Texas Tobacco Products Tax, Oral Nicotine

Texas Court of Appeals Excludes Oral Nicotine Products from Definition of Other Tobacco Products

Alternative tobacco products have been around for several years and are a growing market for smoke shops, c-stores, and others who also carry traditional tobacco products. However, states are only beginning to navigate how these novel products fit within traditional tobacco tax systems and recent legislative changes. The Court of Appeals of Texas recently considered the issue of whether oral nicotine products (with nicotine isolate derived from tobacco) were subject to Texas’ excise tax on tobacco products in RJR Vapor Co., LLC v. Hegar (681 S.W. 3d 867 (2023). While the Texas Comptroller is currently seeking review of the case by the Texas Supreme Court, the Court of Appeals held that oral nicotine products do not fall within the state’s definition of taxable tobacco products.

How Texas Code Defines Tobacco Products Subject to Excise Tax

Businesses that receive cigars and tobacco products for the purpose of making a first sale in Texas are generally responsible for obtaining a permit to collect and remit applicable Cigar and Tobacco Products Tax. The Texas Tax Code Section 155.001(15) defines “tobacco product” to include the following:

• Cigars;
• Smoking tobacco;
• Chewing tobacco;
• Snuff; and
• An article or product that is made of tobacco or a tobacco substitute and that is not a cigarette or an e-cigarette.

The taxpayer in this case manufactured and distributed oral nicotine pouches and lozenges that included nicotine isolate. The taxpayer purchased its nicotine isolate from a third-party vendor that derived the isolate from processed tobacco. However, the taxpayer does not purchase, process, or handle tobacco in its production of the oral nicotine products and these products did not contain any part or trace of tobacco leaf.

The Court’s Reasoning for Excluding RJR Vapor Co., LLC’s Oral Nicotine Products from Taxation

The Texas Comptroller argued the taxpayer’s oral nicotine products were taxable tobacco products under the Tax Code’s “catch-all” definition of taxable tobacco products. First, the Texas Comptroller claimed the oral nicotine products were made of tobacco because the nicotine isolate was made from tobacco leaf. The Comptroller further argued the products were made of a tobacco substitute by claiming the nicotine isolate replaced the role of the tobacco in the product. 

The Court of Appeals of Texas rejected both of these arguments. Essential to the Court’s reasoning was the fact that no traces of the tobacco leaf were in the products other than the nicotine isolate, which can be found in plants other than tobacco. In support of this reason, the Court highlighted the importance of the difference between a product being “made of” versus “made from” something in determining what constitutes a product made of tobacco. Citing basic rules of grammar, the Court acknowledged that “made of” refers to the material or quality of something while “made from” refers more to how an item is manufactured. For example, it’s the difference between saying books are made of paper while paper is made from trees. The Court presumed the Tax Code’s definition of tobacco product intentionally uses “made of” and departs from the federal definition of tobacco product, which explicitly includes products containing nicotine and that are meant for human consumption. In rejecting the Comptroller’s argument that the oral nicotine products were a tobacco substitute, the Court explained that an item must serve as a substitute for the tobacco leaves because of the other defined tobacco products in the Tax Code (e.g., cigars, smoking tobacco, snuff, and chew). 

Get Help Fighting a State’s Aggressive Tobacco Tax Enforcement on Alternative Products

As tobacco and nicotine products continue to advance, what constitutes a taxable tobacco product will be harder to define. This could be especially true in states that fail to update their tax codes and administrative rules. As a result, state tax authorities may take aggressive tax enforcement stances unsupported by the law. If you’re a distributor or retailer of alternative tobacco and nicotine products, it’s important to carefully review the excise taxes that may or may not apply to them. When disputes about taxability arise during audit or assessment, our tobacco tax professionals are here to help. We provide rigorous defense services for taxpayers looking to combat unfair tax assessments and other challenges involving compliance as a seller of tobacco products or related alternatives.