Cigarette industry flays VAT move

The cigarette industry is keeping its fingers crossed with tax policymakers seriously mulling the possibilities of states extending the value-added tax (VAT) to cigarettes to compensate the loss of central sales tax (CST) revenues.

"The imposition of VAT will most definitely lead to a rise in the prices of cigarettes. A rise in prices of cigarettes will invariably cause an increase in the inflow of contraband, which is already costing the government around Rs 2,000 crore in revenue loss and also significantly denting farmers' income," B V Javaregowda, member of the Tobacco Board of the ministry of commerce, said.

Today, the tax incidence on cigarettes is nearly 130 per cent of the value of the product (ex-factory price less excise duty), making it one of the highest taxed products in the country, according to industry sources.

According to rough estimates, the imposition of VAT on cigarettes will lead to an additional tax burden of roughly Rs 2,000 crore per annum, taking the VAT rate at 12.5 per cent at current prices. This would represent a 25 per cent increase in the current levels of taxation and given the price elasticity of cigarettes, it would lead to a steep decline in cigarette volumes.

It is estimated that this itself will lead to a loss in excise revenue to the tune of Rs 1,000 crore.

The tobacco industry feared that the steep increase in cigarette taxes will increase the already lucrative margins between the tax-paid and tax-evaded stocks and provide further fillip to contraband trade.

Moreover, the industry felt that nearly 90 per cent of the value addition in cigarettes takes place during the manufacturing process. Beyond the factory gate, out of the remaining 10 per cent, nearly 7 to 8 per cent comprises the retailers' margin, who by virtue of their relatively lower margin are anyway out of the VAT net.

This implies that the entire administrative machinery will have to concentrate only on the balance 2 per cent of the value chain, which is inefficient and expensive.

The VAT on cigarettes will not help farmers and exports either because with higher incidence of taxes, tobacco consumption shifts to lower end of the value chain such as bidis and chewing tobacco, which do not have potential to remunerate the farmers adequately, making them poorer, Javaregowda said.

"The imposition of VAT on cigarette tobacco "" which is nothing but a tax on tax "" will seriously threaten the livelihood of around seven lakh cigarette farmers and thirty lakh family members in Andhra Pradesh and Karnataka.

Past experience tells us that a significant increase in tax on cigarettes has resulted in drastic drop in income of cigarette tobacco farmers," Sivaram Prasad, general secretary, Tobacco Growers' Welfare Association, said.

Moreover, the industry argued that tobacco consumption cannot be curbed by higher taxes because in India most of the consumption (around 85 per cent) is in non-cigarette products.

Higher taxes on tobacco will shift tobacco consumption to low quality products with high risk factors.