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Beattie’s Distillers, a potato vodka company based in Alliston, Ont., is one of the newcomers to the sector.

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Despite regulatory challenges, small-scale distilleries are riding a groundswell of support, with net sales in Ontario growing by 64 per cent to $3.7-million for the 2015-16 fiscal year, according to internal LCBO statistics obtained by The Globe and Mail.

The surge in interest for independently produced whisky, gin, vodka and other spirits is an outgrowth of consumer demand for locally made beverages, such as craft beer and wine, says Stacee Roth, spirits director at Ontario's liquor control board. "We're now at the point where Ontario craft distillers see the same kind of development as craft brewers did probably 15 years ago," she says.

Net sales for all Ontario-made liquor products increased during 2015-2016. Local craft beer climbed 35 per cent; regional cider increased 54 per cent; local wine increased 8 per cent.

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Beattie's Distillers, a potato vodka company based in Alliston, Ont., is one of the newcomers to the sector. The company began batch making in February and started distributing its products to the LCBO in April. To date, they've sold 250,000 bottles to 200 LCBO stores at $34.25 each, says Andy Murison, head of marketing at the company.

The trick is to gauge consumer market interest and satiate demand with newfangled, local products, says Mr. Murison, who changed tack after working for Diageo and Mark Anthony Group, two multinational liquor companies.

"We've seen the move from consumers," he says. "We naturally assumed the next stage would be into craft distilling."

One reason behind this shift, he says, is the unique character of each producer.

"The authenticity of being able to know the people behind a brand is what's making craft special," says Mr. Murison. "The craft distiller or the craft brewer has a story to tell, has a strong presence in the community."

However, starting up a distillery from scratch has many challenges, including quality control. Earlier this month, Beattie's Distillers had its vodka recalled from LCBO shelves due to a "manufacturing error."

"We had an episode about five weeks ago where we submitted batch into the LCBO with alcohol content below the standard," says Mr. Murison. "It was a production error produced by the co-packer we're working with. We found it, rectified it and worked with the LCBO. There was no harm or risk to consumer health."

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The vodka will be back in the LCBO by Wednesday, he says.

There are about 24 microdistilleries in the province, says Charles Benoit, head of the Ontario Craft Distillers Association and co-owner of Toronto Distillery Co. "There's now an ecosystem of supplier support for small distilleries," he says, but adds that small-scale distilleries struggle with regulatory issues.

For a 750 ml bottle of whisky priced at $26.85, for example, the supplier would earn $6.13, according to a 2013 LCBO pricing index. The LCBO markup cost is $13.52. The Ontario Ministry of Finance is responsible for such a high markup price at the LCBO, he says.

"What we have on the spirits side is an ad valorem tax based on the value as opposed to unit of measurement," says Mr. Benoit. "For spirits it's at 140 per cent."

On top of this, a 13 per cent commission is deducted at LCBO stores and for in-house sales, he says.

"The one thing the province needs to look at is how we can equalize tax for spirits," says Mr. Murison. "The taxation and markup is significantly higher than what it is for craft beer. If we could get spirits into the same conversation as beer, I think the industry could grow even fast and further."

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The markup cost for Ontario craft beer at the LCBO is $6.05; the supplier earns $16.80 for a case of 24 bottles.

Each province has its own rules for small-scale spirit makers. Craft distilleries making less than 50,000 litres of spirits in British Columbia are exempt from markup costs on products sold to businesses, says a B.C. Liquor Distribution Branch policy document.

A B.C. distillery producing more than 100,000 litres of liquor will no longer qualify as a craft distiller and will be opted out from the exemption. A distillery output of 100,000 litres will face a 163 per cent markup rate, for example.

Ontario-made spirits are not afforded the same leniency craft beer is, says Mr. Benoit, which effects the producers' bottom line.

"What helps the craft beer a lot is the flat tax," he says. "A tax on litres of beer sold. Ontario's beer tax doesn't discriminate. You pay about 40 cents a bottle, regardless of whether that bottle costs you $12 to make or $1.20, so that really incentivizes premium production."

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