Different prices for same cigarettes?

Cigarette pricing in India can go the liquor way as ITC, the undisputed leader in the sector, may consider state-specific pricing for its popular brands. This comes after the ad valorem duty imposed in the Union Budget, coupled with the varying value added tax (VAT) rates across states.

Breaking from the earlier specific excise duty structure, finance minister, Pranab Mukherjee introduced an ad valorem duty of 10 per cent on half of the maximum retail price of filter cigarettes over 65mm.

ITC has already raised prices of select brands such as Classic, Gold Flake Filter King, India Kings and Navy Cut. Going forward, there could be some restructuring in the pricing structure, too. There are about 30 different effective tax rates across the country; the highest VAT rate is in Rajasthan at 50 per cent, while the lowest at 12.5 per cent is in Arunachal Pradesh.

"In view of the high ad valorem component and differential state VAT rates, manufacturers may be forced to resort to state-specific pricing," a company spokesperson said.

Varying sales tax rates and excise duty across states is what makes prices of liquor differ across the country, leading to arbitrage. So, if prices of a bottle of Antiquity in Maharashtra are different from Punjab, the same could become a reality for a pack of Classic cigarettes.

An unintended outcome would be the attractive tax arbitrage opportunity it would provide, for illegal inter-state diversion of stocks and the trade falling

into the hands of organised criminal syndicates, the ITC spokesperson noted.

There are other problems with the ad valorem levy. The company feels it would result in unproductive costs in managing logistical complexities. More important, it could lead to disputes in calculating ad valorem excise duties.

Nikhil Vora, managing director, IDFC Securities, feels the ad valorem levy is a potential structural negative for ITC, as it would limit its power to continue expanding margins as it has done over the past five years, despite a less than two per cent volume growth. State-specific pricing, he thinks, would be tough to manage and was not a solution for the longterm.

ITC didn't want to comment on the impact of ad valorem on its margins. "The hike illustrates the intent of the government to capture the pricing element in the domestic cigarettes business. The government is taking cognizance of the fact that companies like ITC have maintained profit growth despite contraction in volumes, which limits the government's revenue potential," an IDFC Scurities report said.

"The introduction of a 65 mm slab is a step in the right direction and demonstrates the government's definitive action in addressing the proliferation of illegal non-duty paid cigarettes available in the market at Re 1 for a 69 mm length.

However, to effectively combat this menace of illegal cigarettes available at lower prices, it is important to reduce the duty further, to enable the legal industry to position a product at a similar price point," the company spokesperson said.