BEFORE THE DEPARTMENT OF REVENUE

OF THE STATE OF MONTANA

TO: All Concerned Persons

1. On August 10, 2006, the department published MAR Notice No. 42-2-762 regarding the proposed adoption, amendment, and repeal of the above-stated rules at page 1943 of the 2006 Montana Administrative Register, issue no. 15.

2. A public hearing was held on August 31, 2006, to consider the proposed adoption, amendment, and repeal of the above-stated rules. The department received oral and written testimony at and subsequent to the hearing. The department has separated the testimony into two categories, those in favor and those opposed. Comments 1 through 13 represent testimony in support of the rules and comments 14 through 19 represent opposition. The department’s collective response is after the last comment in each category.

3. The department received overwhelming support for the adoption of the rules from the following proponents:

COMMENT NO. 1: Linda Lee, Section Supervisor for the Montana Tobacco Youth Prevention Program (MTUPP), Department of Public Health and Human Services (DPHHS), thanked the Department of Revenue (department) for taking this subject seriously and for taking action that protects Montanans now rather than waiting for federal action.

Ms. Lee stated DPHHS supports the rules because these rules will help prevent youth from starting a lifetime of tobacco addiction. Also, the rules address the problem with one type of tobacco product, the self-identified little cigars. These rules will simply classify a product that is self-marketed as little cigars to comply with Montana’s efforts to prevent the marketing of cigarettes on an individual or small pack basis as required for cigarettes and set the tax on little cigars the same as cigarettes.

Ms. Lee stated that increased marketing of new tobacco products like little cigars is a great concern because these products are in every respect a cigarette substitute designed to be used like cigarettes and to appeal to young cigarette smokers. Little cigars avoid the laws governing cigarettes - particularly Montana’s restriction on pack size and Montana’s increase of the tobacco tax. Both pack size and price are proven methods to reduce tobacco consumption and youth initiation to tobacco addiction. Little cigars appeal to youth because little cigars cost less than cigarettes and they come with flavorings, such as chocolate and raspberry. Youth may mistakenly believe they are smoking a product that poses less health risks because it’s labeled a cigar. But the products are made to be smoked and inhaled just like cigarettes, which means they present the same addiction and health dangers. Little cigars can be sold in any quantity, making it easier to purchase and easier to market to youth.

Montana and most states prohibit cigarettes from being sold in small packs or individually, specifically to make them higher priced, and thus, less-affordable in order to protect our youth. These laws are intended to keep less expensive "kiddie packs" of five or eight cigarettes or individually sold cigarettes, out of the hands of children. Numerous studies have established that increasing cigarette prices reduces smoking among children.

As argued by the Attorneys General of 40 states, led by Montana’s Attorney General in a recent petition before the United States Department of Treasury’s Alcohol, Tobacco and Trade Bureau (TTB), the manufacturers also evade the more restrictive public health protections that apply to cigarettes and not cigars. Cigarettes must carry health-warning labels, but only seven cigar manufacturers are required to place warnings on their packages. The ingredients of cigarettes, but not cigars, must be reported to the Center for Disease Control. Master Settlement Agreement (MSA) payments must be made on cigarettes, but not cigars. Cigars are not subject to the advertising and youth-targeting restrictions of the MSA.

Cigars and their use are a further concern to MTUPP. Real cigars are not a safe alternative to cigarettes, yet some former cigarette smokers perceive cigars as a safer alternative to cigarettes. One little cigar web site reinforces this belief by advertising, "if you want to quit smoking and try something better tasting, this is a great alternative!" Combining this misinformation with lower price and limited marketing restrictions we perceive our tobacco prevention gains could be reversed unless Montana acts now.

COMMENT NO. 2: Dr. Richard Sargent, Helena, Montana, stated that he was representing physicians for prevention. He also stated that he is the Vice Chairman of the Tobacco Prevention Advisory Board representing the American Heart Association, American Lung Association, American Cancer Society, and the Montana Medical Association.

Dr. Sargent stated that in the last month Federal Judge Gladys Kessler found that the tobacco industry is a racketeer-influenced and corrupt organization, and that behavior is on-going. He stated that this statement is very instructive because it helps us to say, "Let’s look at what they are doing right now in the field of little cigars."

Dr. Sargent presented copies of web site documents into the record. The Phillip Morris document calls it a "cigarillos" type product that should be developed to be acceptable taste-wise for the usual cigarette smokers.

Also, in an article entitled "The Might of Minis" taken from tobacco on-line which is an article dealing with little cigars, he stated that the article shows "little cigars" are a smoking alternative to cigarettes and not to cigars. The document states, "The popularity of mini cigars is at least partially due to the cost increase of cigarettes." This type of marketing is intended for the initiation of cigarette smoking and is merchandised separately from cigars because they are more likely to appeal to the cross-over cigarette smoker.

Dr. Sargent stated that these are little cigars aimed at the cigarette smoker and at dodging the taxes put on cigarettes.

Dr. Sargent presented data concerning per capita consumption of tobacco products in the United States and while the number of small cigars has been increasing, it still is dwarfed by the number of cigarettes sold. So when opponents of these changes say this will lead to economic devastation - look at that. This is less than 1% of their total sales.

Dr. Sargent offered a press release from the "Altria" web site that indicated small cigars with filters were developed to address the issue of the budget-conscience adult.

He also introduced material showing that, two years ago, the Connecticut Department of Revenue adopted rules similar to the ones proposed by Montana.

COMMENT NO. 3: Kelly O’Sullivan, Assistant Attorney General for the State of Montana and Chair for the Little Cigar Working Group of the National Association of Attorneys General (NAAG) stated the NAAG submitted a petition to the TTB in May 2006, requesting the TTB revise their rules in order to fairly address the issue of little cigars being sold as cigarettes.

Ms. O’Sullivan stated the Department of Justice (DOJ), as well as the Attorney General’s Office very strongly support the new rules being proposed by the department.

Ms. O’Sullivan stated "little cigars" are what she calls "brown cigarettes." These are little cigars and yet they are filtered, are the size, shape, and diameter of a cigarette. They come in a pack like a cigarette and in every respect they look like a cigarette but they are wrapped in brown paper.

Ms. O’Sullivan stated the department has the legal authority to adopt these rules. The department is the taxing authority for the state of Montana and is charged with the responsibility for enforcing the tax laws of this state.

Ms. O’Sullivan explained that the definition of "cigarette" is found in 16-11-102, MCA, and that definition has three parts. The definition indicates a cigarette includes: any roll of tobacco wrapped in paper or any substance not containing tobacco; and tobacco, in any form, that is functional in the product and that, because of its appearance, the type of tobacco used in the filler, or its packaging and labeling, is likely to be offered to or purchased by consumers as a cigarette.

Ms. O’Sullivan stated the key language in looking at these rules is the phrase, "is offered to or purchased by consumers as a cigarette." Also, the third section of the statutory definition is "a roll of tobacco wrapped in any substance containing tobacco that, because of its appearance or the type of tobacco used in the filler and regardless of its packaging and labeling, is likely to be offered to or purchased by consumers as a cigarette." Based on this statute, as well as 16-11-201, MCA, Ms. O’Sullivan stated the department has the legal authority to adopt rules to further define cigarettes.

Ms. O’Sullivan stated 16-11-201, MCA, refers to the powers of the department to prescribe rules not inconsistent with the provisions of chapter 16, MCA, for the detailed and efficient administration of that chapter.

Ms. O’Sullivan stated the rules would change the tax classification of these little brown cigarettes but what the rules would not do is require these products to be escrowed, be on directories, or have MSA payments paid. The DOJ is charged with administering the statutes relating to the MSA. The fact that the department has chosen wisely to go forward with these rules does not affect the administration of the MSA laws.

Ms. O’Sullivan stated Montana citizens passed I-149, which raised tobacco taxes $1.00 per pack. That tax increase went into effect January 2005. Children are price sensitive consumers and part of the reason for I-149 was to keep tobacco products out of the hands of children. So to the extent the tobacco product costs more, it is more difficult for a child to buy that product. But what has happened now, with the advent of these little cigars, is that these products are taxed as "cigars" which means they are taxed at 50% of the wholesale value of the product, as opposed to cigarettes which are taxed at $1.70 per pack. The federal excise taxes paid on a pack of cigarettes are $3.90. Federal excise taxes on a pack of little cigars, such as these, are $0.40. The Montana state tax on a carton of 200 cigarettes is $17.00. The Montana state tax for a carton of little cigars is based on the wholesale value of the little cigars but if we assume the wholesale value is $7.80, then the tax on a carton of little cigars would be $3.60. So a carton of cigarettes would be taxed in Montana at $20.90. A carton of little cigars is taxed in Montana at $4.00. So clearly there is tremendous tax difference between a cigarette and a little cigar and that tax difference is part of the reason why the department has chosen to come forward with these rules in order to take these products out of the hands of children.

Ms. O’Sullivan stated single sticks and 10-pack little cigars are available in some of the convenient stores in Montana and they are available to children at a very low price.

Little cigar sales have gone up 95% since 1999. They have increased 85% since 2002. Thus far, if little cigar consumption continues as it is at this point, 2006 will equal the highest little cigar sales ever set in the United States, which was set in 1973. She stated that there is some evidence that youth are trading cigarettes for little cigars but that there isn’t a lot of data available. She was aware of only two specific studies related to youth and in both cases the youth reported smoking cigar products more than cigarette products.

Ms. O’Sullivan stated there is a concern regarding the pack size because when the MSA was signed in 1998 it contained a provision that all cigarettes must be sold in packs of at least 20 or more. Unfortunately, that law had a sunset provision of December 2001. Montana enacted a minimum pack size which is provided in 16-11-307, MCA. That statute requires cigarettes to be sold in packs of at least 20. Little cigars are not required to be sold in packs of at least 20, so there are "kiddie packs," which include 8 packs, 5 packs, or single sticks of little brown cigarettes that are available for children to consume.

Ms. O’Sullivan further stated that these little cigars are almost all flavored and the flavors are ones that appeal to children. These include flavors such as: wildberry, cherry, grape, tangerine, and blackberry. They are basically the modern day version of a candy cigarette.

Ms. O’Sullivan stated these products are placed in a manner that they are competing with cigarettes, they are not back behind the counter with the cigarettes, they are not even with the other cigars, they are on the counter with the beef jerky and the bubble-gum, where the kids are likely to see them.

Ms. O’Sullivan stated that manufacturers of these products are not required to place warning labels on these packs like cigarettes. The Federal Cigarette Advertising Act applies only to cigarettes. That law is administered by the Federal Trade Commission (FTC) but the FTC does not determine whether a product is a cigarette or a little cigar. The agency that is charged with doing that is the TTB, and the FTC simply looks at whatever the label on the package says and they take that at face value - if it says "cigars" then it is not required to have a warning label on it. Because of a lawsuit initiated by the FTC, seven of the largest cigar manufacturers do put warning labels on their products, but the rest of them are not required to do so and, therefore, do not.

Ms. O’Sullivan stated the entity that decides if a product is a cigar or cigarette is the tobacco product manufacturer. They make a product, they decide what it is, they label it, and then they pay the appropriate amount of tax on it. If they label it as a cigarette they have to put the warning labels on it, they have to report the ingredients to the Center for Disease Control (CDC) of the Federal Department of Health and Human Services. But if they decide it is a cigar, then they don’t have to put warning labels on it, they don’t have report to the CDC, and they pay a much lower tax rate. That is allowed because the federal TTB has issued a ruling, Ruling 73-22, that allows tobacco product manufacturers to self-designate their products. That was one of the main issues the states took to the TTB in May 2006, and that was the reason the petition was presented because it was felt that the TTB needs to be responsible for making the decision about what really is a cigar or a cigarette and they should not be leaving that decision to the tobacco manufacturer. So, in May 2006, 39 states and one territory petitioned the TTB to issue new rules that would define cigars and cigarettes. The TTB stated they hope to have rules by 2009 to address these problems. She stated that it is not known when the TTB will issue those rules, maybe it will be next week, maybe it will be 2009, but even if they do issue them there is no guarantee that the rules will be anything that will be appropriate for Montana. Ms. O’Sullivan stated that is why she applauds the department for these insightful standards and the excellent job of looking at Montana’s interests and values, the health of our children, and doing what needs to be done to protect them now rather than later. The department has developed very specific criteria of what makes a cigarette and supports the rules that will define little cigars or "brown cigarettes" as cigarettes for tax classification purposes.

COMMENT NO. 4: Dr. Robert Shepard, Helena, Montana, provided testimony in support of the rules and described various tobacco products and explained the differences in these products. A "cigar" is typically rolled tobacco, rolled in tobacco leaf, there is no paper, and there is no filter. A "cigarillo" is "little cigar" in Spanish and is typically cut tobacco, but is rolled, doesn’t have a filter and sometimes, they have a little bite piece on the end. A "cigarette" is cut tobacco rolled in paper, generally has a filter, and comes in a particular size and shape. A "little cigar" is cut tobacco rolled in paper and has a filter. The only difference between a "cigarette" and a "little cigar" is a "little cigar" is a cigarette with a tan and the "little cigar" is often flavored.

Dr. Sargent presented a pack that he described as very stylish with a spider on the front, pops open, and is very cool. This pack contains ten sticks. This product is wrapped in paper, uses cut tobacco, has a filter, and has its own built-in lighter.

Dr. Sargent showed a single little cigar and a lip gloss container designed to be sold to children and explained these two items are easily confused by their packaging.

Dr. Sargent stated that the research data is very clear - one cigarette a week for six weeks will addict the majority of adolescents that smoke at that level. But since people range in a differential amount as little as one cigarette will addict some children. In others it may take more. But there is always a range. A cigarette a week for six weeks is enough to get the majority of kids addicted. That is why the tobacco industry does single sales. They would like to talk about tobacco being a choice. It is not a choice, it is an addiction, and once you become addicted it is one of the most difficult addictions to quit. He stated that statistics go like this: If you dabble with alcohol, the odds are 1-10 that you will become an alcoholic; if you dabble with cocaine, the odds are 1-6 that you will become a coke addict; and if you dabble with nicotine, the odds are 9-10 you are going to get hooked. That is why the industry wants kids to dabble in it and why they want single sales.

COMMENT NO. 5: Tyler Steinebach, a senior at Superior High School testified in favor of the rules because he believes that the little cigars are a problem with school age children. He stated that he had two ten-stick packs of little cigars and a single strawberry flavored little cigar which he had purchased and he is only 17. He stated this sale and purpose of the purchase had been reported to the owner of the store. He explained that he had shown the strawberry flavored little cigar to his seven-year-old cousin and asked her what she thought it was. She told him she thought it was a marker. So he took her to the store where he had purchased it and had her look through the selection of "markers" and she picked out one she wanted. He then told her what the product really was. He stated that he did this to point out that these products are attractive to kids not only her age but many 10 and 12 year olds. He stated he has seen these young people smoking the chocolate mint flavored ones and that these young people have told him these little cigars are much better than the cigarettes they used to smoke. Also, when their parents talk about how they are addicted to smoking two packs of cigarettes a day, these kids say that they don’t have to worry about getting addicted to a pack of those cigarettes because they can get a pack of eight little cigars and that way they can control how many they use. He stated that what he has found is that if they smell good, taste good, and look good, kids are likely to try them, especially if they are also easy to get and easy to conceal. He also stated that when he purchased the single strawberry flavored mini cigar the store clerk didn’t even know what she had sold him but when he told her what it was, she immediately asked for it back.

He stated that he believes these little cigars should be in packs of at least 20 just like the rules asked for and it should be classified as a cigarette. Calling them a little cigar only gives the kids a little more confidence that they are not smoking a cigarette. He stated that he believes the tobacco industry is doing a good job at what they are trying to do, which is to get kids to use their products because it is working.

COMMENT NO. 6: Dick Paulson, Executive Director of the American Lung Association of the Northern Rockies representing that association and the children across Montana, stated that those organizations fully support the proposed changes related to packaging and sale of tobacco products. This really is a full-fledged effort aimed at our children in trying to evade the tax provisions Montanans so strongly support. He stated he had received a call from a mother begging him for a program that would help her 12-year-old son quit smoking. We need to send a strong message to the businesses that are also selling these products because they are setting them out where the youth have access to them, and they are designed to entice our kids with the cute packaging and candy flavors at a very low price. This is truly unacceptable and he supports the department in making these needed changes.

COMMENT NO. 7: Kathy McGowan, American Cancer Society, thanked the department and the Department of Justice for the collaboration in getting these rules in front of the public. It is very heartening for the rest of us in the advocacy community to have your acknowledgement of this problem.

Ms. McGowan stated that these proposed rules more accurately reflect the intent of the initiative which the American Cancer Society and the Alliance for Healthy Montana got behind just a short while ago, and basically that it is very disheartening that our own folks in our own communities have chosen to take an end run around that initiative. She stated that it behooves all of us as caretakers of the health of our youth and the rest of our citizens to make sure that that end run is blocked. We very much thank you for helping in that regard.

COMMENT NO. 8: Cliff Christian, American Heart Association and American Stroke Association, testified that he had been hooked on nicotine because he believed Mickey Mantel when he told me "Lucky Strikes" were cool to smoke. He believed him because he loved Mickey Mantel, which is not dissimilar from what we see today in the tobacco advertising for little cigars.

Mr. Christian discussed comparing the heart of a young athlete which is strong and mighty and pumps the blood the way it should, in contrast to someone with heart disease from smoking. The heart, it is complicated but for lack of a better explanation - a heart that has dealt with tobacco for many years is like a broken carburetor and it just barely functions. Also, look at a lung of a baby or a young child - the lungs are pink, strong, and are pumping oxygen so when that little child goes out for recess those lungs are going to be pumping like crazy. Compare that with a lung of a smoker of 20 years, that may have emphysema, and in order to move from the couch to the car has to have oxygen injected into their nose so they can live. Because without that oxygen, their lungs are going to stop functioning sooner than normal. But that person, with that black ugly tar-filled lung caused from tobacco, is still going to die an early death.

Mr. Christian showed two items, one with brown paper wrapped around it which is a cigarette with a "tan", and another one with bright white paper. But they both wrap around tobacco so they are virtually the same product.

Mr. Christian stated that he believes the department has the authority to adopt the rules. Also, we have hired one of the best attorneys in the country to look at whether or not the department has the authority, and you do. The Department of Justice has said you have the authority and it does. So, let’s get this done. Promulgate it as fast as we can, and get it into place as fast as we can. He stated he was afraid the department would delay the adoption long enough for the legislature to take a look at it.

COMMENT NO. 9: Christine Page Nei, Government Relations Director for the American Cancer Society, stated she was presenting testimony on behalf of the Campaign for Tobacco Free Kids. The Campaign for Tobacco Free Kids is this nation’s largest nonprofit, nongovernmental, educational, advocacy organization solely devoted to reducing the harm caused by tobacco use and exposure to second-hand smoke, especially among children, and it lends its support to the proposed rule changes by the department.

Ms. Page Nei stated the criteria outlined by the department’s proposals are reasonable and clearly distinguish between real cigars and cigarettes, which are simply masquerading as little cigars. If in fact a tobacco product is truly a cigar, the manufacturer of the product should not have any difficulty meeting the requirements of this provision. Real cigars are not sold in packs containing 20 to 25 sticks. Real cigars are not available for sale in cartons of 10 packs, sold in soft packs, hard packs, flip-top boxes, clamshells, or other cigarette type boxes. Real cigars are not the length and diameter found in commercially manufactured cigarettes. They are not sold with cellulose acetate or integrated filters. They are not sold in weights less than three pounds per thousand sticks. They are not marketed or advertised to consumers as a cigarette or cigarette substitute.

The department has proposed a fair system by which manufacturers of tobacco products including little cigars and cigarettes can receive a decision in a timely manner as to whether or not their products fall within this new proposed definition. This proposal is fair to cigarette manufacturers, whose products are competing with little cigars for market share. This proposal is fair to traditional cigar manufacturers, whose products would not fall under the auspices of this proposal. And this proposal would fairly include those products (little cigars) that have been designed to avoid categorization, and taxation, as cigarettes.

There is a growing body of evidence seen at the national level which shows a resurgence in cigar use, particularly among youth, driven by four key factors: 1) The price deferential between cigarettes and cigars, particularly little cigars, that makes cigars significantly cheaper and more affordable and encourages initiation of cigar use and decreases quit attempts; 2) the increase in the availability of flavored cigars that appeal to youth; 3) few restrictions on the marketing and advertising of cigars; and 4) efforts by tobacco manufacturers to label products as little cigars as opposed to cigarettes (thus avoiding higher cigarette taxes and making the products more affordable) and designing little cigars (and their packaging) to appear very similar to cigarettes.

Ms. Page Nei stated the tobacco manufacturers provide lots of support to back up their claim. There are three policies these manufacturers would like the department to see as relevant. One - the key policy issue is the popularity of cigars in this price disparity that exits between the cigarettes and cigars. Second - the explosive growth in flavored cigar products on the market. Finally - cigars and cigar manufacturers are not covered by the marketing, promotional, and sales restrictions imposed by the Master Settlement Agreement Kelly O’Sullivan talked about.

The point they want to make is that together the issues of price disparity, enticing flavors, and few limits on marketing and advertising are converging into a significant public health problem that needs to be addressed, at least in part, by strong measures such as those being proposed by the department.

COMMENT NO. 10: Betty Beverly, Executive Director, Montana Senior Citizens Association, also a partner with the Alliance for Healthy Montana. She stated they have been working since 1999 on this tobacco issue and as a "grandmother" and "great-grandmother", she is really concerned about the packaging of these little cigars. She also stated that many senior citizens are addicted to tobacco, and they are on oxygen. So many of them wish they had never become addicted because they have such debilitating disease from tobacco. These senior citizens tell her they don’t want to see this happen to their children and their grandchildren and their great-grandchildren.

Ms. Beverly stated she really commends the department and the Department of Justice for bringing forth these rules and looks forward to a speedy resolution.

COMMENT NO. 11: Jim Ahrens, Chairman of the Alliance for Healthy Montana stated he supports the rules and mentioned that the intensive care units across the state have many patients with tobacco related illnesses. The alliance is a group of organizations, including insurers, hospitals, doctors, social service agencies, public health agencies, heart, lung, cancer, stroke, AARP, Montana Senior Citizens, and several others who have been involved in all of the initiatives dealing with reducing tobacco usage in Montana. He stated they had all worked hard on this issue, and they commend the department for its work putting the rules forward and urge the department to move the rules forward quickly.

COMMENT NO. 12: Erin McGowan Fincham, representing the State Auditor’s Office, thanked the department for bringing these rules forward. Ms. McGowan Fincham stated Commissioner Morrison has worked closely with the Alliance for a Healthy Montana on two initiatives, both Initiative 146, which identified that tobacco addiction is very critical and a portion of the tobacco settlement funding should go toward that process, and Initiative 149, which allocated funding to various health care programs. One of those health care programs, Insure Montana, is administered by the State Auditor’s Office. Both of those initiatives passed by over 60% of the public vote, which says that in the Montana public’s eye tobacco prevention, preventing our youth from picking up tobacco habits, is very critical. Over 60% of our voting public supported those measures. She stated she had visited with Montana adults who used tobacco products who supported both of those measures in order to prevent youth initiation.

Ms. McGowan Fincham stated they very much support the clarification in the rule brought forward by the department and it is very obvious the circumvention of the cigarette tax in this instance disproportionately targets Montana youth, so it is critical the cigarette tax avoidance be prevented both to prevent future generations from beginning to use tobacco products, and to allow the department to collect cigarette taxes as intended by Montana law.

COMMENT NO. 13: G. Steven Brown, Attorney at Law, representing the American Cancer Society (AMS) and American Heart Association (AHA), provided supplemental written testimony in favor of the adoption of proposed New Rules I through IV and the amendment and repeal of the department's existing rules.

Mr. Brown addressed comments made by opponents at the hearing as follows: The opponents suggested that the department's proposed new rules unlawfully "engraft contradictory language" to the statutory definition of "cigarette" and that the attempt to tax "little cigars" and similar products as cigarettes is an "end run" around the 2005 legislation. The opponents' suggestion that the department's proposed new rules violate the rulemaking requirements of the Montana Administrative Procedure Act (MAPA), controlling statutes, and applicable case law is without merit.

The department has unambiguous authority to adopt rules consistent with and necessary for the "detailed and efficient administration" of Title 16, chapter 11, MCA, which is entitled "Tax on Cigarettes." Section 16-11-103(l), MCA. Included in the delegation of rulemaking authority is the power to "adopt rules for the effective collection and refund of the tax imposed" under Title 16, chapter 11, MCA. The department also has the authority to administer parts of the Youth Access Act (Title 16, chapter 11, part 3, MCA) and may adopt rules to "implement Sections 16-11-301 through 16-11-308." Section 16-11-312, MCA. The sale of cigarettes, including cigarettes disguised as "little cigars," is clearly subject to the department's rulemaking, taxation, and regulatory powers.

Montana's rules of statutory construction provide that the definition of a word or phrase in any Montana statute "is applicable to the same word or phrase wherever it occurs, except where a contrary intention plainly appears." Section 1-2-107, MCA. The opponents' assertion that the expansive definition of "cigarette" in 16-11-102(2), MCA, was not intended to be used to tax and/or regulate the sale of "little cigars" to consumers, especially sales to minors, is baseless. Nothing in the 2005 legislation revising the definition of "cigarette" remotely suggests that the amended definition of "cigarette" could only be used to regulate cigarette smuggling or internet sales. The opposite is true. The department is obligated by law to apply the expansive statutory definition of "cigarette" to all of the functions it performs under Title 16, chapter 11, MCA.

Within the context of the preceding statutory provisions, the opponents' accusation that the department is impermissibly engrafting additional and contradictory requirements on to the enabling legislation by classifying "little cigars" as cigarettes fails. Proposed New Rules I through IV are in "harmony" and consistent with the enabling legislation and the statutory definition of the term "cigarette" in 16-11-102(2), MCA; are reasonably necessary to effectuate the purpose of the enabling statute; and increase the fairness of the department's regulatory/taxation process by establishing an administrative process for hearing and deciding challenges to a determination that a tobacco product is a cigarette. Bick v. State Department of Justice, (1986) 224 Mont. 455, 458-459, 730 P.2d 418. Proposed New Rule II provides reasonable objective criteria consistent with the statutory definition of the term "cigarette" for distinguishing between a "cigarette" and a "cigar." These criteria provide greater certainty to those who sell tobacco products in Montana and protect the public, and especially minors, from an obvious attempt by the tobacco industry to circumvent Montana's clearly stated public policy of regulating and taxing tobacco sales in the state.

AMS and AHA urge the department to adopt and amend its administrative rules as proposed in MAR Notice No. 42-2-762.

RESPONSE TO COMMENTS NO. 1 - 13: The department would like to thank all the proponents for their comments and support in what the department believes to be a very important action.

The department takes its responsibility of enforcing the Youth Access to Tobacco Products Control Act in Title 16, MCA, very seriously, as well as the authority to administer the tax that governs tobacco sales in this state. These rules will establish criteria for the department to follow when making a determination of whether little cigars should be classified as cigarettes for the tax application process.

Since the rule hearing in August, the TTB has drafted proposed amendments to the federal definitions of "cigarette" and "cigar" for federal taxing purposes. The department does not know if or when those amendments may become effective. If the TTB adopts its proposed definition of "cigarette", and there is no guarantee that they will, the resulting classification of most "little cigar" products will mirror the results of the department’s rules.

The department has no doubt that it has full authority to adopt these rules as they are proposed. Some proponents voiced concern that the department would not act quickly or that it would allow the legislature to address this issue. At this time, Montana’s 2007 Legislature has convened and there is a likelihood that this subject will be presented to that body for consideration. Therefore, the department has elected to adopt New Rules II (42.31.206) and III (42.31.207) with a delayed effective date of July 1, 2007. That will allow opponents the opportunity to bring this issue to the Legislature for action.

4. The department received oral and written objections to the adoption of the rules from the following:

COMMENT NO. 14: Mark Staples, representing the Montana Wholesalers, and who emphatically noted such, stated that he does not represent, nor has heard from, nor is involved with, big tobacco on this issue. He does not know what their position is, and doesn’t care.

Mr. Staples started his testimony by making the comparison between the hearing process and the legislative process by stating that this hearing strikes him today as deja vu, just like a legislative hearing. Same room, same parties, same testimonies, and many of which he does not disagree with as they are riveting and meaningful. He states he is friends with many of the proponents and hopes they feel the same way. Mr. Staples’ testimony compares this hearing to a legislative hearing by stating the only thing missing is the duly elected legislators who are not appointed but who are constitutionally empowered to decide such issues as these: to raise taxes, and, to be honest, to extend categorical restrictions and make sweeping public policy that may be necessary, valid, and justified.

Mr. Staples further stated that most of the arguments made by the proponents are policy arguments and that for those that know that he is a lawyer and that he believes in the process know that it should be correctly applied and anticipated that he would bring this up as an improper forum for this. He states that the truth of the matter is that the arguments from the other side that have retained national-caliber lawyer have been policy arguments that lie before the legislature.

Mr. Staples further states that what is missing in this hearing are those who ask questions, those who weigh the issues and then proceed through a committee deliberating decisions moving it to the next body and then through the bidding process – the legislature.

Mr. Staples further emphasized that everyone has been told never to take this issue to the legislature and to try to avoid the legislature. We have been told this by a group that is more organized, has more grass-roots, more e-mail capacity, more instant messaging that he has encountered in the past 25 years. He has never met a more effectively organized, strategizing, and successful lobbying legal group and states that if that is a "back-handed compliment" they can take it as that. This group has learned their lessons from "Big Tobacco" in an initiative drive 8-10-12 years ago where they were out-organized, out-spent, and who swore, which you can see, would never happen again. So you can see this is hardly a shrinking violet group that can’t make an absolutely overwhelming case to a legislature and put on a very good initiative at the drop of a hat.

Mr. Staples identified himself as one of two opponents and stated that a little background was necessary. He stated he felt there was an irregularity in the drafting of this administrative rule as a draft was sent out earlier to the wholesaler community, and manufacturers, whereas a matter of fact "Big Tobacco" was behind this. Mr. Staples indicated this statement was made because he was told by insiders in the Department of Revenue that "Big Tobacco" did not want some of their sales migrated to little cigars or they do not want the miniscule portion of the settlement fund gone. Mr. Staples proceeds to explain that the original hearing notice was sent out advertising a hearing date the second week of September. This date was the date people prepared for; however, less than three weeks ago, the date was suddenly changed, and therefore, we will not see much of a turn out from opponents. He states that even though the opponents are not here, there are legitimate arguments and opposition.

Mr. Staples agreed that this is much about the youth of Montana, and he emphasized from a personal standpoint, and that of the wholesalers and retailers, they would agree that the products that resemble "lipstick tubes" in single sticks should be pulled from the store shelves. He mentioned that it was not required by law that these products be removed, because there isn’t a law that says these little cigars can’t be sold separately. He stated that this product has been around for some 80 years, most of which has had the same packaging and flavoring that appealed to middle-aged women and was around long before they were ever taxed. Mr. Staples stated that this rule action was so sweeping, so comprehensive that nothing but a "big fat stogy" would escape the rules, and if that is what Montana wants it should not be done in rules.

Mr. Staples questioned how the department could presume to enforce this action by rule. He stated that the operative word to consider from the law was "likely." The law states in part, "likely to be sold or purchased as a cigarette", and he questioned where that almost unconstitutionally vague definition came from. He pointed out that it was inserted into law by the 2005 Legislature through a cooperative effort of the Department of Revenue, Department of Justice, wholesalers, and retailers to address internet sales, cross-border smuggling, and mail-order sales. It was also added to give agencies the important tools needed to deal with those subjects. He stated that, to his knowledge during the months of preparing the bill, which was drafted through a collaborative effort, and the months spent passing it through the legislature, the issue of little cigars was never mentioned.

Mr. Staples pointed out that there are laws in Montana against selling tobacco to children which provide for massive penalties for retailers who break these laws. He indicated that sting operations are conducted daily in Montana and a statutory mandate requires the retailers to achieve a compliance level, of which to his knowledge the retailers have never fallen below. This would imply that compliance is high.

Mr. Staples stated that this law was a difficult one to get enacted. Big Tobacco opposed the bill, his clients, the wholesalers and retailers, defended the bill saying that it was the right thing to do for Montana in order to address smuggling and internet sales.

Mr. Staples stated the statistics presented at the hearing were slim and there were no surveys conducted in Montana, and the proponents to this rule have tremendous resources to conduct surveys to find out if this really is a problem.

Mr. Staples further stated that there are more cigarettes sold in Montana in three days than the entire category of little cigars in a year. He indicated that this is all about losing revenue and adding this category of tobacco to the Master Settlement.

Mr. Staples stated that this is not a subject that should be brought before a Hearing Examiner who helped draft the rules. That is not due process. There are laws in place that deal with underage smoking, and if they are not effective, amend them. He stated the department has the power to extend the current rules to achieve what they don’t believe they are achieving. If the department believes young people are buying, despite the restrictions and penalties imposed, then it should go to the legislature and address the things that were omitted from the initiative drive and seek a tax increase.

Mr. Staples stated that he had discussed these rules with the largest chain of convenient stores in the state and told them that he didn’t think these products should be on the counters or that there should even be single stick sales. He further stated that he intended to use his persuasive powers to get these products off the counters immediately.

Mr. Staples indicated that if the department didn’t believe that the TTB was doing its job then it should tell the Montana Legislature and ask them to fix the law to address this issue. He stated the Montana Supreme Court has said, "The courts have uniformly held that administrative regulations are impermissibly out of harmony with legislative guidelines if they engraft additional and contradictory requirements on the statute and if they engrafted additional contradictory requirements on the statute which were not envisioned by the legislature." He further stated that but for slipping the word "likely" into the definitional section of the bill, that this department could not have passed, which is a statement of fact that cannot be denied, they could not have passed this bill, nor could the DOJ without the wholesalers and retailers of this state. This may not be unconstitutional, but it is unconscionable.

COMMENT NO. 15: Ronna Alexander, representing the Convenient Store Association in Montana, testified that about 80% of those businesses fit the description of a convenient store. She further stated that it is true some of the members that sell small cigars have seen an increase of sales of some of these products since the sales of cigarettes have decreased over the last couple of years with the large tax increases recently put into effect. The overall decrease on an average for our industry right now is about 30% compared to three years ago when tobacco products represented about 35% of their gross profit margins. She stated that this is somewhat of a negative effect on that industry but nobody really cares about the negative effect to the industry.

Ms. Alexander stated that she takes great exception to a statement by Ms. O’Sullivan that Ms. Alexander believes to be quite false. Her statement was, "that mini cigars are available to children in convenient stores." Ms. Alexander stated that is not true - convenient stores do not sell tobacco products to kids. There are laws against it and significant penalties for doing so. There are occasional times when convenient stores, bars, and grocery stores have an incident in a sting operation where they sell to a minor. She states that the last SYNAR report (federal Synar Amendment 1992), that she had seen shows 93% compliance in Montana. She indicated that the members of her association don’t want to sell tobacco products to kids and they serve the community in many positive ways.

Ms. Alexander reiterated the comments made by Mr. Staples concerning the enactment of House Bill 687 and stated that she also believes the rules cover an area not intended by the bill which would create a tax increase for these products.

She stated that it may need to be changed but that the legislature needs to address it rather than through rules.

Ms. Alexander stated Montana has a responsibility to find a balance between consumers and the businesses that serve consumers and this doesn’t seem to be a balance. She suggested that the legislature will be meeting in four months and this subject would be more appropriate in that venue.

COMMENT NO. 16: Denis Asay, representing the Smoker Friendly tobacco stores in Montana, provided written comments. He stated that they operate stores in eight cities including Billings, Bozeman, Helena, Great Falls, Havre, Kalispell, Missoula, and Lewistown.

Mr. Asay stated they understand that the goal of the rule is to try and prevent minors from purchasing little cigars. However, they take serious exception to the means to achieve this goal. He stated that currently, little cigars are taxed at 50% of the wholesale price and cigarettes are taxed at a rate of $1.70 per pack. By reclassifying little cigars as cigarettes, the practical impact would be taxing little cigars at $1.70 per pack rather than at 50% of the wholesale price. This would represent a significant tax increase on little cigars.

Mr. Asay stated that if the goal of the rule is to prevent minors from purchasing little cigars, increasing a tax is not the proper way to go about it. He further stated that in their tobacco stores, they don't allow minors to enter the store unless they are accompanied by a parent. Minors know they are not supposed to be in a Smoker Friendly tobacco store, so they don't have the ability to access little cigars at these stores. Moreover, convenient store owners train their employees not to sell tobacco to minors because of the severe penalties and fines they would face if a clerk were to inadvertently sell tobacco products to an underage person. Retailers are not in the business of selling tobacco to minors.

Mr. Asay stated a number of consumers who buy little cigars are senior citizens. He stated that the statements that packaging little cigars to make them attractive to young smokers simply is not true. Mr. Asay invited the department to spend a day in one of their stores and see that the purchasers of little cigars are by and large our state's older citizens.

Mr. Asay stated excise taxes are the most regressive taxes imposed on the population harming those least able to afford the tax. Little cigars, like all tobacco products, are a legal product purchased by adult consumers. If this tax is imposed, consumers of little cigars will simply stop purchasing them from Montana retailers. Consumers will purchase little cigars most likely over the Internet and Montana will lose all of the excise tax it would have otherwise collected.

Mr. Asay stated they take great pride in their stores and over the years they have invested not only money but time to cultivate loyal customers. He further stated they want to keep those customers, but this proposed rule will make little cigars much more expensive and will most likely cause our customers to purchase their little cigars over the internet. He stated that he didn’t believe their customers should not be forced to purchase the tobacco products in other states over the internet.

COMMENT NO. 17: J. Thomas Ryan, representing Swisher International, Inc. (Swisher), presented written comments stating that Swisher is a manufacturer and distributor of cigars and smokeless tobacco products; it is not, and never has been, in the cigarette business. He further stated among Swisher's better known cigar brands are Swisher Sweets, King Edward, BlackStone, and Santa Fe. Each of these brands is made in a wide variety of shapes and styles to appeal to the multitude of preferences expressed by Swisher customers, including little cigar smokers.

Mr. Ryan stated Swisher, which has made and sold cigars throughout the United States for 100 years or more, started offering little cigars for sale in the early 1980s in response to an increasing demand for smaller cigars in light of the growing difficulty smokers had in finding times and places to enjoy traditional sized cigars. In fact, recent years have seen a dramatic shift away from the larger panetelas and coronas of all Swisher brands and toward the smaller cigarillos or little cigars sold under those brand names.

He further stated to many nonsmokers, little cigars have been thought to be merely a marketing strategy devised by cigarette makers to avoid high excise taxes and the relatively new burden cigarette makers accepted by entering into the Master Settlement Agreement of 1998 ("MSA") to settle the numerous lawsuits outstanding against them. Accordingly, numerous attempts have been made to increase taxes on little cigars, to treat little cigar makers as cigarette makers who failed to sign the MSA and generally to make it more difficult for little cigars to be viably marketed.

Mr. Ryan stated that little cigars are a legitimate category of tobacco product that has existed for more than 25 years and around which a system of regulations has grown up to assure that they are not perceived as or confused with cigarettes and, most importantly, so that the category is not used as a way for cigarette manufacturers to avoid payment of cigarette excise taxes. Little cigars are fundamentally different from cigarettes: the two are made from different materials, are smoked in different ways and provide different forms of satisfaction. Further, little cigars are taxed separately from cigarettes by the federal government as well as by almost all of the states. In addition, no little cigar maker was a party to the lawsuits settled by the MSA; nor did any of them accept the burdens of the MSA (which, in fact, makes no reference either to little cigars or to their manufacturers).

Mr. Ryan stated TTB has taken great care to distinguish between cigarettes and little cigars in order to establish a national definition for little cigars. To that end, it has defined the kind of filler tobacco that must be used in little cigars, described the specifications for the only reconstituted tobacco that will qualify for use as little cigar wrapper, and established specific guidelines for the way little cigar packages must be marked to avoid confusion with cigarettes as well as limitations on the advertising and marketing of these products. Further, the TTB has long monitored such factors as alkalinity and carbohydrate levels in little cigars to ascertain whether manufacturers were in fact selling disguised cigarettes. While there may have been some manufacturers who have ignored these TTB requirements and labeled their cigarette products as little cigars, the vast majority of little cigars sold in the United States comply with federal law.

Mr. Ryan stated that because of the confusion of regulators in some states who had not taken note of the little cigar business until recently and, perhaps also, because of an overeagerness to replace tax and other revenue being lost as cigarettes decline in popularity and sales, a number of jurisdictions have taken steps to increase the tax on little cigars or to make them fit into a more productive category than their own.

He further stated that while the legislatures in a number of jurisdictions have increased the excise tax on little cigars to the level at which cigarettes are taxed, other jurisdictions like Montana have opted to take a short cut around their legislature by trying to redefine little cigars as cigarettes in an attempt to accomplish their goal outside the legislative process. This latter tactic has a profoundly chaotic effect on the cigar market, and most jurisdictions which have started down this road have recognized the risks and retreated.

Mr. Ryan stated that, to date, unfortunately, Montana appears to be continuing on this course despite the dire consequences that will result:

(i) thorough confusion in the market place;

(ii) perhaps permanent injury to an industry with an old and legitimate history;

(iii) one constitutional crisis that pits a state's regulators against their federal counterparts, and another in which regulators seek to usurp legislative power; and

(iv) a disruption of interstate commerce.

Mr. Ryan stated that federal law requires little cigar packages to be marked as such and to bear health warnings relevant to cigars, not to cigarettes. By redefining little cigars as cigarettes, Montana authorities will create confusion by requiring cigarette tax stamps - and perhaps cigarette warning labels - to appear on cigar packages alongside prescribed cigar warnings. Consumers who want products that taste, smell, and draw like cigarettes will be encouraged to purchase products that are entirely different.

Mr. Ryan stated few cigar manufacturers will be willing to alter their packaging to conform to Montana regulation rather than federal law and so will probably elect not to sell their products to Montana distributors. Then, unless retailers obtain products from outside Montana and alter the packaging in a way that will violate federal law and invite litigation from manufacturers, sales of little cigars through legitimate retail channels in the state will diminish dramatically and consumers will be forced to purchase little cigars from other jurisdictions (reducing excise tax revenue that would have been collected on in-state sales).

Mr. Ryan further stated that by redefining the term "cigarette" to include little cigars, the department also will set the stage for a federal preemption lawsuit, litigation to prevent the injury to interstate commerce that will result from non-Montana distributors being prohibited from selling legitimate products across state lines into Montana as well as lawsuits to prevent regulators from assuming the authority of the legislature to levy taxes.

Mr. Ryan stated the definition of "cigarette" contained in the proposed regulation noted above was constructed solely as an ultra vires attempt to turn little cigars into something they are not and to raise taxes and other revenues which the legislature has chosen not to levy. Its elements were selected so that virtually every little cigar produced in the United States will be deemed a cigarette in Montana.

He further stated that if the department is interested in eliminating the confusion between little cigars and cigarettes, it should support TTB's enforcement of the distinctions it has drawn, including the new rulemaking which the TTB plans to announce momentarily, rather than proceeding down a path that will only result in litigation, chaotic markets, and misinformed consumers.

COMMENT NO. 18: James A. Deer, Secretary and Legal Counsel for Single Stick,. Inc. (Single Stick), submitted written comments strongly urging the department to not adopt the rules. He stated Single Stick is a company which has been engaged in the cigar business since 1998. It manufactures both large and small cigars in its own facilities located in Phoenix, Arizona, and in Stantonsburg, North Carolina. Single Stick sells its cigar products in interstate commerce with customers in 45 states of the United States and in foreign countries. Single Stick manufactures its products under permits issued by the TTB, which enforces a comprehensive system of legislation, regulations, and rulings which govern the manufacture and sale of tobacco products, including cigarettes and cigars. Single Stick’s products carry the federally required information on their packaging. Single Stick has voluntarily submitted its products for testing in the TTB’s national laboratory, and all of the products submitted have been classified by the TTB as cigar products.

Mr. Deer stated Single Stick markets its products to adult consumers in packages including a 20 count, 10 count, 8 count, and singly. Single Stick, pursuant to the resolution of its board, does not target minors in its advertising. He stated Single Stick does not advertise in media which appeals to minors, or show its products in any advertising context which would encourage minors to use the product. Single Stick does not offer materials bearing its products’ logo or premiums or incentives such as "gear" nor has it ever employed figures or cartoons such as "Marlboro Man" or "Joe Camel." He stated that the vast majority of tobacco products consumed in the United States are products manufactured by the major cigarette manufacturers as reported annually for years in the SAMSHA studies of smoking by minors. Single Stick is an active member of the Cigar Association of America and endorses its statement and policies against sales or inducements to minors.

Mr. Deer also stated that Single Stick supports and adopts the comments filed by the Cigar Association in its opposition dated August 31, 2006, and strongly opposes the adoption of the rules. He argued as a reason not to adopt the rules that the classification of the product and taxation of it as a cigarette would, because of the inability to apply tax stamps and lack of adequate denominations for its packages, effectively remove its products, which are otherwise legal, from the marketplace. Other methods exist for the taxation of cigar products which would not place this impermissible burden on interstate commerce.

Mr. Deer stated the provision in Rule IV which requires "clear and convincing evidence" in an administrative hearing is contrary to the existing standards of proof in an administrative action in Montana and is not authorized by statute.

He further stated it is their belief the rules as written violate the separation of powers clause in the Montana Constitution, and are preempted as to the attempted redefinition of the little cigar product by the federal rules as administered by the TTB as part of a comprehensive federal system of regulation touching all parts of the tobacco business. They violate of the Commerce Clause insofar as they interfere with the packaging and sale of products which are otherwise illegal in interstate commerce.

COMMENT NO. 19: Thomas A. Briant, Executive Director, National Association of Tobacco Outlets (NATO), submitted written testimony in opposition to the proposed rule because the department is increasing the excise tax on little cigars which is beyond the scope of the agency's authority and because the underlying purpose of the rule (preventing minors from purchasing little cigars) is already accomplished through the vigilance of retailers and their efforts to stop the sale of tobacco products to minors.

Mr. Briant stated that Article VIII of the Montana State Constitution grants the Montana Legislature the power to adopt taxes through the enactment of legislative statutes. This grant of power to enact taxes through the legislative process precludes state administrative agencies from usurping that very power. In fact, Section 2 of Article VIII states that the legislature cannot surrender, suspend, or contract away the power to tax. However, the reclassification of little cigars as cigarettes will change the way little cigars are taxed. That is, little cigars will no longer be taxed at 50% of the wholesale price, but taxed as if they were cigarettes at $1.70 per pack. The end result will be a significant tax increase on little cigars that has not been enacted by the legislature. In the absence of legislative action to change the method of taxation on little cigars, the proposed rule should be withdrawn since it oversteps the administrative authority of the department.

Mr. Briant stated with regard to the department's purpose to prevent minors from purchasing little cigars, that goal is also being met without the need to adopt this proposed rule. He further stated that NATO represents primarily tobacco stores in which the sale of tobacco products generally accounts for 90% or more of a store's revenue. With this high percentage of "adult only" tobacco products offered for sale, tobacco store owners as a rule do not allow underage children into their store unless accompanied by a responsible adult or parent. Tobacco store retailers are very similar to liquor stores in this regard and remain vigilant by not allowing minors in their stores, let alone allowing them to browse the store and shop for any tobacco products.

Mr. Briant stated the appropriate venue for consideration of this proposed rule is the Montana Legislature. With the legislature's power to enact taxes, and this proposed rule changing both the method and rate of taxation on a legal tobacco product, the department is precluded by the Montana Constitution from proceeding with this rulemaking procedure regarding the reclassification of little cigars. He further stated that NATO requests the department cease rulemaking proceedings on this matter and refer the issue to the state legislature.

RESPONSE TO COMMENTS NO. 14-19: The opponents suggested that the department's proposed new rules unlawfully engraft contradictory language to the statutory definition of "cigarette" and that the attempt to tax "little cigars" and similar products as cigarettes is an "end run" around the 2005 legislation of House Bill 687. The opponents further suggest that the department's proposed new rules violate the rulemaking requirements of the Montana Administrative Procedure Act (MAPA), controlling statutes, and applicable case law. However, the department disagrees because the department has unambiguous authority to adopt rules to enforce Title 16, chapter 11, MCA. In addition to this rulemaking authority, the department also has been delegated authority to administer parts of the Youth Access to Tobacco Products Control Act (Title 16, chapter 11, part 3, MCA) and may adopt rules to "implement Sections 16-11-301 through 16-11-308." This authority includes the sale of cigarettes, including cigarettes which may be disguised as "little cigars," and is clearly within the department's rulemaking, taxation, and regulatory powers.

Opponents have asserted that the department is expanding the definition of "cigarette" as found in 16-11-102(2), MCA, and that statute was not intended to be used as a taxing authority or to establish a regulation mechanism for little cigars. This assertion is without merit. Nothing in the 2005 legislation revising the definition of "cigarette" or its legislative history suggests that the amended definition of "cigarette" may only be used to regulate cigarette smuggling or internet sales. The opposite is true. The department is obligated by law to apply the new statutory definition of "cigarette" to all of the functions it performs under Title 16, chapter 11, MCA, and to assume that the legislative change carried with it the intent to modify what products are considered "cigarettes" in Montana.

The department believes that proposed New Rules I through IV are in fact consistent with the enabling legislation and the statutory definition of the term "cigarette" in 16-11-102(2), MCA. The department further believes these rules are necessary to effectuate the purpose of the enabling statute; and increase the fairness of the department's delegated regulatory and taxing responsibilities by establishing an administrative process for hearing and deciding challenges to determinations that a tobacco product is a cigarette.

As stated in Response to Comments 1 through 13 above, the TTB has proposed amendments to the federal definitions of "cigarette" and "cigar" and the department is not certain that the amendments will be implemented. However, even if TTB adopts the proposal, the department has three concerns that are not addressed by TTB’s proposal. Those concerns are:

(a) TTB’s determination that a product is a cigarette does not relieve the department of the responsibility to make a similar determination under Montana’s tax code. Montana’s definition of "cigarette" differs from that of the TTB. It is necessary that the department provide, by rule, the specific criteria the department will use to make this determination.

(b) TTB’s regulations do not include a minimum package size. In order to prevent the single stick sales of little cigars in Montana, the department needs to independently classify these products as cigarettes under Montana code so that Montana’s minimum package size applies.

(c) TTB has extended the comment period on its proposed amendments until March 26, 2007. Finalization of the amendments is anticipated to occur sometime around the last quarter of 2007, and implementation of the proposed amendments is estimated to be around the first quarter of 2008. To protect Montana’s citizens, especially its youth, the department needs to address this issue sooner than that.

Although it is clear that the department has full authority to adopt these rules as proposed, in order to accommodate the opponents’ request to bring this matter before the 2007 Legislature, the department has elected to adopt New Rules II (42.31.206) and III (42.31.207) with a delayed effective date of July 1, 2007.

5. As a result of the comments received the department adopts New Rule III with the following changes, new matter underlined, stricken matter interlined:

NEW RULE III (42.31.207) DEPARTMENT DETERMINATIONS (1) through (6) remain the same.

(7) ARM 42.31.206 and 42.31.207 are not effective until July 1, 2007.

AUTH: 16-11-103, MCA

IMP: 16-11-102, MCA

6. Therefore, the department adopts New Rule III (42.31.207) with the amendments listed above and adopts New Rule I (42.31.326), New Rule II (42.31.206), New Rule IV (42.31.208), New Rule V (42.31.318); amends ARM 42.31.102; 42.31.201, 42.31.202, 42.31.203, 42.31.204, 42.31.212, 42.31.221, 42.31.303, 42.31.308, 42.31.309, 42.31.330, 42.31.345; and repeal of ARM 42.31.103, 42.31.108, 42.31.109, 42.31.205, 42.31.340, 42.31.701, and 42.31.703 as proposed.

7. An electronic copy of this Adoption Notice is available through the department's site on the World Wide Web at www.mt.gov/revenue, under "for your reference"; "DOR administrative rules"; and "upcoming events and proposed rule changes." The department strives to make the electronic copy of this Adoption Notice conform to the official version of the Notice, as printed in the Montana Administrative Register, but advises all concerned persons that in the event of a discrepancy between the official printed text of the Notice and the electronic version of the Notice, only the official printed text will be considered. In addition, although the department strives to keep its web site accessible at all times, concerned persons should be aware that the web site may be unavailable during some periods, due to system maintenance or technical problems.

                 /s/ Cleo Anderson                                                /s/ Dan R. Bucks

                 CLEO ANDERSON                                            DAN R. BUCKS

                 Rule Reviewer                                                      Director of Revenue

Certified to Secretary of State January 16, 2007