Claims and counter claims

Three flavours are produced with the help of concentrates available through imports and open market purchases. A fixed formula to combine the concentrates with water is acceptable internationally. However, input-output variations are common for variety of reasons including the extent of dilution - using less than the recommended or declared level of concentrate per unit of output, exaggerated claims on the level of wastage, and the use of smuggled/counterfeit concentrates. The problem is deep rooted in the absence of effective monitoring of production. Hence, the manufacturers and tax collectors have divergent view on the level of actual vis-‡-vis declared production. Moreover, the price mechanism is flawed as no explicit account is made for retailer's margin and chilling factor. As a consequence, consumers are charged higher than the printed price at the retail level. The combined effect of these production and price distortions has been a low tax yield for the government and excess burden for the consumers.

In response to these concerns, the manufacturers claim that since a clearance in supervised the difference between the actual and the theoretical production should not create apprehensions. They, on the other hand allege that high rates of central excise duty and sales tax, on beverages as well as concentrates, and other cost-push factors are the primary factors behind reduced sales. Moreover, the availability of similar products produced in the unorganised sector and cottage industries is a constraining factor to raise demand appropriately, especially for the branded products.

Tax policy initiatives

Over the years a number of tax policy initiatives have been undertaken after long deliberations between the beverage manufacturers and the government to resolve issues that were deemed detrimental for maintaining conducive working environment. The policy initiatives included rationalisation of duty structure at various points in time and transition from capacity to supervised production and self-clearance.

The revenue analysis indicates that the rationalisation of CED rates whereby the duty on concentrates was reduced in FY 97-98 from 100 per cent to 50 per cent, and on aerated beverages from 17.5 per cent to 15 per cent of the retail price did not yield significant improvement in CED collection. The massive reduction of duty at the concentrate stage and 16.6 per cent decrease at the final manufactured stage brought about a mere 5.19 per cent increase in revenues. Even worst has been the outcome of duty reduction in FY 02-03 when CED was slashed from 15 per cent t 12 per cent with the hope that 'supply-side economics' will prevail - the sales will increase and additional revenue will be generated for the government. Instead, the reverse has happened. The recorded evidence confirms that the CED collection has, in fact, declined in each and every month of FY 02-03 as compared to the PFY. The overall decline in CED revenue has been 17 per cent, which is significant considering that the beverage industry is one of the five major revenue spinners in the CED regime (Table 1). It may be argued that the decline in revenue is because of decline in production, but this claim cannot be confirmed. With the abolishing of RTI form, there was no mechanism during FY 02-03 to keep track of production. Even though the clearance data confirms a decline of 8.6 per cent, but this evidence alone is not sufficient to justify the shortfall.

Two related points create further confusion in this respect. First, it has been observed that the Industry did not pass the benefit of reduction in CED to the consumers. The retail prices have either been kept at the level of the past year prices or they have been increased. To verify this point, a limited market survey was conducted, which confirms the following. Except for the promotional period, which often lasts for a short duration, the retail price of one-and-a-half litre bottle remained fixed at Rs45 during CFY, as was the case during FY 01-02. Some retailers were found charging extra two to three rupees for chilled bottles, thus raising the price to Rs48 per bottle; the price of one-litre bottle increased from Rs25 in FY 01-02 to Rs30 in FY 02-03; the price of disposable bottle increased from Rs12 to Rs15; and finally the price of the returnable bottle remained fixed at Rs10 during the current and the past year (Table 2).

Second, it is true that the ratio between concentrate and production is much lower in Pakistan than the international standards. However, factors like low capacity of the manufacturing units and old (vintage) of machinery alone cannot account for the low production when concentrate to output ratio is found increasing. The data confirms that the concentrate to output ratio has, in fact, gone from 33 per cent to 39 per cent between FY 99-00 and FY 02-03 (table 3) The anecdotal evidence for the current year is not too different than this.

Resolving the Problem

Since the phenomenon of bestowing favours by reducing tax rates has worked neither for the government nor for the consumers, a number of areas, as identified below, require immediate intervention.

(a) Precise information on 'true' production of aerated waters remains and unsettled issue. The claims on wastage, dilution, and the use of smuggled/counterfeit concentrates cannot be verified unless an effective mechanism is in place to monitor each and every stage of the production process. Ever since the issue became debatable, a lot of effort has been put in to understand the intricacies of the problem. A Report was prepared by M/S KPMG to confirm the standard equation between inputs and output. Comments on this Report were sought from field offices. However, nothing has been established so far. In order to make any meaningful headway, the Report and the responses from Collectors can be used as the initial step to devise a mutually agreed and workable strategy for the future.

(b) The experience suggests that when taxpayers are given the choice of self-assessment, the need for audit and a penalty regime increases manifold. The information on sales tax audit of the industry reveals that for 170 units, only 12 audits were conducted in FY 00-01, 20 in FY 01-02, and 18 in FY 02-03. Whereas the cumulative amount detected through these audits was as high as Rs 178.4 million, the amount recovered was only Rs4.5 million, implying that the recovery rate was only 2.5 per cent.

A further analysis of number of audits and geographical distribution of units reveal that for 37 units currently operating in Karachi, the number of audits conducted during the past three years was six. On the other hand, for 14 units operating in Hyderabad twelve audits were conducted and for 19 units in Peshawar ten audits were undertaken. A similar mismatch can be observed for other places also.

The shift in administrative policy from capacity to supervised production and clearance requires that the frequency of audit be increased as the industry falls into a high-risk category where evasion is supposedly high. More importantly, there should be a proportionate relationship between the number of audits and the operational units.

(c) The reason for low recovery of the detected amount and failure to win contravention cases is simple. Neither the input-output ratio nor charges related to wastage could be established adequately in the court. Similarly, the combined use of genuine vis-‡-vis smuggled or indigenous concentrates is difficult to prove. However, notwithstanding the apparent difficulties, a mechanism needs to be devised to address these issues. The cross-country evidence could be helpful in this respect.

(d) The two leading multinational companies have captured nearly 80 per cent of the market share. Despite reaping economies of scale through their size and advertisement, they have created non-competitive environment for small local manufacturers. This monopolistic situation needs to be critically studied.

(e) The possibility of collusion between producers and tax personnel posted to supervise clearance cannot be ruled out altogether. This matter relates to tax administration and should be on the high priority agenda.

(f) Finally, the view that the demand for beverages produced by multinationals has declined because of the anti-American sentiments is perhaps inaccurate in entirety. It has to be verified whether the widespread acceptance of locally produced products is because of low price or otherwise. After all the ten-rupee difference in the retail price of one-and-a-half liter bottle is not small enough to be ignored when the difference in quality or taste is a matter of perception. Likewise the demand erosion can be the result of a shift in consumer preference from soft drinks to mineral water as a result of aggressive marketing by the mineral water industry.

(Author Affiliation: Mr. Naeem Ahmed is Research officer at Fiscal Research Wing of CBR)

Table 1: Revenue Growth from Beverages

(Rs Million)

CED Sales Tax CED Growth (%) ST (D) Growth (%)

Months 00-01 01-02 02-03 00-01 01-02 02-03 02/01 03/02 02/01 0302

Jul 221.9 242.7 226.8 181.2 210.2 203.4 9.4 -6.6 16.0 -3.2

Aug 232.6 264.9 217.1 160.3 182.4 2.39.9 13.9 -18.0 13.8 31.5

Sep 199.1 224 169.1 155.5 183.6 235.7 12.5 -24.5 18.1 28.4

Oct 173.8 184.8 167.9 127.1 159.5 160.8 6.3 -9.1 25.5 0.8

Nov 103.8 127.9 122.3 121.1 121.8 156.5 23.2 -4.4 0.6 28.5

Dec 100.7 127.6 94.6 68.7 82.6 100.3 26.7 -25.9 20.2 21.4

Jan 86.8 82.7 66.6 50.3 80.5 81.4 -4.7 -19.5 60.0 1.1

Feb 151.6 200.5 186.2 30.9 36.6 40.5 32.3 -7.1 18.4 10.7

Mar 329.3 280.4 206.1 73.2 114 165.3 -14.8 -26.5 55.7 45.0

Apr 313.5 377.1 280.2 197.6 197.6 167.1 20.3 -25.7 0.0 -15.4

May 388.3 412.6 327.6 195.7 281.2 269 6.3 -20.6 43.7 -4.3

Jun 342.6 342.7 314.9 246.7 339.1 356.2 -5.2 -3.0 37.5 5.0

Table 2: Price Differential according to Bottle Size/Capacity

Bottle Size Capacity Printed Price Retail Price Retail Price Difference Total

in FY 02-03 in FY 01-02 between Retail Price ST

Printed & Charged

Price (Rs.)

1-1/2 lit bottle 37.17 5.58 42.75 45 45 2.25

1 lit bottle 22.3 3.35 25.65 30 25 4.35

Disposable 12.75 1.86 14.61 15 12 0.39

Returnable 8.2 0.0 8.2 10 10 1.8

Table 3: Production and Input-Output Ratio

Beverage Concentrate Growth Beverages Growth I-O Ratio

99-00 192,711 -1.7 585,799 9.1 32.9

00-01 236,329 22.6 669,435 14.3 35.3

01-02 251,539 6.4 650,968 -1.8 38.6