JULY 18, 2015

M K Gupta IRS (Retd.)

RECENT WHO REPORT on the global TOBACCO epidemic, 2015 has examined the impact of raising taxes on tobacco control. Article 6 of the Framework Convention on Tobacco Control (FCTC) provides that “the Parties recognize that price and tax measures are an effective and important means of reducing tobacco consumption by various segments of the population, in particular young persons”. WHO is of the view that the taxes on tobacco should be more than 75% of the retail prices to have effect on consumption.

2. The Report highlights the following tactics adopted by Tobacco Industry which are tax specific.

•  Stockpiling. Tobacco companies often oversupply products to the market before a tax increase takes effect, thus delaying paying the new, higher tax until the overstock is cleared.

•  Changing product attributes or production processes. Because of complex tobacco tax structures that levy different tax rates based on different characteristics (e.g., length, weight, price or product type), the tobacco industry may exploit different tax classifications by changing physical product attributes or production methods to achieve lower tax rates.

•  Lowering prices. To reduce tax liability or meet sales revenue targets, tobacco companies may simply lower prices, which may not reduce overall profits if lower prices generate more sales.

•  Over-shifting of prices. By increasing prices more than the amount of a tax increase, the industry can compensate for revenue reductions resulting from decreased sales and potentially increase profit margins.

•  Under-shifting prices. Increasing prices by less than the amount of a tax increase lowers the impact of the increase on demand and allows the industry to lessen the effect of the increase on consumers.

•  Timing of price increases. Increasing prices before a tax increase comes into effect allows tobacco companies to sensitize customers to new, higher prices, thus preventing “sticker shock” and simultaneously generating additional profits.

•  Price discrimination and promotions. Selling the same product at different prices to different customers, often through targeted price-related promotions, can preserve affordability of products across all income groups following a tax increase, prevent price-sensitive users from quitting or reducing consumption, and ensure that potential new customers are not deterred by high prices.

3. An attempt is made in this article to detail the tactics adopted by Indian Cigarette Industry over the years which were tax specific.

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3.1 In 1975 Sikkim became one of the States of India. The Central Excise Act, 1944 was extended to the State of Sikkim with effect from 1.2.1983 vide Notification No. 9/83-CE, dated 1.2.1983. Prior to this date Cigarette Industry established factories for manufacturing cigarettes in Sikkim and did not pay any duty on the ground that the Central Excise Act, 1944 was not extended to the State of Sikkim. It was general perception of the department that the goods were shown manufactured in Sikkim on papers only whereas actual manufacture was in taxable jurisdiction only. Assuming cigarettes were actually produced in Sikkim but the same were sold to consumers all over the country at a price applicable to taxable cigarettes.

3.2 A particular manufacturer established a cigarette factory in Mizoram in 1980's and did not pay duty on the ground that the Central Acts were not to be applicable as per the understanding between Central Leaders and State Leaders. To hoodwink the consumers, competitors and tax department, it was shown on the cigarette packets as if the cigarettes were manufactured in a licensed factory at Mumbai.

3.3 To defeat the provisions of the Industries (Development & Regulation) Act, 1951, many cigarette factories were opened for manufacturing popular brands on job work basis/ Franchise agreements. Most of these factories indulged in suppression of production and thus avoided taxes. The production of VFC tobacco used for manufacturing cigarettes increased many fold from 1980 but there is no corresponding increase in production of cigarettes. It is no doubt that VFC tobacco exports have increased but exports to certain countries in recent years appears to be of doubtful nature.

3.4 In 1999 area based exemption was introduced in North Eastern States. Many cigarette factories were established in these areas. Industry encashed the taxes without any benefit to consumers. Realizing the manipulations and loss to revenue, the government withdrew the exemption scheme retrospectively in respect of Cigarettes and other tobacco products.

3.5. Prior to March 1983 duty on cigarettes comprised of (i) a basic duty of three hundred per cent ad valorem plus rupees twenty per thousand; and (ii) an additional duty of one hundred and ten per cent ad valorem plus ten rupees per thousand. Thus the total duty leviable was 410% plus Rs. 30 per one thousand cigarettes. The tax was leviable on the value determined from the price at which cigarettes were sold to the wholesale dealer. Duty paid was approximately 60% of retail price. The Industry avoided payment of correct duty by generating margins at the end of WDs by offloading taxable components towards advertising, marketing, distribution and interest on security deposits.

3.6 (a) In the Budget of 1983 the rates of duty were fixed on graded scale on the basis of retail price (MRP). The result of this new excise structure was that duty was between 70% to 73% of the MRP. The industry adopted its various means to avoid the proper payment of duty by reducing the retailer margins to about 0.01 % of the MRP. The retailers were left to realize their margins by selling the goods in excess of MRP. For example for a particular brand of cigarettes MRP was fixed Rs.2.35 for a pack of 10 cigarettes. The purchase price of the retailer was about Rs 2.34. Consequently the retailers charged Rs .2.50. Had the MRP been Rs.2.50 extra duty payable would have been more by Rs 1.725. The net result was the excise duty realization remained about 60% of the actual retail price. Some manufactures avoided duty by introducing twin brands of the same cigarettes. One brand was having MRP Rs 1.0 and the other Rs 2/-. However both the brands were sold at MRP 2/-. These tactics adopted by the industry endangered the revenue to a great extent.

(b) To meet the above challenge the government in Sept. 2005 revised the structure of duty to realize tax between 70% to 74% of the MRP. The effect of the changes was that the industry could fix the MRP in five slabs as against the earlier scheme of multiple slabs which changed with increase of each Rs 5 per thousand cigarettes. This change had tremendous impact on the industry. Firstly it checked avoidance of tax by way of twin brands. Secondly the maximum revenue was generated from the cigarettes sold at MRP Rs 1.70 or Rs 3 per pack of 10 cigarettes. The industry still manipulated the MRP by reducing the retailer's margin to 10 paise per thousand cigarettes in respect of most of the brands. For example 1000 cigarettes of pack of MRP of Rs 1.7 were purchased by the retailers at Rs 169.90. The industry envisaged and visualized that the same would be sold At Rs 2 per pack. The manipulations regarding MRP continued due to the fact that industry's margins were under pressure. The Industry introduced many brands bearing MRP Rs. 1.70 for a pack of 10 cigarettes during this period to take the tax advantage.

3.7 In 1987 the Government moved to an entirely new scheme of specific excise duty based on the length of cigarette.

The scheme introduced in 1987 was as below:

(a) The impact of this scheme was tremendous. Firstly most of the King Size Brands 75-85 mm having MRP 1.70 disappeared from the market. The duty on non filter cigarettes increased from Rs. 125 to Rs. 150. However duty in respect of filter cigarettes of length 60-70 mm decreased from Rs.225 to 200, in respect of length 70-75 m from Rs 400 to 300 and in respect of premier brands of length 75-85 from Rs. 600 to 400. The duty amount decreased to 52-66 % of MRP which was earlier around 75%. This duty structure led to increase of huge profits of the Industry and substantial benefits to stockholders by way of hefty dividends and bonuses.

(b) In 1994 the duty on non filter cigarettes of less than <60mm was reduced from Rs. 120 to 60 per 1000 cigarettes. The production of such cigarettes increased from 5 billion in 1994-95 to 18 billion in 1996-97. This helped the industry to attract the Bidi Smokers to shift to cigarette smoking.

(c) In the year 2012 non filter category of less than < 65 and >65<70mm were introduced. Similar changes were made in filter category. This was a biggest bonanza to the Cigarette Industry as the popular brands of the premium categories in higher lengths were introduced in lower lengths. It not only saved taxes but helped Industry to increase the volumes and the profits.

3.8 From 1989 onwards the rates of duty have increased from year to year barring in some years 2002,2003,2003,2009 and 2011. However the duty incidence in relation to MRP has decreased drastically as can be seen in respect of some popular brands after introduction of duty structure on length basis in 1987.

It is worth observing that the retail prices have increased by more than 15 times since introduction of duty on length basis where as duty rates increased by 6 to 9 times.

4. To conclude, the Cigarette Industry in India has adopted various tactics from time to time to exploit the tax structure to its advantage without caring for the social objective envisaged by the policy makers to curb the consumption by raising taxes. There is need to revisit the taxation system and other policy issues to curb the consumption of cigarettes in India. Some of the suggestions are as below:

•  Ensure tax is minimum 75% of the MRP.

•  Sale of loose cigarettes should be banned.

•  Cigarettes shall be sold in standard packaging containing 20 cigarettes.

•  Complete control on production and disposal of VFC tobacco.

•  Cigarette manufacturing in small scale sector shall be banned.

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