Documented tobacco sector: Factors for decrease in revenue collection identified

Major factors responsible for decrease in revenue collection from documented tobacco sector during 2019-2020 include weak enforcement, increase in Federal Excise Duty (FED) on cigarettes, and decrease in advance adjustable FED of Rs300 per kg to Rs10 per kg, resulting in sudden jump in share of illicit cigarette traded by up to 37.4 percent.

The legitimate tobacco industry has attributed the cause of declining revenue from the sector in the current fiscal year mainly to poor enforcement by the Federal Board of Revenue (FBR) in checking of illicit trade during the current fiscal year.

Experts explained the factors behind the decrease in the revenue from the documented tobacco sector during the current fiscal year.

In March 2017, the illicit tobacco sector was at its peak touching 41 percent market share of the total tobacco industry in Pakistan.

The government was faced with massive revenue shortfalls from the tobacco sector, which declined by 33 percent from Rs110.7 billion in 2016.

The then government decided to introduce two important fiscal measures in the Federal Budget 2017-2018, first being the reintroduction of third tier in excise structure, and the second being the introduction of advanced adjustable FED at the rate of Rs10 per kg of tobacco.

The third tier excise structure allowed the legitimate sector to reposition their brands and bridge the price gap between documented and illicit cigarette brands, allowing price sensitive consumers to move back up the ladder, who had down traded to low quality cheap cigarettes because of the increasing price differential.

Tax experts say that the reduction in adjustable FED on tobacco have three serious implications.

First, local cigarette manufacturers have again started massive evasion of taxes on cigarettes by concealing quantity of tobacco consumed in the manufacture of cigarettes. Second, this anti-documentation move of the government would send a wrong message domestically as well as globally that Pakistan has taken away the documentation regime.

Third, a check on the local cigarette manufacturers to maintain record of the tobacco being consumed would be taken away, resulting in increase in illicit trade of cigarettes.

These measures coupled with strong enforcement decreased the market share of illicit cigarette manufacturers from 41 percent to 34 percent in a span of one year, increasing government revenue back multifold.

In 2018, the Pakistan Tehreek-e-Insaf (PTI) government decided to increase this tax to Rs300/kg in the mini-budget, so to further increase the cost of tax evasion for the illicit manufacturers.

This severely impacted illicit manufacturers, who decided to use the power corridors to drive their campaign.

The National Assembly Speaker, Asad Qaiser, constituted a committee including senators, senior federal and provincial ministers and some members such as Senator Dilawar Khan, Shahram Khan Tarakai, and Atif Khan belonging to the tobacco business.

They managed to succeed in this campaign and in the 2019 budget, not only was this tax reverted to Rs10 per kg but the illicit manufacturers also managed to succeed in eliminating the 3rd tier in the excise structure bringing it back to two-tier.

The excise rates have increased by more than 93 percent in the last 18 months, and it has reflected in the market share of duty not paid cigarettes, which went up to 37.6 percent in March 2020 causing the government a potential revenue loss of Rs63 billion.

Legitimate tobacco industry proposed the budget markers that advance adjustable FED tax not only be increased but it should be raised up to Rs500/kg to increase the cost of tax evasion for the illicit cigarette manufacturers.

They will be forced to document and declare their tobacco purchasing and processing and will be liable to pay their dues to the Government of Pakistan as per their sales and revenues.

The present government is currently losing potential revenue of more than Rs60 billion, which is going straight into the pockets of these illegal manufacturers and helping them to maneuver the laws and pressurize the decision makers to enact regulations favoring them.