Illicit trade in cigarettes causes Rs24 billion annual revenue loss of Pakistan

KARACHI: There are multiple and far-reaching consequences of illicit trade in cigarettes. This includes annual revenue loss of over Rs24 billion to the Government of Pakistan, a report named ‘Challenge of illicit trade in cigarettes’ prepared by Nielsen said.

Nielsen operates in more than 100 countries and is a global leader in measurement and information. This research has been undertaken and compiled by Nielsen in July 2015 on the request of Pakistan Tobacco Company Ltd (PTC) and Philip Morris Pakistan Limited.

Illicit trade in cigarettes, whether in the form of smuggling, local tax evasion or counterfeit, is a global phenomenon, with one in every 10 cigarettes and tobacco products reported to be illicit. Experts are of the view that it would be hard to find a more ideal candidate for illicit trade than cigarettes.

The product is small, lightweight and profitable for illicit trade because the sale price is many times the cost of manufacture, mostly due to high levels of local tax in most countries. All countries, be they developed, developing or in transition, suffer multiple negative consequences of this illicit trade.

In 2013, Pakistan ranked 4th highest in Asia on the basis of share of illicit cigarette segment in total cigarette market in the country. In Pakistan, approx. 1 out of every 4 cigarettes sold is illicit, which is 137 basis points higher than the global average.

In 2014, more than 19.5 billion illicit cigarettes were sold in Pakistan. On average, more than 1.6 billion illicit cigarettes are sold in Pakistan every month, and this illicit segment continues to grow. During the last six years, the illicit segment has grown by 43.5% and the tax-paid cigarette volume has declined by 11%. On average more than 1 billion illicit cigarettes are annually added to the illicit segment in Pakistan.

This high prevalence is driven by a multitude of demand and supply factors. As fiscal and regulatory burden on tax-paid segment increases, more and more consumers are purchasing illicit substitutes that are either cheaper (due to tax-evasion) or are noncompliant (due to lack of health warnings).

Macro-economic factors including rates of employment, income, and inflation also impact affordability of cigarettes and hence the level of illicit trade. Pricing and regulatory differential with neighbouring Afghanistan

also plays a key role in continued inflow of smuggled cigarettes into Pakistan (in 2014 more than 2 billion cigarettes were smuggled into Pakistan).

High profit margin that retailers make by selling illicit products also drives the growth of such tax-evaded products. Above all, lax enforcement of fiscal and regulatory laws is the key factor that influences the incidence of illicit trade in Pakistan.

In 2014, 17.3 billion local tax-evaded (LTE) cigarettes were sold in Pakistan, which is 21.1% of the total cigarette market in Pakistan. These LTE cigarettes are extremely cheap. The average selling price of LTE brands in Pakistan is Rs. 27 per packet, which is far below the minimum tax per packet of Rs. 33.80.

Selling a packet of cigarettes below the minimum applicable tax is itself clear evidence of tax evasion. On the other hand, most of the tax-paid brands are priced at Rs 57. In the last four years alone, this price differential between tax-paid and tax-evaded brands has increased by a 100%.

This growing price gap between the two segments is fuelling the growth of LTE cigarettes in Pakistan, making it 89% of the total illicit segment.

Manufacturing and distribution of LTE cigarettes in Pakistan is not some covert operation. An elaborate and well established supply chain is there to ensure the availability of these products across the country.

Cigarette making itself is an elaborate process. Manufacturing and marketing of such a huge quantity of cigarettes (17.3 billion LTE cigarettes in 2014) involves extensive operations involving buying of raw materials, treatment of raw material, conversion into manufactured cigarettes, storage facilities and an extensive country wide distribution network. The under-declaration of raw materials, including tobacco crop, cigarette paper, and filter rods, helps in under-declaration of volume of cigarettes manufactured that ultimately assists in evasion of excise duty and sales tax on cigarettes (final taxable product).

There are multiple and far-reaching consequences of illicit trade in cigarettes. This includes annual revenue loss of over Rs. 24 billion to the Government of Pakistan. This reduced domestic revenue generation makes Pakistan more dependent upon foreign aid and loans.

Availability of tax-evaded and cheaper cigarettes increases the accessibility and affordability of tobacco products thus undermining the public health agenda. Despite public health driven increased regulatory and fiscal burden, the smoking incidence remains virtually unchanged in Pakistan.

During 2008 and 2013 the smoking incidence in Pakistan only reduced by 0.2 percentage points, because the volume has shifted from the tax-paid segment to the illicit segment.

During this period, the tax-paid segment volume declined by 10.1% and the illicit segment volume grew by 24.8%. Moreover, the lax compliance environment creates a perception of a soft-state which negatively impacts the foreign direct investment potential.

The criminalization of legal trade itself has socioeconomic consequences. Proceeds from illegal tobacco are a means of amassing great wealth for criminal groups to finance other organized crime activities, including drugs, human and arms trafficking, as well as terrorism. Last but not least, illicit trade undermines the legitimate and compliant cigarette sector which faces a non-level playing field.

That is why tax-paid segment having 76.3% market share contributes 99.3% of the total annual tax revenue from the cigarette industry, whereas those who have the remaining 23.7% market share (illicit segment) contribute only 0.7% of the total revenue.

Over the years, the Government of Pakistan has put in place a robust regulatory regime intended to curtail illicit trade in cigarettes.

Over 25 Acts of Parliament, Presidential Ordinances and Statutory Rules prescribe strict laws regulating virtually every step of the cigarette industry supply chain.

These include laws and rules regulating crop buying, procurement and use of raw materials, manufacturing, transportation and distribution, and finally import and retailing of tobacco products.

Despite this comprehensive regulatory framework, illicit segment occupies almost a quarter share of the overall cigarette market in Pakistan. This clearly shows that lax enforcement of fiscal and regulatory laws is the real hurdle in curtailing this.

There is a need to execute a comprehensive and holistic strategy to tackle illicit trade in cigarettes. Multiple laws already exist and if enforced rigorously can bring down the incidence of the illicit segment and help the Government in raising more revenue.

Measures that can assist in enforcement include establishment of a single, dedicated task force headed by a Federal Minister, district level mobile enforcement units, expanding capacity of customs, and joint capacity building workshop for law enforcement agency officials.

Mass media campaigns on print, electronic and social media can be used to increase awareness about illicit trade. Illicit Free City Campaign, along with Citizen Journalism, can also be launched as pilot projects. Re-calibration of cigarette taxation policy to make it more balanced can help in reducing consumers switching to cheaper tax-evaded substitutes.

Summary trials for on-spot penalties for illicit traders can increase risk of penalties. Harmonization of fiscal and regulatory laws with neighbours can reduce inflow of illicit cigarettes into Pakistan.

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