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'Disparity in tax rates spurs contraband cigarette sales’
Economic Times - 19 Sep 2009

INCREASING tax on cigarettes every passing year and the health ministry’s anti-smoking campaigns have made life tough for cigarette makers. the country’s largest cigarette maker ITC’s Divisional chief executive (tobacco division) Kurush Grant elaborates the challenges faced by the industry before ET’s Anuradha Himatsingka. Excerpts:

What are your views on discriminatory taxes on cigarettes vis-àvis other tobacco products?

Though cigarettes account for less than 15% of the total tobacco consumed in India, it contributes more than 90% of the total tax revenue collected from the tobacco industry. While the intent of the government has been to reduce the aggregate consumption of tobacco, extremely high tax rates on cigarettes has only served to squeezed demand for the cigarette form of tobacco, even as total consumption of tobacco in the country continues to grow.

In fact, it is only tax which makes cigarettes more expensive than bidis and chewing tobacco.

Even ministry of health, in its publications, has said increase in taxation on cigarettes leads a section of consumers to move to revenue-inefficient tobacco products, including smuggled and tax evaded cigarettes.

Conversely, when cigarette tax rates are stable and the economy is growing, people upgrade to cigarettes from other revenue inefficient forms of tobacco. This, in turn, helps tax collections as well. Though the tax rates on other forms of tobacco are much lower (compared to cigarettes), tax avoidance is high in that sector.

Apart from disparity in taxation on tobacco products, is the cigarette industry beset with other problems?

While disparity in taxation on tobacco products has always been a cause for concern, it has now led to other alarming consequences. The high arbitrage opportunity in tax avoidance, given the extremely high rates, have led to the trade moving into unscrupulous hands.

The markets are today flooded with contraband and tax avoiding illegal cigarettes. On the one hand, you have cigarettes getting smuggled into India from neighbouring as well as western countries. I am told that these contraband cigarettes have a market share of higher than 20% in some markets like Indore.

This apart, the vacuum created by exit of the popular low priced non-filter cigarettes has been occupied by duty-evading regular size filter cigarettes which are sold to consumers at Rs 10 per packet of 10 cigarettes (a rate lower than the tax payable on these cigarettes).

These low priced illegal cigarettes including the likes of Forever, Harbour, Perfect, Impact which do not pay bulk of the tax, are a growing threat to the legitimate industry, government revenue, market stability and the social objective of regulating tobacco consumption.

Yet, they control 15% of the market share and are available across the country. In rural Madhya Pradesh, they control 40% of the market share. Internationally, tax evaded cigarettes are a major cause for concern. Canada and UK too face similar problems.

To eliminate this fast growing illegal industry, enforcement must be strengthened so that the legitimate cigarette industry does not suffer. In addition, the government can also consider introduction of a new tax slab that would enable the legitimate industry to offer consumers 'tax paid cigarettes' at competitive price points.

Will imposition of graphic health warnings adversely impact cigarette manufacturers?

Imposition of graphic health warnings on tobacco products has impacted cigarettes more than other forms of tobacco products due to design specifications. At the same time, it has given a fillip to the growth of smuggled contraband trade as these cigarette packs do not carry the specified graphic warnings. Legitimate cigarette industry strictly following the graphic health warnings is impacted by such blatant avoidance by the illegal industry.

The severe taxation and regulatory milieu for cigarettes in India remains a cause for concern. Coming close on the heels of the smoking ban in public places, the cigarette industry was subjected to imposition of pictorial graphic warnings during the quarter. In this backdrop and keeping in mind that the cigarettes business still accounts for nearly 50% of the total earnings, how challenging has marketing of cigarettes become for a company like ITC?

The marketing of cigarettes to existing tobacco consumers has always been a competitively challenging task. Due to the taxation regime and large scale illegal trade taking advantage of it, it becomes even more challenging since the level playing field is an uneven one.

However, our robust strategies and attention to quality have seen us in good stead. This has resulted in our strong brands such as Gold Flake, Navy Cut, Bristol, Flake, Classic and others receiving constant consumer preference.

What, according to ITC, should be the structure of the proposed goods & service tax (GST) which would benefit both government as well as cigarette manufacturers?

Historically, highly taxed products have a specific rate rather than advalorem rates and are ideally taxed at a single point at the factory gates itself. Cigarettes, given the high rates of taxation, merit only a single point central excise duty as it has been proved to be the most efficient way of collecting tax for such a product. The goods and services tax (GST) is meant to be a tax on value.

In cigarettes, more than 90% of the value is created at the manufacturing point itself and should be taxed at a specific rate at that single point, since it is impractical to collect levies from millions of small retailers and convenience shops.

For a highly taxed product like cigarettes, where taxes are almost 190% of the ex-factory price, it is best to keep it outside the ambit of the proposed GST. Cigarettes should continue with single-point, specific central excise levy with a revenue neutral additional excise duty which can be passed on to the states.

In fact, a single point specific duty has been recommended by most of the expert tax panels set up to look into the structure of taxation and centre-state share of taxes. The Tobacco Institute of India has made several representations in this regard.

Will implementation of GST impact the movement of smuggled contraband cigarettes which already enjoy an illegal advantage of tax arbitrage? Please elaborate.

It will depend entirely on the manner in which GST is implemented on tobacco. A single point, first point specific excise duty subsuming all other taxes would certainly be the more revenue efficient methodology.

ITC's marketing and distribution network services some 2 million outlets a day. How is the company planning to expand its distribution reach, especially since the company has been launching a spate of products in the personal care and branded packaged food segment?

The reach of ITC's distribution network is well known. Any expansion in this reach will always be based on a combination of growth in new channels and requirements of existing and new products.

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