ITC – Hybrid tax structure remains a concern:: RBS

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Rajasthan's move to raise VAT on cigarettes from 20% to 40% will not have a material impact on
ITC as it accounts for just 2% of its sales. The impact would be more adverse for ITC's
competitors, but we are worried about the hybrid structure where excise duty is linked to volumes
sold, and VAT levy to price.
Rajasthan State Budget raises VAT of cigarettes to 40%
􀀟 Yesterday, the Rajasthan State Government raised the VAT on cigarettes to the highest
levels in India at 40% ( from 20% earlier). When VAT was first implemented in 2008, the
standard rate was 12.5%, various state governments like Uttar Pradesh, Maharashtra have
over the years raised the rates well beyond 12.5%. The weighted average VAT rate for ITC as
a result is around 15% currently, and with this increase by Rajasthan, we estimate the
increase would be only marginal, as ITC derives a very small portion of its sales from
Rajasthan. ITC's competitors would face an adverse impact, as the state accounts for a larger
proportion of their volumes. For ITC, we estimate, a significant portion of its sales comes from
states of Tamil Nadu, Andhra Pradesh, Karnataka, West Bengal and Maharashtra.
Hybrid tax structure is a medium term worry
􀀟 VAT taxation structure is levied on selling price of cigarettes, and hence there is a temptation
for the state governments to raise tax rates to garner more revenues especially when
cigarette price hikes are moderate (like post the recent budget which spared excise hikes,
and hence ITC left its prices unchanged). However, since the excise duty structure is linked to
volume sold (as it is based on a duty on a per stick basis), the Central Government is
indirectly concerned with volume growth, as that is only long-term driver for tax buoyancy.
The recent budget left excise duty unchanged, as FY11 cigarette volumes have been
marginally negative. However, with conflicting modes of levy at the Central and State taxation,
we believe, the long-term implications would not be positive. A speedy migration to common
GST regime with a moderate tax levy of 15-20% of selling price would be structurally positive
for ITC.


We remain positive on ITC
􀀟 ITC's volume recovery will likely remain intact, as the larger taxation levy on cigarettes, ie,
excise (which is #55% of selling price) has remained unchanged for FY12. While, there are
couple of more state budgets which are expected in the next few weeks, we believe, the
eventual migration to a unified GST regime would significantly reduce the current concerns of
hybrid taxation structure.