Calcutta, Sept. 1: The Bengal government today raised the value-added tax (VAT) on cigarettes to 20 per cent from 13.5 per cent, desisting from hitting the 30 per cent ceiling permissible after a switch earlier this week.

The tax increase is unlikely to change the price many consumers pay as it will be largely borne by cigarette manufacturers and wholesalers. But the increased levy runs the risk of creating an “arbitrage opportunity” that can encourage smuggling from other states and somewhat blunt the government’s drive to generate more revenue.

While presenting the Finance Bill on Monday, finance minister Amit Mitra had said tobacco products were being put in a schedule that allowed VAT up to 30 per cent. The new rate, which was not specified then, was notified by the finance department today.

What smokers pay for a pack of the most popular brands is expected to remain untouched since maximum retail prices are unlikely to be changed. ITC, which manufactures three out of every four packs sold in the country, sells all its popular brands at the same rate across the country, although the VAT rates differ from state to state.

However, other players like Godfrey Phillips are likely to raise the prices of their low-priced brands at the retail level as well.

In either case, the VAT increase in Bengal opens up a window of lucrative opportunity for unscrupulous operators if they smuggle in cigarette cartons from other states where the same tax is lower.

For instance, just one carton of Gold Flake Kings can make a smuggler richer by as much as Rs 68 if it is brought in from neighbouring Orissa (see chart). A carton is not much bigger than a loaf of bread and a huge quantity can easily be smuggled in after hoodwinking law-enforcers.

The smugglers’ margin may come down a bit if cigarette manufacturers do not pass the entire burden to the trade.

The tax on tobacco products is 13.5 per cent in Orissa and Bihar and 14 per cent in Jharkhand — all below the new slab of 20 per cent notified by Bengal today.

This means that a stretch of “tobacco tax haven” will run alongside Bengal, unwittingly tempting traders to link up with smuggling channels, make a killing and deny revenue to the cash-strapped coffers of the state.

The problem could be more acute in districts that border other states. “Unless the administration keeps a close vigil, smuggling would impact revenue collection on account of cigarettes,” an industry executive said.

Tobacco manufacturers ITC and Godfrey Phillips declined to comment. Udayan Lall, the director of Tobacco Institute of India, said: “We always request moderation on taxes. Ultimately, they prove to be counterproductive.”

An industry veteran raised another area of concern: sale of contraband cigarettes. “High and differential tax rates provide an attractive arbitrage opportunity for smuggling, tax evasion and incentive for illegal manufacturing of stocks,” he pointed out.

It is unlikely that the entire burden will be passed on to the retailer by the wholesaler and the manufacturer. Industry observers said manufacturers like ITC might take a hit on their profitability and try to cushion a part of the impact on the wholesalers. But some of the increase is expected to be passed on to the trade channel (wholesalers and shops).