINUED

1 Accounting policies continued and recognised in the income statement in the same Non-derivative financial assets are classified as either periods as the hedged item. Where the underlying available-for-sale investments, loans and receivables or transaction does not result in such an asset, the cash and cash equivalents. Apart from available-for-sale accumulated gains and losses are immediately recognised investments, they are stated at amortised cost using in the income statement; RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH the effective interest method, subject to reduction for • for derivatives that are designated as fair value hedges, allowances for estimated irrecoverable amounts. For the carrying value of the hedged item is adjusted for the interest-bearing assets, their carrying value includes fair value changes attributable to the risk being hedged, accrued interest receivable. with the corresponding entry being made in the income Available-for-sale investments are stated at fair value, with statement. The changes in fair value of these derivatives changes in fair value being recognised directly in equity. are also recognised in the income statement; When such investments are derecognised (e.g. through • for derivatives that are designated as hedges of net disposal) or become impaired, the accumulated gains and investments in foreign operations, the changes in losses, previously recognised in equity, are recognised in their fair values are recognised directly in equity, to the income statement. the extent that they are effective, with the ineffective Cash and cash equivalents include cash in hand and portion being recognised in the income statement. deposits held on call, together with other short term Where non-derivatives such as foreign currency borrowings highly liquid investments. Cash equivalents normally are designated as net investment hedges, the relevant comprise instruments with maturities of three months or exchange differences are similarly recognised. The less at date of acquisition. In the cash flow statement, cash accumulated gains and losses are recognised in the and cash equivalents are shown net of bank overdrafts, income statement when the foreign operation is which are included as current borrowings in the liabilities disposed of; and on the balance sheet. • for derivatives that do not qualify for hedge accounting Non-derivative financial liabilities are stated at amortised or are not designated as hedges, the changes in their cost using the effective interest method. For borrowings, fair values are recognised in the income statement in their carrying value includes accrued interest payable, as the period in which they arise. well as unamortised issue costs. Hedge accounting is discontinued when a hedging

OE NTEACCOUNTS THE ON NOTES Derivative financial assets and liabilities are stated at fair instrument is derecognised (e.g. through expiry or value, which includes accrued interest receivable and disposal), or no longer qualifies for hedge accounting. payable where relevant. Changes in their fair values are Where the hedged item is a highly probable forecast recognised as follows: transaction, the related gains and losses remain in equity until the transaction takes place, when they are removed • for derivatives that are designated as cash flow from equity in the same manner as for cash flow hedges hedges, the changes in their fair values are recognised as described above. When a hedged future transaction is directly in equity, to the extent that they are effective, no longer expected to occur, any related gains and losses, with the ineffective portion being recognised in the previously recognised in equity, are immediately recognised income statement. Where the hedged item results in in the income statement. a non-financial asset, the accumulated gains and losses, previously recognised in equity, are included in the Derivative fair value changes recognised in the income initial carrying value of the asset (basis adjustment) statement are either reflected in arriving at profit from WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 83

operations (if the hedged item is similarly reflected) or Provisions in finance costs. Provisions are recognised when either a legal or constructive obligation as a result of a past event exists at Dividends the balance sheet date, it is probable that an outflow of Final dividend distributions to the Company’s shareholders economic resources will be required to settle the are recognised as a liability in the Group’s financial GROUP TOBACCO AMERICAN BRITISH obligation and a reasonable estimate can be made of the statements in the period in which the dividends are amount of the obligation. approved by the Company’s shareholders at the Annual General Meeting, while interim dividend distributions Contingent liabilities are recognised in the period in which the dividends are Subsidiaries and associate companies are defendants declared and paid. in tobacco-related litigation. Provision for this litigation would be made at such time as an unfavourable outcome Segmental analysis became probable and the amount could be reasonably A segment is a distinguishable component of the Group estimated. that is engaged in providing products or services within a particular economic environment, and the Group’s The Group records its external legal fees and other external geographical segments form the focus of the Group’s defence costs for tobacco-related litigation as these costs internal reporting systems. The Group is a single product fall due. business providing cigarettes and other tobacco products. Repurchase of share capital While the Group has clearly differentiated brands, global When share capital is repurchased the amount of segmentation between a wide portfolio of brands is not consideration paid, including directly attributable costs, part of the regular internally reported financial information. is recognised as a deduction from equity. Repurchased It is not feasible to segment global results by brand shares which are not cancelled, or shares purchased for the without a high degree of estimation, especially given that employee share ownership trusts, are classified as treasury geographically the same operations are used to produce shares and presented as a deduction from total equity. the different brands, and brand results are managed in the context of the geographic markets in which they are sold. Future changes to accounting policies Certain changes to IFRS will be applicable for the Group The prices agreed between Group companies for accounts in future years. To the extent that the Group has intra-group sales of materials, manufactured goods, not adopted these early in the accounts to 31 December charges for royalties, commissions, services and fees,

2006, they will not affect the Group reported profit or ACCOUNTS THE ON NOTES are based on normal commercial practices which would equity but they will affect disclosures. apply between independent businesses. Royalty income, less related expenditure, is included in the region in The requirements, which have been endorsed by the which the licensor is based. EU, are effective from 1 January 2007 and are considered to affect the Group, relate to disclosures under IFRS7 Exceptional items Financial Instruments: disclosures and amendments to Exceptional items are items in the profit from operations IAS1 – Capital disclosures. In addition, IFRS8 Operating and the Group share of the post-tax results of associates Segments will be effective from 1 January 2009 if, as which individually or, if of a similar type, in aggregate, expected, it is endorsed by the EU. However, once endorsed, are relevant to an understanding of the Group’s financial it would be possible to adopt IFRS8 before 2009. performance. These items are separately disclosed as memorandum information on the face of the income statement and in the segmental analyses. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 84 British American Tobacco Directors’ Report and Accounts 2006

NOTES ON THE ACCOUNTS CONTINUED

2 Segmental analyses Segmental analyses of revenue, profit, assets and liabilities for the year ended 31 December: Europe Asia-Pacific 2006 2005 2006 2005

£m £m £m £m RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH Revenue External sales 3,495 3,456 1,755 1,646 Inter-segment sales 526 569 27 3 Revenue 4,021 4,025 1,782 1,649

Results Segment result before restructuring costs and (losses)/gains on disposal of a business, brands and joint venture 781 784 616 531 Restructuring costs (132) (160) (7) (14) (Losses)/gains on disposal of a business, brands and joint venture 27 72 Segmental result 676 696 609 517

Unallocated costs Profit from operations Net finance costs Share of post-tax results of associates and joint ventures Profit on ordinary activities before taxation Taxation on ordinary activities Profit for the year

Attributable to: Shareholders’ equity

OE NTEACCOUNTS THE ON NOTES Minority interests

Unallocated costs represent net corporate costs not directly attributable to individual segments. Other segment items Capital expenditure 232 199 59 69 Depreciation and amortisation 126 137 48 64 Impairment and accelerated depreciation 49 44 4 Assets Segment assets before goodwill 2,653 2,678 1,056 1,149 Goodwill 3,295 3,389 1,244 1,317 Segment assets including goodwill page 86 5,948 6,067 2,300 2,466 Investments in associates and joint ventures 203 206 394 382 Unallocated assets Total assets page 76

Liabilities Segment liabilities page 86 1,797 1,899 532 573 Unallocated liabilities Total liabilities page 76

The restructuring costs and (losses)/gains on disposal of a business, brands and joint venture are explained on pages 88 and89innote3. The impact of acquisitions made during the year is given on page 123 in note 26. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 85

Latin America Africa and Middle East America-Pacific Elimination Consolidated 2006 2005 2006 2005 2006 2005 2006 2005 2006 2005 restated restated £m £m £m £m £m £m £m £m £m £m RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH

1,780 1,541 1,063 964 1,090 1,108 9,183 8,715 2 4 24 34 579 610 1,782 1,545 1,087 998 1,090 1,108 9,762 9,325

611 530 468 434 424 436 2,900 2,715 (6) (24) (9) (53) (82) (216) (271) 14 41 72 611 524 444 425 385 354 2,725 2,516

(103) (96) 2,622 2,420 (289) (228) 431 392 2,764 2,584 (716) (690) 2,048 1,894

1,896 1,767

152 127 ACCOUNTS THE ON NOTES

102 78 69 68 51 50 513 464 64 59 39 30 35 35 312 325 2 3 1 37 7 89 58

1,191 1,165 1,004 1,104 560 676 (439) (324) 6,025 6,448 186 123 803 1,018 1,822 2,040 7,350 7,887 1,377 1,288 1,807 2,122 2,382 2,716 (439) (324) 13,375 14,335 2 2 10 8 1,499 1,595 2,108 2,193 2,293 2,523 17,776 19,051

564 568 546 472 580 725 (625) (510) 3,394 3,727 7,694 8,447 11,088 12,174

Segment assets and segment liabilities include inter company balances with entities reported as corporate liabilities and corporate assets on page 86. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 86 British American Tobacco Directors’ Report and Accounts 2006

NOTES ON THE ACCOUNTS CONTINUED

2 Segmental analyses continued (a) Segment revenue The segmental analysis of revenue is based on location of manufacture. Figures based on external sales by subsidiaries in each segment are as follows: 2006 2005

RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH £m £m Europe 3,545 3,497 Asia-Pacific 1,839 1,758 Latin America 1,791 1,555 Africa and Middle East 1,489 1,405 America-Pacific 1,098 1,110 Segment revenue pages 84 and 85 9,762 9,325

(b) Segment assets 2006 2005 restated £m £m Total assets page 76 17,776 19,051 Less – investments in associates and joint ventures 2,108 2,193 – available-for-sale investments note 15 152 123 – deferred tax assets 273 290 – interest receivable note 14 1 1 – income tax receivable 59 81 – dividends receivable from associates note 14 48 45 – derivatives in respect of net debt note 16 125 133 – loans 85 98 – cash equivalents note 19 972 1,272 – corporate assets 578 480 Segment assets pages 84 and 85 13,375 14,335 OE NTEACCOUNTS THE ON NOTES (c) Segment liabilities 2006 2005 restated £m £m Total current and non-current liabilities page 76 11,088 12,174 Less – borrowings note 21 6,626 7,260 – deferred tax liabilities 296 277 – derivatives in respect of net debt note 16 79 116 – dividends payable 4 8 – income tax payable 292 374 – interest payable note 23 12 17 – corporate liabilities 385 395 Segment liabilities pages 84 and 85 3,394 3,727 WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 87

2 Segmental analyses continued (d) Segmental analysis of the Group’s share of the revenue and post-tax results of associates and joint ventures External revenue 2006 2005 £m £m RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH Europe 771 642 Asia-Pacific 456 371 Latin America 1 1 Africa and Middle East 20 15 America-Pacific 1,942 1,927 3,190 2,956

Post-tax results Segment result Adjusted segment result* 2006 2005 2006 2005 £m £m £m £m Europe 46 39 46 39 Asia-Pacific 92 107 92 81 Africa and Middle East 4 2 4 2 America-Pacific 289 244 285 267 431 392 427 389 *Excluding restructuring costs, US Federal tobacco buy-out, brand impairments and exceptional tax credits and other impairments (page 90 note 5).

3 Profit from operations (a) Employee benefit costs 2006 2005 £m £m Wages and salaries 1,233 1,228 Social security costs 159 152 Other pension and retirement benefit costs page 98 note 12 112 123 ACCOUNTS THE ON NOTES Share-based payments page 124 note 27 50 54 1,554 1,557

(b) Depreciation and amortisation costs 2006 2005 £m £m Intangibles other than goodwill – amortisation 34 35 Property, plant and equipment – depreciation 278 290 – impairment and accelerated depreciation 89 58 401 383

Impairment and accelerated depreciation in respect of property, plant and equipment arose in relation to the restructuring costs (see note (e) below) and in respect of the impairment of a business (see note (f) below). (c) Other operating income This represents income arising from the Group’s activities which falls outside the definition of revenue and includes gains on the disposals of subsidiaries, joint venture and brands, property disposals, service fees and other shared costs charged to third parties, manufacturing fees and trademark income. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 88 British American Tobacco Directors’ Report and Accounts 2006

NOTES ON THE ACCOUNTS CONTINUED

3 Profit from operations continued (d) Other operating expenses include: 2006 2005 £m £m Research and development expenses (excluding employee benefit costs and depreciation) 36 29

RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH Exchange differences 7 (23) Loss on net monetary position 1 Rent of plant and equipment (operating leases) – minimum lease payments 25 26 – contingent rents 1 1 Rent of property (operating leases) – minimum lease payments 61 61 – sublease payments 2 2 Audit fees payable to PricewaterhouseCoopers LLP 1.3 1.3 Fees for other services payable to PricewaterhouseCoopers firms and associates – other services pursuant to statutory legislation 6.3 5.6 – tax advisory services 4.3 2.4 – tax compliance 0.4 0.5 – services relating to information technology 0.1 0.1 – other non-audit services 0.3 0.8

Fees for other services pursuant to statutory legislation payable to PricewaterhouseCoopers firms and associates include £6.1 million (2005: £5.3 million) for local statutory and Group reporting audits. In addition, the Group paid £0.6 million (2005: £0.5 million) in audit fees to other audit firms, which are excluded from the table above. Total research and development costs including employee benefit costs and depreciation were £76 million (2005: £66 million). (e) Restructuring costs These were the costs incurred as a result of a review of the Group’s manufacturing operations and organisational structure, including the initiative to reduce overheads and indirect costs, and are included in the profit from operations under the following headings:

OE NTEACCOUNTS THE ON NOTES 2006 2005 £m £m Employee benefit costs 100 165 Depreciation and amortisation costs 74 58 Other operating expenses 62 48 Other operating income (20) 216 271

The restructuring costs in 2006 principally relate to manufacturing rationalisation in the Netherlands, with further costs for the earlier restructurings in the UK and Ireland and in Canada. The initial recognition of these earlier restructurings comprised the main costs in 2005. Other operating income relates to gains on property disposals arising from the restructuring exercises. (f) (Losses)/gains on disposal of a business, brands and joint venture In April 2005, the Group sold its Benson & Hedges and Silk Cut trademarks in Malta and Cyprus to Gallaher Group plc (Gallaher), together with the Silk Cut trademark in Lithuania, resulting in a gain on disposal of £68 million included in other operating income in the profit from operations. The transactions were in accordance with contracts of 1993 and 1994 in which Gallaher agreed to acquire these trademarks in European Union states and the accession of Malta, Cyprus and Lithuania necessitated the sale. As described on page 123 in note 26, on 4 October 2005, the Group announced that it had agreed the sale of its 55 per cent shareholding in BARH Ltd to Honda and the sale was completed on 20 December 2005. As a result of these transactions a gain of £5 million was included in other operating income in the profit from operations for 2005. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 89

3 Profit from operations continued On 10 March 2006, the Group’s Italian subsidiary signed an agreement to sell its cigar business, Toscano, to Maccaferri for €95 million. The sale was subject to regulatory and governmental approval and was completed on 19 July 2006. This resulted in the recognition of a loss of £19 million, including an impairment charge of £15 million, which is included in depreciation and amortisation costs in the profit from operations. GROUP TOBACCO AMERICAN BRITISH On 29 September 2006, the Group signed a trademark transfer agreement with Philip Morris International. Under this arrangement the Group agreed to sell its Muratti Ambassador brand in certain markets, as well as the L&M and Chesterfield trademarks in Hong Kong and Macao, while acquiring the Benson & Hedges trademark in certain African countries, which resulted in a net payment to the Group of US$115 million. The agreement was subject to regulatory approval which was received, and the transactions completed on 29 November 2006, resulting in a gain of £60 million included in other operating income in the profit from operations.

4 Net finance costs 2006 2005 restated £m £m £m £m Finance costs – interest payable 410 373 – fair value changes (212) 218 – exchange differences 197 (246) – loss on net monetary position 4 1 399 346 Finance income – interest and dividend income (122) (106) – exchange differences 12 (12) (110) (118) Net finance costs 289 228 OE NTEACCOUNTS THE ON NOTES

Net finance costs comprise: Interest payable – bank borrowings 94 59 – finance leases 3 4 – other 313 310 410 373 Interest receivable (120) (105) Dividend income (2) (1) (122) (106) Fair value changes on derivatives – cash flow hedges transferred from equity 4 29 – fair value changes on hedged items (111) 14 – fair value hedges 39 28 – ineffective portion of cash flow hedges (1) – instruments not designated as hedges (144) 148 (212) 218 Exchange differences 209 (258) Loss on net monetary position 4 1 1 (39) 289 228

Other interest payable includes interest on the bonds and notes detailed in note 21. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 90 British American Tobacco Directors’ Report and Accounts 2006

NOTES ON THE ACCOUNTS CONTINUED

4 Net finance costs continued In December 2005, the International Accounting Standards Board issued an amendment to IAS21 on foreign exchange rates. The amendment to IAS21 allowed inter company balances that form part of a reporting entity’s net investment in a foreign operation to be denominated in a currency other than the functional currency of either the ultimate parent or the foreign operation itself. This means that certain exchange differences previously taken to the income statement RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH are instead reflected directly in changes in total equity. However, this amendment was only adopted by the EU in 2006. Therefore the previously published results for 2005 have been restated accordingly, which has resulted in an increase in net finance costs above of £4 million and a corresponding reduction in differences on exchange in equity movements (page 112 note 20). The £40 million movement to a charge of £1 million for net fair value changes and exchange differences is principally due to: (a) £19 million of gains in 2005 which distort net finance costs as described on page 92 in note 7; and (b) the impact of interest rate movements on the fair value of derivatives to be recognised in the accounts.

5 Associates and joint ventures Total Group’s share Total Group’s share 2006 2006 2005 2005 £m £m £m £m Gross turnover including duty, excise and other taxes 11,831 4,384 11,441 4,077 Duty, excise and other taxes (3,349) (1,194) (3,351) (1,121) Revenue 8,482 3,190 8,090 2,956

Profit from operations 1,765 677 1,546 566 Net finance costs (61) (26) (17) (8) Profit on ordinary activities before taxation 1,704 651 1,529 558 Taxation on ordinary activities (564) (216) (452) (163) Profit on ordinary activities after taxation 1,140 435 1,077 395 OE NTEACCOUNTS THE ON NOTES after (charging)/crediting – restructuring costs (32) (13) – US Federal tobacco buy-out (28) (12) – brand impairments (30) (13) (68) (29) – exceptional tax credits and other impairments 40 17 154 57 Attributable to British American Tobacco’s shareholders page 74 431 392

Minority interests 4 3

Dividends – listed investments (222) (175) – unlisted investments (45) (27) (267) (202)

The share of post-tax results of associates and joint ventures is after restructuring costs, the US Federal tobacco buy-out, brand impairments, exceptional tax credits and other impairments. In 2006, Reynolds American benefited from the favourable resolution of tax matters of which the Group’s share was £17 million (2005: £31 million). Reynolds American also modified the previously anticipated level of support between certain brands and the projected net sales of certain brands, resulting in a brand impairment charge of which the Group’s share amounted to £13 million (net of tax) (2005: £29 million). WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 91

5 Associates and joint ventures continued In 2005, Reynolds American also incurred restructuring costs and a one-off charge related to the stabilisation inventory pool losses associated with the US tobacco quota buy-out programme. The Group’s share (net of tax) of these amounted to £13 million and £12 million respectively.

In 2005, the contribution from ITC Limited in India included a benefit of £26 million (net of tax), principally related to GROUP TOBACCO AMERICAN BRITISH the write back of provisions for taxes offset by the impairment of a non-current investment.

6 Taxation on ordinary activities (a) Summary of tax on ordinary activities 2006 2005 £m £m UK corporation tax 14 42 comprising – current year tax expense 768 591 – double taxation relief (754) (549) Overseas tax 681 693 comprising – current year tax expense 743 705 – adjustments in respect of prior periods (62) (12)

Total current tax 695 735 Deferred tax 21 (45) comprising – deferred tax relating to origination and reversal of temporary differences 16 (2) – deferred tax relating to a previously unrecognised tax loss (14) (42) – deferred tax relating to changes in tax rates 19 (1)

716 690

(b) Factors affecting the tax charge ACCOUNTS THE ON NOTES The taxation charge differs from the standard 30 per cent rate of corporation tax in the UK. The major causes of this difference are listed below: 2006 2005 restated £m % £m % Profit before tax 2,764 2,584 Less: share of associates post-tax profit (431) (392) 2,333 2,192

Tax at 30% (2005: 30%) on the above 700 30.0 658 30.0 Factors affecting the tax rate: Tax at standard rates other than UK corporation tax rate (56) (2.4) (45) (2.1) National tax rate relief (15) (0.6) (24) (1.1) State and local taxes 50 2.1 58 2.6 Permanent differences 9 0.5 (30) (1.4) Overseas withholding taxes 50 2.1 50 2.3 Double taxation relief on UK profits (13) (0.6) (9) (0.4) Unutilised tax losses 13 0.6 13 0.6 Adjustments in respect of previous periods (62) (2.7) (12) (0.5) Deferred tax charges at other tax rates 21 0.9 32 1.5 Deferred tax attributable to an increase in the rate of domestic income tax 19 0.8 (1) (0.0) 716 30.7 690 31.5 WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 92 British American Tobacco Directors’ Report and Accounts 2006

NOTES ON THE ACCOUNTS CONTINUED

6 Taxation on ordinary activities continued (c) Tax on items recognised directly in equity 2006 2005 £m £m Current tax 14 19

RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH Deferred tax (2) 22 Charged to equity 12 41

7 Earnings per share Basic earnings per share are based on equity earnings of £1,896 million (2005 restated: £1,767 million, as explained on page 89 in note 4) and 2,059 million (2005: 2,095 million) ordinary shares of 25p each, being the weighted average number of shares in issue during the year (excluding shares held to satisfy the Group’s employee share schemes). For the calculation of diluted earnings per share, the weighted average number of shares in issue is increased to 2,076 million (2005: 2,112 million) to reflect the potential dilutive effect of employee share schemes. 2006 2005 restated Weighted Weighted average average number of Earnings number of Earnings Earnings shares per share Earnings shares per share £m m pence £m m pence Basic earnings per share 1,896 2,059 92.08 1,767 2,095 84.34 Share options and convertible redeemable preference shares 17 (0.75) 17 (0.68) Diluted earnings per share 1,896 2,076 91.33 1,767 2,112 83.66

Earnings have been affected by a number of exceptional items. To illustrate the impact of these, an alternative earnings per share is shown below: Alternative earnings per share calculation Diluted Basic OE NTEACCOUNTS THE ON NOTES 2006 2005 2006 2005 restated restated Earnings Earnings Earnings Earnings Earnings per share Earnings per share Earnings per share Earnings per share £m pence £m pence £m pence £m pence Unadjusted earnings per share 1,896 91.33 1,767 83.66 1,896 92.08 1,767 84.34 Restructuring costs per income statement 216 10.40 271 12.83 216 10.49 271 12.93 Tax and minority interests on restructuring costs (48) (2.31) (57) (2.70) (48) (2.33) (57) (2.72) Losses/(gains) on disposal of a business, brands and joint venture per income statement (41) (1.98) (72) (3.41) (41) (1.99) (72) (3.44) Tax on losses/(gains) on disposal of a business, brands and joint venture 18 0.87 18 0.87 Associates: restructuring costs, US Federal tobacco buy-out, brand impairments, exceptional tax credits and other impairments per income statement (4) (0.19) (3) (0.14) (4) (0.19) (3) (0.14) Net finance costs adjustment per note below (19) (0.90) (19) (0.91) Adjusted earnings per share 2,037 98.12 1,887 89.34 2,037 98.93 1,887 90.06 WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 93

7 Earnings per share continued IFRS requires fair value changes for derivatives, which do not meet the tests for hedge accounting under IAS39, to be included in the income statement. In addition, certain exchange differences are required to be in the income statement under IFRS and, as they are subject to exchange rate movements in the period, they can be a volatile element of net finance costs, and one which does not always reflect an economic gain or loss for the Group. Consequently, in calculating RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH the adjusted earnings per share, the following items are excluded: (a) £nil million (2005: £8 million gain) relating to derivatives for which hedge accounting was obtained during 2005; and (b) £nil million (2005: £11 million gain) relating to exchange gains in net finance costs where there is a compensating exchange loss reflected in differences in exchange taken directly to changes in total equity.

8 Dividends and other appropriations 2006 2005 Pence Pence per share £m per share £m Ordinary shares Interim 2006 paid 13 September 2006 15.70 323 2005 paid 14 September 2005 14.00 293 Final 2005 paid 4 May 2006 33.00 685 2004 paid 4 May 2005 29.20 617 48.70 1,008 43.20 910

The Directors have recommended to shareholders a final dividend of 40.20 pence per share for the year ended 31 December 2006. If approved, this dividend will be paid to shareholders on 3 May 2007. This dividend is subject to approval by shareholders at the Annual General Meeting and therefore, in accordance with IAS10, it has not been included as a liability in these Financial Statements. The total estimated dividend to be paid is £821 million which takes the total dividends declared in respect of 2006 to £1,144 million (2005: £977 million) representing 55.90 pence per share (2005: 47.00 pence per share). ACCOUNTS THE ON NOTES As described on page 146 in note 3, while the 2006 interim dividend did not comply with the technical requirements of the Companies Act 1985, the payment has been presented as a dividend payment above. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 94 British American Tobacco Directors’ Report and Accounts 2006

NOTES ON THE ACCOUNTS CONTINUED

9 Intangible assets Trademarks Assets in Computer brands and the course of Goodwill software licences development Total £m £m £m £m £m 1 January 2006 RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH Cost 7,887 228 16 31 8,162 Accumulated amortisation and impairment (162) (13) (175) Net book value at 1 January 2006 7,887 66 3 31 7,987

Differences on exchange (617) (4) (1) (622) Additions – internal development 91221 – acquisitions of subsidiaries and minority interests 80 5 85 – separately acquired 23 2 14 39 Reallocations 17 (17) Amortisation charge (33) (1) (34) 31 December 2006 Cost 7,350 258 23 39 7,670 Accumulated amortisation and impairment (180) (14) (194) Net book value at 31 December 2006 7,350 78 9 39 7,476

1 January 2005 Cost 7,607 210 14 17 7,848 Accumulated amortisation and impairment (136) (12) (148) Net book value at 1 January 2005 7,607 74 2 17 7,700

Differences on exchange 271 8 (1) 278 Additions – internal development 6 21 27 OE NTEACCOUNTS THE ON NOTES – acquisitions of subsidiaries 9 9 – separately acquired 11 2 1 14 Reallocations 7 (7) Disposals (5) (5) Amortisation charge (35) (1) (36) 31 December 2005 Cost 7,887 228 16 31 8,162 Accumulated amortisation and impairment (162) (13) (175) Net book value at 31 December 2005 7,887 66 3 31 7,987

Included in computer software and assets in the course of development above are internally developed assets with a carrying value of £80 million (2005: £64 million). The costs of internally developed assets include capitalised expenses of third party consultants as well as software licence fees from third party suppliers. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 95

9 Intangible assets continued Impairment testing for intangible assets with indefinite lives including goodwill Goodwill of £7,350 million (2005: £7,887 million) included in intangible assets in the balance sheet is mainly the result of the following acquisitions: Rothmans Group £3,889 million (2005: £4,206 million); Imperial Tobacco Canada £1,768 million (2005: £2,004 million); and ETI (Italy) £1,113 million (2005: £1,135 million). The principal allocations RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH of goodwill in the Rothmans’ acquisition are to the cash-generating units of Continental Europe and South Africa, with the remainder mainly relating to operations in the domestic and export market in the United Kingdom and operations in Asia-Pacific. Goodwill has been allocated for impairment testing purposes to 13 (2005: 12) individual cash-generating units – four in Europe, one in Africa and Middle East, three in Asia-Pacific, three (2005: two) in Latin America and two in America-Pacific. The carrying amounts of goodwill allocated to the cash-generating units of South Africa (£803 million, 2005: £1,017 million), Continental Europe (£1,020 million, 2005: £1,040 million), Canada (£1,768 million, 2005: £2,004 million) and Italy (£1,119 million, 2005: £1,141 million) are considered significant in comparison with the total carrying amount of goodwill. A further cash-generating unit was established in 2006 with the purchase of minority interests in Chile (page 123 note 26). The recoverable amount of all cash-generating units has been determined on a value-in-use basis. The key assumptions for the recoverable amount of all units are the long term growth rate and the discount rate. The long term growth rate is a nominal rate used purely for the impairment testing of goodwill under IAS36 Impairment of Assets and does not reflect long term planning assumptions used by the Group for investment proposals or for any other assessments. The discount rate is based on the weighted average cost of capital, taking into account the cost of capital and borrowings, to which specific market-related premium adjustments are made. These assumptions have been applied to the individual cash flows of each unit as compiled by local management in the different markets. The valuation uses cash flow projections based on detailed financial budgets approved by management covering a two year period, with cash flow beyond two years extrapolated by a nominal growth rate of 3 per cent per annum for the years three to 10, whereafter a zero per cent growth rate has been assumed (2005: 3 per cent growth rate in perpetuity). This long term growth rate used does not exceed the expected long term average growth rate for the markets in which the cash-generating units operate. In some instances, such as recent acquisitions or start-up ventures, the valuation is expanded to reflect the medium term plan of management, spanning five years or beyond, with the cash flow beyond these years to year 10, extrapolated by the growth rate of 3 per cent, as above. ACCOUNTS THE ON NOTES Pre-tax discount rates of between 8.1 per cent and 17.9 per cent (2005: 8.1 per cent to 15.7 per cent) were used, based on the Group’s weighted average cost of capital, together with any premium applicable for country/area inflation and economical and political risks. The pre-tax discount rates used for the cash-generating units which are significant in comparison with the total carrying amount of goodwill are 12.1 per cent for South Africa (2005: 12.1 per cent), 9.8 per cent for Continental Europe (2005: 9.8 per cent), 10 per cent for Canada (2005: 11 per cent) and 10.7 per cent for Italy (2005: 10.7 per cent). No impairment charges were recognised in 2006 (2005: £nil). If discounted cash flows per cash-generating unit should fall by 10 per cent, or the discount rate was increased at an after tax rate of 1 per cent, there would be no impairment. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 96 British American Tobacco Directors’ Report and Accounts 2006

NOTES ON THE ACCOUNTS CONTINUED

10 Property, plant and equipment Assets in Freehold Leasehold Plant and the course of property property equipment construction Total £m £m £m £m £m 1 January 2006 as restated RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH Cost 909 212 3,602 194 4,917 Accumulated depreciation and impairment (321) (59) (2,206) (2,586) Net book value at 1 January 2006 588 153 1,396 194 2,331

Differences on exchange (35) (8) (100) (15) (158) Additions 15 2 181 255 453 Reallocations 19 193 (212) Depreciation (22) (9) (274) (305) Impairment (8) (40) (48) Disposals (16) (24) (40) Disposal of subsidiaries (25) (1) (26) 31 December 2006 Cost 833 202 3,348 222 4,605 Accumulated depreciation and impairment (317) (64) (2,017) (2,398) Net book value at 31 December 2006 516 138 1,331 222 2,207

1 January 2005 Cost 854 195 3,267 138 4,454 Accumulated depreciation and impairment (287) (48) (1,957) (2,292) Net book value at 1 January 2005 567 147 1,310 138 2,162

Differences on exchange 27 16 79 6 128 Additions 9 3 163 248 423 Acquisitions of subsidiaries 7 7 OE NTEACCOUNTS THE ON NOTES Reallocations 30 4 164 (198) Depreciation (29) (15) (257) (301) Impairment (2) (56) (58) Disposals (16) (14) (30) 31 December 2005 Cost 909 212 3,602 194 4,917 Accumulated depreciation and impairment (321) (59) (2,206) (2,586) Net book value at 31 December 2005 as restated 588 153 1,396 194 2,331

Assets held under finance leases 31 December 2006 Cost 394 97 Accumulated depreciation and impairment (1) (37) (38) Net book value at 31 December 2006 257 59

31 December 2005 Cost 3 110 113 Accumulated depreciation and impairment (49) (49) Net book value at 31 December 2005 as restated 361 64

Assets held under finance leases are secured under finance lease obligations on page 116 in note 21. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 97

10 Property, plant and equipment continued The International Accounting Standard Board issued IFRIC Interpretation 4 which is applicable for annual reporting periods beginning on or after 1 January 2006. This interpretation is to determine whether an arrangement, which is not in the legal form of a lease, is in substance a lease and should be accounted for in accordance with IAS17 Leases. Consequently, the previously published results for 2005 have been restated to increase additions to property, plant RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH and equipment and assets held under finance leases at 31 December 2005 shown above by £4 million. Borrowings in respect of finance lease obligations have been increased by a similar amount (page 116 note 21). At the end of 2006, assets held under finance leases of £7 million were recognised on a similar basis. 2006 2005 £m £m Cost of freehold land within freehold property on which no depreciation is provided 70 84 Leasehold property comprises – net book value of long leasehold 95 106 – net book value of short leasehold 43 47 138 153

Contracts placed for future expenditure 31 34

Bank borrowings are secured by property, plant and equipment to the value of £15 million (2005: £nil).

11 Investments in associates and joint ventures 2006 2005 £m £m 1 January 2,193 1,717 Differences on exchange (254) 186 Share of profit after taxation page 90 note 5 431 392 Dividends page 90 note 5 (267) (202) Acquisitions 1 95 Other equity movements 4 5 31 December 2,108 2,193 ACCOUNTS THE ON NOTES

Non-current assets 3,386 2,889 Current assets 1,603 1,724 Non-current liabilities (1,635) (1,053) Current liabilities (1,246) (1,367) 2,108 2,193

Reynolds American Inc. (market value £4,145 million (2005: £3,440 million)) 1,499 1,595 Other listed associates (market value £2,473 million (2005: £2,250 million)) 394 382 Unlisted 215 216 2,108 2,193 WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 98 British American Tobacco Directors’ Report and Accounts 2006

NOTES ON THE ACCOUNTS CONTINUED

11 Investments in associates and joint ventures continued On 25 April 2006, Reynolds American Inc. announced an agreement to acquire Conwood, the second largest manufacturer of smokeless tobacco products in the USA, for US$3.5 billion, and the acquisition was completed on 31 May 2006. The acquisition was funded principally with debt, and the fair value of the assets acquired and liabilities assumed were US$4.1 billion and US$0.6 billion respectively. The Group’s share of non-current assets above includes RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH £540 million of goodwill and £300 million of brands arising from the Conwood acquisition. In addition, the non-current assets above include £1,207 million (2005: £1,376 million) of goodwill and £479 million (2005: £569 million) of brands arising from the Reynolds American transaction in 2004. Details of the Group’s contingent liabilities are set out on page 130 in note 30. In addition to US litigation involving Group companies, which is covered by the R.J. Reynolds Tobacco Company (RJRT) indemnity referred to in note 30, Reynolds American Inc. (RAI) group companies are named in litigation which does not involve Group companies. While it is impossible to be certain of the outcome of any particular case or of the amount of any possible adverse verdict, it is not impossible that the results of operations or cash flows of RAI, in particular quarterly or annual periods, could be materially affected by this and by the final outcome of any particular litigation. However, having regard to the contingent liability disclosures on litigation made by RAI in its public financial reports, the Directors are satisfied with the carrying value included above for RAI. The Group’s share of the RAI results for the year to 31 December 2006 includes £24 million (2005: £35 million) in respect of external legal fees and other external product liability defence costs. On 21 October 2005, the Group announced the exercise of its pre-emption rights over shares in Skandinavisk Tobakskompagni AS (STK), and the transaction was completed on 12 December 2005. As a result, the Group’s shareholding in STK increased from 26.6 per cent to 32.3 per cent, at a purchase price of £95 million, giving rise to £69 million of goodwill.

12 Retirement benefit schemes The Group’s subsidiary undertakings operate over 120 active retirement benefit arrangements worldwide. These arrangements have been developed in accordance with local practices in the countries concerned. The majority of scheme members belong to defined benefit schemes, most of which are funded externally, although the Group also OE NTEACCOUNTS THE ON NOTES operates a number of defined contribution schemes. The liabilities arising in the defined benefit schemes are determined in accordance with the advice of independent, professionally qualified actuaries, using the projected unit credit method. All schemes are formally valued at least every three years. The principal pension schemes are in the UK, Germany, Canada, the Netherlands and Switzerland. Together these schemes account for over 88 per cent of the total obligations of the Group’s defined benefit schemes. In addition, the Group operates significant schemes in Canada which provide employees with certain other retirement benefits such as healthcare. The liabilities in respect of these benefits are also assessed by qualified independent actuaries, applying the projected unit credit method. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 99

12 Retirement benefit schemes continued The amounts recognised in the balance sheet were determined as follows: Pension schemes Healthcare schemes Total 2006 2005 2006 2005 2006 2005 £m £m £m £m £m £m RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH Present value of funded scheme facilities (4,189) (4,379) (10) (7) (4,199) (4,386) Fair value of funded scheme assets 3,938 3,824 12 12 3,950 3,836 (251) (555) 2 5 (249) (550) Unrecognised funded scheme liabilities (61) (70) (61) (70) (312) (625) 2 5 (310) (620) Present value of unfunded scheme liabilities (107) (115) (115) (129) (222) (244) Net unrecognised actuarial losses 111 342 14 13 125 355 Unrecognised past service cost 1 1 1 1 (307) (397) (99) (111) (406) (508)

The above net liability was recognised in the balance sheet as follows – retirement benefit scheme liabilities (335) (427) (100) (116) (435) (543) – retirement benefit scheme assets 28 30 1 5 29 35 (307) (397) (99) (111) (406) (508)

In Jamaica, the pension scheme holds shares in Carreras Group Ltd. with a fair value of £6 million (2005: £5 million). In Switzerland, a pension scheme owns a property with a fair value of £10 million (2005: £11 million), part of which is occupied by British American Tobacco Switzerland SA. The amounts recognised in the income statement were as follows: Pension schemes Healthcare schemes Total 2006 2005 2006 2005 2006 2005 £m £m £m £m £m £m OE NTEACCOUNTS THE ON NOTES Defined benefit schemes – current service cost 90 79 3 2 93 81 – interest cost 207 201 7 7 214 208 – expected return on scheme assets (237) (216) (1) (1) (238) (217) – net actuarial losses/(gains) recognised 6 (1) 6 (1) –pastservicecost 9 829 10 – settlements and curtailments 9 18 2 9 20 – surplus recognition movement 4 7 4 7 88 96 9 12 97 108 Defined contribution schemes 15 15 15 15 103 111 9 12 112 123

The above charges were recognised within employee benefit costs in 2006 and 2005 (page 87 note 3(a)) and include £13 million (2005: £23 million) in respect of pension schemes and £nil million (2005: £2 million) in respect of healthcare schemes reported as part of the restructuring costs charged in arriving at profit from operations (page 88 note 3(e)). The reduction in the amounts recognised in the Income Statement in 2006 is principally due to the change in the impact of costs related to the restructurings noted above. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 100 British American Tobacco Directors’ Report and Accounts 2006

NOTES ON THE ACCOUNTS CONTINUED

12 Retirement benefit schemes continued Pension schemes Healthcare schemes Total 2006 2005 2006 2005 2006 2005 £m £m £m £m £m £m Actual return on scheme assets 370 474 3 1 373 475 RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH The movements in scheme liabilities were as follows: Pension schemes Healthcare schemes Total 2006 2005 2006 2005 2006 2005 £m £m £m £m £m £m Present value at 1 January 4,494 3,746 136 106 4,630 3,852 Exchange differences (162) 86 (18) 12 (180) 98 Current service cost 89 81 2 2 91 83 Interest cost 202 206 6 8 208 214 Past service costs – vested 8 918 10 Past service costs – unvested 1 1 2 Contributions by scheme members 4 5 4 5 Benefits paid (253) (228) (7) (11) (260) (239) Settlements and curtailments 4 20 2 4 22 Acquisitions of subsidiaries 11 11 Disposals of subsidiaries (1) (1) Scheme changes (6) (6) Actuarial (gains)/losses (83) 557 6 15 (77) 572 Present value at 31 December 4,296 4,494 125 136 4,421 4,630

Funded schemes 4,189 4,379 10 7 4,199 4,386 Unfunded schemes 107 115 115 129 222 244 4,296 4,494 125 136 4,421 4,630

OE NTEACCOUNTS THE ON NOTES The actuarial gains in 2006 principally relate to increases in discount rates. The actuarial losses in 2005 are principally due to reductions in discount rates generally, and improved life expectancies in the UK and Germany. The movements in funded scheme assets were as follows: Pension schemes Healthcare schemes Total 2006 2005 2006 2005 2006 2005 £m £m £m £m £m £m Fair value of scheme assets at 1 January 3,824 3,328 12 11 3,836 3,339 Exchange differences (152) 77 (3) 1 (155) 78 Expected return on scheme assets 231 221 1 1 232 222 Company contributions 144 146 5 5 149 151 Contributions by scheme members 4 5 4 5 Benefits paid (246) (219) (5) (6) (251) (225) Acquisitions of subsidiaries 13 13 Scheme changes (6) (6) Actuarial gains 139 253 2 141 253 Fair value of scheme assets at 31 December 3,938 3,824 12 12 3,950 3,836

Contributions to defined benefit schemes are determined after consultation with the respective trustees and actuaries of the individual externally funded schemes, taking into account regulatory requirements. Contributions in 2007 are expected to be £131 million for pension schemes and £6 million for healthcare schemes, compared to £144 million and £5 million respectively in 2006. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 101

12 Retirement benefit schemes continued The movements in the unrecognised funded scheme surpluses were as follows: Pension schemes Healthcare schemes Total 2006 2005 2006 2005 2006 2005 £m £m £m £m £m £m RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH Unrecognised funded scheme surpluses at 1 January (70) (60) (70) (60) Exchange differences 13 (2) 13 (2) Movement in year (4) (8) (4) (8) Unrecognised funded scheme surpluses at 31 December (61) (70) (61) (70)

The movements in the net unrecognised actuarial losses/(gains) were as follows: Pension schemes Healthcare schemes Total 2006 2005 2006 2005 2006 2005 £m £m £m £m £m £m Net actuarial losses/(gains) at 1 January 342 43 13 (2) 355 41 Exchange differences (3) (6) (3) (6) (6) Actuarial (gains): scheme assets (139) (253) (2) (141) (253) Actuarial (gains)/losses: scheme liabilities (83) 557 6 15 (77) 572 Actuarial (losses)/gains recognised (6) 1 (6) 1 Net actuarial losses/(gains) at 31 December 111 342 14 13 125 355

The principal actuarial assumptions (weighted to reflect individual scheme differences) used in the following principal countries were as follows: UK Germany Canada Netherlands Switzerland %%%%% 31 December 2006 Rate of increase in salaries 5.1 2.5 4.0 2.4 1.6

Rate of increase in pensions in payment 3.1 2.0 Nil 2.0 1.0 ACCOUNTS THE ON NOTES Rate of increase in deferred pensions 3.1 Nil Nil 2.0 Discount rate 5.1 4.5 4.7 4.6 3.2 General inflation 3.1 2.0 3.0 2.0 1.0

For healthcare inflation in Canada, the assumption was 10 per cent reducing to 5 per cent by 2012. For the remaining pension schemes, typical assumptions were that real salary increases will be from 2 per cent to 4 per cent per annum and discount rates will be from 2 per cent to 5 per cent above inflation. Pension increases, where allowed for, were generally assumed to be in line with inflation. UK Germany Canada Netherlands Switzerland %%%%% 31 December 2005 Rate of increase in salaries 5.0 2.5 4.0 2.3 1.6 Rate of increase in pensions in payment 3.0 1.6 Nil 2.0 1.0 Rate of increase in deferred pensions 3.0 Nil Nil 2.0 Discount rate 4.7 4.0 4.7 4.2 3.2 General inflation 3.0 1.6 3.0 2.0 1.0

For healthcare inflation in Canada, the assumption was 10 per cent reducing to 5 per cent by 2011. For the remaining pension schemes, typical assumptions were that real salary increases will be from 2 per cent to 4 per cent per annum and discount rates will be from 2 to 5 per cent above inflation. Pension increases, where allowed for, were generally assumed to be in line with inflation. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 102 British American Tobacco Directors’ Report and Accounts 2006

NOTES ON THE ACCOUNTS CONTINUED

12 Retirement benefit schemes continued Mortality assumptions are subject to regular review. In the UK, Canada, Germany, the Netherlands and Switzerland the same tables were used for both years. In the UK, for post-retirement mortality assumptions at 31 December 2006 and 31 December 2005, the table PXA92 (B=1965) rated up two years for active and deferred members and PXA92 (B=1935) tables rated up four years for current pensioners, all with the medium cohort effect, have been used. In Canada RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH UP94 tables, in Germany Heubeck tables 2005G, in the Netherlands GBM/V 1995-2000 tables, with an age setback of two years for males and one year for females, and EVK 2000 mortality tables in Switzerland, have been used. Based on the above, the weighted average life expectancy, in years, for mortality tables used to determine benefit obligations is as follows: UK Germany Canada Netherlands Switzerland Male Female Male Female Male Female Male Female Male Female Member age 65 (current life expectancy) 18.5 21.3 17.6 21.7 19.0 21.6 17.3 20.9 17.6 20.4 Member age 45 (life expectancy at age 65) 21.2 24.0 20.4 24.4 19.0 21.6 17.3 20.9 20.6 23.3

A one percentage point change in healthcare inflation would have the following effects, which were similar in 2005:

1 percentage 1 percentage point increase point decrease £m £m 31 December 2006 Effect on total of current service cost and interest cost 1 (1) Effect on healthcare scheme liabilities 16 (13)

The expected rates of return on scheme assets in the following principal countries were as follows: UK Germany Canada Netherlands Switzerland %%%%% 31 December 2006 Equities 7.5 8.0 8.2 8.2 7.0 Bonds 4.8 5.5 5.5 4.1 4.5 Property 7.5 4.5 6.9 5.0

OE NTEACCOUNTS THE ON NOTES Other assets 8.1 Nil 3.2 2.0

For the remaining pension schemes, typical expected long term real rates of return ranged from 2 per cent to 7 per cent. UK Germany Canada Netherlands Switzerland %%%%% 31 December 2005 Equities 7.1 8.0 7.5 7.6 7.0 Bonds 4.3 5.5 6.5 3.8 4.5 Property 7.1 4.5 6.3 5.0 Other assets 7.0 Nil 2.0 2.0

For the remaining pension schemes, typical expected long term real rates of return ranged from 2 per cent to 7 per cent. UK Germany Canada Netherlands Switzerland %%%%% 31 December 2004 Equities 7.5 8.0 7.8 7.1 7.0 Bonds 4.9 6.0 6.5 3.7 4.5 Property 7.5 4.5 6.4 5.5 Other assets 7.0 Nil 2.0 2.0

For the remaining pension schemes, typical expected long term real rates of return ranged from 2 per cent to 5 per cent. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 103

12 Retirement benefit schemes continued Expected rates of return were determined taking into account the current level of expected returns on risk free investments, the historical level of risk premium associated with other invested assets, and the expectations for future returns on such assets. The major categories of assets as a percentage of the total fair value of scheme assets were as follows:

UK Germany Canada Netherlands Switzerland Others Total GROUP TOBACCO AMERICAN BRITISH %%%%%%% 31 December 2006 Equities 53.4 43.6 60.2 36.4 35.9 23.4 46.8 Bonds 36.5 28.8 34.7 44.9 48.7 54.4 38.7 Property 5.1 27.6 8.7 9.2 1.7 7.8 Other assets 5.0 5.1 10.0 6.2 20.5 6.7 31 December 2005 Equities 57.9 38.7 59.6 40.3 41.3 24.4 48.4 Bonds 33.0 31.9 35.0 45.0 45.8 54.1 37.8 Property 4.4 29.4 8.0 6.7 1.7 7.4 Other assets 4.7 5.4 6.7 6.2 19.8 6.4

The history of the present value of the scheme liabilities, fair value of the scheme assets, the scheme net deficits and experience gains and losses were as follows: 2006 2005 2004 £m £m £m Historical information Scheme liabilities 4,421 4,630 3,852 Scheme assets 3,950 3,836 3,339 Scheme net deficits (471) (794) (513) Experience losses/(gains) on scheme liabilities 35 (6) 68 Experience gains on scheme assets (141) (253) (64)

13 Deferred tax ACCOUNTS THE ON NOTES Deferred tax assets comprise: Excess of depreciation Other Stock over capital Tax Retirement Fair value temporary relief allowances losses benefits losses differences Total £m £m £m £m £m £m £m At 1 January 2006 40 9 18 137 221 425 Exchange differences (3) (1) (1) (10) (21) (36) Credited/(charged) to the income statement 1 (4) 34 (16) (8) 7 Other 5 9 (19) 1 (4) (8) At 31 December 2006 43 13 32 112 188 388

At 1 January 2005 32 14 36 123 167 372 Change in accounting policy page 120 note 24 10 10 At 1 January 2005 32 14 36 123 10 167 382 Exchange differences 3 1 1 5 14 24 Credited/(charged) to the income statement 5 (4) 31 1 24 57 Charged to equity (10) (10) Other (2) (50) 8 16 (28) At 31 December 2005 40 9 18 137 221 425 WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 104 British American Tobacco Directors’ Report and Accounts 2006

NOTES ON THE ACCOUNTS CONTINUED

13 Deferred tax continued Deferred tax liabilities comprise: Undistributed Excess of capital earnings of Other Stock allowances over associates and Retirement Fair value temporary relief depreciation subsidiaries benefits gains differences Total £m £m £m £m £m £m £m RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH At 1 January 2006 30 154 73 98 15 42 412 Exchange differences (1) (12) (3) (2) (2) (9) (29) Charged/(credited) to the income statement (4) (8) 17 20 (2) 4 27 Credited to equity (2) (2) Other 2 6 (2) (1) (2) 3 At 31 December 2006 27 140 87 114 8 35 411

At 1 January 2005 37 138 49 91 44 359 Change in accounting policy page 120 note 24 33 At 1 January 2005 37 138 49 91 3 44 362 Exchange differences (1) 12 1 1 13 Charged/(credited) to the income statement (7) 5 20 5 (13) 10 Charged to equity 12 12 Acquisitions of subsidiaries 1 1 1 3 Other (2) 3 11 12 At 31 December 2005 30 154 73 98 15 42 412

2006 2005 £m £m Net deferred tax liabilities/(assets) 23 (13) OE NTEACCOUNTS THE ON NOTES The net deferred tax liabilities/(assets) are reflected in the Balance Sheet as follows, after offsetting assets and liabilities where there is a legally enforceable right to offset current tax assets and liabilities and where the deferred income taxes relate to the same fiscal authority. 2006 2005 £m £m Deferred tax assets (273) (290) Deferred tax liabilities 296 277 23 (13)

Deferred tax expected to be recovered within 12 months: 2006 2005 £m £m Deferred tax assets (86) (126) Deferred tax liabilities 105 87 19 (39)

At the Balance Sheet date, the Group has recognised and unrecognised deferred tax assets in respect of unused tax losses of £144 million (2005: £137 million) available for offset against future profits. A deferred tax asset has been recognised in respect of £32 million (2005: £18 million) of such losses, as realisation of the related tax benefit is probable. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 105

13 Deferred tax continued Unrecognised deferred tax assets in respect of unused income tax losses of £67 million (2005: £69 million) have no expiry date and unused income tax losses of £35 million (2005: £40 million) expire after five years. Unrecognised deferred tax assets in respect of unused capital tax losses of £10 million (2005: £10 million) have no expiry date.

At the Balance Sheet date, the Group has unrecognised deferred tax assets in respect of deductible temporary differences of GROUP TOBACCO AMERICAN BRITISH £183 million (2005: £179 million) and unused tax credits of £136 million (2005: £133 million). £nil million (2005: £10 million) of these unrecognised deferred tax assets expire after five years, whilst the remainder have no expiry period. At the Balance Sheet date, the aggregate amount of temporary differences associated with undistributed earnings of subsidiaries for which deferred tax liabilities have not been recognised was £5 billion (2005: £5 billion). No liability has been recognised in respect of these differences because the Group is in a position to control the timing of the reversal of the temporary differences, and it is probable that such differences will not reverse in the foreseeable future.

14 Trade and other receivables 2006 2005 £m £m Trade receivables 1,083 1,093 Loans and other receivables 530 511 Prepayments and accrued income 147 170 1,760 1,774

Analysed on the balance sheet as – current 1,568 1,577 – non-current 192 197 1,760 1,774

Impairment of trade receivables charged in the year as part of other operating expenses was £17 million (2005: £7 million). Prepayments and accrued income include £48 million (2005: £45 million) in respect of dividends from associates and

£1 million (2005: £1 million) in respect of interest. ACCOUNTS THE ON NOTES Trade and other receivables are predominantly denominated in the functional currencies of subsidiary undertakings apart from the following: 2006 2005 £m £m US dollar 106 140 UK sterling 4 1 Euro 22 35 Other currencies 24 32

Trade and other receivables also include certain interest bearing amounts and their effective interest rates as follows: 2006 2005 2006 2005 £m £m % % US dollar* 64 78 4.6 3.7 Euro 1 3 3.6 3.4 Other currencies 36 33 10.6 11.4 *Includes US$100 million (£51 million) (2005: £58 million) representing a bond posted in connection with the Engle class action in the US (page 131 note 30). There is no material difference between the above amounts for trade and other receivables and their fair value, due to the short term duration of the majority of trade and other receivables. There is no concentration of credit risk with respect to trade receivables as the Group has a large number of customers, internationally dispersed. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 106 British American Tobacco Directors’ Report and Accounts 2006

NOTES ON THE ACCOUNTS CONTINUED

15 Available-for-sale investments 2006 2005 £m £m 1 January 123 100 Change in accounting policy page 120 note 24 16 RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH 123 116 Differences on exchange (1) 1 Additions and advances 85 179 Revaluations (2) (1) Disposals and repayments (54) (173) Other movements 1 1 31 December 152 123

Current 128 96 Non-current 24 27 152 123

Investments have the following maturities: 2006 2005 £m £m Equity investments 25 26 Non-equity investments – within one year 73 24 – beyond one year and within two years 4 18 – beyond two years and within three years 21 6 – beyond three years and within four years 12 21 – beyond four years and within five years 14 – beyond five years 17 14 152 123 OE NTEACCOUNTS THE ON NOTES Investments are denominated in the functional currency of the subsidiary undertaking or other currencies as shown below: 2006 2005 £m £m Functional currencies 92 118 US dollar 56 2 Other currencies 4 3 152 123

Non-equity investments are denominated in the following currencies: 2006 2005 £m £m US dollar 56 2 UK sterling 71 89 Other currencies 6 127 97

Effective interest rates applicable to non-equity investments are as follows: 2006 2005 % % On US dollar 4.8 5.8 On UK sterling 5.3 5.6 On other currencies 18.7 WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 107

16 Derivative financial instruments 2006 2005 Assets Liabilities Assets Liabilities £m £m £m £m Fair value hedges

– interest rate swaps 25 19 80 GROUP TOBACCO AMERICAN BRITISH – cross-currency swaps 24 4 710 Cash flow hedges – interest rate swaps 1 – cross-currency swaps 10 1 – forward foreign currency contracts 20 1 29 8 Net investment hedges – cross-currency swaps 53 21 – forward foreign currency contracts 31 10 329 Trading – interest rate swaps 1 – cross-currency swaps 43 57 – forward foreign currency contracts 29 13 16 38 – others 18 23 717 200 113 173 162

Current 124 84 86 143 Non-current 76 29 87 19 200 113 173 162

Current assets and liabilities include – net interest receivable 35 (5) 30 (8) – trading derivatives that mature beyond one year 37 59 Derivatives – in respect of net debt 125 79 133 116 ACCOUNTS THE ON NOTES – other 75 34 40 46 200 113 173 162

Some derivative financial instruments are not designated as hedges and have been classified as trading derivatives. The fair values of derivatives are determined based on market data (primarily yield curves, implied volatilities and exchange rates) to calculate the present value of all estimated flows associated with each derivative at the Balance Sheet date. In the absence of sufficient market data, fair values have been based on the quoted market price of similar derivatives. For cash flow hedges, the timing of expected cash flows is as follows: 2006 2005 Assets Liabilities Assets Liabilities £m £m £m £m Within one year 11 1 31 10 Between one and two years 2 7 Between two and three years 7 1 20 1 39 10 WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 108 British American Tobacco Directors’ Report and Accounts 2006

NOTES ON THE ACCOUNTS CONTINUED

16 Derivative financial instruments continued The maturity dates of all derivative financial instruments are as follows: 2006 2005 Assets Liabilities Assets Liabilities £m £m £m £m RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH Within one year 89 52 56 92 Between one and two years 530 711 Between two and three years 67 1 141 Between three and four years 61 Between four and five years 4 Beyond five years 35 30 48 18 200 113 173 162

In summary by type, the fair value of derivative financial instruments is as follows: 2006 2005 Assets Liabilities Assets Liabilities £m £m £m £m Interest rate swaps 25 19 80 2 Cross-currency swaps 77 47 38 68 Forward foreign currency contracts 80 24 48 75 Others 18 23 717 200 113 173 162

(a) Interest rate swaps Interest rate % 2006 Maturity Principal Assets Liabilities date currency m £m Original Swapped £m £m Fixed to floating 2009 EUR 550 371 4.9 note (a) 10 2009 EUR 250 168 4.1 note (a) 4 OE NTEACCOUNTS THE ON NOTES 2013 EUR 400 270 5.1 note (a) 7 2013 GBP 350 350 5.8 note (a) 19 2019 GBP 250 250 6.4 note (a) 4 Floating to fixed 2007 AUD 50 20 note (a) 5.5 25 19

Interest rate % 2005 Maturity Principal Assets Liabilities date currency m £m Original Swapped £m £m Fixed to floating 2009 EUR 550 378 4.9 note (a) 23 2009 EUR 250 172 4.1 note (a) 10 2013 EUR 400 275 5.1 note (a) 23 2013 GBP 350 350 5.8 note (a) 2019 GBP 250 250 6.4 note (a) 24 Floating to fixed 2006 CHF 50 22 note (a) 4.8 1 2006 CAD 350 175 note (a) 4.6 1 2006 AUD 175 75 note (a) 5.7 2007 AUD 50 21 note (a) 5.5 80 2 Note (a): The floating rate interest rates are based on LIBOR (or local equivalent) plus a margin ranging between nil and 137 basis points. The fixed to floating swaps have been used to manage the interest rate profile of external borrowings and are reflected in the repricing table on page 116 in note 21. The floating to fixed swaps have been used to manage the interest rate profile of both internal and external financing arrangements, and those relating to external borrowings are also reflected in the repricing table on page 116 in note 21. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 109

16 Derivative financial instruments continued (b) Cross-currency swaps Principal Principal 2006 original swapped Maturity Original Interest rate currency Swapped Interest rate currency Assets Liabilities date currency % m £m currency % m £m £m £m

Fixed to fixed 2007 USD 5.8 70 36 KRW 7.5 85,876 47 13 GROUP TOBACCO AMERICAN BRITISH 2009 EUR 4.9 500 337 USD 6.5 564 288 53 Fixed to floating 2008 GBP 6.5 217 217 AUD note (b) 607 244 30 2009 EUR 4.9 150 101 GBP note (b) 104 104 1 2012 EUR 3.6 750 505 USD note (b) 907 463 22 2016 GBP 5.5 325 325 EUR note (b) 473 319 3 2019 EUR 4.6 20 13 USD note (b) 22 11 2 77 47

Principal Principal 2005 original swapped Maturity Original Interest rate currency Swapped Interest rate currency Assets Liabilities date currency % m £m currency % m £m £m £m Fixed to fixed 2006 DEM 5.4 250 88 USD 6.7 137 80 8 2006 USD 4.4 45 26 KRW 6.5 52,785 30 5 2007 USD 5.8 70 41 KRW 7.5 85,876 49 11 2009 EUR 4.9 500 344 USD 6.5 564 329 23 Fixed to floating 2006 EUR 5.1 500 344 CAD note (b) 699 349 2 2008 GBP 6.5 217 217 AUD note (b) 607 259 41 2009 EUR 4.9 150 103 GBP note (b) 104 104 5 2012 EUR 3.6 750 515 USD note (b) 907 528 9 2019 EUR 4.6 20 14 USD note (b) 22 13 2 38 68 Note (b): The floating rate interest rates are based on LIBOR plus a margin ranging between 66 and 127 basis points. The US dollar/South Korean won swaps have been used to manage internal financing arrangements. The remaining swaps have been used to manage the currency profile of external borrowings and are reflected in the currency table ACCOUNTS THE ON NOTES on page 116 in note 21. The fixed to floating swaps are also reflected in the repricing table on page 116 in note 21. (c) Forward foreign currency contracts Forward foreign currency contracts are denominated in the following currencies: Fair values of assets 2006 2005 Currencies purchased forward Currencies purchased forward EUR GBP USD CHF CAD AUD Total EUR GBP USD ZAR Total £m £m £m £m £m £m £m £m £m £m £m £m Currencies sold forward AUD 11 CAD 15 15 CHF 5511 2 CYP 11 EUR 19 19 15 6 GBP 83112 JPY 20 20 27 27 USD 18 18 11 ZAR 11 60 20 80 8336148 WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 110 British American Tobacco Directors’ Report and Accounts 2006

NOTES ON THE ACCOUNTS CONTINUED

16 Derivative financial instruments continued Fair values of liabilities 2006 2005 Currencies purchased forward Currencies purchased forward EUR GBP USD CHF CAD AUD Total EUR GBP USD ZAR Total £m £m £m £m £m £m £m £m £m £m £m £m RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH Currencies sold forward AUD 31 4 77 CAD 71 8 CHF 11 EUR 12 3 44 GBP 26 8 HKD 77 HUF 22 KRW 11 NZD 22 11 SGD 11 USD 1113 21 34 RUR 11 ZAR 14 5 99 1942622413 60 2 75

Forward foreign currency contracts have been used to hedge both internal and external forecast transactions as well as the hedging of internal and external assets and liabilities. Certain contracts were used to manage the currency profile of external borrowings and are reflected in the currency table on page 116 in note 21, and their nominal values are as follows: 2006 2005 £m £m £m £m Forward contracts to purchase GBP, sell CHF (74) 73 (78) 77 Forward contracts to purchase GBP, sell CAD (308) 307

OE NTEACCOUNTS THE ON NOTES Forward contracts to purchase GBP, sell AUD (525) 529

(d) Others 2006 2005 Assets Liabilities Assets Liabilities £m £m £m £m Others: Bund forwards note i 15 16 78 Interest derivative note ii 7 9 Sinking fund policy note iii 3 18 23 717 Notes: (i) Forward contracts to purchase and sell German government securities with a nominal value of €1.86 billion (2005: €1.87 billion) taken out to manage internal financing arrangements and maturing within one year. (ii) Remaining impact of an interest derivative with a nominal value of €1 billion maturing in 2013. (iii) Investment in sinking fund policy with a nominal value of ZAR 51 million. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 111

17 Inventories 2006 2005 £m £m Raw materials and consumables 1,182 1,280 Finished goods and work in progress 721 836

Goods purchased for resale 153 158 GROUP TOBACCO AMERICAN BRITISH 2,056 2,274

Inventories pledged as security for liabilities amount to £11 million (2005: £4 million). Write-offs taken to other operating expenses in the Income Statement comprised £26 million (2005: £35 million), including amounts relating to restructuring costs.

18 Income tax receivable and payable Income tax balances shown on the Group Balance Sheet as current assets and current liabilities are expected to be received or paid within 12 months of the Balance Sheet date for both 2006 and 2005.

19 Cash and cash equivalents ` 2006 2005 £m £m Cash and bank balances 484 518 Cash equivalents 972 1,272 1,456 1,790

Cash equivalents mainly comprise short term deposits with an original maturity of three months or less. The carrying value of cash and cash equivalents approximates their fair value. Cash and cash equivalents are denominated in the functional currency of the subsidiary undertaking or other currencies as shown below: 2006 2005 £m £m OE NTEACCOUNTS THE ON NOTES Functional currency 896 1,090 US dollar 352 584 UK sterling 7 4 Euro 179 108 Other currencies 22 4 1,456 1,790

Cash and bank balances are non-interest bearing. Effective interest rates applicable to cash equivalents are as follows: 2006 2005 2006 2005 values values rates rates £m £m % % US dollar 290 527 4.9 3.8 UK sterling 142 206 5.1 4.5 Euro 146 112 3.6 2.3 Canadian dollar 17 20 4.2 3.3 Other currencies 377 407 7.5 8.4 972 1,272 WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 112 British American Tobacco Directors’ Report and Accounts 2006

NOTES ON THE ACCOUNTS CONTINUED

19 Cash and cash equivalents continued In the Group Cash Flow Statement, net cash and cash equivalents are shown after deducting bank overdrafts, as follows: 2006 2005 £m £m Cash and cash equivalents as above 1,456 1,790 RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH Less – accrued interest (1) – overdrafts (179) (126) Net cash and cash equivalents 1,276 1,664

Cash and cash equivalents include restricted amounts of £65 million (2005: £77 million).

20 Capital and reserves – reconciliation of movement in total equity Share premium, capital redemption and merger Other Retained Shareholders’ Minority Total Share capital reserves reserves earnings funds interests equity £m £m £m £m £m £m £m 1 January 2006 as restated 524 3,874 981 1,251 6,630 247 6,877 Differences on exchange (665) (665) (20) (685) Cash flow hedges – net fair value gains 13 13 13 – reclassified and reported in net profit (15) (15) (15) Available-for-sale investments – net fair value losses (2) (2) (2) Net investment hedges – net fair value gains 117 117 117 Tax on items recognised directly in equity page 92 note 6(c) (10) (10) (2) (12) OE NTEACCOUNTS THE ON NOTES Profit for the year 1,896 1,896 152 2,048 Employee share options – value of employee services 41 41 41 – proceeds from shares issued 5232828 Dividends and other appropriations – ordinary shares (1,008) (1,008) (1,008) – to minority interests (137) (137) Purchase of own shares – held in employee share ownership trusts (77) (77) (77) – share buy-back programme (7) 7 (500) (500) (500) Acquisition of minority interests (13) (13) Other movements 13 13 13 31 December 2006 517 3,886 419 1,639 6,461 227 6,688 WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 113

20 Capital and reserves – reconciliation of movement in total equity continued Share premium, capital redemption and merger Other Retained Shareholders’ Minority Total Share capital reserves reserves earnings funds interests equity

£m £m £m £m £m £m £m GROUP TOBACCO AMERICAN BRITISH 1 January 2005 535 3,857 625 902 5,919 198 6,117 Change in accounting policy page 89 note 4 (7) 7 Change in accounting policy page 120 note 24 1 (44) (43) 1 (42) 535 3,857 619 865 5,876 199 6,075 Differences on exchange 394 394 31 425 Cash flow hedges – net fair value gains 18 18 (1) 17 – reclassified and reported in net profit 37 37 1 38 – reclassified as basis adjustments 3 3 3 Available-for-sale investments – net fair value losses (1) (1) (1) – reclassified and reported in net profit 1 1 1 Net investment hedges – net fair value losses (52) (52) (52) Tax on items recognised directly in equity page 92 note 6(c) (39) (39) (2) (41) Profit for the year 1,767 1,767 127 1,894 Employee share options – value of employee services 42 42 42 – proceeds from shares issued 6 24 30 30 Dividends and other appropriations

– ordinary shares (910) (910) (910) ACCOUNTS THE ON NOTES – to minority interests (112) (112) Purchase of own shares – held in employee share ownership trusts (48) (48) (48) – share buy-back programme (11) 11 (501) (501) (501) Other movements 1 12 13 4 17 31 December 2005 524 3,874 981 1,251 6,630 247 6,877

As described on page 89 in note 4, differences on exchange in 2005 have been restated by £4 million with a corresponding change in net finance costs and consequently profit for the year. The change in accounting policy had a £nil impact on the reported net finance costs and differences on exchange in 2006. The change to the translation reserve and retained earnings as at 1 January 2005 was £7 million as shown above with a consequent change of £3 million as at 31 December 2005. Details relating to the authorised and allotted share capital, and movements therein, are included on page 146 in note 3. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 114 British American Tobacco Directors’ Report and Accounts 2006

NOTES ON THE ACCOUNTS CONTINUED

20 Capital and reserves – reconciliation of movement in total equity continued Share premium account, capital redemption reserves and merger reserves comprise: Share Capital premium redemption Merger account reserves reserves Total £m £m £m £m RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH 1 January 2005 37 72 3,748 3,857 31 December 2005 43 83 3,748 3,874 31 December 2006 48 90 3,748 3,886

The share premium account includes the difference between the value of shares issued and their nominal value. The increase of £5 million (2005: £6 million) relates solely to ordinary shares issued under the Company’s share option schemes. These schemes are described in the Remuneration Report on pages 53 to 66. On the purchase of own shares as part of the buy-back programme, a transfer is made from retained earnings to the capital redemption reserve equivalent to the nominal value of shares purchased. As described on page 146 in note 3, a technical infringement of the Companies Act 1985 occurred in relation to £100 million of the £500 million shares purchased under the buy-back programme in the table on page 112, which therefore remain in the share capital shown above and are excluded from the transfer to the capital redemption reserve. In 1999, shares were issued for the acquisition of the Rothmans International B.V. Group, and the difference between the fair value of shares issued and their nominal value was credited to merger reserves. Movements in other reserves and retained earnings (which is after deducting treasury shares) shown above comprise: Retained earnings Available- Total Translation Hedging for-sale Other other Treasury reserve reserve reserve reserves reserves shares Other £m £m £m £m £m £m £m 1 January 2006 as restated 383 10 15 573 981 (182) 1,433 Differences on exchange (665) (665) Cash flow hedges – net fair value gains 13 13 OE NTEACCOUNTS THE ON NOTES – reclassified and reported in net profit (15) (15) Available-for-sale investments – net fair value losses (2) (2) Net investment hedges – net fair value gains 117 117 Tax on items recognised directly in equity page 92 note 6(c) (12) 2 (10) Profit for the year 1,896 Employee share options – value of employee services 41 – proceeds from shares issued 23 Dividends and other appropriations – ordinary shares (1,008) Purchase of own shares – held in employee share ownership trusts (77) – share buy-back programme (500) Other movements 39 (26) 31 December 2006 (177) 10 13 573 419 (197) 1,836 WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 115

20 Capital and reserves – reconciliation of movement in total equity continued Total Retained earnings Translation Available- other reserve Hedging for-sale Other reserves Treasury Other restated reserve reserve reserves restated shares restated £m £m £m £m £m £m £m

1 January 2005 52 573 625 (190) 1,092 GROUP TOBACCO AMERICAN BRITISH Change in accounting policy page 89 note 4 (7) (7) 7 Change in accounting policy page 120 note 24 12 (26) 15 1 (44) 57 (26) 15 573 619 (190) 1,055 Differences on exchange 394 394 Cash flow hedges – net fair value gains 18 18 – reclassified and reported in net profit 37 37 – reclassified as basis adjustments 3 3 Available-for-sale investments – net fair value losses (1) (1) – reclassified and reported in net profit 1 1 Net investment hedges – net fair value losses (52) (52) Tax on items recognised directly in equity page 92 note 6(c) (17) (22) (39) Profit for the year 1,767 Employee share options – value of employee services 42 – proceeds from shares issued 24 Dividends and other appropriations – ordinary shares (910)

Purchase of own shares ACCOUNTS THE ON NOTES – held in employee share ownership trusts (48) – share buy-back programme (501) Other movements 1 1 32 (20) 31 December 2005 383 10 15 573 981 (182) 1,433

The translation reserve is as explained in the accounting policy on foreign currencies on page 79. The hedging reserve and the available-for-sale reserve are as explained in the accounting policy on financial instruments on page 81. Other reserves comprise: (a) £483 million which arose in 1998 from merger accounting in a Scheme of Arrangement and Reconstruction whereby British American Tobacco p.l.c. acquired the entire share capital of B.A.T Industries p.l.c. and the share capital of that company’s principal financial services subsidiaries were distributed, so effectively demerging them; and (b) in the Rothmans transaction noted on page 114, convertible redeemable preference shares were issued as part of the consideration. The discount on these shares was amortised by crediting other reserves and charging retained earnings. The £90 million balance in other reserves comprises the accumulated balance in respect of the preference shares converted during 2004. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 116 British American Tobacco Directors’ Report and Accounts 2006

NOTES ON THE ACCOUNTS CONTINUED

21 Borrowings

2006 2005 restated Currency Maturity dates Interest rates £m £m Eurobonds Euro 2006 to 2019 3.6% to 5.4% 3,465 3,881 RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH UK sterling 2008 to 2019 5.5% to 6.5% 1,364 1,087 Floating rate notes Euro 2006 to 2010 floating rate 355 692 Other notes Japanese yen 2006 1.4% 75 Malaysian ringgit 2007 to 2009 4.6% to 7.9% 103 109 US dollar 2008 6.9% 176 200 Other currencies 93 196 Syndicated bank loans US dollar 2006 to 2007 floating rate 358 404 Bank loans 460 418 Other loans 11 8 Finance leases 62 64 Overdrafts 179 126 6,626 7,260

The floating rate interest rates are based on EURIBOR or US LIBOR plus a margin ranging between 36 and 200 basis points. 2006 2005 restated £m £m Current 1,058 2,202 Non-current 5,568 5,058 6,626 7,260

As described on page 96 in note 10, borrowings in respect of finance leases for 2005 have been restated by a £4 million increase to comply with IFRIC Interpretation 4. At the end of 2006, finance lease obligations of £8 million were included within borrowings on a similar basis.

OE NTEACCOUNTS THE ON NOTES Current borrowings include interest payable of £133 million at 31 December 2006 (2005: £128 million). In addition, the carrying value of non-current borrowings which are subject to fair value hedges has been decreased by £52 million at 31 December 2006 (2005: increased by £57 million). The carrying value of current borrowings which are subject to fair value hedges has been adjusted by £nil at 31 December 2006 (2005: increased by £2 million). The fair value of borrowings is estimated to be £6,772 million (2005: £7,498 million) and has been determined using quoted market prices, market prices of comparable instruments at the Balance Sheet date or discounted cash flow analysis. 2006 2005 restated £m £m Amounts secured on Group assets 88 68

Amounts secured include finance leases of £62 million (2005: £64 million) and the remaining amounts are secured on certain property and inventory of the Group (page 96 note 10 and page 111 note 17). WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 117

21 Borrowings continued Borrowings are repayable as follows: 2006 2005 restated £m £m

Within one year 1,058 2,202 GROUP TOBACCO AMERICAN BRITISH Between one and two years 419 514 Between two and three years 1,240 445 Between three and four years 361 1,230 Between four and five years 828 3 Beyond five years 2,720 2,866 6,626 7,260

Borrowings are denominated in the functional currency of the subsidiary undertaking or other currencies as shown below: Functional US UK Canadian Australian Other currency dollar sterling Euro dollar dollar currencies Total £m £m £m £m £m £m £m £m 31 December 2006 Total borrowings 3,128 809 327 2,362 6,626 Effect of derivative financial instruments – cross-currency swaps (113) 762 (325) (637) 244 (69) – forward foreign currency contracts (907) 307 529 73 2 2,108 1,571 2 1,725 307 773 73 6,559

31 December 2005 Total borrowings (restated) 3,319 889 218 2,833 1 7,260 Effect of derivative financial instruments – cross-currency swaps 104 950 (217) (1,408) 349 259 37 – forward foreign currency contracts (78) 77 (1) 3,345 1,839 1 1,425 349 259 78 7,296 OE NTEACCOUNTS THE ON NOTES

Details of the derivative financial instruments included in these tables are given on page 107 in note 16. The exposure to interest rate changes when borrowings are repriced is as follows: Within Between Between Between Between Beyond 1 year 1-2 years 2-3 years 3-4 years 4-5 years 5 years Total £m £m £m £m £m £m £m 31 December 2006 Total borrowings 1,505 419 1,240 8 735 2,719 6,626 Effect of derivative financial instruments – interest rate swaps 1,409 (539) (870) – cross-currency swaps 1,141 (217) (101) (843) (20) 4,055 202 600 8 735 1,006 6,606

31 December 2005 Total borrowings (restated) 2,564 166 431 1,230 3 2,866 7,260 Effect of derivative financial instruments – interest rate swaps 1,404 21 (550) (875) – cross-currency swaps 904 (217) (103) (529) 55 4,872 187 214 577 3 1,462 7,315

Details of the derivative financial instruments included in these tables are given on page 107 in note 16. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 118 British American Tobacco Directors’ Report and Accounts 2006

NOTES ON THE ACCOUNTS CONTINUED

21 Borrowings continued Effective interest rates are as follows: 2006 2005 2006 2005 restated £m £m % %

RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH US dollar 866 936 6.6 6.0 UK sterling 1,382 1,090 5.4 6.2 Euro 3,814 4,595 4.5 4.2 Canadian dollar 13 13 5.8 5.0 Australian dollar 7 86 6.5 6.5 Other currencies 544 540 6.8 7.0 6,626 7,260

The values and rates shown above do not reflect the effect of the interest rate and cross-currency swaps detailed on page 107 in note 16. Finance lease liabilities are payable as follows: 2006 2005 Principal Interest Total Principal Interest Total restated restated restated £m £m £m £m £m £m Within one year 18 3 21 19 4 23 Between one and two years 17 2 19 15 3 18 Between two and three years 13 1 14 13 1 14 Between three and four years 81910 10 Between four and five years 3333 Beyond five years 314415 62 8 70 64 9 73

Borrowings facilities 2006 2005 £m £m OE NTEACCOUNTS THE ON NOTES Undrawn committed facilities expiring – within one year 85 116 – between one and two years 57 – between four and five years 1,750 1,750 1,892 1,866

The facilities include undrawn amounts in respect of the Group’s central banking facility of £1.75 billion (2005: £1.75 billion). WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 119

22 Other provisions for liabilities and charges Restructuring Employee of existing Acquired related Other businesses businesses benefits provisions Total £m £m £m £m £m 1 January 2006 222 76 25 172 495 Differences on exchange (15) (4) (2) (13) (34) GROUP TOBACCO AMERICAN BRITISH Provided in respect of the year 99 (12) 1 38 126 Utilised during the year (111) (19) (4) (31) (165) Other movements (4) (6) 2 (8) 31 December 2006 191 41 14 168 414

Analysed on the Balance Sheet as – current 120 24 5 104 253 – non-current 71 17 9 64 161 191 41 14 168 414

1 January 2005 156 105 28 152 441 Differences on exchange 3 1 2 9 15 Provided in respect of the year 157 4 84 245 Utilised during the year (94) (30) (9) (66) (199) Other movements (7) (7) 31 December 2005 222 76 25 172 495

Analysed on the Balance Sheet as – current 103 19 6 106 234 – non-current 119 57 19 66 261 222 76 25 172 495

The restructuring provisions relate to the restructuring costs incurred and reported as exceptional items in the Income Statement. The principal restructurings provided in 2006 and 2005 are as described on page 88 in note 3(e). While ACCOUNTS THE ON NOTES some elements of the non-current provisions of £71 million will unwind over several years, as termination payments are made over extended periods in some countries, it is estimated that approximately 67 per cent will unwind in 2008 and approximately 90 per cent within five years. Provisions in respect of acquired businesses mostly relate to those which were part of the integration of the Rothmans businesses in 1999, the transition of Imperial Tobacco Canada Ltd. to a subsidiary in 2000 and the reorganisation of the Italian business acquired in 2003. While some elements of the non-current provisions of £17 million will unwind over several years, it is estimated that approximately 75 per cent will unwind within five years. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 120 British American Tobacco Directors’ Report and Accounts 2006

NOTES ON THE ACCOUNTS CONTINUED

22 Other provisions for liabilities and charges continued Employee related benefits mainly relate to long term employee benefits other than post-retirement benefits. As the principal components of these provisions are long service awards and ‘jubilee’ payments due after a certain service period, they will unwind over several years. It is estimated that approximately 60 per cent of the non-current provisions of £9 million will unwind within five years. RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH Other provisions comprise balances set up in the ordinary course of general business that cannot be classified within the other categories, such as sales returns, onerous contracts and the age verification scheme in Japan, together with amounts in respect of supplier, excise and other disputes. The nature of the amounts provided in respect of disputes is such that the extent and timing of cash flows is difficult to estimate and the ultimate liability may vary from the amounts provided. Amounts provided in respect of 2006 above are shown net of reversals of unused provisions which include £15 million for restructuring of existing businesses, £12 million for acquired businesses, £2 million for employee related benefits and £12 million for other provisions.

23 Trade and other payables 2006 2005 £m £m Trade payables 611 550 Duty, excise and other taxes 1,467 1,581 Accrued charges and deferred income 553 620 Social security and other taxation 9 2 Sundry payables 272 310 2,912 3,063

Analysed on the Balance Sheet as – current 2,766 2,883 – non-current 146 180

OE NTEACCOUNTS THE ON NOTES 2,912 3,063

Accrued charges and deferred income include £12 million (2005: £17 million) in respect of interest payable. There is no material difference between the above amounts for trade and other payables and their fair value, due to the short term duration of the majority of trade and other payables. Trade and other payables are predominantly denominated in the functional currencies of subsidiary undertakings with less than 6 per cent in other currencies.

24 Financial instruments The accounting policy change in 2005 reflected the application of IAS32 and IAS39 on financial instruments from 1 January 2005. The £42 million reduction in equity at that date reflected: – the measurement of available-for-sale investments at fair value: £16 million gain; – the recognition of derivative financial instruments and derecognition of deferred losses on derivatives: £65 million loss; and – deferred tax asset of £10 million and deferred tax liability of £3 million in respect of the above adjustments. Management of financial risks One of the principal responsibilities of Treasury is to manage the financial risks arising from the Group’s underlying operations. Specifically, Treasury manages, within an overall policy framework, the Group’s exposure to funding and liquidity, interest rate, foreign exchange and counterparty risks. Derivative contracts are only entered into to facilitate the management of these risks. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 121

24 Financial instruments continued The Group’s management of specific risks is dealt with as follows: Liquidity risk It is the policy of the Group to maximise financial flexibility and minimise refinancing risk by issuing debt with a range of maturities, generally matching the projected cash flows of the Group and obtaining this financing from a wide range GROUP TOBACCO AMERICAN BRITISH of providers. Furthermore, it is the policy that short term sources of funds (including drawings under US dollar and euro commercial paper programmes) are backed by undrawn committed lines of credit and cash. During 2006, the Group’s central banking facility at £1.75 billion was extended on existing terms under a one year extension option to a term of five years (plus a further one year extension option). The Group continues to target investment-grade credit ratings; as at end 2006, the ratings from Moody’s and S&P were Baa1/BBB+ (end 2005: Baa1/BBB+). The strength of the ratings has underpinned the success of the debt issuance during 2005 and 2006 and the Group continues to enjoy full access to the debt capital markets. Subsidiary companies are funded by share capital and retained earnings, loans from the central finance companies on commercial terms, or through local borrowings by the subsidiaries in appropriate currencies. All contractual borrowing covenants have been met and none of them is expected to inhibit the Group’s operations or funding plans. Currency risk The Group is subject to exposure on the translation of the net assets of foreign currency subsidiaries and associates into its reporting currency, sterling. The Group’s primary balance sheet translation exposures are to the US dollar, Canadian dollar, euro and South African rand. These exposures are kept under continuous review and the Group’s policy is to minimise all balance sheet translation exposure where it is practicable and cost effective to do so. The exposures are managed by matching currency assets with currency borrowings. At 31 December 2006, the currency profile of the Group’s gross debt, after taking into account derivative contracts, was 25 (2005: 26) per cent US dollar, 48 (2005: 44) per cent euro, 5 (2005: 5) per cent Canadian dollar, 1 (2005: 12) per cent sterling, 12 (2005: 5) per cent Australian dollar and 9 (2005: 8) per cent other currencies. The Group faces currency exposures arising from the translation of profits earned in foreign currency subsidiaries and associates; these exposures are not normally hedged. Exposures also arise from: (i) foreign currency denominated trading transactions undertaken by subsidiaries. These exposures comprise committed ACCOUNTS THE ON NOTES and highly probable forecast sales and purchases, which are offset wherever possible. The remaining exposures are hedged within the Treasury policies and procedures with forward foreign exchange contracts and options, which are designated as hedges of the foreign exchange risk of the identified future transactions; and (ii) forecast dividend flows from subsidiaries to the centre. To ensure cash flow certainty, the Group hedges such flows using forward foreign exchange contracts designated as net investment hedges of the foreign exchange risk arising from the investments in these subsidiaries. Interest rate risk The objectives of the Group’s interest rate risk management policy are to lessen the impact of adverse interest rate movements on the earnings, cash flow and economic value of the Group, and to safeguard against any possible breach of its financial covenants. Additional objectives are to minimise the cost of hedging and the associated counterparty risk. In order to manage its interest rate risk, the Group maintains both floating rate and fixed rate debt. The desired ratio of fixed to variable rate debt is determined as a result of regular reviews of market conditions and strategy by Treasury and the board of the main central finance company. At 31 December 2006, the ratio of floating to fixed rate borrowings was 58:42 (2005: 55:45). Underlying borrowings are arranged on both a fixed rate and a floating rate basis and, where appropriate, the Group uses derivatives, primarily interest rate swaps, to vary the fixed and floating mix. The interest rate profile of liquid assets is taken into account in determining the net interest rate exposure. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 122 British American Tobacco Directors’ Report and Accounts 2006

NOTES ON THE ACCOUNTS CONTINUED

24 Financial instruments continued Credit risk The Group has no significant concentrations of customer credit risk. Subsidiaries have policies in place requiring appropriate credit checks on potential customers before sales commence.

RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH Cash deposits and other financial instruments give rise to credit risk on the amounts due from bank counterparties. Credit risk is managed on a global basis by limiting the aggregate amount and duration of exposure to any one counterparty, taking into account its credit rating. The credit ratings of counterparties are reviewed regularly. Price risk The Group is exposed to equity price risk on equity investments held by the Group. These are classified on the consolidated balance sheet as available-for-sale investments. The Group is not exposed to commodity price risk. Hedge accounting In order to qualify for hedge accounting, the Group is required to document prospectively the relationship between the item being hedged and the hedging instrument. The Group is also required to demonstrate an assessment of the relationship between the hedged item and the hedging instrument, which shows that the hedge will be highly effective on an on-going basis. This effectiveness testing is reperformed periodically to ensure that the hedge has remained, and is expected to remain highly effective. Fair value estimation Derivative financial instruments The fair values of derivatives are determined based on market data (primarily yield curves, implied volatilities and exchange rates) to calculate the present value of all estimated flows associated with each derivative at the balance sheet date. In the absence of sufficient market data, fair values have been based on the quoted market price of similar derivatives. Other financial instruments The fair values of financial assets and liabilities with maturities of less than one year are assumed to approximate to their book values. For financial assets and liabilities with maturities of more than one year, fair values are based on quoted market prices, market prices of comparable instruments at the balance sheet date or discounted cash flow analysis.

25 Cash flow OE NTEACCOUNTS THE ON NOTES Cash generated from operations 2006 2005 restated £m £m Profit before taxation 2,764 2,584 Adjustments for – share of post-tax results of associates and joint ventures (431) (392) – net finance costs 289 228 – gains on disposal of brands and joint venture (60) (72) – depreciation and impairment of property, plant and equipment 367 348 – amortisation of intangible assets 34 35 – decrease/(increase) in inventories 21 (28) – increase in trade and other receivables (105) (178) – increase in trade and other payables 57 326 – decrease in net retirement benefit liabilities (69) (52) – (decrease)/increase in provisions for liabilities and charges (68) 61 – other 17 33 Cash generated from operations 2,816 2,893

Profit before taxation includes charges in respect of Group restructuring costs referred to on page 88 in note 3(e). These are also reflected in the movements in depreciation, inventories, receivables, payables and provisions above, and in the proceeds on disposal of property, plant and equipment shown on page 77. The cash outflow in respect of the Group restructuring costs was £177 million (2005: £143 million), of which £220 million (2005: £143 million) is included in cash generated from operations above. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 123

25 Cash flow continued Cash flows from investing activities (a) Proceeds on disposals of intangibles The cash inflows in 2006 and 2005 principally reflect the sale of brands (page 88 note 3(f)).

(b) Purchases and disposals of investments GROUP TOBACCO AMERICAN BRITISH Purchases and disposals of investments (which comprise available-for-sale investments and loans and receivables) include an outflow in respect of current investments of £41 million for the year to 31 December 2006 (2005: £7 million decrease) and £4 million sales proceeds from non-current investments for the year to 31 December 2006 (2005: £15 million). (c) Purchases of subsidiaries and minority interests In 2006, the cash outflow principally reflects the cost of acquiring minority interests in the Group’s Chilean subsidiary. In 2005, the cash outflow principally reflected the purchase of Restomat AG in Switzerland, net of £6 million cash and cash equivalents in the acquired company (see note 26 below). (d) Proceeds on disposal of subsidiaries In 2006, the proceeds principally reflect the sale of Toscano in Italy (see note 26 below). (e) Purchases of associates The outflow in 2005 reflects the increase in the shareholding in Skandinavisk Tobakskompagni AS (page 97 note 11). Cash flows from financing activities (a) In 2006, reductions in borrowing principally reflect repayment of €1 billion floating rate notes, a deutschmark 1 billion Eurobond and a €500 million Eurobond, whilst new borrowings principally reflected €600 million Eurobonds with a 2014 maturity, £325 million Eurobonds with a 2016 maturity and €525 million floating rate notes with a 2010 maturity. In 2005, reductions in borrowings principally reflect repayment of a US$400 million Eurobond, €300 million floating rate notes and a deutschmark 500 million Eurobond, whilst new borrowings principally reflect a €750 million Eurobond with a 2012 maturity. (b) The movement relating to derivative financial instruments is in respect of derivatives taken out to hedge cash and cash equivalents and external borrowings, derivatives taken out to hedge inter company loans and derivatives treated as net investment hedges. Derivatives taken out as cash flow hedges in respect of financing activities are also included in the movement relating to derivative financial instruments, while other such derivatives in respect of operating and ACCOUNTS THE ON NOTES investing activities are reflected along with the underlying transactions.

26 Business combinations and disposals (a) The Group ceased to be the controlling company of British American Racing (Holdings) Ltd. (BAR) on 8 December 2004 when BAR went into administration. The Group consequently ceased to consolidate BAR from that date. On 7 January 2005, BARH Ltd., a newly formed joint venture between British American Tobacco and Honda Motor Co. Ltd. acquired the BAR business. On 4 October 2005, the Group announced that it had agreed the sale of its 55 per cent shareholding in BARH to Honda, and the sale was completed on 20 December 2005. For the period from 7 January 2005 to 20 December 2005, BARH was equity accounted, reflecting shared control with Honda. These transactions resulted in a net gain of £5 million in 2005, included in other operating income in profit from operations (page 88 note 3(f)). (b) On 25 November 2005, the Group acquired Restomat AG, the largest operator of cigarette vending machines in Switzerland, for a cash consideration of £25 million. The net assets acquired were £10 million of non-current assets and £15 million of current assets (including £6 million of cash and cash equivalents) less £2 million of non-current liabilities and £5 million of current liabilities. The acquisition resulted in goodwill of £7 million. In the period from 1 January 2005 to 25 November 2005, the profit from operations and the profit for the period was £2 million. (c) As described on page 88 in note 3(f), the Group’s Italian subsidiary sold its cigar business on 19 July 2006. (d) In August 2006, the Group purchased minority interests in its subsidiary in Chile for a cost of £91 million, raising the Group shareholding from 70.4 per cent to 96.4 per cent. The goodwill arising on this transaction was £80 million and the minority interests in Group equity were reduced by £11 million. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 124 British American Tobacco Directors’ Report and Accounts 2006

NOTES ON THE ACCOUNTS CONTINUED

27 Share-based payments During the period ended 31 December 2006, the following material share-based payment arrangements existed, which are described below:

Long Term Deferred Share Sharesave Share Option Share Reward Type of arrangement Incentive Plan Bonus Scheme Scheme Scheme Scheme RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH Timing of grant Annually in March Annually Annually See note (a) Annually (2005 – May) in March in November in April Number of 2,712,841 1,835,223 3 year – 126,844 n/a 334,738 options/shares 5 year – 154,664 granted in 2006 Number of 3,472,111 2,275,558 3 year – 224,885 n/a305,888 options/shares 5 year – 190,160 granted in 2005 Fair value per share £10.10 £13.00 3 year – £3.65 n/a £13.85 for 2006 grant 5 year – £3.91 Fair value per share £7.29 £8.12 3 year – £3.12 n/a £9.31 for 2005 grant 5 year – £3.33 Method of Both equity and Both equity and Equity Both equity and Equity settlement cash-settled grants cash-settled grants cash-settled grants Contractual life 10 years 3 years 3.5 or 5.5 years 10 years 3 years Vesting conditions See note (b) See note (c) See note (d) See note (e) See note (f) Notes: (a) The granting of options under this scheme ceased with the last grant made in March 2004. Eligible individuals are entitled to participate in the Long Term Incentive Plan and Deferred Share Bonus Scheme. (b) Nil-cost options exercisable three years from date of grant, with payout subject to performance conditions based on earnings per share relative to inflation (50 per cent of grant) and total shareholder return, combining the share price and dividend performance of the Company by reference to two comparator groups (50 per cent of grant). Participants are not entitled to dividends prior to the exercise of the options. For grants made in 2005 and thereafter, a cash equivalent dividend will accrue through the vesting period and will be paid on vesting. (c) Free shares released three years from date of grant and may be subject to forfeit if participant leaves employment before the end of the three year holding period. Participants receive a separate payment equivalent to a proportion of the dividend during the holding period. (d) Options granted by invitation at a 20 per cent discount to the market price. Options are exercisable at the end of a three year or five year savings contract. Participants are not entitled to dividends prior to the exercise of the options.

OE NTEACCOUNTS THE ON NOTES (e) Options exercisable three years from date of grant and subject to earnings per share performance condition relative to inflation. Participants are not entitled to receive dividends in the period prior to the exercise of the options. (f) Free shares granted (maximum £3,000 in any year) subject to a three year holding period and may be subject to forfeit if the employee leaves within this period. Participants are entitled to receive dividends during the holding period which are reinvested to buy further shares. During the period, the Company operated a Partnership Share Scheme, which was open to all eligible employees, where employees can allocate part of their pre-tax salary to purchase shares in British American Tobacco p.l.c. The maximum amount that can be allocated in this way to any individual is £1,500 in any tax year. The shares purchased are held in a UK-based trust and are normally capable of transfer to participants tax free after a five year holding period. Further details on the operation of share-based payment arrangements can be found in the Remuneration Report. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 125

27 Share-based payments continued Share option schemes Details of the movements for equity-settled share option schemes during the years ended 31 December 2006 and 31 December 2005 covering the Share Option and Sharesave Schemes were as follows. The last of the former B.A.T Industries Employee Share ‘E’ Option Scheme options were exercised in 2005. RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH 2006 2005 Weighted Weighted average exercise average exercise Number price per share Number price per share of options £ of options £ Outstanding at start of year 12,648,695 6.39 17,352,182 5.97 Granted during the period 281,508 11.52 415,045 9.77 Exercised during the period (4,234,650) 5.75 (4,864,295) 5.20 Forfeited during the period (245,872) 7.01 (254,237) 5.89 Outstanding at end of year 8,449,681 6.86 12,648,695 6.39

Exercisable at end of year 3,626,882 5.55 3,267,697 5.19

In addition to the above options, the movement in nil-cost equity-settled options from the Long Term Incentive Plan was as follows: 2006 2005 Number Number of options of options Outstanding at start of year 9,403,252 9,851,735 Granted during the period 2,224,313 3,099,082 Exercised during the period (2,478,316) (2,078,722) Forfeited during the period (1,040,994) (1,468,843) Outstanding at end of year 8,108,255 9,403,252

Exercisable at end of year 922,014 744,082 OE NTEACCOUNTS THE ON NOTES The weighted average British American Tobacco p.l.c. share price at the date of exercise for share options exercised during the period was £13.94 (2005: £10.05). A detailed breakdown of the range of exercise prices for options outstanding for the years ended 31 December 2006 and 31 December 2005 is shown in the table below: 2006 2005 Weighted Weighted Weighted Weighted Number average remaining average exercise Number average remaining average exercise outstanding contractual life price per share outstanding contractual life price per share Range of exercise prices at end of year in years £ at end of year in years £ Nil-cost 8,108,255 7.8 n/a 9,403,252 8.0 n/a £2.53 to £4.99 389,805 2.0 3.19 966,689 1.8 3.46 £5.00 to £6.99 3,908,880 4.1 5.74 7,330,469 5.5 5.81 £7.00 to £8.99 3,488,622 6.4 7.83 3,936,492 7.4 7.83 £9.00 to £12.50 662,374 3.9 10.51 415,045 4.4 9.77 16,557,936 6.4 3.50 22,051,947 6.7 3.66

The weighted average fair value of equity-settled Share Option Schemes’ shares granted during 2006 was £9.39 (2005: £6.81). WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 126 British American Tobacco Directors’ Report and Accounts 2006

NOTES ON THE ACCOUNTS CONTINUED

27 Share-based payments continued Assumptions used in the Black-Scholes models to determine the fair value of share options at grant date were as follows: 2006 2005 Long Term Sharesave Long Term Sharesave Incentive Plan Schemes* Incentive Plan Schemes* RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH Share price at date of grant (£) 14.34 14.40 10.37 12.21 Exercise price (£) nil-cost 11.52 nil-cost 9.77 Volatility (%) 23 21 27 24 Average expected term to exercise (years) 3.5 3.2/5.2 3.5 3.2/5.2 Risk free rate (%) 4.4 4.9/4.8 4.3 4.2/4.2 Expected dividend yield (%) 3.3 3.4 4.0 3.5 *Where two figures have been quoted for the Sharesave Schemes, the first number represents the assumptions for the three year savings contract and the second number for the five year savings contract. Market condition features were incorporated into the Monte-Carlo models for the total shareholder return elements of the Long Term Incentive Plan, in determining fair value at grant date. Assumptions used in these models were as follows: 2006 2005 % % Average share price volatility FTSE 100 comparator group 31 34 Average share price volatility FMCG comparator group 23 26 Average correlation FTSE 100 comparator group 26 24 Average correlation FMCG comparator group 18 16

The expected British American Tobacco p.l.c. share price volatility was determined taking account of the daily share price movements over a five year period. The respective FMCG and FTSE 100 share price volatility and correlations were also determined over the same periods. The average expected term to exercise used in the models has been adjusted, based on management’s best estimate, for the effects of non-transferability, exercise restrictions and behavioural conditions, forfeiture and historical experience. The risk free rate has been determined from market yield curves for government gilts with outstanding terms equal to the average expected term to exercise for each relevant grant. The expected dividend yield was determined by OE NTEACCOUNTS THE ON NOTES calculating the yield from the last two declared dividends divided by the grant share price. For grants containing earnings per share performance conditions, the payout calculation is based on the average of expectations published in analysts’ forecasts. Other equity share-based payment arrangements (other than share options) Details of the movements of other equity share-based payment arrangements during the years ended 31 December 2006 and 31 December 2005, covering the Deferred Share Bonus and Share Reward Schemes, were as follows: 2006 2005 Number of shares Number of shares Outstanding at start of year 7,001,271 7,284,592 Granted during the period 1,959,868 2,310,273 Exercised during the period (3,037,981) (2,461,386) Forfeited during the period (89,287) (132,208) Outstanding at end of year 5,833,871 7,001,271

Exercisable at end of year 383,294 643,825 The shares outstanding for the year ended 31 December 2006 had a weighted average contractual life of 1.1 years (2005: 1.1 years). WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 127

27 Share-based payments continued The fair value for other equity share-based payment arrangements granted during the period was determined using the Black-Scholes model with the following input assumptions at their grant date: 2006 2005 Deferred Share Share Reward Deferred Share Share Reward RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH Bonus Scheme Scheme Bonus Scheme Scheme Grant price (£) 14.34 13.85 9.29 9.31 Expected volatility (%) 23 23 30 30 Average expected term to exercise (years) 3.0 5.0 3.0 5.0 Risk free rate (%) 4.4 4.5 4.8 4.7 Expected dividend yield (%) 3.3 3.4 4.5 4.5

The weighted average fair value of other equity share-based payment arrangements granted during 2006 was £13.14 (2005: £8.27). Cash-settled share-based payment arrangements The Group issues to certain employees cash-settled share-based payments that require the Group to pay the intrinsic value of these share-based payments to the employee at the date of exercise. The Group has recorded liabilities at the end of 2006 of £14,294,315 (2005: £13,359,675) of which £3,456,071 (2005: £2,698,902) was in respect of vested grants. Fair value was determined from the Black-Scholes and Monte-Carlo models, using assumptions revised at the balance sheet date for cash-settled share-based payment arrangements. The Group recorded total expenses of £9,306,250 in 2006 (2005: £11,581,489). Details of movements for cash-settled arrangements in respect of the Share Option Scheme during the years ended 31 December 2006 and 31 December 2005, were as follows: 2006 2005 Weighted Weighted average exercise average exercise Number price per share Number price per share of options £ of options £ Outstanding at start of year 1,057,496 6.40 1,859,995 6.35

Granted during the period n/a n/a n/a n/a ACCOUNTS THE ON NOTES Exercised during the period (605,634) 6.19 (774,940) 6.28 Forfeited during the period (20,582) 6.69 (27,559) 6.21 Outstanding at end of year 431,280 6.69 1,057,496 6.40

Exercisable at end of year 313,101 6.17 375,833 6.38

In addition to the above, the movement in other nil-cost cash-settled arrangements during the years ended 31 December 2006 and 31 December 2005, covering the Long Term Incentive Plan and Deferred Share Bonus Scheme, were as follows: 2006 2005 Number Number of shares of shares Outstanding at start of year 1,215,861 1,030,400 Granted during the period 698,621 644,202 Exercised during the period (239,513) (408,380) Forfeited during the period (60,263) (50,361) Outstanding at end of year 1,614,706 1,215,861

Exercisable at end of year 63,934 16,190

Assumptions used to determine the fair value of cash-settled share-based payment arrangements at date of grant, can be found in the sections relating to share option schemes and other equity share-based payment arrangements. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 128 British American Tobacco Directors’ Report and Accounts 2006

NOTES ON THE ACCOUNTS CONTINUED

27 Share-based payments continued The weighted average British American Tobacco p.l.c. share price at the date of exercise for cash-settled share-based arrangements exercised during the period was £14.05 (2005: £10.05). A detailed breakdown of the range of exercise prices for cash-settled share-based payment arrangements outstanding for the years ended 31 December 2006 and 31 December 2005 are shown in the table below: RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH 2006 2005 Weighted Weighted Weighted Weighted Number average remaining average exercise Number average remaining average exercise outstanding contractual life price per share outstanding contractual life price per share Range of exercise prices at end of year in years £ at end of year in years £ Nil-cost 1,614,706 6.1 n/a 1,215,861 5.6 n/a £5.60 to £5.98 163,481 6.1 5.97 546,929 7.1 5.98 £6.39 to £8.09 267,799 6.0 7.14 510,567 6.7 6.86 2,045,986 6.1 1.41 2,273,357 6.2 2.98

Share-based payment expense The amounts recognised in the Income Statement in respect of share-based payments were as follows: 2006 2005 £m £m Equity-settled share-based payments 41 42 Cash-settled share-based payments 9 12 Total amount recognised in the Income Statement page 87 note 3(a) 50 54

28 Group employees The average number of persons employed by the Group and its associates during the year, including Directors, was 97,431 (2005: 96,952). 2006 2005 Number Number Europe 18,953 19,479

OE NTEACCOUNTS THE ON NOTES Asia-Pacific 10,128 10,407 Latin America 14,941 13,969 Africa and Middle East 8,993 9,247 America-Pacific 2,130 2,262 Subsidiary undertakings 55,145 55,364 Associates 42,286 41,588 97,431 96,952

Details of Directors’ remuneration, share options and retirement benefits are given in the Remuneration Report on pages 53 to 66. Included within the employee numbers for Europe are certain employees in the UK in respect of central functions. Some of the costs of these employees are allocated or charged to the various regions and markets in the Group. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 129

29 Related party disclosures The Group has a number of transactions and relationships with related parties, as defined in IAS24 on related party disclosures, all of which are undertaken in the normal course of trading. Details of these are set out below. Transactions and balances with associates relate mainly to the sale and purchase of cigarettes and tobacco leaf. Amounts receivable from associates in respect of dividends included in the table below were £48 million (2005: £45 million). The Group’s GROUP TOBACCO AMERICAN BRITISH share of dividends from associates included in other net income in the table below, was £267 million (2005: £202 million). Legal fees recovered from Reynolds American Inc. included in other net income amounted to £2 million (2005: £10 million). 2006 2005 £m £m Transactions – revenue 35 43 – purchases (292) (304) – other net income 272 184 Amounts receivable at 31 December 58 64 Amounts payable at 31 December (24) (33)

As described on page 123 in note 26, between 7 January 2005 and 20 December 2005 the Group had an interest in BARH Ltd., a joint venture between British American Tobacco and Honda Motor Co. Ltd. As part of this relationship, the Group had a funding obligation to BARH through to the end of 2006. Payments of US$67.5 million relating to Lucky Strike sponsorship for 2005 and 2006, were made during 2005 and these are included in the table above under other net income. The key management personnel of British American Tobacco consist of the members of the Board of Directors of British American Tobacco p.l.c. and the members of the Management Board. No such person had any material interest during the year in a contract of significance (other than a service contract) with the Company or any subsidiary company. The term key management personnel in this context includes the respective members of their households. 2006 2005 £m £m The total compensation for key management personnel, including Directors, was

– salaries and other short term employee benefits 14 11 ACCOUNTS THE ON NOTES – post-employment benefits 3 2 – share-based payments 6 5 23 18

There were no termination benefits paid or other long term benefits applicable in respect of key personnel. Other than in their capacity as shareholders, there have been no material transactions with Compagnie Financière Richemont SA and Remgro Limited, who together indirectly own 29.2 per cent (2005: 28.6 per cent) of the fully diluted ordinary share capital of British American Tobacco p.l.c. at 31 December 2006. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 130 British American Tobacco Directors’ Report and Accounts 2006

NOTES ON THE ACCOUNTS CONTINUED

30 Contingent liabilities and financial commitments There are contingent liabilities in respect of litigation, overseas taxes and guarantees in various countries. Product liability litigation Group companies, notably Brown & Williamson Holdings, Inc. (formerly Brown & Williamson Tobacco Corporation)

RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH (B&W), as well as other leading cigarette manufacturers, are defendants, principally in the US, in a number of product liability cases. In a number of these cases, the amounts of compensatory and punitive damages sought are significant. Indemnity On 30 July 2004, B&W completed transactions combining its US tobacco business assets, liabilities and operations with R.J. Reynolds Tobacco Company. A new company called R.J. Reynolds Tobacco Company (RJRT) was created as a result of the combination transactions. These transactions (the Business Combination) were accomplished through a publicly traded holding company Reynolds American Inc. (RAI), which is the indirect parent corporation of RJRT. As a result of the Business Combination: (a) B&W discontinued the active conduct of any tobacco business in the US; (b) B&W contributed to RJRT all of its assets other than the capital stock of certain subsidiaries engaged in non-US businesses and other limited categories of assets; (c) RJRT assumed all liabilities of B&W (except liabilities to the extent relating to businesses and assets not contributed by B&W to RJRT and other limited categories of liabilities) and contributed subsidiaries or otherwise to the extent related to B&W’s tobacco business as conducted in the US on or prior to 30 July 2004; and (d) RJRT agreed to indemnify B&W and each of its affiliates (other than RAI and its subsidiaries) against, among other matters, all losses, liabilities, damages, expenses, judgments, attorneys’ fees, etc, to the extent relating to or arising from such assumed liabilities or the assets contributed by B&W to RJRT (the RJRT Indemnification). The scope of the RJRT Indemnification includes all expenses and contingent liabilities in connection with litigation to the extent relating to or arising from B&W’s US tobacco business as conducted on or prior to 30 July 2004, including smoking and health tobacco litigation, whether the litigation is commenced before or after 30 July 2004 (the tobacco litigation). Pursuant to the terms of the RJRT Indemnification, RJRT is liable for any possible judgments, the posting of appeal bonds or security, and all other expenses of and responsibility for managing the defence of the tobacco litigation. RJRT has assumed control of the defence of the tobacco litigation involving B&W and RJRT is also a party in most (but not all) of the same cases. Accordingly, RJRT uses or plans to use the same law firm or firms to represent both B&W and RJRT in any single or similar case (except in certain limited circumstances) as RJRT’s interests are typically aligned with B&W’s interests, and RJRT has substantial experience in managing recognised external legal counsel in defending OE NTEACCOUNTS THE ON NOTES tobacco litigation, and external counsel have independent professional responsibilities to represent the interests of B&W. In addition, in accordance with the terms of the RJRT Indemnification, affiliates of B&W have retained control of the defence in certain tobacco litigation cases with respect to which such affiliates are entitled to indemnification. US litigation The total number of US product liability cases pending at 31 December 2006 involving B&W and other Group companies was approximately 3,492 (2005: 3,810). At 31 December 2006, UK-based Group companies have been named as co-defendants in some seven of those cases (2005: 965). The reduction in this figure is primarily in consequence of the dismissal of B.A.T Industries p.l.c. as a defendant in the West Virginia consolidated smoking and health cases (see below under UK-based Group companies). Only one case against B&W was tried in 2006 (VanDenBurg), which resulted in a defence verdict. No US cases involving the UK-based Group companies were tried in 2006. Only perhaps five cases are likely to come to trial in 2007, some involving amounts ranging possibly into the hundreds of millions and even billions of dollars. Since many of these pending cases seek unspecified damages, it is not possible to quantify the total amounts being claimed, but the aggregate amounts involved in such litigation are significant. The cases fall into four broad categories: (a) Medical reimbursement cases These civil actions seek to recover amounts spent by government entities and other third party providers on healthcare and welfare costs claimed to result from illnesses associated with smoking. Although B&W continues to be a defendant in healthcare cost recovery cases involving plaintiffs such as hospitals, Native American tribes, and foreign governments, the vast majority of such cases have been dismissed on legal grounds. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 131

30 Contingent liabilities and financial commitments continued At 31 December 2006, one reimbursement suit was pending against B&W by an Indian tribe, and no suits were pending against B&W by county or other political subdivisions of the states. The Master Settlement Agreement (MSA) with the 46 states includes a credit for any amounts paid in suits brought by the states’ political subdivisions; nevertheless, RJRT intends to defend and is defending these cases vigorously. Based on somewhat different theories of claim are two RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH non-governmental medical reimbursement cases and health insurers’ claims. One third party reimbursement case (City of St. Louis), consists of more than 60 public and non-profit hospitals in Missouri seeking reimbursement of past and future alleged smoking related healthcare costs. No trial date is currently set for this case. At 31 December 2006, B&W was named as a defendant in two (2005: two) cases brought by foreign government entities in a single US court (Republic of Panama and State of São Paulo) seeking reimbursement of medical costs which they incurred for treatment for persons in their own countries who are alleged to have smoked imported cigarettes, including those manufactured by B&W. These two cases, originally filed in state court in Louisiana, were consolidated and then dismissed by the trial court on the basis that Louisiana was the inappropriate forum. These plaintiffs filed new cases in the Superior Court for the State of Delaware on 19 July 2005. On 13 July 2006, the Delaware Superior Court granted defendants’ motion to dismiss. Plaintiffs filed notices of appeal to the Supreme Court of Delaware on 19 July 2006. Oral argument on plaintiffs’ appeal was heard on 6 December 2006 by the Supreme Court of Delaware, which reserved decision. (b) Class actions At 31 December 2006, B&W was named as a defendant in some 15 (2005: 15) separate actions attempting to assert claims on behalf of classes of persons allegedly injured or financially impacted through smoking or where classes of tobacco claimants have been certified. Even if the classes remain certified and the possibility of class-based liability is eventually established, it is likely that individual trials will still be necessary to resolve any actual claims. Class-action suits have been filed in a number of states against individual cigarette manufacturers and their parent corporations, alleging that the use of the terms ‘lights’ and ‘ultralights’ constitutes unfair and deceptive trade practices. A class action complaint (Schwab) was filed in the US District Court for the Eastern District of New York on 11 May 2004 against B&W and certain UK-based Group companies. The complaint challenges the practices of defendants with respect to the marketing, advertising, promotion and sale of ‘light’ cigarettes. The court granted plaintiffs’ motion for class certification on 25 September 2006. By order dated 17 November 2006, the Second Circuit Court of Appeals granted defendants’ motion to stay the district court proceedings in this case, and further granted defendants’ petition for leave to appeal the district court’s class ACCOUNTS THE ON NOTES certification order. Other types of class-action suits assert claims on behalf of classes of individuals who claim to be addicted, injured, or at greater risk of injury by the use of tobacco or exposure to environmental tobacco smoke, or the legal survivors of such persons. In Engle (Florida), one jury awarded a total of US$12.7 million to three class representatives, and in a later stage of this three phase trial process, a jury assessed US$17.6 billion in punitive damages against B&W. In November 2000, B&W posted a surety bond in the amount of US$100 million (the amount required by Florida law) to stay execution of this punitive damages award. On 21 May 2003, the intermediate appellate court reversed the trial court’s judgment and remanded the case to the trial court with instructions to decertify the class. On 16 July 2003, plaintiffs filed a motion for rehearing which was denied on 22 September 2003. On 12 May 2004, the Florida Supreme Court agreed to review this case and, on 6 July 2006, it upheld the intermediate appellate court’s decision to decertify the class, and vacated the jury’s punitive damages award. Further, the Florida Supreme Court permitted the judgments entered for two of the three Engle class representatives to stand, but dismissed the judgment entered in favour of the third Engle class representative. Finally, the Court has permitted putative Engle class members to file individual lawsuits against the Engle defendants within one year of the Court’s decision. The Court’s order precludes defendants from litigating certain issues of liability against the putative Engle class members in these individual actions. On 7 August 2006, defendants filed a motion for rehearing before the Florida Supreme Court, which was granted in part, and denied in part, on 21 December 2006. The Florida Supreme Court’s 21 December 2006 ruling did not amend any of the earlier decision’s major holdings, which included decertifying the class, vacating the punitive damages judgment, and permitting individual members of the former class to file separate suits. Instead, the ruling addressed the claims on which the Engle jury’s phase one verdict will be applicable to the individual lawsuits that were permitted to stand. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 132 British American Tobacco Directors’ Report and Accounts 2006

NOTES ON THE ACCOUNTS CONTINUED

30 Contingent liabilities and financial commitments continued In the first ‘phase three’ trial of an individual Engle class member (Lukacs), the jury awarded the plaintiff US$37.5 million in compensatory damages (B&W’s share: US$8.4 million). On 1 April 2003, the jury award was reduced to US$25.125 million (B&W’s share: US$5.65 million) but no final judgment will be entered until the Engle appeal is fully resolved. Therefore the time to appeal this case has not yet begun to run. RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH In a Louisiana medical monitoring case brought on behalf of Louisiana smokers (Scott), on 28 July 2003, the jury returned a verdict in favour of defendants on the medical monitoring claim but made findings against defendants with respect to claims relating to fraud, conspiracy, marketing to minors and smoking cessation. On 21 May 2004, the jury returned a verdict in the amount of US$591 million on the class’s claim for a smoking cessation programme. On 1 July 2004, the court upheld the jury’s verdict and entered final judgment. On 29 September 2004, defendants posted a US$50 million bond (legislation in Louisiana limits the amount of a bond to prevent execution upon such a judgment to US$50 million collectively for signatories to the MSA). RJRT posted US$25 million (i.e. the portions for RJRT and B&W) towards the bond. On 12 April 2006, the Louisiana Fourth Circuit Court of Appeal heard argument on defendants’ appeal. The appellate court issued a decision on 7 February 2007 that affirmed class certification and upheld the smoking cessation programme for certain smokers who began smoking before 1988, but reduced the US$591 million jury award by US$312 million and rejected any award of prejudgment interest. Defendants are in the process of seeking further review of this decision. A federal judge in New York certified a nation-wide punitive-damages-only class (Simon II) in September 2002. Defendants sought reconsideration of the certification ruling, which was denied on 25 October 2002. On 14 February 2003, the US Court of Appeals for the Second Circuit granted defendants’ petition to review the class certification decision. Oral argument was heard on 20 November 2003. On 6 May 2005, the Second Circuit Court of Appeals vacated the district court’s class certification order. The district court permitted plaintiffs to voluntarily dismiss this action on 8 December 2005. The district court entered its final judgment dismissing this case on 20 March 2006. (c) Individual cases Approximately 3,471 cases were pending against B&W at 31 December 2006 (2005: 3,767) filed by or on behalf of individuals in which it is contended that diseases or deaths have been caused by cigarette smoking or by exposure to environmental tobacco smoke (ETS). Of these cases: (a) approximately 75 per cent are ETS cases brought by flight attendants who were members of a class action (Broin) that was settled on terms that allow compensatory but not punitive damages claims by class members; (b) approximately 20 per cent of the individual cases against B&W are cases OE NTEACCOUNTS THE ON NOTES brought in consolidated proceedings in West Virginia; and (c) only about 5 per cent are cases filed by other individuals. Of the individual cases that went to trial or were decided or remained on appeal during 2006, several resulted in verdicts against B&W: In November 2003, a Missouri jury (Thompson) awarded US$210,000 damages against B&W. A notice of appeal was filed on 8 March 2004. Oral argument before the Missouri Court of Appeals was heard on 3 November 2005. The Missouri Court of Appeals affirmed the judgment on all points on 22 August 2006. B&W moved before the Missouri Court of Appeals to transfer this appeal to the Missouri Supreme Court on 6 September 2006. B&W’s motion was denied by the Missouri Court of Appeals on 26 September 2006. On 10 October 2006, B&W filed an application with the Missouri Supreme Court for transfer of this action to the Missouri Supreme Court. The Missouri Supreme Court denied B&W’s application on 19 December 2006. In December 2003, a New York jury (Frankson) awarded US$350,000 compensatory damages against B&W and two industry organisations. In January 2004, the same jury awarded US$20 million punitive damages. On 22 June 2004, the trial judge granted a new trial unless the parties agreed to an increase in compensatory damages to US$500,000 and a decrease in punitive damages to US$5 million, of which US$4 million would be assigned to B&W. Plaintiffs agreed to a decrease in punitive damages, but B&W has not agreed to an increase in compensatory damages. On 25 January 2005, B&W appealed to an intermediate New York State appellate court. Oral argument was heard on 8 May 2006. The appellate court affirmed the judgment on 5 July 2006. B&W filed a motion for leave to reargue, or in the alternative, for leave to appeal to the New York Court of Appeals, on 3 August 2006. The intermediate appellate court denied this motion on 5 October 2006. On 8 December 2006, the trial judge granted plaintiff’s application for entry of judgment, and granted plaintiff’s motion to vacate that part of the 2004 order granting a new trial unless the parties agreed to an increase in compensatory damages to US$500,000. B&W intends to seek further appellate review of the trial court’s judgment. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 133

30 Contingent liabilities and financial commitments continued On 1 February 2005, a Missouri jury (Smith) awarded US$500,000 in compensatory damages against B&W and then, on 2 February 2005, awarded US$20 million in punitive damages, also against B&W. On 1 June 2005, B&W filed its notice of appeal. B&W filed its opening appellate brief on 28 April 2006. Oral argument was heard on 31 August 2006 and a decision is awaited. RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH On 18 March 2005, a New York jury (Rose) awarded US$1.7 million in compensatory damages against B&W. On 18 August 2005, B&W filed its notice of appeal. RJRT posted a bond in the approximate amount of US$2.058 million on 7 February 2006. Oral argument on this appeal was heard on 12 December 2006 by an intermediate New York appellate court, which reserved decision. (d) Other claims The Flintkote Company (Flintkote), a US asbestos production and sales company, was included in the acquisition of Genstar Corporation by Imasco in 1986 and became a Group subsidiary following the restructuring of Imasco Limited (now Imperial Tobacco Canada Limited (Imperial)) in 2000. Soon after this acquisition, and as part of the acquisition plan, Genstar began to sell most of its assets, including the non-asbestos related operations and subsidiaries of Flintkote. The liquidation of Flintkote assets produced cash proceeds and, having obtained advice that sufficient assets would remain to satisfy liabilities, Flintkote and Imasco authorised the payment of two dividends. In 2003, Imperial divested Flintkote and then, in 2004, Flintkote filed for bankruptcy in the United States Bankruptcy Court for the District of Delaware. In 2006, Flintkote, certain representatives of both the present and future asbestos claimants as well as certain individual asbestos claimants were permitted by the bankruptcy court to file a complaint against Imperial and numerous other defendants for the recovery of the dividends and other compensation under various legal theories. The parties are presently engaged in case management discussions to establish the scope and manner of discovery in this case. This litigation is expected to take several years to proceed to trial. At 31 December 2006, no cases (2005: 1) were pending against B&W on behalf of asbestos companies. In these cases, certain asbestos companies sought reimbursement for costs and judgments paid in litigation brought by third parties against them. These companies claimed that, but for the smoking of the claimants, their damages would have been less. The final asbestos contribution claim (Fibreboard) was voluntarily dismissed by plaintiffs on 28 July 2006. In Wisconsin, the authorities have identified potentially responsible parties to fund the clean up of the Fox River, Wisconsin.

The pollution was caused by discharges of toxic material from paper mills operating close to the river. The cost of the ACCOUNTS THE ON NOTES clean up work is currently estimated to be in the order of US$600 million. Among the potentially responsible parties are NCR Corporation and Appleton Papers Inc. who may be liable for a proportion of the clean up costs. B.A.T Industries p.l.c. purchased what was then NCR’s Appleton Papers Division from NCR Corporation and spun off this business in 1990, obtaining full indemnities from Appleton Papers Inc. for past and future environmental claims. Disputes between NCR Corporation and B.A.T Industries p.l.c. as to the indemnities given and received under the purchase agreement in 1978 have been the subject of arbitration in 1998 and 2006. Under the terms of the arbitration awards, B.A.T Industries p.l.c. has an obligation to share the costs of environmental claims with NCR Corporation, but has never been required to pay any sums in this regard because Appleton Papers Inc. has paid any sums demanded. It is believed that all future environmental liabilities will continue to be met directly by Appleton Papers Inc. by self-funding or insurance cover and no demand will be made upon B.A.T Industries p.l.c. by NCR Corporation. Settlement of state health care reimbursement cases During 2003, agreement was reached on certain disputed MSA payments relating to MSA calculations based on 1999 and 2000 sales. This agreement resulted in a benefit of £27 million which is excluded from the 2003 costs shown in the consolidated audited annual accounts of the Company for the financial year ended 31 December 2004. In other developments, after an Independent Auditor found that the terms of the MSA were a ‘significant factor’ in market share losses experienced by signatories to the MSA in 2003, several US tobacco companies, including B&W, asserted their rights under the NPM (or Non-Participating Manufacturer) Adjustment provision of the MSA to recover a payment credit or offset – against their April 2006 payment obligations – for MSA payments made in April 2004 in respect of cigarettes shipped or sold in the US in 2003. The amount at stake exceeds US$1 billion. The settling states oppose these MSA payment reduction claims and, in late April 2006, began filing motions in MSA courts across the country seeking enforcement of certain MSA provisions and a declaration of the parties’ rights under the NPM Adjustment provision of the MSA. Defendants have opposed these motions, arguing that their NPM Adjustment claims must go instead to arbitration. To date, the overwhelming majority of MSA courts to decide these motions have ruled in defendants’ favour. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 134 British American Tobacco Directors’ Report and Accounts 2006

NOTES ON THE ACCOUNTS CONTINUED

30 Contingent liabilities and financial commitments continued UK-based Group companies At 31 December 2006, B.A.T Industries p.l.c. was a defendant in the US in one class action, the Schwab case mentioned previously. In that case, B.A.T Industries p.l.c. was substituted for British American Tobacco p.l.c. as a defendant. In the West Virginia consolidated smoking and health cases, the court so-ordered the parties’ stipulation and order dismissing RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH B.A.T Industries p.l.c. from the action, with prejudice, on 12 December 2006. This is a significant decision as B.A.T Industries p.l.c. was previously a defendant in around 1,000 consolidated individual cases in West Virginia. British American Tobacco (Investments) Limited has been dismissed from those West Virginia consolidated smoking and health cases in which it was a defendant. British American Tobacco (Investments) Limited had been served in one reimbursement case (City of St. Louis), the Department of Justice case (see below), two class actions (Cleary and Schwab), and three individual actions. Conduct based claims On 22 September 1999, the US Department of Justice brought an action in the US District Court for the District of Columbia against various industry members, including RJRT, B&W, B.A.T Industries p.l.c., and British American Tobacco (Investments) Limited. B.A.T Industries p.l.c. was dismissed for lack of personal jurisdiction on 28 September 2000. The Government sought to recover federal funds expended in providing healthcare to smokers who have developed diseases and injuries alleged to be smoking-related, and, in addition, sought, pursuant to the federal Racketeer Influenced and Corrupt Organisations Act (RICO), disgorgement of profits the Government contends were earned as a consequence of a RICO ‘enterprise’. On 28 September 2000, the portion of the claim which sought recovery of federal funds expended in providing healthcare to smokers who have developed diseases and injuries alleged to be smoking-related was dismissed. The bench (non-jury) trial of the RICO portion of the claim began on 21 September 2004, and ended on 9 June 2005. On 17 November 2004, the Washington DC Circuit Court of Appeals heard an appeal by defendants against an earlier District Court decision that disgorgement of profits is an appropriate remedy to the RICO violations alleged by the Government. On 4 February 2005, the Court of Appeals allowed the appeal, ruling that the Government could not claim disgorgement of profits. On 17 October 2005, the US Supreme Court declined to hear the appeal by the US Government in respect of the claim for disgorgement of US$280 billion of past profits from the US tobacco industry. The disgorgement claim was a centrepiece of the Government’s claim. On 17 August 2006, the district court issued its final judgment, consisting of some 1,600 pages of factual findings

OE NTEACCOUNTS THE ON NOTES and legal conclusions. The court found in favour of the Government, and against certain defendants, including B&W and British American Tobacco (Investments) Limited. The court also ordered a wide array of injunctive relief, including a ban on the use of ‘lights’ and other similar descriptors with effect from 1 January 2007. Compliance with the court-ordered remedies may cost RJRT and British American Tobacco (Investments) Limited millions of dollars. In addition, the Government is seeking the recovery of roughly US$1.9 million in litigation costs. Defendants filed a motion to stay enforcement of the judgment shortly after the judgment was issued. The court denied defendants’ stay motion on 28 September 2006. Defendants, including B&W and British American Tobacco (Investments) Limited, filed their notices of appeal to the Washington DC Circuit Court of Appeals on 11 September 2006, and filed an emergency motion to stay the judgment before the same court on 29 September 2006. On 31 October 2006, the Court of Appeals granted defendants’ motion to stay enforcement of the judgment pending the outcome of the appeal. Various departments of the Republic of Colombia brought actions against various tobacco companies including B&W and other UK-based Group companies alleging that defendants engaged in cigarette smuggling and money laundering in their territories. Each of these actions sought compensatory, punitive and treble damages. Defendants’ motion to dismiss the complaint was granted in 2002 and plaintiffs appealed. The US Court of Appeals for the Second Circuit affirmed the dismissals, and on 9 January 2006, the US Supreme Court denied plaintiffs’ petition for a writ of certiorari. In the Daric Smith case, purchasers of cigarettes in the State of Kansas brought a class action in the Kansas State Court against B&W, British American Tobacco (Investments) Limited and certain other tobacco companies seeking injunctive relief, treble damages, interest and costs. The allegations are that the defendants participated in a conspiracy to fix or maintain the price of cigarettes sold in the US, including the State of Kansas, in violation of the Kansas Restraint of Trade Act. The matter will be defended vigorously. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 135

30 Contingent liabilities and financial commitments continued Product liability outside the US At 31 December 2006, active claims against Group companies existed in 18 (2005: 19) countries outside the US but the only countries with more than five active claims were Argentina, Brazil, Canada, Chile, Italy and the Republic of Ireland.

At 31 December 2006, there were some 1,142 (2005: 1,097) pending individual cases in Italy. Some 1,113 (2005: 1,077) GROUP TOBACCO AMERICAN BRITISH of these cases are pending before Justice of the Peace courts, the majority of which relate to claims of alleged fraud in connection with ‘light’ cigarettes. Because of the type of court involved, the most that any individual plaintiff can recover is €1,033. 678 of these cases have been suspended or decisions given in favour of British American Tobacco Italia S.p.A. There are around 27 smoking and health cases pending before Italian Civil Courts, filed by or on behalf of individuals, in which it is contended that diseases or deaths have been caused by cigarette smoking. There are also two labour cases for alleged occupational exposure pending in Italy. In Canada, the government of the Province of British Columbia brought a claim pursuant to the provisions of the Tobacco Damages and Health Care Costs Recovery Act 2000 against domestic and foreign ‘manufacturers’ seeking to recover the plaintiff’s costs of health care benefits. The constitutionality of the 2000 Act was challenged by certain defendants and, on 5 June 2003, the British Columbia Supreme Court found the Act to be beyond the competence of the British Columbia legislature and, accordingly, dismissed the government’s claim. The government appealed that decision to the British Columbia Court of Appeal which, on 20 May 2004, overturned the lower court’s decision and declared the Act to be constitutionally valid. Defendants appealed to the Supreme Court of Canada in June and that court gave its judgment in September 2005, dismissing the appeals and declaring the Act to be constitutionally valid. Non-Canadian defendants challenged the personal jurisdiction of the British Columbia Court and those motions were heard in the Supreme Court of British Columbia. On 23 June 2006, the court dismissed all defendants’ motions, finding that there is a ‘real and substantial connection’ between British Columbia and the foreign defendants. Subsequently, defendants were granted leave to appeal. The appeal was dismissed on 15 September 2006. Defendants filed leave to appeal to the Supreme Court on 10 November 2006. Similar legislation has been enacted, but not yet brought into force, in some other Canadian provinces, and is also being considered by other Canadian provinces. In addition, there are five class actions and four individual cases in Canada. In the Knight class action, the Supreme Court of British Columbia certified a class of all consumers of cigarettes bearing ‘light’ or ‘mild’ descriptors since 1974 manufactured in British Columbia by Imperial, the Group’s operating company in Canada. Imperial filed an appeal against ACCOUNTS THE ON NOTES the certification which was heard in February 2006. The Appeal Court confirmed the certification of the class but has limited any financial liability, if proved, to the period from 1997. This is a ‘lights’ class action in which the plaintiff alleges that the marketing of light and mild cigarettes is deceptive because it conveys a false and misleading message that those cigarettes are less harmful than regular cigarettes. Although the claim arises from health concerns, it does not seek compensation for personal injury. Instead it seeks compensation for amounts spent on ‘light and mild’ products and a disgorgement of profits from Imperial. The motion of the Federal Government to strike out the third party notice issued against them by Imperial was heard in February 2006 and a decision is awaited. A similar ‘lights’ and ‘mild’ class action claim has been filed in Newfoundland. Imperial has filed a third party notice against the Federal Government. No hearing date has been set. There are currently two class actions in Quebec. On 21 February 2005, the Quebec Superior Court granted certification. The court certified two classes, which include residents of Quebec who suffered from lung, throat and laryngeal cancer or emphysema, and residents who were addicted to nicotine at the time the proceedings were filed and who have since remained addicted. There is no right of appeal. Plaintiffs have served a Statement of Claim. This litigation is expected to take several years to proceed to trial. The other class action is an attempt to establish a class claiming for personal injury or damage to property from fires caused by cigarettes that did not automatically extinguish on being dropped or left unattended. Certification of such a class was denied in October 2005. Plaintiffs have appealed. No hearing date has been set for the appeal. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 136 British American Tobacco Directors’ Report and Accounts 2006

NOTES ON THE ACCOUNTS CONTINUED

30 Contingent liabilities and financial commitments continued Other litigation outside the US In November 2004, the Royal Canadian Mounted Police (RCMP) obtained a warrant to search and seize business records and documents at the head office of Imperial Tobacco Canada Ltd. in Montreal. The affidavit filed by the RCMP to obtain the search warrant made allegations in relation to the smuggling of cigarettes in Canada between RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH 1989 and 1994, naming Imperial, British American Tobacco p.l.c., B.A.T. Industries p.l.c., and certain former directors and employees. No charges have yet been laid. Imperial believes that it has conducted itself appropriately at all times, but cannot predict the outcome of any such investigation, or whether additional investigations will occur. Two actions have been started in Russia by a minority shareholder in OJSC Company British American Tobacco-Yava (BAT-Yava), a Russian incorporated subsidiary of British American Tobacco Holdings (Russia) B.V. The minority shareholder, Branston Holdings, issued a claim in Moscow seeking to have a contract between BAT-Yava and its sister company invalidated, and issued another claim in the Stavropol region alleging that certain of the directors of BAT-Yava, and other parties, took various unlawful steps. The Moscow Court has dismissed the claim and the Stavropol Court has ordered the transfer of the case filed there to Moscow. An appeal of the dismissed Moscow case has been sent to the Moscow Appellate Court. Branston has also threatened actions in the Netherlands and England but has not yet commenced these. The Company considers these actions to be without merit and will defend the claims strenuously. Conclusion While it is impossible to be certain of the outcome of any particular case or of the amount of any possible adverse verdict, the Company believes that the defences of the Group companies to all these various claims are meritorious both on the law and the facts, and a vigorous defence is being made everywhere. If an adverse judgment is entered against any of the Group companies in any case, an appeal will be made. Such appeals could require the appellants to post appeal bonds or substitute security in amounts which could in some cases equal or exceed the amount of the judgment. In any event, with regard to US litigation, the Group has the benefit of the RJRT Indemnification. At least in the aggregate, and despite the quality of defences available to the Group, it is not impossible that the results of operations or cash flows of the Group, in particular quarterly or annual periods, could be materially affected by this and by the final outcome of any particular litigation. Having regard to all these matters, the Directors (i) do not consider it appropriate to make any provision in respect of any pending litigation and (ii) do not believe that the ultimate outcome of this litigation will significantly impair the OE NTEACCOUNTS THE ON NOTES financial condition of the Group. Guarantees Performance guarantees given to third parties in respect of Group companies were £157 million (2005: £167 million). Operating leases Total future minimum lease payments under non-cancellable operating leases comprise leases where payments fall due: 2006 2005 £m £m Property Within one year 50 49 Between one and five years 112 99 Beyond five years 167 231 329 379

Plant and equipment Within one year 17 15 Between one and five years 19 12 Beyond five years 1 36 28 WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 137

FIVE YEAR SUMMARY

2006 2005 2004 2003 2002 IFRS IFRS IFRS UK GAAP UK GAAP restated restated For the years ended 31 December £m £m £m £m £m Income statement Gross turnover including duty, excise and other taxes 25,189 23,984 31,833 25,622 24,682 RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH Revenue (after deducting duty, excise and other taxes) 9,762 9,325 10,768 10,570 10,600 Profit from operations* 2,622 2,420 3,760 1,852 2,303 Profit before taxation 2,764 2,584 3,637 1,567 2,113 Profit for the year (before minority interest) 2,048 1,894 2,964 788 1,295 *after (charging)/crediting – restructuring costs (216) (271) (206) (437) – investment costs written off (50) – (losses)/gains on disposal of subsidiaries, joint ventures, non-current investments and brands 41 72 1,427 – goodwill amortisation (405) (378)

2006 2005 2004 2003 2002 IFRS IFRS IFRS UK GAAP UK GAAP restated restated pence pence pence pence pence Earnings per share – basic unadjusted 92.08 84.34 133.76 26.93 50.91 – diluted unadjusted 91.33 83.66 131.45 26.69 50.10 – diluted adjusted 98.12 89.34 76.62 69.21 66.54 Dividends declared per share 55.90 47.00 41.90 38.80 35.20

2006 2005 2004 2003 2002 IFRS IFRS IFRS UK GAAP UK GAAP restated At 31 December £m £m £m £m £m

Balance sheet SUMMARY YEAR FIVE Non-current assets 12,385 13,147 12,095 Fixed assets 11,313 9,563 Current assets 5,391 5,904 5,680 7,544 6,616 Total assets 17,776 19,051 17,775 18,857 16,179

Shareholders’ funds 6,461 6,630 5,919 4,361 5,078 Minority interests 227 247 198 225 267 Total equity 6,688 6,877 6,117 4,586 5,345 Non-current liabilities 6,635 6,338 7,218 Current liabilities 4,453 5,836 4,440 Borrowings 7,610 5,314 Provisions and other creditors 6,661 5,520 Total liabilities 11,088 12,174 11,658 14,271 10,834 Total equity and liabilities 17,776 19,051 17,775 18,857 16,179

The information above has been restated, where applicable, to reflect the adoption of IFRIC Interpretation 4 (page 96 note 10) and the amendment to IAS21 (page 89 note 4). The information included in the five year summary for the years ended 31 December 2002 and 31 December 2003 is as published under UK GAAP and has not been restated to IFRS. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 138 British American Tobacco Directors’ Report and Accounts 2006

FIVE YEAR SUMMARY CONTINUED

The main adjustments in changing to IFRS, including the amendment to IAS21, were as follows: Post- retirement UK GAAP benefits Goodwill Dividends Reallocations Other IFRS (a)(b)(c)(d)(e) £m £m £m £m £m £m £m

RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH Shareholders’ funds 1 January 2004 4,361 (493) 585 (66) 4,387 Shareholders’ funds 31 December 2004 5,220 (237) 473 617 (154) 5,919 Year ended 31 December 2004 Profit from operations 1,794 59 454 1,323 130 3,760 Profit for the year (before minority interests) 1,224 29 491 1,132 88 2,964 Earnings per share Basic 55.20p 133.76p

Adjusted diluted 75.83p 76.62p

(a) All cumulative actuarial gains and losses were recognised at 1 January 2004. (b) Under UK GAAP, goodwill was amortised over its useful economic life, while from 1 January 2004 goodwill is not amortised under IFRS. (c) Under UK GAAP, the final dividend for the year was provided in the results for that year while under IFRS it is provided in the year that it is declared. (d) In respect of the Reynolds American transaction in 2004, which combined the Group’s US domestic business (B&W) with R.J. Reynolds: – a £918 million unrecognised gain, included in the statement of total recognised gains and losses in UK GAAP, is included in profit from operations under IFRS; and – a write-back of £216 million under UK GAAP for goodwill previously written off to reserves, is not required under IFRS, which results in an additional gain on the partial disposal of B&W.

IEYA SUMMARY YEAR FIVE In addition, the gains and losses on the disposal of subsidiaries and fixed asset investments were shown below profit from operations under UK GAAP (£185 million). (e) The other adjustments principally reflect: – provisions for deferred tax on the unremitted profit of associates and part of the unremitted profit of subsidiaries required under IFRS but not UK GAAP; – the application of IFRS to the results of associates; and – an additional gain on the partial disposal of B&W in 2004 of £128 million, as a result of the IFRS adjustments for B&W in respect of post-retirement benefits. Also, as explained on page 120 in note 24, IAS32 and IAS39, which deal with financial instruments, were applied from 1 January 2005 and consequently the figures for 2004, 2003 and 2002 do not reflect the impact of those standards. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 139

QUARTERLY ANALYSES OF PROFIT

The figures shown below have been produced using average rates of exchange on a quarterly basis since the beginning of the year. Thus the discrete quarters have not been restated for subsequent movements in foreign exchange rates during the year, which are reflected in the results for subsequent quarters. As described on page 89 in note 4, certain exchange movements are now required to be reflected in equity movements.

The quarterly analyses for 2005 below have been restated to reflect these changes. As the adjusted diluted earnings GROUP TOBACCO AMERICAN BRITISH per share calculations already reflected these adjustments, no restatement of these amounts is required. 3 months to year to 31 Mar 2006 30 Jun 2006 30 Sept 2006 31 Dec 2006 31 Dec 2006 restated £m £m £m £m £m Profit from operations 616 709 619 678 2,622 after (charging)/crediting – restructuring costs (21) (27) (116) (52) (216) – (losses)/gains on disposal of a business, brands and joint venture (15) (1) 57 41 Net finance costs (68) (56) (85) (80) (289) Share of post-tax results of associates and joint ventures 120 123 105 83 431 after (charging)/crediting – brand impairments (13) (13) – exceptional tax credits and other impairments 16 1 17

Profit before taxation 668 776 639 681 2,764

Earnings per share Basic 21.81p 26.57p 21.73p 21.97p 92.08p

Adjusted diluted 22.05p 27.06p 25.89p 23.12p 98.12p

3 months to year to

31 Mar 2005 30 Jun 2005 30 Sept 2005 31 Dec 2005 31 Dec 2005 PROFIT OF ANALYSES QUARTERLY restated restated restated restated restated £m £m £m £m £m Profit from operations 582 671 648 519 2,420 after (charging)/crediting – restructuring costs (42) (100) (129) (271) – gains on disposal of brands and joint venture 68 4 72 Net finance costs (46) (57) (59) (66) (228) Share of post-tax results of associates and joint ventures 88 108 81 115 392 after (charging)/crediting – restructuring costs (7) (5) (1) (13) – US Federal tobacco buy-out (11) (1) (12) – brand impairments (29) (29) – exceptional tax credits 26 1 30 57 Profit before taxation 624 722 670 568 2,584

Earnings per share Basic 20.26p 23.88p 21.21p 18.99p 84.34p

Adjusted diluted 19.26p 21.59p 25.79p 22.70p 89.34p WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 140 British American Tobacco Directors’ Report and Accounts 2006

PRINCIPAL SUBSIDIARY UNDERTAKINGS

% equity shares held % equity shares held Europe Russia Great Britain OJSC British American Tobacco – STF99 B.A.T Industries p.l.c. 100 OJSC British American Tobacco – Yava95† B.A.T (U.K. and Export) Ltd.100 CJSC British American Tobacco – SPb 100† RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH B.A.T. International Finance p.l.c. 100* Serbia BATMark Ltd. 100* Duvanska Industrija ‘Vranje’ A.D. 88 British-American Tobacco (Holdings) Ltd.100 British American Tobacco International (Holdings) B.V. Spain (incorporated in the Netherlands) ■100 British American Tobacco España, S.A. 100 British American Tobacco (1998) Ltd. 100* British American Tobacco (Brands) Ltd.100 Switzerland British American Tobacco (Investments) Ltd.100 British American Tobacco International Ltd.100 British American Tobacco UK Ltd.100 British American Tobacco Switzerland S.A. 100 Tobacco Insurance Co. Ltd.100 Ukraine Weston Investment Co. Ltd. 100 A/T B.A.T. – Prilucky Tobacco Co. 99 Belgium Uzbekistan British American Tobacco Belgium S.A.100 UZBAT A.O. 97 Tabacofina-Vander Elst N.V. 100 America-Pacific Cyprus Canada B.A.T (Cyprus) Ltd. 100 Imperial Tobacco Canada Ltd. 100 Czech Republic Japan British American Tobacco (Czech Republic), s.r.o. 100 BAT Pacific, Inc (incorporated in the US)100 Finland BAT Pacific Corporation100 British American Tobacco Nordic Oy 100 British American Tobacco Japan K.K. (Ltd.) 100 France United States of America British American Tobacco France SAS 100 B.A.T Capital Corporation 100* BATUS Japan, Inc 100 Germany Brown & Williamson Holdings, Inc.100 RNIA USDAYUNDERTAKINGS SUBSIDIARY PRINCIPAL British-American Tobacco (Germany) GmbH100 British American Tobacco (Brands) Inc. 100 British American Tobacco (Industrie) GmbH ● 100 Asia-Pacific Greece Australia British American Tobacco Hellas S.A. 100 British American Tobacco Australia Ltd. 100 Hungary Bangladesh BAT Pécsi Dohánygyár Kft. 100 British American Tobacco Bangladesh Co. Ltd. 65 Italy Cambodia British American Tobacco Italia S.p.A. 100 British American Tobacco (Cambodia) Ltd. 71 Netherlands China British American Tobacco The Netherlands B.V.100 B.A.T. China Ltd. (incorporated in Great Britain)100 British American Tobacco Holdings British-American Tobacco Co. (Hong Kong) Ltd. (The Netherlands) B.V. 100 (incorporated in Hong Kong) 100 Poland Indonesia British-American Tobacco Polska S.A. 96 PT BAT Indonesia Tbk 71 Republic of Ireland Malaysia P.J. Carroll & Company Ltd. 100 British American Tobacco (Malaysia) Berhad 50 Romania New Zealand British-American Tobacco (Romania) Trading SRL 100 British American Tobacco (New Zealand) Ltd. 100 WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 141

% equity shares held % equity shares held Pakistan Venezuela Pakistan Tobacco Co. Ltd. 94 C.A. Cigarrera Bigott Sucs. 100 Papua New Guinea Africa and Middle East

British American Tobacco (PNG) Ltd. 100 Cameroon GROUP TOBACCO AMERICAN BRITISH British American Tobacco Cameroun S.A. 99 Singapore British-American Tobacco (Singapore) Pte Ltd.100 Congo British-American Tobacco Marketing British American Tobacco Congo SARL 100 (Singapore) Pte Ltd. 100 Egypt South Korea British American Tobacco Egypt LLC 100 British American Tobacco Korea Ltd.100 Ghana British American Tobacco Korea Manufacturing Ltd. 100 British American Tobacco Ghana Ltd. 55 Sri Lanka Kenya Ceylon Tobacco Co. Ltd. 84 British American Tobacco Kenya Ltd. 60 Vietnam La Reunion B.A.T Vietnam Ltd. (incorporated in Great Britain)100 B.A.T. La Reunion SAS 100 British American Tobacco-Vinataba (JV) Ltd. 70 Malawi Latin America British American Tobacco (Malawi) Ltd. 100 Argentina Nobleza-Piccardo S.A.I.C.y F. 96 Mauritius British-American Tobacco (Mauritius) p.l.c. Brazil (incorporated in Great Britain) 100 Souza Cruz S.A. 75 Mozambique Chile Sociedade Agricola de Tabacos Lda. 95 Compania Chilena de Tabacos S.A. 96 Nigeria Guyana British American Tobacco (Nigeria) Ltd. 100 Demerara Tobacco Co. Ltd. 70

South Africa UNDERTAKINGS SUBSIDIARY PRINCIPAL Honduras British American Tobacco Holdings Tabacalera Hondureña S.A. 80 South Africa (Pty) Ltd. 100 Jamaica Turkey Carreras Group Ltd.  50 British American Tobacco Sigara ve Mexico Tütüncülük Sanayi ve Ticaret A.S. 87 British American Tobacco Mexico, S.A. de C.V. 100 Uganda Panama British American Tobacco Uganda Ltd. 90 British American Tobacco Central America S.A.78 Zambia Tabacalera Istmeña S.A. 100 British American Tobacco (Zambia) plc 78 Peru Zimbabwe Tabacalera Nacional S.A.A. 97^ British American Tobacco Zimbabwe (Holdings) Ltd.57 Trinidad & Tobago Export Leaf Tobacco Company of Africa (Pvt) Ltd.100 The West Indian Tobacco Company Ltd. 50 Tobacco Processors Zimbabwe (Pvt) Ltd. 70

Subsidiary undertakings held directly by British American Tobacco p.l.c. are indicated thus *; all others are held by sub-holding companies. Unless otherwise stated, the country of incorporation and operation is that under which the company is listed. All subsidiary undertakings are involved in activities related to the manufacture, distribution or sale of tobacco products. All companies’ shares are ordinary shares or common stock except for those indicated thus †, which include preference shares, and those indicated thus ^, which include investment stock (non-voting). ● Financial year end is 30 November. ■ Financial year end is 14 January. Financial year end is 31 March. A complete list of subsidiary and associated undertakings will be attached to the next British American Tobacco p.l.c. annual return to the Registrar of Companies. The Company has taken advantage of the exemption under Section 231(5) of the Companies Act 1985 by providing information only in relation to subsidiaryundertakings whose results or financial position, in the opinion of the Directors, principally affected the Financial Statements. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 142 British American Tobacco Directors’ Report and Accounts 2006

PRINCIPAL ASSOCIATE UNDERTAKINGS

Latest Total issued % published capital shares information £m held Europe Denmark

RTS MRCNTBCOGROUP TOBACCO AMERICAN BRITISH Skandinavisk Tobakskompagni AS Class I Ordinary 30.09.06 1 tobacco Class II Ordinary 35 32

America-Pacific United States of America Reynolds American Inc. Common Stock 31.12.06 * 42 tobacco  Preferred Stock **

Asia-Pacific India ITC Ltd.  Ordinary 31.12.06 43 32 tobacco paper and packaging hotels

VST Industries Ltd.  Ordinary 31.12.06 2 32 tobacco

Listed overseas. * As at 31 December 2006, Reynolds American Inc. had issued 295,624,741 shares (US$0.0001 Common Stock), of which the Group held 123,905,524. **As at 31 December 2006, Reynolds American Inc. had issued 1,000,000 shares (US$0.01 Preferred Stock), in which the Group held no interest. RNIA SOIT UNDERTAKINGS ASSOCIATE PRINCIPAL WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 143

REPORT OF THE INDEPENDENT AUDITORS TO THE MEMBERS OF BRITISH AMERICAN TOBACCO p.l.c.

We have audited the parent company Financial Statements We read other information contained in the Annual Report of British American Tobacco p.l.c. for the year ended and Accounts and consider whether it is consistent with the 31 December 2006 which comprise the Balance Sheet audited parent company Financial Statements. The other and the related notes. These parent company Financial information comprises only the Annual Review, the Directors’ Statements have been prepared under the accounting Report, the unaudited part of the Remuneration Report, the policies set out therein. We have also audited the information Corporate Governance Statement, the five year summary, in the Remuneration Report contained in the Directors’ the quarterly analyses of profit and the Group Financial p.l.c. TOBACCO AMERICAN BRITISH Report and Accounts 2006 that is described as having Statements. We consider the implications for our report if been audited. we become aware of any apparent misstatements or material inconsistencies with the parent company Financial Statements. We have reported separately on the Group Financial Our responsibilities do not extend to any other information. Statements of British American Tobacco p.l.c. for the year ended 31 December 2006. Basis of audit opinion We conducted our audit in accordance with International Respective responsibilities of Directors and auditors Standards on Auditing (UK and Ireland) issued by the The Directors’ responsibilities for preparing the Annual Auditing Practices Board. An audit includes examination, Report and Accounts, including the Remuneration Report on a test basis, of evidence relevant to the amounts and and the parent company Financial Statements, in accordance disclosures in the parent company Financial Statements with applicable law and United Kingdom Accounting and the part of the Remuneration Report to be audited. Standards (United Kingdom Generally Accepted Accounting It also includes an assessment of the significant estimates Practice) are set out in the Statement of Directors’ and judgements made by the Directors in the preparation Responsibility in relation to the Financial Statements, of the parent company Financial Statements, and of whether included in the Directors’ Report. the accounting policies are appropriate to the Company’s Our responsibility is to audit the parent company Financial circumstances, consistently applied and adequately disclosed. Statements and the part of the Remuneration Report to be We planned and performed our audit so as to obtain all audited in accordance with relevant legal and regulatory the information and explanations which we considered requirements and International Standards on Auditing (UK necessary in order to provide us with sufficient evidence and Ireland). This report, including the opinion, has been to give reasonable assurance that the parent company prepared for and only for the Company’s members as a Financial Statements and the part of the Remuneration body in accordance with Section 235 of the Companies Report to be audited are free from material misstatement, Act 1985 and for no other purpose. We do not, in giving whether caused by fraud or other irregularity or error. this opinion, accept or assume responsibility for any other AUDITORS INDEPENDENT THE OF REPORT In forming our opinion, we also evaluated the overall purpose or to any other person to whom this report is adequacy of the presentation of information in the shown or into whose hands it may come, save where parent company Financial Statements and the part of expressly agreed by our prior consent in writing. the Remuneration Report to be audited. We report to you our opinion as to whether the parent Opinion company Financial Statements give a true and fair view In our opinion: and whether the parent company Financial Statements • the parent company Financial Statements give a true and the part of the Remuneration Report to be audited and fair view, in accordance with United Kingdom have been properly prepared in accordance with the Generally Accepted Accounting Practice, of the state Companies Act 1985. We also report to you whether, of the Company’s affairs as at 31 December 2006; in our opinion, the information given in the Directors’ • the parent company Financial Statements and the part Report is consistent with the parent company Financial of the Remuneration Report to be audited have been Statements. The information given in the Directors’ properly prepared in accordance with the Companies Report includes that specific information presented in Act 1985; and the Operating and Financial Review that is cross referred • the information given in the Directors’ Report is from the Business Review section of the Directors’ Report. consistent with the parent company Financial Statements. In addition, we report to you if, in our opinion, the PricewaterhouseCoopers LLP Company has not kept proper accounting records, if we Chartered Accountants and Registered Auditors have not received all the information and explanations 1 Embankment Place, London we require for our audit, or if information specified by law regarding Directors’ remuneration and other transactions 1 March 2007 is not disclosed. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 144 British American Tobacco Directors’ Report and Accounts 2006

ACCOUNTING POLICIES

Basis of accounting Fixed asset investments The Financial Statements have been prepared on the Fixed asset investments are stated at cost, together with going concern basis under the historical cost convention subsequent capital contributions, less provisions for any and in accordance with the Companies Act 1985 and UK impairment in value. Generally Accepted Accounting Principles. Dividends

RTS MRCNTBCOp.l.c. TOBACCO AMERICAN BRITISH The Company has adopted the amendment to FRS26 Final dividend distributions to the Company’s shareholders ‘Financial Guarantee Contracts and Credit Insurance’ are recognised as a liability in the financial statements in in these Financial Statements. As a result, guarantees the period in which the dividends are approved by the have been recorded at their fair value less accumulated Company’s shareholders, while interim dividend distributions amortisation. are recognised in the period in which the dividends are declared and paid. The effect of the change in accounting policy to adopt the amendment to FRS26 was to increase profit in 2005 Repurchase of share capital by £5 million and 2006 by £nil million. As at 31 December When share capital is repurchased, the amount of 2005, investments in Group companies were increased by consideration paid, including directly attributable costs, £25 million, amounts due from Group undertakings by is recognised as a deduction from equity. Repurchased £77 million and sundry creditors by £97 million. shares which are not cancelled, or shares purchased for the employee share ownership trusts, are classified as treasury Cash flow statement shares and presented as a deduction from total equity. The cash flows of the Company are included in the consolidated cash flow statement of British American Related parties Tobacco p.l.c. which is included in this Directors’ Report The Company has taken advantage of the exemption and Accounts. Consequently, the Company is exempt under paragraph 3(b) of FRS8 from disclosing transactions under the terms of FRS1 (Revised) from publishing a with related parties that are part of the British American cash flow statement. Tobacco p.l.c. Group. Foreign currencies Financial instruments Transactions arising in currencies other than sterling The financial instrument disclosures of the Company are translated at the rate of exchange ruling on the are included in the consolidated Group accounts which date of the transaction. Assets and liabilities expressed are included in this Directors’ Report and Accounts.

CONIGPOLICIES ACCOUNTING in currencies other than sterling are translated at rates Consequently, the Company is exempt under paragraph of exchange ruling at the end of the financial year. All 3C (b) of FRS25 from publishing these financial instrument exchange differences are taken to the profit and loss disclosures. account in the year. Accounting for income Income is included in the profit and loss account when all contractual or other applicable conditions for recognition have been met. Provisions are made for bad and doubtful debts, including where delays are anticipated in the receipt of monies from overseas. Taxation Taxation provided is that chargeable on the profits of the period, together with deferred taxation. Deferred taxation is provided in full on timing differences between the recognition of gains and losses in the financial statements and their recognition in tax computations. However, the Company does not discount deferred tax assets and liabilities. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 145

BALANCE SHEET – BRITISH AMERICAN TOBACCO p.l.c. AT 31 DECEMBER

2006 2005 restated Notes £m £m Assets Fixed assets Investments in Group companies 1 4,047 4,047 RTS MRCNTBCOp.l.c. TOBACCO AMERICAN BRITISH 4,047 4,047 Current assets Debtors 2 2,246 2,002 2,246 2,002 Total assets 6,293 6,049

Equity Capital and reserves Share capital 517 524 Share premium account 48 43 Capital redemption reserves 90 83 Other reserves 90 90 Profit and loss account 1,356 1,069 after deducting – cost of own shares held in employee share ownership trusts (197) (182)

Shareholders’ funds 3 2,101 1,809 Liabilities Creditors 4 4,192 4,240 Total equity and liabilities 6,293 6,049

Prior year results have been restated in accordance with the amendment to FRS26 as described on page 144.

On behalf of the Board SHEET BALANCE Jan du Plessis Chairman 1 March 2007 WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 146 British American Tobacco Directors’ Report and Accounts 2006

NOTES ON THE ACCOUNTS

1 Investments in Group companies The Company’s directly owned subsidiaries are British American Tobacco (1998) Limited, B.A.T. International Finance p.l.c., B.A.T Capital Corporation, BATMark Limited, British American Ventures Limited and British American Tobacco QUEST Limited. The Directors are of the opinion that the individual investments in the subsidiary undertakings have a value not less RTS MRCNTBCOp.l.c. TOBACCO AMERICAN BRITISH than the amount at which they are shown in the Balance Sheet. 2006 2005 restated £m £m 4,047 4,047

As described on page 144, the investments in 2005 have been increased by £25 million as a result of the amendment to FRS26.

2 Debtors 2006 2005 restated £m £m Amounts due from Group undertakings 2,246 2,002

Included in debtors are amounts of £99 million (2005: £60 million) falling due after one year. As described on page 144, debtors in 2005 have been increased by £77 million as a result of the amendment to FRS26.

3 Shareholders’ funds Share Capital Share premium redemption Other Profit and capital account reserves reserves loss account Total £m £m £m £m £m £m 1 January 2006 524 43 83 90 1,064 1,804 Change in accounting policy 55

OE NTEACCOUNTS THE ON NOTES 524 43 83 90 1,069 1,809 Increase in share capital – share options 55 Transfer from profit and loss account 1,809 1,809 Dividends and other appropriations ordinary shares page 93 note 8 (1,008) (1,008) Purchase of own shares (7) 7 (500) (500) Consideration paid for purchase of own shares held in employee share ownership trusts (77) (77) Consideration received on the exercise of options over own shares held in employee share ownership trusts 23 23 Other movements 40 40 31 December 2006 517 48 90 90 1,356 2,101

The accounting policy change is in respect of guarantees provided to other Group companies, required to be recognised at fair value in the Balance Sheet as a result of the amendment to FRS26 Financial Instruments: Measurement. The guarantees are recognised based on the net present value of the fee income (actual or notional) charged thereon. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da Directors’ Report and Accounts 2006 British American Tobacco 147

3 Shareholders’ funds continued Dividends paid are recognised in the year in which they are declared, and dividends received are recognised in the year in which they are received. The final dividend which has been declared for the year ended 31 December 2006 is shown on page 93 in note 8 and will be recognised in the financial statements for the year ended 31 December 2007. In 2006, for the first time, the Company needed to file interim accounts which were prepared to recognise additional dividend income in 2006. As a result of the Company not doing so, the interim dividend of £323 million paid on p.l.c. TOBACCO AMERICAN BRITISH 13 September 2006 did not comply with the technical requirements of the Companies Act 1985. It is proposed that the appropriation of distributable profits to the payment of the interim dividend will be ratified by shareholders by way of special resolution at the Annual General Meeting. As permitted by Section 230 of the Companies Act 1985, the profit and loss of the Company has not been presented in these Financial Statements. The profit for the year ended 31 December 2006 was £1,809 million (2005 restated: £2,168 million). Details of Directors’ remuneration, share options and retirement benefits are given in the Remuneration Report on pages 53 to 66. Ordinary Convertible redeemable shares of 25p each preference shares of 25p each Share capital Number of shares Number of shares £m Authorised 1 January 2006 and 31 December 2006 2,858,265,349 241,734,651 775.00 Allotted, called up and fully paid 1 January 2006 2,096,139,187 524.03 Changes during the year – share option schemes 994,757 0.25 – purchase of own shares (28,330,000) (7.08) 31 December 2006 2,068,803,944 517.20

Between 22 September 2006 and 4 December 2006, the Company sought to repurchase 6,927,790 shares for an aggregate consideration of £100 million, which are included in the purchases of own shares of £500 million on page 146.

However, as a result of the technical infringement of the Companies Act 1985, the repurchase and cancellation of these ACCOUNTS THE ON NOTES shares was invalid and, accordingly, their nominal value is included within the Company’s allotted, called up and fully paid share capital as at 31 December 2006 shown above. These shares will be repurchased on 1 March 2007 from their present holders, the Company’s brokers, at the same prices agreed between 22 September 2006 and 4 December 2006. The above table includes 28 million shares purchased for cancellation at a cost of £400 million. Ordinary Convertible redeemable shares of 25p each preference shares of 25p each Share capital Number of shares Number of shares £m Authorised 1 January 2005 and 31 December 2005 2,858,265,349 241,734,651 775.00 Allotted, called up and fully paid 1 January 2005 2,139,807,599 534.95 Changes during the year – share option schemes 1,571,588 0.39 – purchase of own shares (45,240,000) (11.31) 31 December 2005 2,096,139,187 524.03

During 2005, 45 million shares were purchased for cancellation at a cost of £501 million. Share premium The increase of £5 million relates solely to ordinary shares issued under the Company’s share option schemes. These schemes are described in the Remuneration Report on pages 53 to 66. WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da 148 British American Tobacco Directors’ Report and Accounts 2006

NOTES ON THE ACCOUNTS CONTINUED

4 Creditors 2006 2005 restated £m £m Amounts due to Group undertakings 2,003 2,094 Loans due to Group undertakings 2,046 2,046

RTS MRCNTBCOp.l.c. TOBACCO AMERICAN BRITISH Sundry creditors 143 100 4,192 4,240

Included in creditors are amounts of £106 million (2005: £69 million) falling due after one year. Loans due to Group undertakings are unsecured and bear interest at a rate of 6.21 per cent. As described on page 144, creditors in 2005 have been increased by £97 million as a result of the amendment to FRS26.

5 Audit fees 2006 2005 Auditors’ fees £30,000 £30,000 Fees paid to PricewaterhouseCoopers LLP for advisory and accountancy services – UK £nil £nil

6 Contingent liabilities and financial commitments British American Tobacco p.l.c. has guaranteed borrowings by subsidiary undertakings of £5,907 million (2005: £6,425 million) and total borrowing facilities of £13,009 million (2005: £15,326 million). Performance guarantees given to third parties in respect of Group companies were £157 million (2005: £167 million). There are contingent liabilities in respect of litigation in various countries (page 130 note 30). OE NTEACCOUNTS THE ON NOTES WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da CONTACT INFORMATION

Registered office Globe House, 4 Temple Place, London WC2R 2PG tel: +44 (0)20 7845 1000, facsimile: +44 (0)20 7240 0555 Incorporated in England and Wales No. 3407696 Secretary Nicola Snook General Counsel Neil Withington Investor relations Enquiries should be directed to Ralph Edmondson or Rachael Brierley, tel: +44 (0)20 7845 1180 Press office Enquiries should be directed to Fran Morrison or David Betteridge, tel: +44 (0)20 7845 2888, e-mail: press_offi[email protected] Auditors PricewaterhouseCoopers LLP, 1 Embankment Place, London WC2N 6RH Registrar Enquiries concerning your shareholding, mandating your dividends (including consolidated dividend tax vouchers) and notifying changes in your personal details Contact Computershare Investor Services PLC, PO Box 82, The Pavilions, Bridgwater Road, Bristol BS99 7NH, tel: 0800 408 0094 (UK); +44 870 889 3159 (International) WorldReginfo - 98675577-a5f8-41aa-ac01-37c1b8bcb2da www.bat.com

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