Philip Morris International Inc. Could Face a $2.2 Billion Fine for Tax Evasion

Tobacco giant Philip Morris International (PM -0.28%) could face a $2.2 billion fine in Thailand if it is found guilty of evading taxes on imported cigarettes. Thai prosecutors claim that PMI dodged about 20 billion baht ($551 million) in taxes by under-declaring import prices for 272 batches of Marlboro and L&M Brand cigarettes from the Philippines between 2003 and 2006.

Bangkok, Thailand. Source: Author

The original investigation started in 2006 under the administration of former Prime Minister Thaksin Shinawatra, who was ousted in a military coup that same year. The case dragged on until 2011, when the attorney general recommended dismissing the charges, but the case was revived in 2013. Philip Morris calls the charges "unjust" and that it shipped the cigarettes "in full compliance with Thai law and international standards of customs valuation." Let's take a closer look at what this new lawsuit means for the company and investors.

Another lawsuit for Philip Morris
Altria (NYSE: MO) spun off its overseas tobacco business as Philip Morris International back in 2008. At the time, the plan was for Altria to tackle domestic declines in smoking rates and anti-tobacco litigation, while PMI was free to expand into high-growth overseas markets. Altria has now moved past most of that litigation, but PMI has become entangled in a string of legal conflicts around the world.

In Latin America, PMI is suing Uruguay over aggressive anti-smoking measures which dramatically reduced its adult smoking rate over the past decade. The company also sued Norway for the ban of in-store cigarette displays and Australia for its plain packaging laws. Though PMI eventually lost both cases after costly legal battles, the company pushed onward, teaming up with British American Tobacco (BTI -0.38%) last May to sue the British government over new plain package regulations which go into effect this year. Still not content, PMI also sued the Thai government over its proposals to increase health warnings on cigarettes.

Source: Pixabay

The company is waging these battles, because it knows that stricter regulations could hurt sales in those countries. PMI revenue has already been hurt by the strong dollar -- a look at geographic growth last quarter reveals how steep those declines were:

Source: PMI 3Q report. *East Europe, Middle East, Africa

Strategy for Southeast Asia
Philip Morris' overseas strategy involves expanding into countries with high smoking rates, acquiring popular local brands to complement its flagship Marlboro business, and frequently making charitable contributions to curry the favor of local governments. Its sponsorship of charitable events sometimes allows PMI to promote its brands at music and sporting events -- something that Altria could never do in the U.S.

Several Southeast Asian nations qualify with high smoking rates, especially among men. According to World Bank data, 42% of Thai men, 48% of Vietnamese men, 72% of Indonesian men, and 45% of Malaysian men smoke, compared to just 21% of American men. Cigarettes in those markets also cost much less than the average price of $5.51 in the United States.

Indonesia, the world's second biggest cigarette market after China, is the most important Asian market for PMI. Marlboro is currently the top-selling brand in the country, and PMI acquired a major stake in Sampoerna, the country's top tobacco maker, over a decade ago. By comparison, Thailand's best-selling cigarette is Krong Thip, a local brand sold by the state-backed Thailand Tobacco Monopoly. As a result, sales in Thailand matter much less to the top line than sales in Indonesia.

Why Thailand still matters
Even if PMI paid $2.2 billion to the Thai government, it would be a slap on a wrist for a company which generated over $80 billion in revenue last year. However, such anti-tobacco measures could influence other nations in the region, which see Thailand as a regional leader on the issue.

The anti-tobacco Action on Smoking and Health Foundation Thailand claims that over 50,700 people die annually from smoking-related diseases across the country and that about 13 million of the country's 67 million people are addicted to cigarettes.

That's why the Thai government is addressing tax loopholes, which could raise the price of PMI cigarettes. Higher prices and bigger health warnings could also educate the public on smoking-related health risks and curb smoking rates. PMI is rightfully concerned that if other countries follow Thailand's lead, sales across Asia will decline.

It's unlikely that the Thai tax evasion and health warning cases will be resolved anytime soon. However, Philip Morris investors should understand why the company is engaged in so many legal battles worldwide as countries try to reduce their smoking rates.