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Jun 01, 2020 PRINT EDITION
Pakistan

Illicit trade of cigarettes: 'Further rise in share may result in closure of factories'

The documented cigarette manufacturing industry has recommended budget makers that any further raise in the share of illicit trade of cigarette would result in closure of factories and decrease in revenue collection of the Federal Bard of Revenue (FBR) in

May 20, 2020

The documented cigarette manufacturing industry has recommended budget makers that any further raise in the share of illicit trade of cigarette would result in closure of factories and decrease in revenue collection of the Federal Bard of Revenue (FBR) in 2020-21. They also stressed the need to immediately increase the advance adjustable FED on un-manufactured tobacco in coming budget to up to Rs 500/kg.
Noor Aftab, Regulatory Affairs Manager Pakistan Tobacco Company shared new reports published by the global agency OXFORD ECONOMICS i.e. "The economics of illicit cigarettes in Pakistan" and international chartered accountant firm-PWC's report on the 'Review of cigarette taxation in Pakistan' through an online session held here on Tuesday.
Noor Aftab was confident that the FBR would definitely consider budget proposals of the documented industry keeping in view the ground realities and increasing share of illicit trade in the country. In this regard, the Parliamentarians can play their important role in formulating legislation to control growing menace of illicit trade.
Noor Aftab stated that the will of the government to improve enforcement, better legislation, policy measures and rationalization of FED on different slabs of cigerttes would result in controlling the increase of illicit trade in Pakistan.
Referring to the report of OXFORD ECONOMICS, Noor Aftab stated that we estimate the total amount of tax evaded by illegal cigarettes in Pakistan in 2018-19 was over Rs50.9 billion. This represented nearly 42% of the total collected from legitimate sales. This equated to 1.3% of all government tax revenues in 2018-19, and 2.1% of all indirect tax revenues. Put another way, tax revenues lost to illicit cigarettes are nearly three times the estimated federal government recurrent and development spend on healthcare in 2018-19. The report estimates that the cost of tax evasion from illicit cigarettes could be far worse in 2019-20. The report projected that the revenue losses from such evasion could reach Rs77.3 billion this year. He regretted decrease in FED on the purchase of un-manufactured tobacco and recommended that the Federal excise duty on non-manufactured tobacco [which was reduced to Rs 10/kg through Finance Ac, 2019] needs to be increased to at least Rs 500/kg. Further, rate of adjustable advance income tax, currently 5%, should to be increased to 10%.
Quoting the OXFORD report he said that If, in the face of increasing illicit activity, international cigarette manufacturers were forced to change their operating models (and in extreme situations close factories), the impact on Pakistan would be far greater than reduced production and factory closures. The supply chains supporting these operations are long, reaching all parts of the economy. The reduced manufacturing within the country would adversely affect all companies - and their employees - operating in these supply chains. Moreover, Pakistan's desire to become an export hub for the region will be hit, as it will be forced to become an importer of tobacco products, report added.
According to the OXFORD ECONOMICS report, we estimate the activity and employment linked to the cigarette factories supported tax revenues of nearly Rs4.2 billion in 2019 over and above that collected on the sales of cigarettes. This included over Rs610 million in direct taxes (i.e. paid by the factories themselves 22), as well as over Rs3.5 billion in tax revenue that was generated through its supply chain and wage-consumption multiplier effects. The total tax generated was equivalent to 0.11% of the government's total tax revenues in 2018-19.
He referred to the chartered accountant report (PWC) that under the framework for efficient & effective enforcement against duty not paid sector, the global chartered accountant firm analyzed that every federal excise duty increase within the structure distorts the market feasibility and the impact is so substantial that 'administrative actions' alone cannot bear any reasonable results.
At the moment, there is limited transparency of the movement of raw materials and finished products throughout the supply chain as evident from increase in duty not paid market share. The monitoring of GLT units, as envisaged under the law should be made more effective to identify points of likely fiscal leakages. This can be accomplished more effectively by adopting the mechanism introduced for sugar industry wherein personnel of Chartered Accountant firms were deputed alongside officers of tax authorities. The dispatch slips from GLT units to cigarette manufacturing companies can easily be reconciled with the sales volume reported by cigarette companies to identify any underreporting of sales.
The government needs to ensure across the board implementation of track and trace system with enforcement to check at retail level. The report said there is a need to overcome poor coordination among government departments, which can be overcome through clear communication & reporting lines. Through this, an across the board implementation of policies would be well received and a foolproof system of check and balance be created. During the last couple of years, volume of counterfeit cigarettes has increased sharply and accordingly to latest estimates, it is approximately 2.75 billion sticks. The government needs to identify these units and take action at retail level to protect local legitimate sector.
The threat posed by smuggling may be mitigated by harmonizing the relevant laws to mandate the printing of a health warning similar to local brands on all imported cigarette packs. Such an efficient & effective enforcement is bound to reduce the duty-not-paid cigarette market share and help government achieve its settled objectives, report added. A global chartered accountant firm has strongly recommended that the government needs to avoid levying any additional tax, levy or charge in any form on cigarette sector as this will provide incentive for further evasion and increase in market share of duty-not-paid cigarettes. According to a new report of an international CA firm PWC on the 'Review of cigarette taxation in Pakistan', the duties on cigarettes need to be reduced so that the market, presently captured by illicit manufacturers, could be reduced. When the supply of illegal cigarettes returns to manageable levels, there should be scope for future tax rate adjustment that will reduce consumption and increase revenue. The report said the volume of counterfeit cigarettes has increased sharply, and accordingly to latest estimates, it is approximately 2.75 billion sticks. The government needs to identify these units and take action at retail level to protect local legitimate sector. The international firm has shared an excise roadmap to contain the duty-not-paid cigarette threat & maximize government tax revenues and also made recommendations for future course of action.
The analysis of the CA firm revealed that the massive decline in government revenues forced the government to restructure the excise regime. The introduction of three tier structure boosted the government revenues by 29% [FY 16-17 to FY 2018-2019]. There was an increase of almost 34% in government revenues in Tier 2-3 which explains the decrease in duty-not-paid market share as consumers shifted to legitimate sector once the prices of duty-paid cigarettes became competitive. However, due to recent increase in excise rates, the sustainability of government revenues is under question. Due to recent amendments, Tier-3 has been removed [which accounts for approximately 70% of revenue]. There has been a slight reduction in Tier-2 rates but since Tier-2 volume is quite low, it is not likely to contribute materially towards government revenues. As observed in previous years, the Tier-3 volume is expected to shift towards illicit segment which will impact government revenues.
The unprecedented increase in excise re-instated the price gap between legit and illicit cigarettes [i.e. Rs 40] which in addition to an increase in duty-not-paid cigarette volume has also put the sustainability of government revenues at risk. The pattern of excise increases is similar to years 2013-2017 during which the successive excise increases widened the gap between legit & illicit cigarettes to Rs 44 which led to a massive decline in government revenues, it analyzed. Due to high inflation rate in Pakistan, the spending power of the consumers has reduced and the consumption volume is expected to shift towards duty-not-paid cigarettes with an adverse impact on government revenues.

Copyright Business Recorder, 2020