Philip Morris paid for India manufacturing despite ban on foreign investment–documents

Godfrey Phillips India

06/03/2019 14:00

(Repeats item first published early on Wednesday with no
changes to text)
    * Philip Morris paid Godfrey Phillips for cigarette
manufacturing
    * Companies circumvented Indian rules-former enforcement
officials
    * Philip Morris, Godfrey Phillips officials deny any
wrongdoing
    * India is a key market for Philip Morris

    By Aditya Kalra
    NEW DELHI, March 6 (Reuters) - Philip Morris International
Inc  PM.N  has for years paid manufacturing costs to its Indian
partner to make its Marlboro cigarettes, circumventing a
nine-year-old government ban on foreign direct investment in the
industry, internal company documents reviewed by Reuters showed.
    The Indian government in 2010 prohibited foreign direct
investment (FDI) in cigarette manufacturing, saying the measure
would enhance its efforts to curb smoking.
    Restricting foreign investment leaves cigarette
manufacturing largely in the hands of domestic players, and is
supposed to prevent any foreign-funded expansion. A year after
the government's decision, Japan Tobacco exited India, citing an
"unsustainable business model".
    Philip Morris, though, stayed in India and used another
route, according to company documents dated between May 2009 and
January 2018. A year before the FDI ban, it struck an exclusive
deal with India's Godfrey Phillips  GDFR.NS  to locally
manufacture the world-famous Marlboro cigarettes. 
    Ever since then, Godfrey has publicly acted as a contract
manufacturer of Marlboro cigarettes in India, while Philip
Morris's majority-owned local unit acts as a wholesale trading
company and promotes the brand.
    But dozens of internal company documents - including invoice
bills, legal agreements, e-mails and accounting statements -
show Philip Morris has for years indirectly paid costs related
to Marlboro cigarette manufacturing in India.
    Some former Indian enforcement officials said the practice
of indirectly paying for manufacturing-related costs violates
regulatory rules. However, some lawyers such as Pratibha Jain, a
partner at Nishith Desai Associates, disagreed, pointing out
that the federal rules did not explicitly prohibit such
payments.
    Philip Morris' director for corporate affairs in India, R.
Venkatesh, in an e-mail, said the company's "business
arrangements with Godfrey Phillips India comply with Indian
Foreign Direct Investment Rules". He did not elaborate. 
    The company did not answer detailed questions for this
article and did not offer any executive for interview, despite
repeated requests from Reuters over the past month.
    
    MANUFACTURING CHARGES
    Six invoices issued by Godfrey showed billing of 45.5
million Indian rupees ($644,200) to Philip Morris between
December 2013 and January 2018 for manufacturing-related
charges. Philip Morris paid for items ranging from large
cigarette-making machines to costs of smaller equipment such as
barcode scanners and printers deployed in Godfrey's factories. 
    One invoice from January 2018 sent from Godfrey to Philip
Morris showed the Indian company had spent 206 million rupees
($3 million) on capital expenditure for Marlboro-related
manufacturing activities since 2009, though it was not clear how
much of that was paid by Philip Morris. 
    Godfrey Phillips' head of corporate affairs, Harmanjit
Singh, said in an email that all the commercial arrangements
"are in complete compliance with the extant regulations
governing the Indian Foreign Direct Investment and other
applicable laws, and, incidentally, all transactions are in
Indian Rupees. Also, it is our considered view that no
illegality can be impugned to these commercial transactions
between the parties."
    Philip Morris' local unit and Godfrey arranged a mechanism
for such transfer of funds around the time they struck the 2009
deal. A 94-page "procurement agreement" signed between the two
sides that year, which is not public but has been reviewed by
Reuters, said that Godfrey may acquire new machinery for solely
manufacturing Marlboro cigarettes and will then "invoice PM
(Philip Morris) India" for charges in a phased manner. Philip
Morris "shall pay such invoice by bank transfer", the agreement
said.
    The agreement specified Philip Morris would make periodic
payments calculated according to the normal depreciation charge
of the machinery, plus 10 percent per annum on its net book
value.
    Other than those regular payments, Philip Morris also signed
off on one-time expenses and refurbishment costs incurred by
Godfrey on at least two occasions in 2013 and 2014, according to
internal e-mails and accounting records. It then accounted those
transactions internally under a heading "Packaging - Research",
accounting records showed.
        
    "THEY ARE CAMOUFLAGING"
    Three former officials and one former head of India's main
financial crime-fighting agency, the Enforcement Directorate,
reviewed the Philip Morris documents for Reuters and said the
dealings should be investigated for circumventing India's
foreign investment rules. 
    One of the former officials said that paying for machines to
manufacture cigarettes essentially resulted in the promotion of
cigarettes, and the government's intent of banning foreign
direct investment in 2010 was to deter that.
    Bhure Lal, a former head of India's Enforcement Directorate,
said the companies "should be investigated ... they are
camouflaging". 
    The current chief of India's Enforcement Directorate, Sanjay
Kumar Mishra, did not respond to a request for comment.
    If the Enforcement Directorate investigates a company and
finds it to be in violation of the rules, Indian law allows it
to impose a penalty of up to three times the amount contravened.
    Jain of Nishith Desai Associates, which also advises global
companies on foreign investment rules and reviewed the Philip
Morris documents for Reuters, said the company was able to
circumvent the FDI prohibition in cigarette manufacturing by
paying for the machines through invoices. That's because the
Indian regulations only restrict direct foreign investments into
a company and were silent on such indirect payments for
machines, she said.
    "The company can argue in its defence that it is only
funding the equipment purchases and not investing directly in an
Indian cigarette manufacturing company, and they would be
technically correct," Jain told Reuters.
        
    INDIA CIGARETTE MARKET
    The Indian journey of Philip Morris, which is one of the
world's largest international tobacco companies, began in the
late 1960s when it acquired a majority stake in the London-based
parent of Godfrey Phillips. It gradually reduced its stake in
Godfrey over the years, in part due to regulatory changes, and
currently holds a 25 percent equity stake.
    Though India banned foreign investment in cigarette
manufacturing in 2010, it still allowed tobacco companies to
invest through technology collaboration and licensing
agreements. Investments could also be made by forming a trading
company. 
    Ahead of the 2010 ban, Philip Morris formed a new wholesale
trading company with Godfrey. The New Delhi-headquartered local
unit, named IPM India Wholesale Trading Pvt. Ltd, is 50.1
percent owned by the global tobacco giant, with the rest owned
by Godfrey and an investment firm.
    Among the payments outlined in the documents, Godfrey in
January 2018 sent an invoice to Philip Morris's local unit for
10.2 million rupees ($144,500), billing for charges for the
preceding six-month period, an invoice showed. In August 2017,
Godfrey sent an invoice for manufacturing-related charges of 9.5
million rupees ($134,600).
    The documents also showed that Philip Morris at times would
discuss with Godfrey which type of equipment should be used for
Marlboro manufacturing, and then sign off on related payments. 
    In July 2016, the head of Philip Morris's India supply chain
operations, Nilay Mehta, asked a Godfrey Phillip executive in an
e-mail to raise a purchase order for an embossing roller, a type
of equipment used in cigarette manufacturing.
    Given the equipment had to be used only for Marlboro
manufacturing, "IPM will be picking the cost for this", Mehta
said in an email to a Godfrey executive on July 26, 2016. 
    Mehta did not respond to an e-mail from Reuters.  
    India has 106 million smokers, second only to China, and a
young demographic makes it an attractive market for tobacco
companies. 
    Philip Morris is a small player in India's estimated $12
billion cigarette market but has seen its market share rise
steadily in recent years. That was aided by its marketing
activities, such as advertising at roadside kiosks and free
distribution of cigarettes at parties. Both tactics were
described as illegal by health officials in a Reuters
investigation published in 2017. (https://reut.rs/2uy9vOr)

 (Reporting by Aditya Kalra in New Delhi;
Editing by Martin Howell and Alex Richardson)
 ((aditya.kalra@thomsonreuters.com; +91-011-49548021; Reuters
Messaging: aditya.kalra.thomsonreuters.com@reuters.net (Twitter:
@adityakalra))