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May 24, 2017

Rs40 bn loss inflicted by locally made tax-evading cigarette brands

ISLAMABAD: Locally manufactured tax evading cigarette brands have taken a huge toll on revenue collection to the tune of Rs40 billion during the current fiscal, 2016-17 due to weak enforcement and a variety of other reasons.

Revenue projection was put at Rs115 billion for this year while actual collection is estimated to be around Rs75 billion, resulting in a deficit of Rs40 billion. The fact that the Federal Board of Revenue (FBR) has constituted a joint task force against tax evaded imported cigarettes and locally produced tax evading cigarettes illustrates the severity of the problem and how serious the government is to combat and reduce illegal cigarettes, especially local tax evaded sector.

At least forty local cigarette manufacturers, selling approximately 145 brands, have captured 41% of the entire cigarette market. But their contribution to national exchequer is limited to a mere 2% only. They are priced as low as Rs15 while the minimum tax payable per pack according to the law is around Rs43. This is a clear testament to the tax evasion. These brands are produced in factories, located in Khyber Pakhtunkhwa (KP) and Azad Kashmir. Their fabulously rich manufacturers, most of them well connected politically, declare only a portion of the actual quantum of cigarettes produced, evading a massive amount of their tax liability.

Over the past two years, the tax evaded cigarette market has tremendously swelled: from 23.4% to go as high as 65% of the total market. It is astounding to see lack of awareness of the criminality involved in illicit cigarette trade.

The price differential between legitimate and illicit brands has hugely shot up as unlawful trade realized that affordability was becoming an issue. Therefore, they started focusing on building their own local brands, marketing them and flouting regulations openly, selling at cheap prices, much below even the minimum taxes applicable in Pakistan. The result is that consumers have started shifting to cheap, widely available tax evading cigarette brands.

A newspaper ad, containing most apt material but having ulterior motives, lists disastrous consequences of smoking. Apparently sponsored by the tax-evading cigarettes’ lobby, it appealed to the government not to introduce third  tier in taxation in the forthcoming budget. The real catch is that this cartel wants the tax compliant cigarette brands to become dearer so that the price differential between legal and illicit segments further shoots up, generating more sales for cheap tax evading products.

In the recent past, the government initiated serious enforcement efforts and concerned officials stated that they were astonished by the quantum and magnitude of tax evaded cigarettes. This indicated that there is a huge black market, requiring the continued focus and attention of the government. There is a need for consistent enforcement and addressing certain fundamental issues that are causing illicit cigarette trade to grow.

There are 13 government agencies and more than 25 laws governing illicit cigarette trade, but unfortunately the root causes for this phenomenal growth remains the same as they were before – weak enforcement of laws and increasing price differential between tax paid and tax evaded cigarette brands.

Importantly, majority of illicit trade is home grown. Research shows that more than 80% of Pakistan’s illicit cigarette problem stems from locally manufactured tax-evaded cigarettes. Tax evaded cigarettes sell as low as one-fifth the price of legitimate brands. Arguments of increasing taxes are counterproductive as consumers keep switching to low priced tax evading cigarettes. The World Health Organization (WHO) states that without prejudice to the sovereign right of the parties to determine and establish their taxation policies basically means that countries have the right to formulate their own policies taking into consideration their own market dynamics.

Ironically, the published accounts of tax-paid companies reflect declining volumes but local firms continue to demand more and more tobacco and sell increasing volumes. The health minister has recognized the existence of such a high incidence of illicit tobacco.

Over the years, the government has put in place a robust regulatory regime intended to reduce and ultimately eliminate illicit cigarette trade, which prescribes strict laws regulating virtually every step of the industry supply chain. They include laws and rules controlling crop, procurement and use of raw materials, manufacturing, distribution, and finally import and selling of tobacco products. Despite this comprehensive regulatory framework, illicit segment occupies almost a shocking half of the overall market, which reflects that affordability is a major concern and that enforcement of fiscal and regulatory laws needs to increase and made consistent.

It is indeed important to deter the youth from having wide accessibility to cheap illicit brands. Numerous laws already exist to stop them from smoking. It is banned for youth to smoke. Every retailer has to prominently display at his premises the sale to underage warning. If in doubt, every retailer has to ask for appropriate evidence of age. Since cheap tax evading cigarettes are readily available for the youth and masses, it is important to break the strongholds of these duty evaders.

Tobacco is generally a controversial topic and pointing fingers on the industry to attract attention is an easy bet. But taking an outside view of a complex industry is a myopic perspective that is ineffective and counterproductive. Illicit cigarette trade has always been there for decades in the form of smuggled and local tax evaded cigarettes.

The health ministry and some internationally funded organizations have been aggressively pushing for increasing taxes and raising prices of cigarettes. Based on such proposals the government has been hiking taxes but record demonstrates that this has resulted in revenue losses with no decline in the overall consumption.