It said the overall volume of illegal cigarettes – both contraband and counterfeit – rose by 6% to reach 6.7 billion cigarettes, almost one in six smoked in the UK.
KPMG said that if the total black market volume had been consumed legally tax revenue of €2.8 billion (£2.2 billion) would have been raised.
Marlboro producer Phillip Morris said it feared a new EU tobacco products directive would increase demand for cheaper illegal tobacco even further.
The directive banned pack sizes smaller than 20 cigarettes and 30g of rolling tobacco from May 20 this year, though retailers have a year to sell existing stocks through.
The company claims the move will force smokers to buy bigger, more expensive packs, making illegal sources of supply more attractive.
Paul Adeleke, corporate affairs director at Philip Morris said: “This illegal activity not only comes with a financial cost, but it fosters criminality in local communities.”
The KMPG report was commissioned by Phillip Morris, British American Tobacco, Imperial Tobacco and Japan Tobacco International.