Budget 2020

Illicit trade in tobacco products-I

Huzaima Bukhari & Dr. Ikramul Haq

Illicit trade in tobacco products (ITTP) is a global occurrence, affecting all regions and countries. It holds an allure for criminals to engage in it as tobacco products are light, small, easy to transport and to conceal. Tobacco is one of the most smuggled commodities in the world, allowing offenders to amass huge profits. Further, penalties are often not sufficient to act as a deterrent—Interpol, Countering Illicit Trade in Tobacco Products: A Guide for Policy-makers.

“Cigarette manufacturers across the country are evading millions of rupees in taxes through fraudulent methods in connivance with government officials, opposition members, and individuals of investigative agencies”— Investigative report aired by Geo News on Aaj Shahzeb Khanzada Kay Sath

“The government has ignored the cabinet’s decision on imposing a health tax on cigarettes in the budget for fiscal year 2019-20 in a bid to generate funds for development of the health sector”—Budget 2019-20: Health tax on cigarettes ignored, The Express Tribune, June 13, 2019

“The tobacco ‘track and trace’ regulations are part of the EU Revised Tobacco Products Directive (2014/40/EU). The UK Government are in the process of introducing the ‘track and trace’ provisions of the Directive into UK law. These regulations will come into effect on 20th May 2019”—Track and Trace

The State, its corporations, instrumentalities and agencies have the public duty to be fair to all concerned. The limited scope of judicial review envisages examination of the question whether there are any malafides, arbitrariness, material irregularity, or unreasonableness in the decision-making process leading to the award of the public contract. Judicial review is concerned with reviewing not the merits of the decision by an executive authority, but the decision-making process leading to the award of a public contract. The Court can examine the decision-making process and interfere if it is found vitiated by malafides, unreasonableness, arbitrariness, or material irregularity. Before interference the Court has to be satisfied that the decision is such that no responsible authority acting reasonably and in accordance with the relevant law could have reached—Judgemnet of Islamabad High Court National Institutional Facilitation Technologies (Pvt.) Limited v Federal Board of Revenue and others [W.P.No.3995 of 2019].

“Only two [tobacco] companies pay 98 percent of total tax [tobacco collection]. The remaining 40% companies pay meagre 2% tax”—Prime Minister, Imran Khan

“The most effective way to reduce tobacco use is to raise the price of tobacco through tax increases and ensure that the tax increases are reflected in prices. Higher prices discourage youth from initiating cigarette smoking and encourage current smokers to quit”—Tobacco Taxes in Pakistan

Despite all the recommendations to the government to scrap the third tier, as it was resulting in the loss of both health and money to the country, the influential tobacco lobby in the country was successful in keeping the slab intact in the revisions made to the Finance Bill in September 2018 by the new government”—Economics of Tobacco Taxation & Consumption in Pakistan, PIDE, 2018

The loss in Federal Excise Duty (FED) due to illicit and smuggled cigarette sector alone is Rs. 100 billion a year. It can be plugged by trace and track (T&T) system—Flourishing tobacco industry and “soft sate”, Surkhyian, November 22, 2019.

It is a well-established and internationally recognised fact thatillicit trade in tobacco products(ITTP) and counterfeiting not only reduce turnover and profit for honest businesses and local producers, they also cause revenue agencies to lose taxes. Failure to declare imported goods, miss-declaration of their nature or value and under-declaration of local production quantities similarly undermine governments’ ability to invest in social services, infrastructure, schools and public health programmes. Being able to detect fraud and enforce tax regulations is crucial to protect revenue, especially for developing countries which rely heavily on custom duties on imported goods.

It is lamentable that after lapse of many years to fulfill its international obligation Pakistan failed to implement track and trace (T&T) system of tobacco products and latest bid was declared unlawful by Islamabad High Court with the directions that “FBR is at liberty to initiate a fresh bidding process strictly in accordance with the law” [details can be seen in the order National Institutional Facilitation Technologies (Pvt.) Limited v Federal Board of Revenue and others available on the website]. In this article, however, we are highlighting the various issues relating to ITTP and its multi-dimensional effect on our governance, politics and society. 

Pakistan is a signatory to the World Health Organisation’s Framework Convention on Tobacco Control [WHO FCTC], which it ratified on November 3, 2004 and also acceded to the FCTC Protocol to Eliminate Illicit Trade in Tobacco Products on June 29, 2018. Pakistan is one of 181 countries that signed on to the FCTC since 2004 and is among 56 parties that have ratified the protocol to eliminate illicit trade in tobacco products. The protocol stipulates that any tobacco track and trace solution shall be independent of the tobacco industry. It is a fact that no regime showed seriousness in implementing track and trace in Pakistan to counter ITTP, recoup revenue losses due to illicit tobacco trade and check tax avoidance by other industries through suppression of sales. The Government of Pakistan Tehreek-i-Insaf (PTI) took the initiative but committed fatal errors in awarding the contract as highlighted by the IHC in its above-referred judgemnet.  

Pakistan’s failure to implement T&T systems to curb illegal cigarette sales for the last many years proves the allegation that “cigarette manufacturers across the country have been evading millions of rupees in taxes through fraudulent methods in connivance with government officials, opposition members, and individuals of investigative agencies”.  Currently, billions of rupees are lost to tax evasion each year. It is pertinent to mention that the tender and implementation of FCTC was delayed for years and FBR even missed deadline of International Monetary Fund (IMF) to issue tobacco track and trace licenses by the end of September 2019 as part of the deal for the release of US$ 6 billion bailout.

In a meeting of sub-committee of National Assembly on agriculture dealing with proposed tax on ‘Duty-Not-Paid’ cigarette sector, held on June 2, 2020, the following facts/issues were highlighted from our side:

– The Federal Excise Duty [FED] rate on Tier-II increased by 93% in last 8/9 months. Tier-I increase was over 30%.

– Compliant industry increased prices of lower Tier-II brands to Rs. 78 while the ‘Duty-Not-Paid’ sector made a minimal increase to Rs. 38. This led to a growing price differential between the duty evading packs and legitimate packs to Rs. 40.

-‘Duty-Not-Paid’ cigarette sector now at 37.6% as on March 31, 2020 which means that essentially the overall consumption has remained the same but consumers due to affordability challenges are buying cheap duty evading cigarette packets that are selling below the Government mandated price of Rs. 62.76 and even the minimum tax per pack of Rs. 44.

– Possible decline in FBR’s revenues by 6.5%—from 124 billion last year to maybe 116 billion this year despite massive increases in FED. The revenue forecast in last year budget speech was Rs. 147 billion which will not be met and there could be even a decline vis-à-vis collection from previous year.

– Potential revenue loss is of Rs. 77 billion because of illicit tobacco trade and counterfeit cigarettes, smuggling every year, in addition to the decline in revenue because of evasion by ‘Duty-Not-Paid’ sector.

– In addition to excise and taxes, the contribution of two multi-nationals is Rs. 43.9 billion rupees per annual. This 43.9 billion and other levies are at risk if ‘Duty-Not-Paid’ sector grows as the compliant units will lose market’s share as unable to operate in the current scenario and with existing footprint.

– Stricter monitoring of Green Leaf Threshing units (GLTs) is needed. There is a link in supply chain of 75,000 plus farmers, 500,000 plus retailers and 45 plus manufacturers but only 11 GLTs are supplying raw material to all manufacturing units of cigarettes.

– Proposed advance adjustable tax on GLTs of Rs. 500/kg is meant to achieve documentation. This adjustable advance tax is to be set off against payable FED against final liability that is to be paid by the cigarette manufacturers and not by the tobacco growers. The actual FED that manufacturers pay becomes this input tax that is adjusted and cleared with no additional payments. It is a measure to strengthen documentation and increase monitoring at every stage in the supply chain.

– Last time when this advance tax was raised, it reduced the operation of ‘Duty-Not-Paid’ sector. They resorted to various tactics trying to malign this much-needed documentation measure and saying it was an additional tax on farmers which was certainly not the case. The law is clear and this is not recoverable or can be passed on to the farmers. This measure of increasing an adjustable advance tax is to ensure that if it had to be re-claimed and adjusted by the ‘Duty-Not-Paid’ manufacturers, then at least, in part a higher portion of the actual due FED would be ascertainable/payable. This would unearth operators that are under-reporting and evading billions in taxes each year.

– Addressing affordability challenges, increasing enforcement and cracking down on supply chain and their source is pivotal to the sustainability of compliant units.

All purchases of tobacco are through Tobacco Board or their contractors as required under their law after paying cess and advance income tax of 5%. Then the question arises how ‘Duty-Not-Paid’ manufacturers bypass it? How GLTs supply them tobacco out of books and if this is what is happening then where is monitoring of FBR?

Section 236X of the Income Tax Ordinance, 2001, inserted in 2017, reads as under:

“236X. Advance tax on tobacco.– (1) Pakistan Tobacco Board or its contractors, at the time of collecting cess on tobacco, directly or indirectly, shall collect advance tax at the rate of five percent of the purchase value of tobacco from every person purchasing tobacco including manufacturers of cigarettes.

(2) Tax collected under this section shall be adjustable”.

Has FBR ever tried to use the data from above provision and reconciled it to quantify tax evasion, if any, by ‘Duty-Not-Paid’ manufacturers.

A write-up published in October 2019, after quoting Prime Minister Imran Khan’s “flamboyant rhetoric and order of a “crackdown” on illegal cigarettes, alleged that “big tobacco has managed to keep a firm hold on Pakistan’s tax structure for years—the Pakistani industry is dominated by two multinational companies and 25 local manufacturers that have succeeded in skewing policy in their advantage for years”.

Zahra Kazmi, a researcher, freelance writer, and a social activist, in her op-ed of November 10, 2017 made the following startling revelations:

“British American Tobacco, a British multinational tobacco company based in London, is famous worldwide for controlling governments through intense lobbying activities and manipulates tax structure to for higher profits.

Currently British American Tobacco has been under investigation by Serious Fraud Office United Kingdom for allegations which surfaced against it in East Africa where it has been accused of making illegal payments to politicians and civil servants. BAT had to issue a statement after the news of investigation surfaced.

“We have been co-operating with the Serious Fraud Office (“SFO”) and British American Tobacco (“BAT”) has been informed that the SFO has now opened a formal investigation. BAT intends to co-operate with that investigation.”

This has happened since long in Pakistan too, however, BAT has been able to manage its corrupt practices. In early 2015 the British High Commissioner was accused of attending lobbying meeting in which British American Tobacco (BAT), the parent company of Pakistan Tobacco Company (PTC), lobbied Finance Minister Ishaq Dar and Minister of State for National Health Services Saira Afzal Tarar.

The meeting was aimed to convince Dar and Tarar to drop the government’s plan to print larger pictorial health warnings on cigarette packs. Though the then High Commissioner Barton has drawn harsh criticism from campaigners and medical experts in UK, however, the news went unnoticed here in Pakistan except being reproduced by one of the English language newspaper which was originally published in Financial Times.

Mr. Kamran who is an anti-tobacco campaigner said that BAT involvement in manipulating local laws has been quite obvious in many cases in recent past. He said that recently as a result of BAT lobbying, the Ministry of Finance proposed a third tier with the purpose to increase revenues from Tobacco products, however, in reality the slab was introduced to benefit BAT. The introduction of third tier/slab will actually result in increase sale of Tobacco products amounting to a total disregard for WHO Framework Convention on Tobacco Control he said.

On inquiring from FBR it was revealed that before there have been two tiers of taxation consisting of an upper tier and a lower tier. The upper tier tax was applied to tobacco products with a price above Rs. 72 and the lower tier tax was applied to tobacco products with a price below Rs. 72. The tax applied to products in the upper tier was Rs. 63.10 whereas the tax applied to the lower tier was Rs. 28.40.

Keeping in view WHO FCTC the MNHS recommended the Finance Ministry to raise the tax on the lower tier to Rs. 44 as tobacco products in this tier were consumed by almost 80% of consumers. Though the suggestions were agreed upon by the MoF, yet MoF, under the influence of British American Tobacco, introduced a third tier of taxation. Under this tier of taxation, tobacco products below the price of Rs.50 will draw the new tax at the rate of Rs.16. The BAT and FBR nexus has been highlighted in a recently published article in The News an English language daily. According to it “This provision has helped cigarette companies boost their sales”.

For example, the British American Tobacco lowered the prices for its top three highest selling brands to below Rs50. The applicable lax therefore reduced from Rs32.98 (as per the new second tax tier) to Rs16 (as per the new third tax tier). The equation is simple: the lower the price more is the demand.”

This has also been confirmed from market survey. Mr. Adil who runs a tuck-shop in Karachi said, “The prices of Capstan by Pall Mall, Gold Flake and Embassy have been reduced drastically after this year budget which is very unusual.” He further conceded that the sale of these three cigarettes brands have gone many fold.

The write-up says, “years later, Pakistan’s regulatory capacity does not look any more promising. With many local politicians or their relatives sitting on the boards of tobacco companies, there is next to no incentive to change the way things currently are. According to Transparency International, Pakistan’s battle against corruption is failing”.

Numerous stories of tax scams appear in the media involving billions but nothing happens thereafter—in most of the cases, matters are hushed up and even reporters do not bother to follow up their own stories. However, the 2018 scam, involving tobacco companies not only caused collossal loss of revenue but also played havoc with health of millions of Pakistanis. Due to lowering of taxes, consumption increased manifold but tax plunged drastically. Had it happened elsewhere in the world, by this time all the culprits would have been behind bars and adequately punished under the law—alas in our country such heinous crimes remain unnoticed and the culprits flourish by minting billions. They evade taxes and flout the rule of law with impunity. What makes things more painful is the fact that all this happened through collusive arrangement between the apex revenue authority and big audit firms that also render tax services to the companies giving them clean reports!

A story appeared in Press on May 24, 2018 reveals that “the Public Accounts Committee (PAC) has recommended a Supreme Court-led investigation to unmask those who have given a whopping Rs.33 billion in benefits to two cigarette manufacturing companies by changing their tax structure”.

According to details, the Auditor General of Pakistan (AGP), in a special audit report, prepared on the direction of PAC, concluded that FBR sustained loss of Rs. 33 billion in just one year due to introduction of the third-tier tax structure through SRO 407(I)/2017 dated May 29, 2017 against the previous two-tier structure under SRO 473(I)/2016 dated June 3, 2016. The third-tier imposing just Rs. 800 as Federal Excise Duty (FED) was 50% less than the lowest previous rate. The AGP claims that after this change, two major players in the market shifted their famous brands to the lowest tax slab and sold their cigarettes with 50% reduction in FED. The AGP’s report alleges that this enhanced the sales of companies but revenues registered a substantial decrease.

The most alarming part of AGP’s report is: “Before price reduction, 23% smokers were smoking less than five cigarettes a day. But after the price reduction now only 1% of the total smokers smoke five cigarettes a day and others have increased consumption”. Where was the Ministry of Health when it was happening? After these revelations, the Press and civil society should join hands to unveil the ugly faces behind the disastrous move. The Chairman PAC reportedly claimed that he had the lists of officials of FBR “who took the gifts”. Why did Chairman PAC wait until the end of the tenure of PAC to reveal all this? It was an ugly joke with the nation. Loss of revenue was important but more important has been health of citizens. The Parliament should have imposed sin tax of over 200% on cigarettes to discourage smoking as done by many countries. The UK has recently imposed sugar tax to refrain people from consuming fizzy drinks. This is how taxes are used to safeguard health of citizens and counter wasteful consumption. In the second instalment, this issue will be highlighted in detail.

_____________________________________________________________________

The writers, lawyers and authors of many books, are Adjunct Faculty at Lahore University of Management Sciences (LUMS).