By Snigdha Kalra
In an interesting turn of events, the government of India lost close to Rs. 8,000 crores resulting from the effects of a move designed to increase revenue. Shares of cigarette manufacturer ITC Ltd. fell by 15% on Tuesday due to the government’s decision to increase the surcharge on cigarettes. This lead to a significant loss for Life Insurance Corporation of India (LIC), a state-owned insurance company, which is a substantial investor in ITC. Ironically, the decision to increase cess on cigarettes was undertaken by the government to avoid losses in tax revenue under the new Goods and Services Tax (GST) regime.
Cess Matters
Finance Minister Arun Jaitley announced on Monday that the GST Council had decided to increase cess on cigarettes. The tax rate under GST brought a lower tax revenue as compared to revenue collected prior to GST rollout.
The tax rate on cigarettes under GST is 28% (the highest tax slab), along with additional cess of 5% and a surcharge depending on cigarette length. Prior to GST rollout, the tax on cigarettes was collected in various forms including central excise and state value added tax. However, under GST, cigarettes were exempted from additional excise duty, which led to a 7-9% fall in total tax revenue collected on cigarettes. This lead to an undue profit for cigarette manufacturers.
According to Jaitley, the cigarette companies could do two things. One, reduce the price of cigarettes, which would not be desirable due to health consequences. The only other way for them was to transfer these windfall profits to their balance sheet. To prevent this from happening, the surcharge on cigarettes was raised, based on their length. The government expected this move to generate an additional tax revenue of Rs. 5,000 crores. However, this is not exactly what happened.
Impact on Government and Private Coffers
The LIC holds a 16.29% share in ITC. Although the company has diversified its operations, it is majorly a cigarette maker. Thus, the increase in surcharge wiped out almost Rs 50,000 crores worth market capitalisation of the company. Consequently, LIC lost Rs. 7,000 crores in the first few minutes of trading on Bombay Stock Exchange on Tuesday. By the end of the day, LIC’s loss was close to Rs 8,150 crores.
The Bigger Question: Should the Government Invest in Cigarettes?
The Indian government has a widespread programme to discourage the use of tobacco. Advertisements on TV, warnings before movies, legally mandated signs on tobacco products and other signs in all forms of media are part of the drive. The fact that the government, on the other hand, invests and profits off of cigarette companies creates a clear conflict.
This issue came into the limelight in April, when a public interest litigation (PIL) was filed against the government and LIC in Bombay High Court for holding shares in ITC. It cited that the government, which actively seeks to tackle health issues associated with tobacco consumption, should not be investing in the tobacco business. The petitioners included R. Venkataramanan, project manager at Tata Trusts, doctors from Tata Memorial Hospital, and Sumitra Pednekar, whose husband died of throat cancer.
LIC argued that they were investing in a perfectly legal manner in a company which had a good track record and was making profits. However, actively discouraging its use on one hand, and investing peoples money in it on the other, does incite questions on ethical grounds.
What Now?
Shares in a company like ITC Ltd. make for a profitable investment. At the same time, the recent attempt of the government to raise revenues has led to the opposite effect, precisely due to its shareholding in this company. It seems to be a double-edged sword, at both ends of which loss presents itself. How the government decides to tackle this dilemma, if at all, is yet to be seen.
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