The Cigarette Story: Tax Arbitrage Fuels Illicit Trade, with 68% of Total Tobacco Consumption Remaining Outside the Tax Net

Published at : Aug 30, 2026 11:26 AM (IST)

Total Views : 145

The Cigarette Story: Tax Arbitrage Fuels Illicit Trade, with 68% of Total Tobacco Consumption Remaining Outside the Tax Net

The Print Times
ITC’s leadership position in the cigarette industry continues to be driven by its unwavering focus on nurturing a future-ready portfolio of world-class products anchored on its integrated seed-to-smoke value chain, superior consumer insights, robust innovation pipeline and world-class product development capabilities.
   During the FY 25-26, FMCG CIGARETTES Business continued to make strategic portfolio and market interventions, with focus on competitive belts, to counter illicit trade and reinforce market standing.
   CIGARETTES Business delivered a resilient performance on the back of sustained volume-led growth momentum. Differentiated and premium offerings continued to perform well leveraging mainstream trademarks and innovation. Consumption of high-cost leaf tobacco inventory weighed on margin, which was partially mitigated through a combination of product mix enrichment and strategic cost management interventions.
   A punitive and discriminatory taxation / regulatory regime over the years has led to significant operating challenges for the legal cigarette industry in the country. It may be recalled that relative stability in taxation over the past few years, coupled with deterrent enforcement actions, checked the growth of illicit trade and enabled the legal cigarette industry to recover volumes lost to illicit trade during the years of high incidence of taxation. This also resulted in the concomitant increase in demand for Indian tobaccos, bolstering revenue to the Exchequer from the tobacco sector.
   However, increase in GST rate from 28% of transaction value to 40% of retail sale price along with a steep hike in excise duties w.e.f. 1st February 2026 upon phasing out of Compensation Cess, have resulted in an unprecedented increase in tax incidence on cigarettes.
Globally, cigarettes constitute the dominant form of tobacco use. However, in India, tobacco use comprises a diverse range of chewing and smoking formats that are available at multiple price points consequent to punitive and discriminatory taxation on cigarettes. While India is the world’s second largest consumer of tobacco, legal cigarettes constitute only 10% of overall tobacco consumption in India, as against a global average of 90%. It is pertinent to note that India accounts for less than 2% of global cigarette consumption despite having 18% of the world’s population - making India’s per capita cigarette consumption amongst the lowest in the world.
   Over the years, high and discriminatory taxes on cigarettes, while aimed at reducing consumption, have had unintended consequences of fuelling the growth of smuggled and domestically manufactured tax-evaded cigarettes, causing a shift to other lightly taxed / tax-evaded forms of tobacco products, comprising illicit cigarettes, bidi, chewing tobacco, gutkha, zarda, snuff, etc. Consequently, while the share of legal cigarettes in total tobacco consumption has declined from 21% in 1981-82 to a mere 10%, aggregate tobacco consumption in the country has increased over the same period. Despite accounting for 1/10th of the tobacco consumed in the country, duty-paid cigarettes contribute more than 4/5th of the revenue generated from the tobacco sector.
   Taxes on cigarettes in India remain one of the highest in the world and are multiple times higher than in developed countries viz. 14x of USA, 7x of Japan, 5x of Germany and so on. Further, the same is also substantially higher than that in neighbouring countries. The recent increase in taxes would further widen this gap.
   India’s per capita cigarette consumption is amongst the lowest in the world and is significantly lower compared to that of China, Japan, USA, UK and even neighbouring countries such as Bangladesh and Pakistan. On the other hand, it has 70% of the world’s smokeless tobacco users.
Punitive taxes on the legal cigarette industry in earlier years have resulted in rapid growth of illicit cigarette trade, making India the 4th largest illicit cigarette market globally according to Euromonitor estimates. Over the years, this has created attractive tax-arbitrage opportunities for unscrupulous players indulging in illicit cigarette trade, accounting for about 1/3rd of the legal industry.
   The recent unprecedented increase in tax incidence would enhance the tax arbitrage providing further impetus to illicit trade and adversely impact millions of farmers, MSMEs, retailers and local value chains, while sub-optimising the revenue potential of the sector.
   As per the Report on the Causes & Control of Illegal Tobacco by Alvarez & Marsal based on study conducted across 71 countries over 17 years (2005 - 2022), illicit trade tends to get embedded in the ecosystem, posing serious challenges to public health and law enforcement.
‘Illicit markets: A Threat to Our National Interests’, a study published by FICCI-TARI in September 2022, noted that “The consumption of illegal cigarettes in India has increased, signalling a shift from legal products to cheaper substitutes or illicit products, which have no or little tax element in them. When taxes are raised beyond a certain optimum level, consumers gravitate towards cheaper alternatives or illicit supplies, which are normally smuggled or tax evaded goods”.
   It is estimated that illicit trade causes an annual revenue loss of appx. Rs. 23000 crores to the Exchequer. With respect to other tobacco products as well, the revenue losses are significant since about 68% of the total tobacco consumed in the country remains outside the tax net. During the year, there were extensive media reports on the multitude of cases of evasion of taxes / duties by dealers in illicit cigarettes which were unearthed by raids conducted by the Directorate of Revenue Intelligence (DRI) and other enforcement agencies. While enforcement measures have been strengthened, global experience suggests that sustainable containment of illicit trade also requires addressing demand-side factors such as tax incidence and affordability pressures.
   The DRI, in its report “Smuggling in India 2024-25” acknowledges the high incidence of taxes in India providing opportunities for illicit trade of cigarettes. The report states: “The Illicit Cigarette Trade thrives due to high taxes and import duties. It is driven by organised syndicates and black markets, causing revenue loss and undermining public health goals.
   Tobacco control measures in India have ranked amongst the most stringent in the world from the time of enactment of the Cigarettes (Regulation of Production, Supply and Distribution) Act, 1975, to the present. India is also one of the few countries where tobacco products are regulated across the value chain – from their manufacture to sale to consumers. The Cigarettes and Other Tobacco Products (Prohibition of Advertisement and Regulation of Trade and Commerce, Production, Supply and Distribution) Act, 2003 (COTPA) requires cigarette packages to display the statutorily mandated pictorial and textual warnings covering 85% of the surface area of the packet - one of the largest in the world.
India is among the top three tobacco growing countries in the world. Tobacco plays a significant role in the Indian economy on account of its considerable contribution to the agricultural, industrial and export sectors5. Besides, the sector also plays a key role in employment generation and provides livelihood to appx. 46 million people.
   As reported in earlier years, ITC and several other stakeholders had challenged the validity of the pictorial and textual warnings covering 85% of the surface area of the packet prescribed under COTPA. The Honourable Karnataka High Court, by its judgment in December, 2017, held the 85% pictorial warnings to be factually incorrect and unconstitutional. Upon Special Leave Petitions filed by the Government and others, the Honourable Supreme Court has stayed the judgment of the High Court. The cases are pending before the Honourable Supreme Court.
The Above report has been extracted from ITC’s Annual Report for FY 25-26
 

Published at : Aug 30, 2026 11:26 AM (IST)

Total Views : 145