SECRET
\\,B A T,)
INDrRECT TAXATION OF
TOBACCO PRODUCTS
ICEY AP.F-k PAM
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BATCo document for Province of British Columbia 23
April 1999'-


CONTENTS
KEY ARF--k : INDIRECT TAXATION OF TOBACCO PRODUCTS
A. THE ISSUE
B. POLICY
C. STRATEGIES
D. F-XPLANATIONS OF STRATEGIES
Level of taxation
Frequency ofTax increases
S tructure of Taxation
Excise collection
Regional Taxes
Retail Prices
Retail Price Index
Company Responsibility
Government Relations
International Trade issues
Industry Relations
Competitor Monitoring
Value Added Tax
Appendix I Structure of Taxation
Appendix II E.-.cise Administration
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BATCo document for Province of British Columbia 23
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S7 CRFT
KFY AR17A : LNDTRFCT TAXATION OF TOBACCO PRODUCTS
A. THE ISSUE
Tobacco indirect taxation (excise tax, sales tax,
VAT and import tariffs) 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, indirect taxation
determines the level of
retail prices. the price structure and therefore
the overall partern 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 and VAT has always been a key
issue but is becomim, even
more so because of Government increases in the
level e;Lhc,- for revenue or
health reasons. with resulMnE-i-
.. _,her real prices. Also. competition,
particularly PNI, increasingly seek to influence
the structure of the taxation
system in order to optimise their competitor
position in the market place.
The critical product category is cigarettes, which
accounts for weLl over 9017.
of global tobacco consumption. this paper
therefore rocuses upon cigarettes,
although there is some reference to other tobacco
products.
International co-operation and cross ferdlisation
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.
Tobacco indirect taxation 'is therefore an issue
for General Mana,,ement
ilthou-h its most direct impact's in the functions
of Marketine ;d Finance.
GenQ ZManagers should advise' Millbank of all
changes in tax structures and
levels. and discuss any proposals for change with
Millbank prior to their
submission to Government.
B. POLICY
To manage the cigarette indirect taxation issue in
order to establish the most
appropriate retail price structur.- whilst
optimising profitabilicy and cash flow
over the long term.
In most instances. long Eerm proCit optimisation
will normally result from a
totally or predominantly specific excise taxation
structure, in prer'erence- 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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BATCo document for Province of British Columbia 23
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C. STRATEGIES
This policy will be achieved by focusing upon the
following main saw2gies
To seek to reduce the rate and/or incidence of
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 remil prices most appropriate to the BAT
brand mix whilst
also optimising, profitability over the longer
term.
1. 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
custome:s and
when payment is made to the Government.
- maximises the involvement of the manufacturer in
the collec:ion of
exc.se and minimises the involvement of the
distributive at-.,-', -Ctlil
trades. The reason for this is to retain
manufacturer control over the
determination of the retail price which is
essential for lone :erm 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
'health' surcharges 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 manage the possible conflicts and to gain
advantage from situations
where indirect taxes are levied on a national and
regional basis.
6. To secure maximum fttedom to determine selling
prices without
Government intmention or approval. whilst also
minimising the
ability of the ret-til trade to vary prices from
those recommended by,
or fted by the manufacturer.
BATCo document for Province of British Columbia 23
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7. 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.
8. To define the management responsibility for
tobacco indirect taxation
within your company both from the public affairs
and commercial
viewpoints.
9. To maintain a dialogue and close working
relationship with key
Gove-nmenE officials and Ministers in order to
influence their indirect
mxation policy and to establish links with other
businesses such as
alcohol. oil etc who may assist in this process.
10. To maintain working re!adonships with local
representatives of
I-NIF;Worid Bank/GATT agencies to be aware of and
influence policy.
11. To lead. but act with the rest of the tobacco
industry and to maximise
te benefits from including other parties such as
fkmers,
processors. suppliers and the trade.
12. To monitor competitor excise payment
disciplines to ensure that we
are not disadvantaged from either slower payment
or non-payment by
our compentors.
13. To seek to ensure that the application of
Vaiue Added Tax to tobacco
products does not increase the total tax burden.
These s---aEegies are explained in greater derail
in the subsequent sections.
D. EXPUNATION OF STRATEGrES
1. Level of Taxation
T-he combined forces of Government revenue needs
and the and-
smoking lobby have resulted in increased real
levels of taxation in
many countnes, a situation which is likely to
intensify further in the
"oresecable future.
Every opportunity to reduce the level of taxation
should be pursued
-,-en thou.
-h the achievement of reductions may never be
easy. If the
mxable base can be expanded e..-. by includin'.
smoking products not
prmntly taxed. then Governments may be persuaded
to effect rate
.eductions on c.-garectes. Reductions have been
achieved in the
Netherlands and other countries in recent years.
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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 iL Arguments supporting this
include :
the inflationary and regressive impact of tax
increases ahead of
inflation, partictilarty upon lower income groups
who frequently
account for a dispmportionately large amount of
tobacco sales-,
the normal economic arguments that tax increases
result in
failing demand, employment, profitability and
investrnent, both
directly upon the company and indirectly upon
suppliers;
increases in taxanon and hence retail price can
result in the
emergence or growth of transit or border trade
business and
hence a fall in revenue yield. This has very
dramatically been
illustrated recently in Canada. The high taxation
policy
followed by te Canadian Governmenc, in an effort
to reduce
smoking incidence, has failed and the hi.-h levels
of ta-xadon
have been reduced.
high tax increases may result in smokers dropping
our of the
manufactured c:zareae market and switching to RYO
which is
often taxed at a lower level or not at all. It is
conceivable that
over-all Government receipts could fall in such
circumstances;
increases in taxation may result in a decline in
consumption
sufficienE to brin- about a fall in revenue yield
to the
Government. i~;use of the inelasticity of demand
for
ci-arettes, over Lhe longer term, this result
rarely occurs.
H;wever, it is not uncommon to see a short term
decline in
revenue yield which can 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
~e continued existence of the local industrv.
increases in taxation are 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 C--
part or all of an increase in excise taxation. CY\
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2. Frequency of Tax Increases
The psycholog of smoker demand is such thaL they
are more likely to
.y
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
levell 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 stracegy-
In markets of high inflation, it is always
preferable to take
manut .acrurers prices increases ahead of
inflation instead of behind it,
with the exact timin-, sometimes determinina the
difference between
ope-rating profitability or a loss. The timing of
manufacturer price
increases however. sometimes has to be integrated
with excise
inc-eases, and it ;s desirable that this should be
so under certain
circurnstances. although flexibility not co do so
should also exist.
3. Structure of Excise Taxation
'rhe structure of anv excise svsz-,.-n deermines
the pricing scenario of
the market place and has a significant impact upon
the level of
profitability. Both . - and Finance should fully
understand the
Marketin..
implications of the current excse 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 ocher instances change may be
appropriate and
possible. The structure is also highly relevant to
the key issue of
product quality with specific excise normally
resulting in higher
product quality then ad valorern because the
latter encourages price
competition and hence cost and quality reducuon.
Thert is no single excise struc-ure 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 determine the structure most appropriate
for them. A speciric
excise structure is more likely to result in
higher long term
profitability than in an ad valorem structure,
however it might not be
appropriate in particular situations given the
current brand portfolio
and competitive position.
Essentially there are two broad methods of excise
taxation in
operation around the world which are applied by
national
Governments as a means of raising revenue upon
tobacco products:
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A speciric system levied upon the cigarette itself
by number or weight
of cigarettes produced or an ad valorem system.
where the tax is
calculated as a percentage of the retail selling
or ex factory price.
A oure snecific svstern bv number of cizarettes
levies a fixed amount
of tax irrespective of size, specification, cost
of manufacture or retail
selling price. Given that tax incidences are
generally high the retail
price range in the market place will therefore be
limited because any
reductions of price have to be absorbed fully by
manufacturers, their
ability to lower prices is restricted to the
variation on costs of
manufacture.
In addition to having a pure specific excise
applicable to all cigarettes
a 'slab or dered' system can be applied whereby
the amount of
spec"fic tax vares; according to the retail price.
(with lower priced
ciga.renes affn a lower tax than high priced
cigarettes), or ocher
physical charac:e-istic ;!.a. length of cigarette.
(longer ci- es
garert
attractin- hiLher :ax).
Some countries have a structure of cigarette
taxation which is based
upon a pecific amount of t--K t>er ke either of
tobacco only or
inclusive of the paper and filter. With such a
structure the amount of
taxation varies according to the cigarette
specification with the result
chat li-hEe- 6--ar.-tes have a significantly lower
price than heavier
cigueltes. The resultant range of retail prices is
therefore similar to
an ad valore-i smacture although the tax is a
specific one. The
principle effect of such a structure is that the
market may switch down
to either shorter cigarettes or cigarettes with
lower circumferences or
densities.
An ad valorem -Ncise is a proportional tax
calculated as a percentage
of the retail selling
,, price or a price agreed between the
manufacturer
and the Government. On occasions. it is calculated
as a percentage of
the --x 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 reduc-don by the manufacturer
will be multiplied by
the ad valorern am resulting in a retail selling
price changed by an
amount much g-reater than the original increase or
reduction by the
manufacturer.
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Although not strictly an excise tax, a sales = or
VAT is being
introduced by rrmny Governments as an indirect tax
applicable to all
consumer -oods including cigarettes. This is
always expressed in
*;,rrr.s and is th*erefore an ad valorem = in
addition to any
percentage
end product ad valorem tax which is applied 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 is part of the total ad valorem element of that
tax.
A mixed end product system is simply a combination
of a specific and
ad valorem structure. Such a system applies in the
European Uaion
and is increasingly being adopted in other
countries in order to
achieve a result which is related to the needs and
purchasing habits of
consumers, the competitor situation and varying
price seamenEs,
whilst providing a more stable mx yield for the
Government.
The structure of taxation for products other than
cigarettes generally
follows one of the above options. In the main,
cigars and ciguenes
do not directly compete against each other with ~e
possible exception
of miniature cigars. Similarly. Pipe tobaccos.
Chewing Tobaccos and
Snuff do not comDete directiv azainsr =zrettes.
However Roll Your
Own smoking tobacco is in direc-, competition with
manufac"ured
cigarttres. Companies must understand the relative
excise incidence
of these two product categories and their impact
upon reiative price
levels and switching between zhe two cateeories.
Although
circumstances vary. the BAT policy is to minimise
the price advantage
of RYO and so maximise the market opportunities
for manufactured
ci-
gare
Further aspects of Elie 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 = is nor paid
until payment has
been received from the distributive trade However,
one should
always press for a period of tax credit which is
positive, which covers
one's costs of administerin- and collectin-, the
tax on behalf of the
Government, which covers any bad debts (if any)
and which is
consistent with the concept of all indirect
taxadon viz : that a
consumption tax should be paid when the product is
consumed. not Cl\
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when it is manufactured or still in the
distribution pipeline. There
have been occasions where Governments have
increased the period of
= credit instead of permitting a price increase
(the latte 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.
Experience of indirect = systems demonsmates
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
,row with resultant
pressure upon manufacturers 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 or an excise
collection system whereby only the manufac-mrers;
are involved, and
where the trade margin is fixed either by law or
practice on the basis
of the price determined by the manuracturer in
agreement with the
Government.
NWhere the excise is linked to the remil. price of
a brand, (noftnally via
an ad valorem element) it is necessary to have
either a fixed remil
price for that brand a recommended retail selling
price or an agreed
price for the purposes of calculating the i-mcise.
This is advisable also
bemuse 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 pric.- upon which
[he 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 compe,_Jcor
disadvantage against local or
national companies who either under declare or
underpay their excise
liability. Adthough banderoles or fiscal stamps
are not desirable
because of their negative impact upon manufacuring
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.
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5. Regional Taxes
In some countries, e.-. USA, Australia, Brazil,
Canada, tobacco
taxation is a mixture of Federal and Regional.
This may offer
opportunities to trade off one authority against
another, either to
achieve lower overall taxation or better tax
credit payment terms.
However. the relationships between the Federal and
Regional
authorities requires careful management since
disharmony between the
two authorities can equally lead to higher levels
of taxation and worse
credit terms.
6. Retail Prices
Retail prices, = levels and increases in taxation
are often c!osely
linked in many countries. Government influence
varies tom
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 by whatever amount they wish,
whenever they wish.
Because circumstances vary widely, it is difficult
to have a global
strategy. However. the interests of the Group are
best served by a
situation where the company is free to determine
the retail price for its
brands which should then be fixed, with the trade
margin being linked
to this either as a Fixed amount or a percentage
(a fixed amount is
pre,crable). Although it is normally difficult to
dictate the de-
gree 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 manufacture- when
excise increases are
passed on to the consumer. although balancing this
with the need to
give the trade a satisfactory level of return b~~
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
indust:-y basis.
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7. 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 ofexcise 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 disiorting
effect.
Companies should oppose any such attempt, and seek
to enlist the
support of trade unions who urilise 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 2L
Government is refusing a necessary price increase
because of its effect
on the index of inflation. However, this should
not be undertaken
unless the positive results will accrue over the
longer term.
S. Company Responsibility
Indirect tobacco taxation and pricing are general
management issues
and in addition will always involve different
busin= functions within
operating companies. However, it is essential to
have clear
responsibilities for the management of them.
The key elements are
strategic planning
_, of excise =- systems and pricing
accounting and computation of options
management of payment and administration
lobbying and Government relations
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Millbank (Tobacco Taxation DepartmenE) is building
expertise and
contacts and a central database of information in
order to assist
ope.-Adng companies. Based on experience from
around the Group,
lobbying arguments are being developed in MHlbank.
Operating
company management should keep Mllbank advised of
developments
on indirect = matters and seek advice whenever
necessary.
9. Goverrunent Relations
The issue of Government relations is closely
linked to that Of Smoking
& Health which is more fully covered in the Public
Affairs key area
pa-per. whereas this paper covers re!ations in the
context of the
cec:nnical aspects of indirect tobacco taxation.
Government officials responsible for tobacco
excise and VAT
pianning and control, from a re!aiivclv low to the
highest level.
snuid be identified and sufficient reg tar contact
maintained while
gu
%I-'-:sEe-ial (Government & Opposition) contacts
should also be
maintained to ensure that the Company is we!l
placed to have its
v;.--.,-s Eaken into consideration when policy is
being determined. Such
cc7:,_lc, should be the responsibUiry ofsenior
management and the
&,zrd to ensure an adequate level and quality of
communication.
An amicable and effective partnership between
company and
Government is the objective. Rather than reacting
to a problem, a
pcsidve and pro-active approach to this subject
MUSE be implemented.
SLC". relations should establish BAT as the
Company to which
Go,emment will cum when they need advicc and
a5sistance upon any
aspect of excise taxation, which of course
requires the existence of the
knowiedge and experience of excise in the Company.
This is
becoming more significant as our competitors seek
to influence and
cnanze 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
ch=ge excise systems too. if indeed such a chang
ge would be
ben.-ficial. In either instance. good and regular
Governmeit relations
are -ssenrial.
In Ns same context. it is also relevant to
maintain close contact with
manufacturers of products also subJect to excise
taxation, particularly
alcchol. where there are many excise similarities.
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10. Internation2l Trade Issues
Increasingly the influence of IMF and World Bank
is being felt in the
area of excise tax and VAT issues. Operating
company Qr~ment
must be aware of their role and seek to influence
decisions from these
bodies e.g. most often ad valorem systems are
proposed by
I.N(F[World Bank, because of their belief, often
misguided, that such
systems are the most simple and maximise
Government revenues. If
this is not in our favour we must lobby against
the proposals.
fNtF/Worid Bank policies are mostly directed from
Washington DC
and Millbank will be establishing contacts there,
in order to assist
operating companies. The proposals of the GATT, in
particular since
the conclusion of the Uruguay Round, and the
implications for world
trade will have an increasing impact on the
tobacco business. Import
tariffs are still an important element in indirect
taxation, but the trend
post Uruguay is rapidlv moving towards a reduc:ion
of tariffs and
other barriers to free trade. To rely on such tax
barriers to 'protect'
an uncompetifive business would not be viable in
the longer term.
Operabrig company management should establish good
working-
relationships with local representatives of IMF.
~Worid Bank/GATT
or-anisations to ensure that our position and
expertise on indirect tax
;4 d trade issues is appreciated. Whenever
possible assistance and
advice should be given. A good relationship will
make any necessary
:ocal lobbying more --lective. Assistance should
be sought from
Nlillbank (Tobacco Taxation Department) if a
resolution of local
issues could be e--pedited by the involvement of
the international H.Q.
of IMFIWorld Bank,'GATT.
11 the eacpanding .-Lobal scenario whereby exports
currently account
for over 20% of BATCo ci-arette sales, tariffs are
an important
indirect tax and commerci;7 issue. Since most of
our exvorts are of
higher quality. higher price international brands.
our policy in export
markets is as follows-.
eliminate tariffs
replace ad valorem 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 of
the tariff (a
on a tax).
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BATCo document for Province of BritiSh Columbia 23
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It should also be pointed out that our policy on
tariffs in domestic
markets is generally the opposite of the above. In
markets where
BAT has a dominant share, or where competition is
limited b
restricted access to the market keeps out imports,
out policy is to
persuade Government to minimise imports through
the application of
hi gh tariffs and other obstacles such as pre
payment or early payMenE
or excise taxes. (However, as noted above this is
becoming more
difficult.)
11. Industry Relations
In a competitive context. :obacco e--c-se =ation
is a key subject for
d Nati
iscussion and aeretment in the . onal
Manufacturers Association.
Collective action and influence by the ;ndustry is
likely to be more
effective and producnve than by individual
companies, although the
laEtCr may also be appropriate from time to time.
Although the !ead
company on excise issues iends to se;ect itself on
the basis of marL--.
share. it can also be on the basis of knowledge,
experience, conmc:s
with Government. Where marke: share means that it
is not BAT
companies should seek to ensure a lead position
through these other
means. Eacise cont:uns many complex aspects which
have to be
mastered if NMA leadership -s zo be established.
Although the mair thrust on excise should and will
always come from
the manufacturers. some benen-E 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
NNIA 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 ensUTe zhac the Group position and
influence exceeds that
of the competition.
112. Competitor Monitoring
BATCo policy is to compiv %ith local excise
legislation wherever we
operate. In a numcer ot countries. our competitors
do not always
have the same policy. In order chat we are not at
a competitive
disadvanta-
ge evidence of avoidance or evasion should be
advised to
Government to ensure compliance. This is often an
issue requiring,
delicate handling but the objec:ive is clear.
13
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13 ATCo document for Province of British Columbia
23 April 1999


13. 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
mxes. This limits their coverage, for example to
manufacturers and
wOoiesalers in countries where retailers do not
keep accounts.
Businesses required to charge and account for VAT
are registered by
the authorities and required to keep specified
accounts and make
periodic returns of the tax due. The tax due is
the difference between
the tax charged on sales and the tax paid on
business purchases in die
period.
F-xc--se duty pe.ods and VAT periods need not
coincide e.g. in some
countries excise periods are monthly and VAT
quarterly.
In many countries, where Governments are not
confident of collecting
ail .~e VAT due from the wholesale or retail
sm-es, manufacturers are
recuired to chasee the tax on wholesale or retail
prices. This can be
acivatimgeous. it depends on the length of credit,
there can be cash
Pow benefits and it ,ives manufacturers a de-ree
of control over retail
prces.
It':s :mportant. when VAT is applied to tobacco
products, to seek to
ensur: :
a) that erxcisc -ates are reduced in compensation
b) that the tax reeime allows the deduction of VAT
on gd business
purchases
c) that the leng th of credit adequately
compensams for the costs of
accounting :or and coilectim, the tax. for the
Government.
d) that the collection of VAT does not extend
beyond the
manufacturing stage. unless controlled by the
manufacturer as
noted above.
Dj Bishop
March 1994
14
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BATCo document for Province of BritiSh Columbia 23
April 1999


APPENDIX I
STRUCTURr OF VXC'Tqr. TAXATION
The principle feat:ures, advantages and
disadvantages of the main types of excise
syst:ems are:
5 =C A specific excise struct:ure is most suited
to a, company
whose brands have high levels of added value or
image
and am positioned in the high and premium price
segments. Becau a specific structure results in
only a
narrow price range between the cheapest and the
most
expensive, there is little oppornmity to compete
an the
basis of price. A specific 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 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
smwture. For example :
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 manufacturer's net
price from 20 to 10 results in an 11 % fall in the
retail price thereby demonstrating the limited
opportunity for price competition.
C An increase of 50 % in the manuiketum's net
price from 20 to 30 results in only an 11 %
increase in the rctail price thereby demonstrating
how simple it is for a manufacn= to increase
profitability provided freedom to raise prices
exists.
N;
cr,
is
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BATCo document for Province of BritiSh Columbia 23
April 1999


For the same reasons as it discourages price
competition, a specific structure tends to
encourage
high q112lity 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.
It may be difficult to achieve a wholly specific
sm=tre
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 struc:ure
should be the target.
7 bere are excLse structures whose features are
essentially specific but whose impact is the same
as an
ad valorem structure. This occurs when Government
has different specific taxes - rding to a pamcular
'slab'. The various slabs being determined by:
length
of cigarette or price of cigarette. A specific
blab
structure is to be preferred to an ad valorem slab
structure.
SPECIFIC BY WEIGHT
This method of taxing cigarettes originated in the
United Kingdom which discontinued it when it
joined
the European Community. However, some countries
still apply such a structure. Its features art
different
from the specific by number and the market impact
can
be different, although it retains the normal
characteristics of a specific system.
The tax might be assessed on the weight of tobacco
used to manufacture the cigarettes e.g. Sri I
anka, or it
can be on the weight of the finished product e. g.
Ausn-alia, Singapore and Malaysia- One of the
problems of this system is that it is
administratively
cumbersome. In addition, unless some form of ardt
is agreed for factory waste the front end weight
system
can be very costly. In Australia the system has
encouraged fierce competition between the
cigarette
manufacturers to reduce product weights and
densities Lr.
and hence prices.
CN
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April 1999


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 profitabUity. However, in a
monopoly or near monopoly market, it my not have
the same results unless a new smaU competitor
starts a
price war. It will also depend upon many factors
such
as the recognition by Competitors and Government
of
the need fbr a profitable price structure to
ensure the
financial health of the manufacturers and the
Ministry
of Finance.
An ad valormn excise structure creates or is best
suited
to a company whose brands am mainly located in the
lower price segments~ or a company whose costs of
rnanufacture are significantly lower than the
competition by virtue of a. dominant market share.
Such a structure enables lowadded value and low
image brands to survive with a significant price
advantage over the higher image brands. 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
creat= the
circumstances where price competition can
flourish.
However, them are many exceptions to this which
demonstra= that many other fktors need to be taken
into acmmt before such a general statement can be
made.
An ad valorem strucmm has a multiplier effect upon
ex
factory price diffemces which enables
manufacturers
to reduce prices at the 'expem' of the Government
inste:ad of by reducing their own profit margins
for
example!
A B C
Retail Price too 50 150
Ad Valorem Excise
(70% of r~tafl price) 70 35 105
Trade Margin
(10% of retail price) to 5 15 C;
Net Manufacturers Price 20 10 30 r1_1
011
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This example demonstrate:s two feanums of an ad
valorem structtrre based upon a base case A :
B - a reduction in the manufacturer's net price by
10
units from 20 to 10 results in a decr- in the
retail
price of 50 units thereby showing the multiplier
effect
of an ad valorem excise structure.
C - sirnil2fly an increase in the manufacturer's
net
by 10 units from 20 to 30 results in an ;ncr- in
the
retail price of 50 units, thereby showing the
rmiltiplier
effect in the context of an increase.
ne,NRMTIPLIER concept occurs directly from an ad
valorem strucrure. In the above case the
multiplier has
a value of 5 which means a net price change of 10
results in a remil price change of 50. It is
calculated as
follows :
M
100 - X
where x = the sum of the proportional elements
expressed as percentages of the retail price.
M = IM - Ix = 1W = lm
100-(ad 100-(70+10 100-80 20
valorem
+ trade
margins)
For the same reason as it encourages price
courperition,
an ad valorem structure can often lead to lower
quality
products whose lower costs can be passed an to the
consumer in the form of lower prices where the
reduction is multiplied through the tax structure.
An ad valorem structure automatically increases
the
amount of excise when a manufacturer increases ;.I
prices. It therefore has an appeal to Government
who
may not therefore need to take any action to in
their revenues. On the other hand, because revenue
yield depends on retail prices, there is a grea=
danger
of Government interference in retail price
determination than there is when the exdw is
specific.
C"
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BATCo document for Province of BritiSh Columbia 23
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In some markets 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 =nsferring some of the elements normally
included in the ex 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 =nsfer some of the 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 wade, particularly if
their margin were increased to absorb the transfer
of
marketing expenses.
A mixed excise structure contains elements of both
specific and ad valorem. Its effect clearly
depends
upon the relative size of the two elements. Such a
system applies throughout the European Community
although different countries have different
relativitics
between the two.
A nuxed 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. The exact balance or relativity
between the
two will depend very much upon the cost structure
of a
market and the retail price structure required.
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APPENDLK II
FXCISE ADNITNITSTRATION
'nere are many aspects of excise administration
which have an impact upon the
coinpany. Although not all of them can be
addressed in a key area paper. some are
worthy of inclusion.
TMING 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 ffiscat stamps. the timing of
payment is normally based upon the
ac-ual purchase of the stamps. the time it takes
to manuracture and deliver and the
stock durations of the manufacturers and the
trade. Arpmenm and supporting
evidence are essenrial to persuade Governments to
accept payment only when the
ci--arertes have been sold to smoke:s 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 vaduations.
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 cheque, 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 cheque can
often be significant in cash flow
EUMS.
REFLN,'DS
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
rellate to the method of payment but should take
into consideration the following
an entitlement to a credit or refund for all goods
retumed by the trade. at the
MEC 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. U7
C1%
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BATCo document for Province of British Columbia 23
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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 bears
the cost of the goods but the
Government bears the excise taxation element. The
transfer of ownership is
often a crucial element in this area.
Provisions for excise taxation and refunds are nOE
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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BATCo document for Province of British Columbia 23
April 1999