Budget 2020

Illicit tobacco trade-II

Huzaima Bukhari & Dr. Ikramul Haq

“….19.1 percent of Pakistani population, which includes 31.8 percent of men and 5.8 percent of women, consume tobacco in one form or the other. Among these tobacco consumers, 9.6 percent of the overall adult population (17.9 percent men, 1 percent women) is daily cigarette smokers. Whereas, 2.7 percent of the adult population (4.4 percent men, 1 percent women) smoke water pipes daily. Furthermore, 7.1 percent adults (10.5 percent men and 3.5 percent of women) use smokeless tobacco daily. Among the young population, 10.7 percent of all youth—including 6.6 percent girls and 13.3 percent boys—consume tobacco or tobacco products—Demographic and Health Survey 2017-18, National Institute of Population Studies, Islamabad

It is pertinent to mention that Pakistan is amongst one of the largest consumers of tobacco in the world—around 25 million Pakistanis of 15 years and above are smokers. The World Health Organization (WHO) and all other world bodies recommend that at least 70% of price of the cigarette should be levied as tax in order to discourage smoking but Federal Board of Revenue (FBR) in the past has been lowering the same for the powerful merchants of death—big cigarette companies and also failed to counter illicit cigarette manufacturing as well as cracking down on counterfeit and smuggled products.

Till fiscal year 2013-14, Federal Excise Duty (FED) collection from tobacco industry was based on two-tier tax structure and collection was Rs. 70.73 billion—99% of it came from two multinational companies, Pakistan Tobacco Company (PTC)— part of British American Tobacco, the world’s largest group and Philip Morris Pakistan Limited (PMPKL)—an affiliate of Philip Morris International (PMI), a leading international tobacco. In addition to FED, the sector paid Rs. 17.7 billion as sales tax. In 2015-16, the collection from this sector under FED and sales tax reached Rs. 114.2 billion. After the introduction of the third tier, turnover of PTC/PMPKL almost doubled but FED collection plunged to Rs. 60 billion. The tax paid in 2016-17 by these two companies was far lower than mandatory requirement of 72%—during the first ten months of the said fiscal year it went as low as 42%. 

When the scam surfaced, strangely, the high-powered body like Public Accounts Committee (PAC) suggested investigation by Supreme Court whereas tax was imprudently reduced by FBR through an SRO [Statutory Regulatory Order] bypassing the Parliament and in violation of Article 77 read with 162 of the Constitution as explained by Supreme Court of Pakistan in Engineer Iqbal Zafar Jhagra and Senator Rukhsana Zuberi v Federation of Pakistan and Others [(2013) 108 TAX 1 (S.C. Pak)]. On the one hand the Parliament during 2013-18 was critical of Supreme Court alleging that it had been encroaching upon its territory and on the other PAC asked for intervention of apex court in a matter that was in its exclusive jurisdiction! After failing to bring the culprits to book, PAC wanted to throw the ball in another’s court! Obviously there was lack of will/sincerity on the part of PAC and Parliament during their tenure [2013-18].

In relation to above scam, the following comments were made in an op-ed, Yet another tax scam, published on May 27, 2018:

“Whatever the outcome of this tax scam, one thing is clear that members of National Assembly throughout their tenure of five years showed little interest in examining such cases, punishing the culprit and retrieving tax losses through PAC. It could have substantially increased tax collection and establish a tax culture leading to improving voluntary compliance.

The report of AGP confirms that nothing has changed in FBR even after the so-called reforms funded through loans worth millions of dollars. It is a sad reflection on FBR’s top management. The mafia-like acts of FBR has encouraged the corrupt, criminals, tax evaders, smugglers, drug dealers, terrorists, rent-seekers, and profit-hungry unscrupulous businessmen not to pay taxes but just give officials their “share”. In quid pro quo the FBR’s stalwarts kept on drafting numerous amnesty schemes for them to whiten their untaxed assets by just paying 2 to 5 percent.

The tax officials occupying key posts are holding the same for serving political masters and not the people. They create favourable tax regimes and concessions for the mighty businessmen—the episode of giving unprecedented relief to tobacco companies is a classic case.  The unholy alliance between the tax evaders and their advisers and tax officials has been depriving the national exchequer of billions of rupees.

Pakistan is controlled and ruled by different mafias—people having collossal untaxed assets generated. These mafias have crippled State institutions. The FBR, being their handmaid, protects them through tax amnesties or non-action. The tax evaders, profit-sharking MNCs, plunderers of national wealth, the corrupt, drug barons and extortionists have captivated the state functionaries. In these circumstances, tax evasion and frauds can only be countered through a permanent public commission, representing the people from all walks of life, which should probe the cases, release its reports in the Press on monthly basis, recommend actions for retrieval of tax losses and suggest punitive measures against the culprits”.

The above scandal surfaced during the Government of Pakistan Muslim League (Nawaz), but thereafter neither the interim government, installed on June 1, 2018 nor the coalition Government of Pakistan Tehreek-i-Insaf (PTI) took any cognizance of the matter—though it was a fit case for National Accountability Bureau (NAB). Prime Minister, Imran Khan since taking oath on August 18, 2018 has been making claims to dismantle all the existing cartels, monopolies, rent-seeking structures and corruption, but so far his government has failed to even enforce World Health Organisation Framework Convention on Tobacco Control (WHO FCTC) and implement Track & Trace (T&T) system as bidding process is declared unlawful by the Islamabad High Court [discussed in the first instalment].

The Prime Minister also did not succeed in imposing health tax on cigarettes in the budget 2019-20, even after giving approval, in person and by cabinet, as Ministry of Law overlooked Articles 144 and149 of the Constitution. Chairing a cabinet meeting on May 29, 2019, Prime Minister decided to end the tax-free cigarette facility for the prime minister, chief ministers and governors of all provinces to control the use of tobacco. He said that the prime minister, chief ministers and governors would now pay the same taxes as other consumers. He also gave the go-ahead for imposing health tax of Rs. 10 per pack of cigarette and said that “earnings from that would be used by the health ministry on welfare projects”. It was also decided that 1% health tax would be imposed on all beverages in the upcoming budget.

In February 2019, the National Health Services and Coordination Division presented a draft of the Health Levy Bill 2019, proposing imposition of a health levy on cigarettes and sugary beverages. However, the FBR opposed the levy on the cigarette manufacturing industry for obvious reasons as stated by PAC (see part I). The Finance Division, on the other hand, agreed to impose the tax on cigarettes. The Cabinet Division argued that “imposition of any tax fell within the meaning of money bill as provided in Article 73(2)(a) of the constitution. A Money Bill would be moved in the National Assembly after seeking approval of the cabinet in accordance with Rule 16(1)(a) and (d) of the Rules of Business 1973”. In the meeting, the Prime Minister also gave approval for rolling back the third slab of FED introduced by the Government of Pakistan Muslim League (Nawaz), which brought down the duty and led to a reduction of billions of rupees in revenue collection, as per officials of the Ministry.

Strangely, the PTI Government later on dropped the cabinet’s decision of imposing health tax on cigarettes in the budget for fiscal year 2019-20 that was to generate funds for development of the health sector. Had it been done we could have garnered sufficient funds to fight Covid-19 epidemic effectively. According to a newspaper, “certain lobbyists appeared to be influencing the affairs and the decision on health levy was not implemented”. Quoting certain sources, the newspaper’s report [Budget 2019-20: Health tax on cigarettes ignored] published on June 13, 2019 revealed:

“….the Federal Board of Revenue (FBR) chairman pointed out that annual revenue collection from cigarette manufacturers was projected to stand at Rs114 billion. However, after ending the third tier of federal excise duty (FED) introduced by the previous Pakistan Muslim League-Nawaz (PML-N) government, the annual revenue receipts from the industry would go up to Rs150 billion. Revenue collection from the cigarette industry was Rs114 billion in 2016 but after introduction of the third FED slab, the revenue flow dropped to Rs80 billion in 2017. However, officials of the health ministry did not agree with arguments of the FBR Chief, saying the cabinet had taken a decision to impose health tax. However, they said, the tax was not made part of the Finance Bill 2019. According to the ministry officials, a certain lobby has managed to create hurdles in the way of including the health tax in the Finance Bill…the cabinet in its meeting held on May 28, 2019 approved the medium term macroeconomic framework after reviewing presentation of the Finance Division on the budget strategy paper. Furthermore, the cabinet decided to impose health tax on tobacco at Rs10 per pack of 20 cigarettes and on carbonated drinks at Rs.1 per 250ml bottle through the Finance Bill.

It also agreed that the revenue generated through the health tax would be earmarked for development of the health sector over and above the budgetary allocation.

The cabinet decided that the Finance Bill would also include measures for tackling the illegal manufacturing and trade of cigarettes and other tobacco products.

The Cabinet Division also wrote a letter on June 3 to the finance secretary, national health services, regulation and coordination secretary and revenue secretary to implement the decision within seven days under Rule 24 of the Rules of Business 1973 in coordination with other divisions, where necessary.

An implementation report may be furnished to the Cabinet Division within seven days of the receipt of the decisions, the cabinet said”.

Even in budget 2020-21, no effort is reportedly made to levy heath tax on cigarettes while facing challenge of Covid-19 outbreak. For levying this tax, the Cabinet in 2019 and till today has failed to take note of the fact that any provincial assembly, (Khyber Pakhtunkhwa PTI has two thirds majority and in Punjab and Baluchistan coalition governments) by a resolution under Article 144 of the Constitution can ask National Assembly, to impose health tax on their behalf and money would go into National Health Fund to provide all citizens modern healthcare to meet challenges like Covid-19 epidemic. It is strange that the Law Ministry did not give this advice even after judgement of Supreme Court on Article 149 of the Constitution in Suo Muto Case 1 of 2020.       

Many countries have imposed sin tax on tobacco and alcohol and United Kingdom in 2018 imposed Soft Drinks Industry Levy (SDIL) that purports to put a charge of 24p on drinks containing 8g of sugar per 100ml and 18p a litre on those with 5-8g of sugar per 100ml, directly payable by manufacturers to Her Majesty Revenue and Customs (HMRC). Had we imposed similar taxes sufficient amount could have been collected and diverted towards improving healthcare system and meet catastrophes like Covid-19 epidemic. The PTI Government again will miss this chance in federal budget for fiscal year 2020-21. However, it can still be presented after taking provinces on board.   

A story [Tobacco industry’s ad on illicit cigarette trade a ‘smokescreen’] published on May 14, 2020 made the following claims:

The Coalition for Tobacco Control (CTC) Tuesday expressed shock at the publication of an advertisement backed by the tobacco industry, calling for stopping illegal trade of cigarettes in Pakistan.

The advertisement, published on the front page of a leading English daily, claims that Pakistan annually loses Rs. 44 billion to illicit cigarette trade. It further claims that this money can be used to educate 2.5 million students, provide electricity to 250,000 homes, and to feed 9 million people with three meals a day for a month. The ad asks for signing a pledge for stopping illicit cigarette trade at www.stopillegaltrade.pk, which is financially backed by Philip Morris Pakistan.

“This ad can be described as the best example of smokescreen,” commented Khurram Hashmi, the National Coordinator of CTC-Pakistan. He added that as Pakistan, like the rest of the world, is facing economic meltdown because of Coronavirus, the tobacco industry is trying to present itself as a helping hand.

Khurram said, according to the World Bank’s country overview of tobacco use in Pakistan, the tobacco industry overestimates illicit trade as one of the ploys to plan decline in the government’s revenues. “The report says a public impression is created that illicit cigarette trade in Pakistan is very massive and is growing with every excise increase.”

The other two ploys, Khurram said, are forestalling (increases in production or stock of the product in anticipation of a tax increase), and price over-shifting (the increase of cigarette prices by more than the tax increase and the inflation rate would require).

“We need to be very careful and, at the same time, vigilant to the ploys that the industry is adopting in these tough times, especially when the budget is just around the corner,” CTC chief added. “This is nothing but a futile attempt to avoid tax raise on their life-threatening product, cigarettes.”

CTC-Pakistan works to strengthen the development and implementation of policies based on provisions of the Framework Convention on Tobacco Control (FCTC) through advocacy campaigns and acting as a technical resource for the Ministry of National Health Services. It has 267 civil society organizations working on tobacco control issues in Pakistan.

The current scenario of evasion of various taxes, duties and other levies by unscrupulous cigarette manufacturers, counterfeit and smuggled products, inefficiency of FBR and Pakistan Tobacco Board [PTB] is summarized below:

• All purchases of tobacco are through PTB’s contractor after bidding process, required under relevant law/rules

[see details at: http://www.ptb.gov.pk/node/11 and http://www.ptb.gov.pk/downloads]

after paying cess and advance income tax of 5% under section 236X of the Income Tax Ordinance, 2001 inserted by Finance Act, 2017, that reads as under.

Section 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.

• The question is: how do buyers bypass section 236X of the Income Tax Ordinance, 2001? According to a former Chairman of PTB, who also served in FBR as a senior officer commented: “The advance income tax paid by the companies is not material as they pay it on declared purchases. The transaction is already documented…and since it is adjustable it does not add to the revenue. Important is the tax collected by the PTB’s contractor. Frankly, PTB has no control over him because he is the successful bidder in an auction and his sole purpose is recovering more amount than his bid to make profit. As per the agreement with PTB he is under obligation to provide information about purchasers which he never does. He is like any other ordinary octroi contractor. Interestingly no such tax on tobacco purchase is collected in Punjab”. This is an open admission of leakage at the very first stage of buying tobacco from growers! Another official of FBR, who has vast experience of monitoring and studying this sector endorsed the above statement and recommended: “The only point where we could enforce things is the Green Leaf Threshing (GLT) stage before we go for T&T”.
• Allegedly, the non-duty paid companies avoid 5% tax under section 236X of the Income Tax Ordinance, 2001 by declaring less tobacco purchases to PTB. They allegedly purchase 2/3 times more tobacco illegally. Collection under section 236X of the Income Tax Ordinance, 2001 in FY 2017-18 was Rs. 569 million, in FY 2018-19, Rs.503 million and in the current FY 2019-20, up to April 2020, Rs. 546 million. Party-wise bifurcation is not available at website of FBR or in any published report. It is obvious that collection under section 236X of the Income Tax Ordinance, 2001 is not properly made/deposited/monitored vis-à-vis total production/sale of tobacco. FBR has also not reconciled in tax year 2018 and 2019 collection under section 236X of the Income Tax Ordinance, 2001 with total annual production of tobacco and total supplies by GLTs. PTC and PMPKL claim to have been making full payments under section 236X of the Income Tax Ordinance, 2001 by cross cheques adjusting it against income tax payable. FBR can/should cross check it from PTB vis-à-vis total purchases made by them and match it with their production/sales.
• According to various Press reports and media campaigns, mostly sponsored by PTC and PMPKL, the total cigarette market in Pakistan is around Rs. 80-85 billion sticks and there are two sectors—one what they call “legitimate taxpaying sector” with 67% market share and a contribution of 98% in revenues, while the other is the “tax-evading sector” with 33% market share and a contribution of only 2% in FBR’s revenues”.
• “In Pakistan 75% of tobacco is cultivated in KPK and 25% in Punjab”— https://www.textroad.com/pdf/JBASR/J.%20Basic.%20Appl.%20Sci.%20Res.,%207(4)1-17,%202017.pdf.
• There is also alleged tax evasion by the no-duty paid companies of Rs.10 per kilogram (kg) of total tobacco volume purchased but not reported to PTB to avoid development cess. These tax-avoiding companies allegedly do not pay even Rs. 300 per kg tax on packed tobacco after processing by GLTs that is adjustable against cigarette production. How do tax-defiant companies bypass this tax and GLTs supply them processed tobacco out of books? FBR needs to explain it. It is shocking that with staff of over 22,000, FBR could not monitor just a handful of GLTs.
• There is Rs.10 per kg tax on packed tobacco by a GLT unit that non-tax paying companies have been allegedly avoiding to the extent of illegally purchased tobacco. It can be verified from PTB by ascertaining the total production of tobacco in a year that is much higher than the declared purchases to PTB. When 100% tobacco produced by the farmers is sold/purchased in the market, why is the total revenue so much lower?

The above facts prove beyond any doubt massive evasion by many buyers not only of 5% advance and adjustable tax under section 236X of the Income Tax ordinance, 2001 but also FED, sales tax, Rs.10 per kg levy on processed tobacco at GLT stage as well as Federal Tobacco Cess and Tobacco Development Cess levied by Khyber Pakhtunkhwa Assembly through Khyber Pakhtunkhwa Finance Act, 1996.

All the above allegations, claims, facts and figures need to be investigated by FBR and other agencies, namely PTB, Federal Investigation Agency (FIA) as fraudulent practices are causing huge loss to the national exchequer. All the culprits and their abettors should be tried under the law after fulfilment of conditions envisaged under Article 10A of the Constitution— fundamental right of every citizen. Along with criminal trials, concrete measures for recovery of lost revenues should be initiated by FBR and other concerned authorities responsible for collecting federal tobacco cess and tobacco development cess. The NAB must also take action if connivance of state officials is proved. 

The following claims are made by two big players (PTC and PMPKL) having booming business and lion’s share in cigarette industry in Pakistan that is health hazard and our successive governments have been more interested in collecting revenues from them rather than discouraging the consumption of their undesirable products and levying health tax:    

• CONSUMPTION: Total consumption of cigarettes in Pakistan has remained constant at approximately 80-85 billion cigarettes per year for the past 10 years. This can be validated by the tobacco leaf production volume, according to PTB records. Assessing cigarette consumption in Pakistan based on legally declared cigarette sales year-on-year would be misrepresentative since cigarette consumption has remained stable over the past 10 years. However, consumption shifts between duty-paid legal cigarettes to non-duty paid illicit cigarettes. Hence to assess consumption, one has to take into account declared and undeclared volumes. Undeclared volumes today stand at almost 40% of the total market.
• ILLICIT CIGARETTE TRADE: Locally manufactured non-duty paid cigarettes produced by cigarette companies situated in Khyber Pakhtunkhwa and Azad Jammu and Kashmir is the major cause of loss of government revenue as these companies continue to under-declare their production. Excise related price increases of legal cigarettes widens the price gap between duty-paid legal cigarettes and non-duty paid illicit cigarettes which encourages down trading and has resulted in the boom of illicit cigarettes trade. As stated above, cigarette consumption has remained stable between 80-85 billion sticks per year. These illicit cigarettes sell between price point of PKR 30-45 per pack which is lower than the FED and sales tax payable per pack.
• THIRD-TIER: FBR data shows that in fiscal year 2016-17 cigarette revenue saw a major decline from PKR 114 Billion (FY 2015-16) to PKR 83 Billion (FY 2016-17). The only reason for this decline was the shift of consumption from duty-paid legal cigarettes to non-duty paid cigarettes. The third-tier was introduced as a fiscal measure to arrest the growth of illicit cigarettes by reducing the price gap between duty-paid legal cigarettes and non-duty paid illicit cigarettes. It is a sheer misconception and misrepresentation of facts that cigarette revenue declined after the introduction of the third-tier. Government revenue data is conclusive evidence that third-tier was a successful measure to increase its revenue, in the absence and lack of enforcement capability.
• FCTC ARTICLE 6: FCTC, International Monetary Fund (IMF) and the World Bank acknowledge that high taxation with lax enforcement creates incentive for illicit cigarette trade. Lack of enforcement in tobacco and in number of other sectors is a harsh reality in Pakistan which we have to be accepted. FCTC Article 6 also recognizes the sovereign right of nations to formulate tax policies in line with their national circumstances.

• TRACK & TRACE: It is a misrepresentation by competitive bidders to malign one of the competitors in an attempt to derail the process because they have not won the bid. There is no link of legal tobacco industry with any of the bidders. The solutions of various bidders have been assessed by a high-powered FBR team for data integrity, system independence and profile of all bidders. All bidders were given full opportunity to present their system subsequent to which an independent team chooses the best suitable solution.

The counter allegations against the two main players (PTC and PMPKL) and suggestions to remedy the situation by local companies/pressure groups/NGOs as well as by World Bank are:

• World Bank in its study: Pakistan: Overview of Tobacco Use, Tobacco Control, Legislation & Taxation claims: “To our opinion, the tobacco industry carefully planned…decline of revenue (probably back in 2013) with the aim to reduce the excise rate. As we saw, this aim was achieved”.
• Government if really wants to stop illicit trade cigarettes they must catch biggest distributors in Pakistan having offices and warehouse at various places.
• No need to go after wholesaler or retails. If agencies interrogate and take action only against 10 to 15 big wholesale dealers almost 80 to 90% illicit sale will be eliminated.
• Government must stop PTC and PMPKL from supplies to their Afghan distributors having allegedly distribution outlets in each city of Pakistan. If agencies get hold of them and properly investigate and interrogate them, the real faces behind the illicit trade in cigarettes would be unveiled.

The above is sordid story of mafia-like operations of illicit tobacco trade in Pakistan, whether all players are complying with laws or not, it cannot be established unless incontrovertible evidence is presented before an independent commission or courts. One thing is clear that illicit trade in tobacco products exposes the efficacy of the State. Pakistan aptly fits in the concept of a “soft state”—famously articulated by the Nobel Laureate, Swedish sociologist. Gunnar Myrdal, in his 1968 three-volume work, Asian Drama: An Inquiry into the Poverty of Nations. It is a broad-based assessment of the degree to which the state, and its machinery, is equipped to deal with its responsibilities of governance. The more soft a state is, the greater the likelihood that there is an unholy nexus between the law-makers, the law-keepers, and the law-breakers. In a nutshell, this is the case of illicit trade in tobacco products in Pakistan destroying health of millions, especially the youth but governments are interested only in revenues and not even health tax as discussed above!

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The writers, lawyers and partners in Huzaima, Ikram & Ijaz, are Adjunct Faculty at Lahore University of Management Sciences (LUMS)