How capacity tax on tobacco industry can give revenues a big leg up

In a major development, the federal cabinet has approved imposition of federal health levy on cigarettes at the rate of Rs10/cigarette pack carrying 20 sticks and Re1 on a 250 millilitre container/bottle of sugary drinks.

As per the estimates shared by Dr Zafar Mirza, Special Assistant to Prime Minister for National Health Services, Rs30 billion would be collected annually from this new tax imposed on cigarettes, while Rs8 billion expected from sale of sugary drinks. This tax is an addition to the taxes already imposed on these products.

The anti-tobacco campaigners, health sector professionals and activists, citizens’ groups etc have hailed this decision.

They think it will make these products expensive and less affordable for users, leading to a fall in their consumption rates.

The suggestion to use this additional revenue exclusively to provide better health facilities to citizens is being also hailed.

These stakeholders have attributed this success largely to an accomplished professional Babar bin Atta, who was appointed adviser to the Prime Minister of Pakistan Imran Khan on tobacco control recently. It is believed by some that he was assigned this duty as a damage control measure after Khan came under severe criticism for accepting a donation worth of Rs5 million from Pakistan Tobacco Company (PTC).

Following this decision, the taxpaying tobacco industry has raised concerns about its certain competitors that indulge in illicit trade and wrongfully capture their market share. There are allegations against many local companies about tax evasion and hiding exact information about their production and sales volumes. Therefore, there is a need to remove anomalies and create a level-playing field of all the cigarette manufacturers in the country.

For the sake of understanding the situation, the case of 12 national cigarette manufacturing companies established in Khyber Pakhtunkhwa (KP) can be discussed here for reference. These companies have contributed almost Rs1.37 billion revenue to the national exchequer during the fiscal year 2017-18 in terms of Federal Excise Duty (FED).

Of these 12 companies, just one is a public limited company listed on the Pakistan Stock Exchange (PSX), which has contributed almost 58 percent of the revenue mentioned above. This company has 12 machines installed for cigarette production.

The remaining 11 companies combined have contributed the remaining 42 percent despite having 65 machines installed collectively.

This difference of contribution to revenue in terms of the FED to the national exchequer by one company versus eleven companies clearly indicates the fact that taxes being paid by these companies to the government are much less compared to their production capacity.

Therefore, as part of the local industry formalisation plan, it has been proposed that the government may implement a “Capacity Tax” on these companies based on the number of machines installed in a cigarette manufacturing company for production of cigarettes.

Taxation experts suggest that this tax may be fixed at a minimum rate of Rs10 million per machine per month.

This rate is reasonable keeping in view the huge production capacity of these machines and the amount of money the owners might earn by operating them at their full capacity. The imposition of this tax will give an immediate boost of Rs9.24 billion annually to the national exchequer.

The said capacity tax is in very much in line with the provisions of Federal Excise Rules 2005 that bind the cigarette manufactures to declare the details of machinery used in the manufacturing of cigarettes and other tobacco products. These details include: the number of machines, their make and model, minimum production capacity in respect to each machine and the brand names of the products that the manufacturer intends to produce.

Any machine not intended to be used for production of taxable goods shall be permanently closed by sealing it with argon gas welding under these rules.

However, it is possible that after the implementation of the proposed Capacity Tax, some of the companies will be phased out for not being able to compete in legal trade environment.

Quite likely some other smaller manufacturers such as Indus Tobacco Company and Saleem Cigarette Industry may reduce their number of machines for the production of cigarettes – these two manufacturers currently contribute only 1.59 percent of the total tax revenue by the national manufacturers.

Nonetheless, even in the unlikely event that the manufacturers listed from number 7 to 12 completely shut down– rather than a mix of some closing down and some reducing their capacity- the decrease in the number of machines will be 41 from the current 77 -and the national exchequer will receive a minimum revenue of around Rs 4.9 billion annually and increasing year-on-year. Over a period of 5 years, with an annual increase of a mere 10 percent in the capacity tax will generate a revenue of Rs37 billion from national manufacturers with the 5th year contributing over Rs7.89 billion, which is the most conservative assessment.

A source in the federal government points out that the whole value chain in the tobacco industry will face monetary and enforcement curbs because their prime objective is to go for tobacco control as per the spirit of World Health Organization’s Framework Convention on Tobacco Control (FCTC). The government, the source adds, might consider measures like imposing capacity tax on local manufacturers as it believes in providing level-playing field to all.