Under VAT effect

A levy of value added tax on cigarettes means a higher cost for customers, and so a shift to cheaper and less-revenue yielding forms of tobacco.

India was the third largest manufacturer of raw tobacco at 5,98,000 tonnes in 2005-06, topped only by China at 26,86,000 tonnes and Brazil at 8,79,000 tonnes . Andhra Pradesh, Gujarat, Karnataka and Uttar Pradesh account for 92 per cent of the Indian crop.

Of this crop, India converted 2,35,000 tonnes into flue-cured tobacco (FCT), while China topped the world producing 19,45,000 tonnes of FCT, followed by Brazil at 6,32,000 tonnes in 2006.

However, in terms of cigarette production, India was a relative pygmy with only an estimated 109 billion sticks in 2006-07, against China's 1,942 billion sticks, and the US and Russia producing nearly 500 billion sticks each.

Nonetheless, the domestic market has seen farmer price realisations increase by 35 per cent, leaf production increase 36 per cent and exports of tobacco and tobacco products increase 59 per cent over the last five years.

This has happened despite the fact that India was the world's second largest consumer of tobacco but also one of the lowest per capita consumers of cigarettes in the world at 85 cigarettes per capita annually.

As cigarettes represented the top-end of the tobacco value chain, there is a case for encouraging consumption to shift to smoking of cigarettes, as it would make farmers grow better tobacco, earn more, help enhance exports and generate more revenues for the government.

Cigarettes, at present, account for only 15 per cent of consumption and generate 85 per cent of the revenue for the tobacco sector at around Rs 8,000 crore per annum.

Around 60 per cent of Indian users consumed tobacco in multiple forms, i.e., they smoke cigarettes and also use other tobacco products like gutkha, zarda, snuff, chewing tobacco and bidis.

Budget 2007 increased the specific rates of excise duty on cigarettes by about 5 per cent. Similarly, excise duty (excluding cess) on bidis, which was last fixed in 2001, was raised from Rs 7 to Rs 11 per thousand for non-machine made bidis and from Rs 17 to Rs 24 per thousand for machine-made bidis.

While pan masala containing tobacco was liable to excise duty of 66 per cent, the exemption for pan masala containing tobacco and other tobacco products that was given to units in the North-eastern states is now withdrawn.

According to cigarette companies, this was because the tax burden on cigarettes was 35 times more, on a per kg basis, than on other tobacco products while the balance 85 per cent of consumption was either lightly taxed or escaped taxation.

This had been compounded by the progressive levy of value added tax (VAT) on cigarettes, a step opposed tooth and nail by the industry because it implied higher cost to consumer, and presumably a shift to cheaper and less-revenue yielding forms of tobacco.

The figures on VAT collection were yet to come in the few months after its roll-out in some states, but prices had increased on the street.

According to the cigarette industry, every percentage point increase in the share of cigarettes in tobacco consumption would yield Rs 540 crore in excise revenue.

Incidentally, the share of cigarettes in tobacco consumption was at 23 per cent of tobacco produced and consumed in 1971-72. According to cigarette producers, a levy of VAT at 12.5 per cent would be the equivalent of a 29 per cent excise increase, as it would be a tax on excise and not a tax on value added.

This was because 90 per cent of value addition in cigarettes was reportedly generated at the manufacturing stage while of the balance 10 per cent trade margins, 8 per cent was in the hands of small retailers below the VAT threshold and, therefore, yielding only 2 per cent to the VAT kitty.

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SNIPPETS

Smuggling challenge
A problem highlighted by domestic cigarette manufacturers in particular, India was understandably an attractive new market for foreign companies but one which severely restricted imports.

High taxes on cigarettes did provide an attractive tax arbitrage opportunity and smuggled cigarettes allegedly accounted for 5-7 per cent of the domestic market.

The industry would like to peg the estimated revenue losses at around Rs 1,500 crore on account of unpaid duties and forex outflow. In addition, farmers were hit as smuggled cigarettes naturally did not use Indian tobacco.

The industry would like cigarette imports on the "restricted" list and prohibition of sale of cigarettes in duty-free shops and its exclusion from duty-free baggage allowance, as also ban on cigarette manufacture in EOUs and SEZs. Higher duties, excise or otherwise, was expected to push up sales of smuggled cigarettes, which in 2005-06 was estimated to be worth about Rs 2,000 crore.

Also, some of the tobacco processing units in the North-east were expected to shut down and sale of smuggled foreign products there to increase because of the withdrawal of the tax holiday.

Export challenge
Despite being the world's third largest tobacco producer, India's value share of global leaf trade was only 3.5 per cent at around Rs 975 crore in 2006.

This was because of the mismatch between domestic production and international requirements caused by the alignment of domestic production to the domestic consumption pattern dominated by non-cigarette tobacco products, which needed tobacco of a quality not acceptable to users overseas.

Only 35 per cent of tobacco grown was of exportable variety in consequence. India was missing out on the export opportunity because of quality constraint despite the fact that output from large exporting countries was projected to decline due to withdrawal of subsidies.

Farmer-friendly tax policies could lead to growing of tobacco in line with international trends.

According to industry estimates, a 10 per cent share of global leaf exports could increase export earnings from Rs 975 crore to Rs 2,835 crore. Higher exports was also expected to result in higher farmer earnings.