Documented tobacco sector: 'FBR will collect over Rs 200 billion in next three years'

Federal Board of Revenue (FBR) Member Inland Revenue (Policy) Dr Hamid Ateeq Sarwar has said that the FBR has estimated to collect over Rs 200 billion from documented tobacco sector in the next three years and FBR's tax policy would recommend only single tier of Federal Excise Duty (FED) on cigarettes.

Addressing the event of launching of research report (quantifying the potential tax base of cigarette industry in Pakistan) organized by Social Policy and Development Centre (SPDC) here on Friday, Dr Hamid Ateeq Sarwar stated that the FBR has abolished third tier on cigarettes in last budget. The FBR's future policy on tobacco sector is to go for one tier on cigarettes. The FBR had collected Rs 150 billion from tobacco sector in the last fiscal year and is projecting over Rs 200 billion in coming years.

"There is a scope to further increase in taxes on tobacco, but we do not want to scare the documented industry. The FBR want to consult the concerned industry during increase of taxes on tobacco products. The revenue from the industry can be increased with increase in taxes to achieve the overall health objectives," he said.

The FBR member said that the track and trace system has been started for tobacco sector and the industry can afford it. The problem will be installation of track and trace system on small units.

He said that 5-10 good players of tobacco industry has shifted to Azad Kashmir to avoid payment of taxes on cigarette and FBR has taken up the matter with tax authorities of AJK to install track and trace system on manufacturers in that area. "We want that the AJK authorities should adopt same rules of excise and track and trace at manufacturing units in the said area," he said.

Dr Hamid Ateeq Sarwar stated that the erstwhile Federally Administered Tribal Areas was also used by some manufactures to avoid taxes collected in Pakistan on cigarettes.

Dr Hamid said that the FBR has asked the AJK tax authorities to also implement track and trace system on the units operating within the jurisdiction of AJK.

According to him, out of total 10 machines of Green Leaf Threshing (GLT) units, one GLT unit has been shifted to Azad Kashmir for processing of tobacco to be used in manufacturing of cigarettes.

He said that the taxation of tobacco sector is a very complex subject and it is very difficult to achieve perfect tax policy for this sector.

He said that the FBR admitted that there is under-reporting within the tobacco sector "but we cannot allege some company that it is involved in under-reporting of taxes." The under-reporting is due to lack of enforcement. But the undeclared tobacco may be used by big companies or such tobacco may be in the hands of others, he further said.

Local manufactures of cigarettes have their representation in the Senate and National Assembly and big companies even approach the Prime Minister to plead their case regarding taxation on tobacco products, he said.

The FBR member IR Policy stated that Pakistan is largely tobacco producing country and around 10 million kg of tobacco is being exported out of the country. One kg of tobacco yield 1,000 sticks of cigarettes. The least profit earner is the farmer of tobacco which gets least profit during the entire chain.

He said that the FBR's tax policy on tobacco was affected due to the pressure of farmers last fiscal year.

Dr Frank J Chaloupka from Institute for Health Research and Policy, University of Illinois, Chicago, stated, "We are working in Pakistan for broader examination of macroeconomic impact of tobacco taxation."

Muhammad Sabir of SPDC informed that revenue loss to the FBR due to undeclared production of tobacco was Rs 37 billion in 2016-17. During 2017, the under-reporting in tobacco sector was 39.5 percent and in 2018 it was 21.5 percent.

The large fiscal imbalances in Pakistan require greater tax revenues. Tobacco taxation can positively contribute to government revenues. Simultaneously, these taxes will also help promote public health objectives.

Referring to the major policy implications, he suggested to link the FED with multi-stage taxes. At present FED is collected at factory level on declared production, which provides an incentive to under-report production. If the FED is linked with GST and GST is collected in the VAT mode, it will help reduce tax evasion. The GST should be collected at three stages - factory, distributors, and wholesalers/retailers.

About the system for Electronic Monitoring of Production (SEMP), he said that while FBR is already in the process to implement SEMP, it is suggested that the implementation process should follow the existing best practices, particularly from developing countries.

The present analysis offers an opportunity to monitor tax evasion by analyzing the financial data of the companies. Such analysis will help build a robust tax collection mechanism for future, Sabir suggested.

The analysis shows seasonality in reported production. The production is generally high during the months before the announcements of federal budget. This is largely an outcome of uncertainties in tax policy. It is suggested that a medium-term tax policy guideline should be followed to avoid major changes in tax rates.

This study estimates the potential levels of output by the cigarette industry to measure the extent of under-reporting of domestic production cigarettes in Pakistan. The methodology is based on quantitative analysis with two alternate approaches: a supply function - annual and monthly - and analysis based on financial time series and panel data.

Analysis of the industry profile provides interesting insights. The aggregate size of firms selected for the analysis increased more than four-fold during the last decade or so, as the net turnover went up from Rs 17.6 billion in 2004 to Rs 70.4 billion in 2018. Among the three firms, the market share of leading company increased from 56 percent to 75 percent during this period. The analysis also shows that the increase in net turnover is more than the increase in the cost of sales. Interestingly, during the last four years under analysis, tobacco firms reported a decline in their sales while profit margins remained substantially higher as compared to previous years. Thus, the decline in sales did not have much impact on profit margins, and also the cost of sales did not have a close association with net turnover.

As far as the linkage between the FED rate and the prices of cigarettes is concerned, high growth in the FED rate did not fully correspond with growth in prices, particularly until 2011-12; however, the trend changed afterwards.

Particularly, the ratio of prices to the FED rate reflects a complete pass through of the FED in prices except for the last two years - 2017 and 2018.

The production of cigarettes remained fairly stable between 61 and 67 billion sticks until 2014-15, whereas considerable fluctuation is evident in the last three years.

The various econometric analyses presented in the report provide evidence of a considerably high level of under-reporting of cigarette production by the firms. The estimates of all the four models show highest extent of under-reporting in 2016-17 and the lowest in 2015-16. The estimates based on monthly time series (supply function) suggest that under-reporting was 47.1 percent in 2016-17. Similarly, under-reporting for 2016, based on financial panel data (production functions) is estimated to be 39.5 percent, Sabir added.