Why the cap on cess puffed up ITC shares
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A 7% jump in ITC Ltd’s share on Friday was puzzling at first and though it closed with a lower gain of 4.9%, it was still substantial. The provocation was the GST council’s caps fixed on the cess on demerit goods. The reaction would have been justified if ITC’s share had fallen in anticipation of the cess. Till Thursday, ITC’s share was just a bit lower than its level in early February but a good 24.4% higher than end-December.
How does the GST council’s decision benefit cigarettes? News reports state that cigarettes will, in addition to a 28% basic tax under GST, also pay a cess of either 290% or Rs4,170 per thousand sticks or a combination of both. This cess is to compensate states for potential losses in revenue due to GST. News reports say the GST Council wants the tax incidence and price of cigarettes to stay at current levels, terming it as revenue-neutral.
More details will become clear when the actual legislation and rules become available. Cigarettes are at present charged a specific excise rate, based on length, which starts from Rs1,681/thousand sticks for filter cigarettes up to 65 mm and to Rs4,421/thousand sticks for cigarettes greater than 75mm. States charge sales tax in addition.
A first reading suggests cigarettes at the higher end will attract a lower levy than the current specific excise rate. But there is the basic tax of 28% also that is being levied. Also, input tax credit cannot be used to lower the cess, and will be restricted to inputs on which a similar cess has been paid, according to the draft compensation bill.
If the government’s effort is to keep revenue and prices at the same level, then firms don’t really gain or lose. The real transformation appears to be a transition to a well defined tax structure. Every fiscal, before budget, ITC’s shares would swing with investor concerns on a potential hike in taxes. The reason could be to raise revenue or to use punitive taxation to curb cigarette consumption. In many years, they were proved right. The past two budgets are an exception. That changes now. Cigarettes are already in the highest tax bracket, the cess rate is capped, and states and municipal authorities cannot levy (or increase) additional taxes. Of course, if tax collections are poorer than expected, the GST council could potentially review these caps. States are to be compensated for five years. That may mean the cess may go after five years unless the governments decide to retain it under some other form.
Even then, as long as there’s no devil in the details, cigarette taxation has entered an era of certainty. Companies can now focus on the market and not worry about taxation. That alone is a good reason to relook valuations and might explain why ITC’s share jumped. With tax uncertainty behind it, the only concern should be public health-related legislation to curb cigarette consumption.