Pre-budget concerns: Tobacco manufacturers hope for ‘rational’ increase in taxes

Industry facing illicit trade, steep excise hikes and pre-budget hoarding.

KARACHI:

With the government expected to raise duties on tobacco products in the federal budget of fiscal year (FY) 2015, tobacco manufacturers are hoping any increase in duties will be rational; seeking a bi-annual excise increase to discourage pre-budget hoarding.

Illicit trade, steep excise hikes and pre-budget hoarding are the key challenges facing the tobacco industry, said an official requesting anonymity.

In what has become a normal practice in the tobacco industry, the trade channels hoard stocks at pre-budget prices for quick gains, the official said. These hoarders also include investors who are not part of the tobacco supply chain and hold stocks in bulk for short-term gains – and that, too, on a higher return on investment (RoI) rate.

The hoarding practice slows down tobacco sales during post-budget months, according to the official – past records also show low tax collections during the first few months of the fiscal year, he said.

While providing details, the official said there was an exceptionally high level of hoarding last year – just ahead of budget FY14 – which distorted industry figures since stock offloading took longer than usual. “The hoarding process continued for about three months last year,” he said.

This happened because the hoarders were expecting a higher raise in taxes, which allow them to make quick profits by selling the cigarettes during post-budget months.

While hoarders profited, the government did not earn any revenues because the stocks were sold on pre-budget prices. The pre-budget hoarding damaged the formal sector and the government alike, the official said.

The industry is seeking a legislation to counter the issue of pre-budget hoarding by way of introducing bi-annual excise increases, in line with the Consumer Price Index. For example, if they plan to increase tobacco taxes by 12%, they should make a 6% increase in June and another 6% increase in January. This would minimise the return for hoarders and discourage pre-budget hoarding, he said.

Besides hoarding, the industry is also concerned about a steep hike in the taxation rate, which, they say would only encourage smuggling and tax evasion by informal sector.

A World Health Organization (WHO) proposal has suggested raising tobacco taxes up to 70%. The industry sources, however, said any increase should be rational. “When you have such a porous border and illicit tobacco trade is almost one-fourth of total market, a steep rise in taxation won’t help,” an official said.

The industry is also seeking increased and effective enforcement of laws to counter the menace of illicit trade in cigarette, which is growing at an exponential rate, undermining government fiscal and health objectives, the official said.

Besides these proposals, the industry also sought support for the reformed mechanism for excise, which disconnects prices from government taxation.

Last year, tobacco experts suggested the Federal Board of Revenue (FBR) to change the excise structure for cigarettes from a complicated three-tier mixed system to a dual-tier fully specific structure – a fully specific system disconnects government revenue from cigarette prices. This structure not only gives the government complete autonomy to manage excise levels but also gives the tobacco industry the liberty to set cigarette prices based on market dynamics, he says.

The reformed structure is set to give a revenue growth of over 14% to the government, which in absolute rupee terms is the highest growth in tax revenues in any given year from the tobacco industry, the official said. The FBR figures show that the revenue from tobacco industry as of April has already crossed Rs70 billion. The revenue by the end of this fiscal year is expected to touch Rs87 billion, which is higher than the projected target for FY14, he said.

Published in The Express Tribune, May 20^th, 2014.

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