KFY ARIFA PAPFR
EXCISE TAXATION
OF
TOBACCO PRODUCTS
P. M. BINGHAM
MAY 1992
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CONTFNTS
KFY ARFA: VXrISIF TAXATION OF TORAcro PRonUrTS
Page
A. THE ISSUE 1
B. POLICY I
C. STRATEGIES 2
D. EXPLANATIONS OF STRATEGIES 3
Level of taxation
Frequency ofTax increases
Excise collection
Retail Prices
Retail Price Index
Company Responsibility
Government Relations
Industry Relations
Competitor Monitoring
Value Added Tax
Appendix I Structure ofTaxation 14
Appendix 11 Excise Administration 20
Appendix III Related Issues 22
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SFCRIFT
KRY ARFA: EXCISE TAXATION OF TOBArco PRODUCTS
A. THE ISSUE
Tobacco excise taxation is the most significant
element of the retail selling
price of tobacco products and hence plays a major
role in determining the
commercial environment in which we operate.
In particular, excise taxation determines the
level of retail prices, the price
structure and therefore the overall pattern of
smoker demand for our products.
It is also closely linked to, and significantly
influences the level of profitability
and cash flow performance of an Operating Company.
Excise taxation has always been a key issue but is
becoming even more so
because of increases in the I evel by Governments
either for revenue or health
reasons, with resultant increases in real price
levels. while competition,
parlicularly P. Morris. increasingly seek to
influence the structure of the
taxation in order to optimise their competitor
position in the market place. The
critical product category is cigarettes which
accounts for well over 90% of
global tobacco consumption. This paper therefore
focuses upon cigarettes
although there is some reference to other tobacco
products.
International co-operation and cross fertilisation
between Governments is
increasing with regard to indirect taxation, as a
result of which both taxation
levels and structures are being shaped by external
influences.
Excise taxation is therefore an issue for General
Management although its most
direct impact is in the functions of Marketing and
Finance. General Managers
should advise BATCo ofall changes in excise
structures and levels, and
discuss any proposals for change with BATCo prior
to their submission to
Government.
B. POLICY
To manage the cigarette excise taxation issue in
order to establish the most
appropriate retail price structure whilst
optimising profitability and cash flow
over the long term.
In most instancM long term prof-it optimisation
will normally result from a
totally or predominantly specific excise taxation
structure, in preference to an
ad valorem one. The optimum balance between
specific and ad valorem will
depend upon the brand mix of each company.
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La
C STRATEGIES
This policy will be achieved by focusing upon the
following main strategies:
1. Seek to reduce excise taxation, or to ensure
that its level does not
increase at a rate greater than inflation.
2. To secure smaller and more frequent increases
in preference to
larger and only occasional increases in excise
taxation.
3. To establish a structure or system of excise
taxation which results
in a range of retail prices most appropriate to
the BAT brand mix
whilst also optimising profitability over the
longer term.
4. To establish a method of collecting the excise
which :
maximises any excise credit terms but at least
ensures revenue
neutrality between when payment is received from
customers and when
payment is made to the Government.
maximises the involvement of the manufacturer in
the collection of
excise and minimises the involvement of the
distributive and retail
trades. The reason for this is to retain
manufacturer control over the
determination of the retail price which is
essential for long term profit
optimisation.
establishes a single retail price for a brand
either by means of a fixed
retail price or a retail price agreed with the
Government as the basis for
calculating any ad valorem excise.
makes it difficult for Governments to impose
"ncalth'surchargcs in the
future or to impose differential taxation linked
to tar : nic delivery
levels;
minimises the ability of competitors to underpay
their excise tax and so
derive a competitor advantage.
5. To secure maximum freedom to determine selling
prices without
Government intervention or approval, whilst also
minimising the ability
of the retail trade to vary prices from those
recommcnded by, or fixed by
the manufacturer.
6. To oppose the removal of tobacco products from
the retail price index,
which has become an objective for the anti-tobacco
lobby in order to
enable Governments to increase taxes and therefore
prices without
considering the inflationary impact of their
actions.
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7. To define the responsibility for excise within
your company both from
the public affairs and commercial viewpoints.
8. To maintain a dialogue with key Government
officials and Ministers in
order to influence their policy, and to establish
links with other
companies such as alcohol, oil etc who may assist
in this process.
9. To lead, but act with the rest of the tobacco
industry and to maximise the
benefits from including other interested parties
such as falmers,
processors, suppliers and the trade.
10. To monitor competitor excise payment
disciplines to ensure that we arc
not disadvantaged from either slower payment or
non-payment by our
competitors.
11. To seek to ensure that the application of
Value Added Tax to tobacco
products does not increase the total tax burden.
These strategies are explained in greater detail
in the subsequent sections.
D. EXPLANA'nON OF STRATEGrES
1. Level a f Taxation
The combined forces of Government revenue needs
and the anti-smoking
lobby have resulted in increased real levels
oftaxation in many countries,
a situation which is likely to intensify further
in the foreseeable future.
Every opportunity to reduce the level of taxation
should be pursued even
though the achievement of reductions may never be
easy. Reductions
have been achieved in the Netherlands and other
countries in recent
years.
Should reductions prove to be unachievable
companies should contain
the increase in taxation to a level below the rate
of inflation or at worst in
line with it. Arguments supporting this include :
the inflationary impact of tax increases ahead of
inflation, particularly
upon lower income groups who frequently account
for a
disproportionately large amount of tobacco sales-,
the normal economic arguments that tax increases
result in falling
demand, employment, PTOritability and investment,
both directly
upon the company and indirectly upon suppliers;
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increases in taxation and hence retail price can
result in the
emergence or growth of transit or border trade
business and hence a
fall in revenue yield;
high tax increases may result in smokers dropping
out of the
manufactured cigarette market and switching to RYO
which is often
taxed at a lower level or not at all. It is
conceivable that overall
Government receipts could fall in such
circumstances-.
increases in taxation may result in a decline in
consumption sufficient
to bring about a fall in revenue yield to the
Government. Because of
the inelasticity of demand for cigarettes over the
longer term, this
result rarely occurs. However, it is not uncommon
to see a short term
decline in revenue yield which ran be pointed out
to Government
when opposing increases;
increases in taxation which reduce consumption may
mean the
destruction of the vitality of the tobacco
industry and thus the erosion
of the tax base which Government may wish to
protect over the long
term. This applies even more in countries with a
significant leaf
export trade which depends to some extent upon the
continued
existence of the local industry.
increases in taxation arc either out of line with
international or
regional norms or would result in the incidence of
taxation becoming
out of line with such norms.
Although it can sometimes happen, it is most
unlikely that an Operating
Company will be in a position where it elects to
absorb a part or all of an
increase in excise taxation.
2. Frequency of Tax Increases
The psychology of smoker demand is such that they
are more likely to
absorb smaller and more frequent price increases
than larger and less
frequent price increases. During negotiations with
Government therefore
it is preferable to seek the former excise
environment. However. this has
also to be interpreted in the context of the
general level of inflation in the
country plus the significance of stick sales and
coinage availability which
may act as a constraint to the implementation of
this strategy.
In markets of high inflation, it is always
preferable to take manufacturers
prices increases ahead of inflation instead
ofbehind it, with the exact
timing sometimes determining the difference
between operating
proritability or a loss. The timing of
manufacturer price
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increases however, sometimes has to be integrated
with excise increases,
and it is desirable that this should be so under
certain circumstances,
although flexibility not to do so should also
exist.
3. Structure of Taxation
The structure of any excise system determines the
pricing scenario of the
market place and has a significant impact upon the
level ofprofitability.
Both Marketing and Finance should fully understand
the implications of
the current excise structure and establish whether
a competitor advantage
might accrue from a change to a different
structure. In many instances,
change may be either inappropriate or impossible
while in other instances
change may be appropriate and possible. The
structure is also highly
relevant to the key issue ofproduct quality with
specific excise normally
resulting in higher product quality then ad
valorem because the latter
encourages price competition and hence cost and
quality reduction.
There is no single excise structure appropriate to
BAT on a global basis
because the competitor and brand mix situations
vary widely. Companies
should evaluate their own position in the market
place in order to
deier-mine the structure most appropriate for
them, although in the
knowledge that excise structures tend to change
only rarely. However, a
specific excise structure is more likely to result
in higher long term
profitability than in an ad valorem structure.
In evaluating excise structures and any subsequent
lobbying of
Goverriments for change. Companies should be aware
of, and if
necessary counter, any IMF/World Bank involvement
because their
advice to Government is invariably to apply ad
valorem systems because
of their be] ief, often misguided, that such
systems maximum revenue
yield and maintain the yield in real terms.
There are two types of excise structure in
operation around the world
which are applied by national Governments as a
means ofraising revenue
upon tobacco products. Although revenue is also
derived from tobacco
import tariffs or duties, these are distinct and
do not form a part ofthis
paper. The two structures are :
a) End Product Excise a tax linked to the end
cigarette product
and based normally upon the final retail
selling price or a price agreed between
the Government and the manufacturer for
the purpose of excise calculation,
although on occasions it can also be
linked to the ex factory selling price of
the manufacturer.
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End product excise structures are either
SPECIFIC, AD VALOREM or a mixture
of the two.
A SPECEFIC excise is a fixed amount
per 000 cigarettes whereby the tax per
cigarette is the same irrespective of size,
speci fication and cost of manufacture or
retail price. With the incidence of
taxation at a high level, the retail price
range in the market place will therefore
be limited because any reductions of price
have to be absorbed by manufacturers
while their ability to lower prices is
restricted to the variation on costs of
manufacture. In addition to having a
fixed specific excise applicable to all
cigarettes a'slib' system can be applied
whereby the amount of sliccific varies
according to the retail price, with lower
priced cigarettes attracting a lower
specific than high priced cigarettes.
An AD VALOREM excise is a
proportional tax calculated as a
percentage ofthe retail selling price or a
price agreed between the manufacturer
and the Government. On occasions. it
has also been calculated as a percentage
of the ex factory selling price. With an
ad valorem structure, the retail price
range in the market place will tend to be
quite wide because any price increase or
reduction by the manufacturer will be
multiplied by the ad valorem tax resulting
in a lower price by an amount much
greater than the original reduction by the
manufacturer.
A MIXED end product structure is
simply a combination of the specific and
ad valorem structures. Such a structure
applies in the European Community and
is increasingly being adopted in other
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countries in order to achieve a syst=
which is related to the needs and
purchasing habits of consumers, the
competitor situation and varying price
segments, whilst providing a more stable
tax yield for the Government.
An additional feature of the end product
excise structure in the European
Community for example, is VALUE
ADDED TAX which is a tax applied to
all consumer goods including cigarettes.
This is always expressed in percentage
terms and is therefore an ad valorem tax
in addition to anv end product ad valorem
tax which is appiied to cigarettes. If such
an additional tax is applied, it is
important to get Government to accept
that it forms part of the overall incidence
of tobacco taxation and that it forms part
of the total ad valorem element of that
tax.
b) Specific by Weight: Some countries have a
structure of
cigarette taxation which is based upon a
specific amount of tax per kg either of
tobacco only or inclusive ofthe paper and
filter. With such a structure the amount
of taxation varies according to the
cigarette specification with the result that
lighter cigarettes have a significantly
lower price than heavier cigarettes. The
resultant range of retail prices is therefore
similar to an ad valorem structure
although the tax is a specific one. The
principle efTect of such a strucrure is that
the market may switch down to either
shorter cigarettes or cigarettes with lower
circumferences or densities. Examples
include Cameroons and Australia where
the Federal excise is upon the overall
weight of the cigarette including the
paper and the filter-
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It should be emphasised that the main excise
distinction is between
specific and ad valorem systems whereby a specific
excise is levied upon
the cigarette itself whereas an ad valorem excise
is levied upon all the
costs and profits included in the final retail
price, except where it is
levied upon only the ex factory price where some
of these elements are
excluded eg. trade margin.
The structure of taxation for products other Lhan
cigarettes generally
follows one of the above options. In the main,
cigars and cigarettes do
not directly compete against each other with the
possible exception of
miniature cigars. Similarly, Pipe tobaccos,
Chewing Tobaccos and Snuff
do not compete directly against cigarettes.
However Roll Your Own
smoking tobacco is in direct competition with
manufactured cigarettes.
Companies must understand the relative excise
incidence of these two
product categories and their impact upon relative
price levels and
switching between the two categories. Although
circumstances vary, the
BAT policy is to minimisc the price advantage of
RYO and so maximise
the market opportunities for manufactured
cigarettes.
Further aspects of the structures of excise
taxation are developed in
Appendix One.
4. Excise Collection
The administration of tobacco excise taxation can
frequently be complex
but within this complexity, opportunities may
exist to derive benefit for
the Company.
In all countries, the timing of excise payment is
crucial because of its
cash flow and profit implications. The minimum
objective should be to
ensure revenue neutrality whereby excise is not
paid until payment has
been received from the distributive trade However,
one should always
press for a period of excise credit which is
positive, which covers one's
costs of administering and collecting the tax on
behalf of the
Government, which covers any bad debts (if any)
and which is consistent
with the concept of all indirect taxation viz:
that a consumption tax
should be paid when the product is consumed, not
when it is
manufactured or still in the distribution
pipeline. There have be=
occasions where Governments have increased the
period of excise credit
instead of permitting a price increase (the latter
being inflationary) as a
means of improving profitability. With regard to
bad debts,
Governments should be lobbied to carry this risk
themselves, thereby
limiting the risk of the manufacturers to the net
cost of the goods only.
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Experience of excise systems demonstrates clearly
that it is preferable to
minimise the involvement of the trade in the
system so that the
manufacturers essentially retain the optimum
influence over the final
retail selling price. In Europe in particular, the
power and influence of
the trade has and still continues to grow with
resultant pressure upon
manufac=ers to give higher margins, bonuses or
other incentive
payments to the trade. One of the means whereby
the influence of the
trade has been contained is the existence of an
excise collection system
whereby only the manufacturers are involved~ and
where the trade
margin is fixed either by law or practice on the
basis of the price
determined by the manufacturer in agreement with
the Government.
Where the excise is linked to the retail price of
a brand, (normally via an
ad valorem element) it is necessary to have either
a fixed retail price for
that brand a recommended retail selling price or
an agreed price for the
purposes ofcalculating the excise. This is
advisable also because it
minimises the ability of the trade to reduce the
retail price and so pass on
to the consumer the multiplied effect of any price
saving. To be able to
vary the price upon which the excise is based and
so vary the excise
itself, would result in the trade effectively
determining the retail price
instead of the manufacturer doing so.
In some countries BAT is at competitor
disadvantage against local or
national companies who either under declare or
underpay their excise
liability. Although banderoles or fiscal stamps
are not desirable because
of their negative impact upon manufacturing
efficiencies, they may offer
some scope for resolving this problem. However,
companies should also
consider the possibility of presenting a case to
Government, provided that
they are sure of the evidence of underpayment.
5. Retail Prices
Retail prices, excise levels and increases in
excise taxation are oflcn
closely linked in many countries. Government
influence varies from
completely controlling retail prices to allowing
full freedom to
manufacturers. Retail prices vary from being fixed
by law or practice to
being free, with the manufacturers and the trade
being able to change
prices bv whatever amount they wish, whenever they
wish.
Because circumstances vary widely, it is diMcult
to have a global
strategy. However, the interests of the Group arc
best served by a
situation where the company is free to determine
the retail price for its
brands uhich should then be fixed, with the trade
margin being linked to
this either as a fixed amount or a percentage (a
fixed amount is
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preferable). Although it is normally difficult to
dictate the degree of
involvement of Government in the excise : price
process, one should seek
to eliminate or minimise the involvement of the
trade so that the balance
of power stays with the manufacturers.
In markets where stick sales predominate, clearly
the trade plays a key
role, but companies should examine every
opportunity to maximise the
prices accruing to the rr=ufacturer when excise
increases are passed on
to the consumer, although balancing this with the
need to give the trad a
satisfactory level of return based upon the actual
stick price.
When permitted, it is normally preferable for the
industry to apply for
and implement price increases collectively and
simultaneously and to
negotiate with Government, where necessary, on an
industry basis.
Unilateral action, particularly to reduce prices
may be detrimental to the
success of any future application to increase
prices either at the same time
or independently of an excise increase. It may
also be detrimental to
market share.
6. Retail Price Index
It is frequently argued by the anti-smoking lobby
that the price of
tobacco products should be removed from the index
of retail prices of the
cost of living index. This would then enable
Government to impose
higher levels of excise for "health' reasons,
without impacting negatively
upon the level of inflation.
The effect of excise increases will be felt in any
economy, whether or not
they are included in an index of retail prices. To
pretend otherwise is
naive while to exclude a bona fide product from
such an index would
give rise to doubts about the validity of
Government statistics generally.
Such an action would limit the use of the index in
economic policy
formulation and economic planning generally
because the use of an
incorrect statistic will always have a distorting
effect-
Companies should oppose any such attempt, and seek
to enlist the
support of trade unions who utilise the index for
wage negotiations,
together with economists and statisticians
sympathetic to the position of
the industry. Although this is the general global
strategy, there may be
circumstances when the level of inflation combined
with price controls
may necessitate its removal if to do so is the
only means of putting the
industry on a basis of profitability, for example
where a Government is
refusing a necessary price increase because of its
effect on the index of
inflation. However, this shatzld not be undertaken
unless the positive
results will accrue over the longer term.
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7. Company Responsibi1ity
Excise taxation and pricing are general management
issues and will
always involve different business functions within
your companies.
However, it is essential to have clear
responsibilities for the management
ofthe excise issue.
The key elements are:
strategic planning of excise and pricing
accounting and computation of options
management of payment and administration
lobbying
S. Government Relations
The issue of Goverriment relations is closely
linked to that of Smoking &
Health which is more fully covered in the Plubiic
Affairs key area paper,
whereas this paper covers relations in the context
ofthe technical aspects
ofexcisc taxation.
Government officials responsible for tobacco
excise planning and
control, from a relatively low to the highest
level, should be identified
and sufficient regular contact maintained while
Ministerial (Government
& Opposition) contacts should also be maintained
to ensure that the
Company is well placed to have its views taken
into consideration when
policy is being determined. Such contact should be
the responsibility of
senior management and the Board to ensure an
adequate level and quality
ofcommunication.
Such relations should establish BAT as the Company
to which
Government will turn when they need advice and
assistance upon any
aspect of excise taxation, which ofcoursc requires
the existence of the
knowledge and experience of excise in the Company.
This is becoming
more significant as our competitors seek to
influence and change
Government policy on excise structures from that
which is appropriate to
BAT to that which is more appropriate to their own
brand mix.
Conversely, we should examine the opportunities to
change excise
systems too, if indeed such a change would be
beneficial. Ineithcr
instance, good and regular Government relations
are essential.
In this same context, it is also relevant to
maintain close contact with
manufacturers of products also subject to excise
taxation particularly
alcohol where there are many excise similarities.
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9. Industry Relations
In a competitive context, tobacco excise taxation
is a key subject for
discussion and agreement in the National
Manufacturers Association.
Collective action and influence by the industry is
likely to be more
effective and productive than by individual
companies, although the latter
may also be appropriate from time to time.
Although the lead company
on excise issues tends to select itself on the
basis of market share, it can
also be on the basis ofknowledge, experience,
contacts with
Goverriment. Where market share means that it is
not BAT companies
should seek to ensure a lead position through
these other means. Excise
contains many complex aspects which have to be
mastered if NMA
leadership is to be established.
Although the main thrust on excise should and will
always come from the
manufacturers, some benefit may be derived from
incorporating natural
allies such as tobacco farmers, processors,
suppliers to the industry,
distributors and retailers in the lobbying
activities of the NMA on excise
levels.
Every opportunity for the industry to agree policy
and act collectively
should be taken. However, if agreement proves
impossible, it will be
necessary to devote the appropriate Company
resources to Government
relations to ensure that the Group position and
influence exceeds that of
the competition.
10. Compefitor Monitoring
BATCo policy is to comply with local excise
legislation wherever we
operate. In a number of countries, our competitors
do not always have
the same policy. In order that we are not at a
competitive disadvantage
evidence of avoidance or evasion should be advised
to Government to
ensure compliance. This is often an issue
requiring delicate handling but
the objective is clear.
11. Value Added Tax
Value Added Taxes (VAT) are always ad valorem.
Ideally they are
charged on the supply, including importation, of
goods and services at
every stage up to sale to a Final consumer. They
are accounts-based
taxes. This limits their coverage, for example to
manufacturers and
wholesalers in countries where retailers do not
keep accounts.
Businesses required to charge and account for VAT
are registered by the
tax authorities and required to keep specified
accounts and make periodic
returns ofthe tax due. The tax due is the
difference between the tax
charged on sales and the tax paid on business
purchases in the period.
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Excise duty periods and VAT periods need not
coincide. In some
countries Excise periods are monthly and VAT
quarterly. L=gths of
credit, before tax must be paid to the
authorities, are often longer for
Excise than VAT.
In many countries, where Governments are not
confident of collecting all
the VAT due from the wholesale or retail staged,
manufacturers are
required to charge the tax on wholesale or retail
prices. This can be
advantageous; it depends on the length of credit
there can be cash flow
benefits; it gives manufacturers a degree of
control over retail prices.'
It is important, when VAT is applied to tobacco
products, to seek to
ensure:
a) that excise rates are reduced in compensation
b) that the tax regime ailows the deduction of VAT
on AU business
purchases
c) that the length of credit adequately
compensates for the costs of
accounting for and collecting the tax for the
Government.
d) that the collection of VAT does not extend
beyond the
manufacturing stage.
P.M. Bingham
April 1992
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APPENDIX I
STRUCTURF OF TAXATION
The two main structures arc explored in some
detail in this appendix viz:
A) End Product Excise
B) Specific by Weight
A. END PRODUCT EXCISE
This method oftaxing cigarettes has been in
existence for a long time. There
are many examples where the three sub systems
apply viz:
Specific A fixed tax per 000 cigarettes, eg. Hong
Kong
Ad Valorem A variable tax expressed as a
percentage of the retail
price cg. Vcne-mela or the ex factory price, cg.
Nigeria.
Mixed A combination of the two eg. the European
Community.
The principle features, advantages and
disadvantages of these type of end
product excise are :
SPECIFIC A specific excise structure is most
suited to a company
whose brands have high levels of added value or
image
and arc positioned in the high and premium price
segments. Because a specific structure results in
only a
narrow price range between the cheapest and the
most
expensive, there is little opportunity to compete
on the
basisofptice. Aspecific structure is the global
policy
of Philip Morris whose brands are normally
positioned
at the top end of the market. Indeed, they lobby
hard to
change structures to specific and in some
instances have
succeeded, cg. Hong Kong.
A specific excise structure is closely associated
with
high levels of profitability and product quality.
Although many factors determine profitability, a
key one
is the nature and extent of price competition, the
opportunities for which are limited with a
specific
structure. For example
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A B C
Retail price 100 89 111
Specific Excise 70 70 70
Trade Margin - 10% 10 9 11
Net Manufacturer Price 20 10 30
This example demonstrates two features; of a
specific
structure based upon base case A :
B A reduction of 50% in the manufacturet's net
price
from 20 to 10 results in an I I% fall in the
retail
price thereby demonstrating the limited
opportunity for price competition.
C. An increase of 50% in the manufacturer's net
price
from 20 to 30 results in only an 11% increase in
the retail price thereby demonstrating how simple
it is for a manufacturer to increase profitability
provided freedom to raise prices exists.
For the same reasons as it discourages price
competition,
a specific structure tends to encourage high
quality
products.
A specific structure requires a positive act by
Government to raise the level of taxation which
may be
difficult to achieve in a political coalition
situation or
where the opposition is strong.
There are excise structures whose features are
essentially
specific but whose impact is the same as an ad
valorem
structure. This occurs when Govemment has
different
specific taxes according to a particular price
level with a
lower specific the lower the price and vice versa
(a'slab'
specific structure). A specific slab structure is
to be
preferTcd to an ad valorem slab structure.
It may be difficult to achieve a wholly specific
structure
in some developing markets because of the
resultant
limited price range which Governments may consider
necessary to meet the divergent needs of smokers.
In
such instances, a predominantly specific structure
should
be the target.
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AD VALOREM The impact of ad valorem excise
structure will vary
according to the local circumstances of a
particular
company. In a highly competitive market it may
result
in a significant degree of price competition and a
resultant low level of profitability. However, in
a
Monopoly or near Monopoly market, it may not have
the
same results unless a new small competitor starts
a price
war. It will also depend upon many factors such as
the
recognition by Competitors and Government of the
need
for a profitable price structure to ensure the
financial
health of the manufacturers and the Ministry of
Finance.
An ad valorem excise structure creates or is best
suited
to a company whose brands are nuinly located in
the
lower price segments, or a company whose costs of
manufacture are significantly lower than the
competition
by virtue of a dominant market share. Such a
structure
enables low added value and low image brands to
survive with a significant price advantage over
the
higher image brands whilst giving no protection at
the
bottom of the market in terms of a lower minimum
price. It also enables the advantage of lower
costs to be
passed on to the consumer with a 'multiplier'
effect on
the retail price.
An ad valorem excise structure is frequently
linked with
lower levels of profitability because it creates
the
circumstances where price competition can
flourish.
However, there are many exceptions to this which
demonstrates that many other factors need to be
taken
into account before such a general statement can
be
made.
An ad valorem structure has a multiplier effect
upon ex
factory price differences which enables
manufacturers to
reduce prices at thc'cxpense' of the Government
instead
of by reducing their own prorit margins for
example.
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A B C
Retail Price 100 50 150
Ad Valorem Excise
(70% ofretail price) 70 35 105
Trade Margin
(10% ofretail price) 10 5 15
Net Manufacturers Price 20 10 30
This example demonstrates two features of an ad
valorem structure based upon a base case A :
13. A reduction in the manufacturer's net price by
10
units from 20 to 10 results in a decrease in the
retail
price of 50 units thereby showing the multiplier
effect of an ad valorem excise structure.
C. Similarly an increase in the manufacturer's net
price
by 10 units ftom 20 to 30 results in an increase
in the
retail price of 50 units, thereby showing the
multiplier effect in the context of an increase.
The MULTIPLIER concept occurs directly from an ad
valorem structure. In the above case the
multiplier has a
value of 5 which means a net price change of 10
results
in a retail price change of5O. It is calculated as
follows
M = ju
100 - x
where x = the sum of the proportional elements
expressed as percentages of the retail price.
M = 10 - 10 -10 19Q
I 00-(ad 100-(70+10) 100-80 20
valorem
+ trade
margins)
For the same reason as it encourages price
competition,
an ad valorem structure can often lead to lower
quality
products whose lower costs can be passed on to the
consumer in the form of lower prices where the
reduction is multiplied through the tax structure.
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An ad valorem structure automatically increases
the
amount of excise when a manufacturer increases its
prices. It therefore has in appeal to Government
who
may not therefore need to take any action to
increase
their revenues. On the other hand. because revenue
yield depends on retail pricm there is a greater
danger
ofGovemment interference in retail price
determination
thin there is when the excise is specific.
In some markeU ad valorem excise is expressed as a
percentage of the ex factory price and not the
retail
price. In such situations, it may be appropriate
to
consider transferring some of the elements
normally
included int he cx factory price to beyond the
point
where the ad valorem is applied and so saving the
multiplier effect impacting upon them. One means
of
achieving this is to transfer some ofthe marketing
expenses. However, one should appreciate that this
might be a short lived tactic which may give rise
to
problems with Government over the longer term and
may enhance the power of the trade, particularly
if their
margin were increased to absorb the transfer of
marketing expenses.
MLXED A mixed excise structure contains elements
ofboth
specific and ad valorem. Its effect clearly
depends upon
the relative size ofthc two elements. Such a
system
applies throughout the European Community although
different countries have different rclativities
between the
two.
A mixed structure can be particularly beneficial
to a
company whose brand mix includes both higher
priced
brands and mid priced brands which are normally
local
or national.
T'he exact balance or relatively between the two
will
depend very much upon the cost structure of a
market
and the retail price structure required.
B. SPECIFIC BY WEIGHT
This method of taxing cigarettes originated in the
United Kingdom .%-hich
discontinued it when it joined the European
Community. However, many
countries still apply such a structure, the most
notable being Australia. The
principle features of such a system arc
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because excise varies in line with the quantity of
tobacco used. the
tendency is for products to be launched with lower
specifications and
hence lower prices. Such an excise system
therefore can lead to intemse
price competition and the significant reduction in
levels of profitability.
For example, in Australia, the cigarette market
has progressively moved
through various phases commencing with 20's king
size full density
products (260 mg) to 25's, Ws 35s 40's and now
50's packings with
densities at the level of2OO mg and lower. As a
resWt, levels of
profitability in this market has fallen
significantly. Although an intensely
competitive markets the excise System has created
a situation in which
price competition can flourish at the expense of
industry profitability.
The method of applying such 2L structure is
important because of the
opportunities to agree specifications with
Government for excise
purposes which may offer scope for paying a lower
level of excise than
the competition.
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APPENDIX 11
F.XCI.Rv ADMTNISTRATION
'17here are many aspects of excise administration
which have an impact upon the
company. Although not all of them can be addressed
in a key area paper, some are
worthy of inclusion.
TMUNG OF PAYMENT
It is important to establish exactly when excise
taxation falls due, and when the clock
starts for any excise credit granted by
Governments.
With banderoles or fiscal stamps, the timing of
payment is normally based upon the
actual purchase of the stamps, the time it takes
to manufacture and deliver and the
stock durations of the manufacturers and the
trade. Arguments and supporting
evidence are essential to persuade Governments to
accept payment only when the
cigarettes have been sold to smokers or as a
minimum when payment has been
received by the manufacturers.
With other systems of collecting excise the same
principles of the timing of payment
apply although the issue of when delivery to the
trade takes place often becomes more
important (is it when goods move from a central to
a regional depot or from the latter
to the trade). This also has implications for
stock valuations.
With regards to the date and day of payment, it is
helpful to establish whether payment
has to be with the Government in the form of a
chcque, whether it has to be in their
account or whether it has to be with them in the
morning or at any time on that date.
The time taken to clear a chequc can often be
significant in cash flow terms.
REFUNDS
It is important to establish a procedure for
refunds or non-payment either to deal with
returns from the trade, damaged goods or bad
debts. The exact details will relate to
the method of payment but should take into
consideration the following:
an entitlement to a credit or refund for all goods
returned by the trade, at the rate
of excise appropriate to them. It is perhaps
unrealistic to expect any refund to be
at a level higher than the excise actually paid
although it might be
administratively simpler to provide for refunds to
be at the current excise rate.
An entitlement to a credit for all goods damaged
during the manufacturing
process, up to the point at which they are
distributed to the trade.
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An entitlement to a credit for all bad debts with
trade non-payment being shared
on the basis that the manufacturer beam the cost
of the goods but the
Government bears the excise taxation element. 'nc
transfer of ownership is
often a crucial element in this area
Provisions for excise taxation and refunds are not
always identical to those for
value added tax (if applicable). Governments
should be persuaded to apply the
same provisions using the more beneficial of the
two.
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APPENDIX III
IRV] -ATFD ISSUvs
A. TIMING OF PRICE INCREASES
The link between excise taxation and retail prices
is obvious but there are two
aspects which relate to the timing of any increase
which are critical :
Manufacturers must lobby for the freedom to
implement price increases at
the same time or separately from excise increases.
Flexibility is the key
here because one may %rish to implement a
manufacturer price increase at
the same time on one occasion or separately on
another.
The management of the implementation of a price
increase is critical to
ensure that there is no negative discrepancy
between tax due and prices
charged and to optimise any opportunity for a'tax
holiday'both from a
manufacturer and a consumer point ofview.
B. VALUE ADDED TAX
VAT is an ad valorem indirect tax which applies in
a growing number of
countries, and which is applied to tobacco
products over and above excise
taxation. In such countries, it is preferable to
integrate the VAT into the
overall tobacco excise taxation structure and
collection procedures, in order to
maintain manufacturer control over retail prices,
to minimise the overall ad
valorem tax proportion, and to benefit from the
often longer credit periods
granted for excise taxation compared with those
for VAT.
For example, in a country such as the Netherlands,
the end product excise
structure is an equal balance between specific and
ad valorem while VAT is
applied additionally at 15.6% of the retail price.
With such a situation, this
means that the ad valorem taxation elements add up
to over 60% of the overall
burden of taxation. However, the VAT is integrated
into the ad valorem excise
element such that the balance is 50:50. This is
advantageous not only because
it reduces the ad valorem proportion but also
because the three months excise
credit is greater than the one month credit period
for VAT.
C. UMFORT TARIFFS
Although import tariffs or duties arc separate
from excise taxation, they have a
relationship in that an excise tax can result in a
multiplication of an import
tariff or because Governments sometimes consider
them in the same revenue
context.
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In the expanding global scenario whereby exports
currently account for 18% of
BATCo cigarette sales, tariffs are an important
commercial issue, Since most
of our exports are ofhigher quality, higher price
international brands, our
policy in export markets is as follows:
eliminate tariffs
replace ad valorerzi tariffs with specific tariffs
persuade Government to raise revenue through
excise and other indirect
taxation not tariffs
lobby for specific or predominantly specific
excise taxation because ad
valorem excise multiplies the amount ofthe
tariff(a tax on a tax).
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