LAW
Ad Valorem Tax on Tobacco Products: Two Sides of the Same Coin
02 July, 2015
Ad Valorem Tax on Tobacco Products: Two Sides of the Same Coin
According to the decision made by the government of Georgia, beginning on July 1 of 2015, a new type of tax will be introduced for tobacco products: the so called ad valorem tax. The new tax is proportional to the fixed value of the goods. In the case of tobacco products, the tax amounts to 5 percent of the sales price of each box of cigarettes. On December 12 of 2014, the Parliament of Georgia passed amendments to the Tax Code that defined the excise duty for 20 units of filtered or unfiltered cigarettes as follows: 90 tetri per box of filtered cigarettes and 25 tetri per box of unfiltered cigarettes plus 5 percent of the retail sales price of each type of product.

Correlation with the Applicable Law

According to Georgia’s Constitution, the introduction of any new tax or an increase in the rate for any tax, except for excise duty, can only be made through a referendum and that such a referendum can only be initiated by the government. The same is stated in Georgia’s Law on Economic Freedom. Thus, the law restricts the power of the government and the Parliament to introduce new types of tax. In order to avoid conflict with these rules, optimal and lawful decisions have been made on applying an ad valorem tax to the existing excise duty on tobacco products.
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Advantages of the Novelty

While planning the introduction of the new tax (which mainly provides for an increase in the excise duty on tobacco products), members of Parliament engaged in rather heated arguments. According to the draft law’s explanatory notes, the planned amendments would have a substantial positive effect on the state’s budget, generating an increase in revenue of approximately 110 million GEL in 2015 as compared to 2014. The draft budget for 2015 showed that revenue would increase to 208 million GEL. In addition, the amendments aim to ensure fair competition in the tobacco market, facilitate tax administration, strengthen tobacco control measures and harmonize Georgia’s taxation provisions with the EU laws.
Generally, an excise duty serves a fiscal purpose and a regulatory purpose. In Georgia, an excise duty is applicable to products that are harmful to a person’s health, such as tobacco products and alcoholic beverages. Thus, an excise duty aims to limit the consumption of those types of products. The Ministry of Finance of Georgia has stated: “In Georgia, tax rates for
tobacco products are very low. Ten years ago, Georgia undertook an obligation with the EU according to which excise duty should, step-by-step, become more aligned with excise duties in Europe. This helps insure that our excise duties are in synch with our neighbours in order to prevent smuggling, which is very important.”
It is worth noting that the introduction of an ad valorem tax is one of the obligations undertaken by Georgia through the Association Agreement; however, Georgia has had five years to fulfil that obligation. Despite this, the government claims that implementing fair competition rules will, in a short-term perspective, prevent low-budget companies from leaving the market.

Disadvantages of the Novelty

Representatives of the tobacco industry started raising claims against the changes immediately after the new tax was initiated. They voiced concerns about the disadvantages that would result from the government’s decision to impose the excise duty.
Their claims were related to the rules on administering the ad valorem tax. According to the tobacco companies, the new provisions allow for a wide interpretation, which increases the risks of creating an illegal market. This would have a negative effect not only on the industry, but also on the state’s revenues. The tobacco industry believes that the government’s ad valorem excise duty policy is not similar to the policies that exist in European or eastern countries. Georgia’s tobacco manufacturers and importers believe that the adopted amendments have many shortcomings and possibly carry a risk of tax evasion by unscrupulous businesses.
The largest importers of tobacco products, British American Tobacco, JTI, Phillip Morris and Imperial asked for the ad valorem tax to be postponed. They requested a transitional period of six months so they could better prepare for the new excise duty. According to tobacco importers, the requested postponement is especially important because this form of taxation is uncommon in other countries of the Caucasus region and thus, the tobacco industry in Georgia needs more time to comply with the new rules.
In addition, industry representatives believe that enforcing the amendment on the day of its implementation would cause confusion in the medium and premium segments of the market, which form a large part of revenue generated by the tobacco industry. The ad valorem part of the excise duty would impose a hardship on the medium and premium market segments as the amount of the new tax varies according to the fixed retail sales price. Thus, while 5 percent of the fixed price for low priced cigarettes is approximately 6 tetri, the ad valorem tax for medium and premium brands will be approximately 13 tetri and 15 tetri, respectively.
Finally, before introducing a new tax or increasing the existing tax rates, it would be reasonable to conduct a better analysis on the expediency and effects of such a decision; the targeted industry should also be involved in that process. Moreover, taxes should be decreased, not increased, and more funds should remain at the disposal of the affected businesses, which will generate more investments and create new employment opportunities.
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As a law firm, Mgaloblishvili Kipiani Dzidziguri (MKD) handles nearly all key aspects of Georgian law and advises on various investments in different sectors of the economy. The firm benefits from a large team of expert lawyers and a well-established network of external professionals to provide its international and domestic clients with more specialization and focus. According to international legal directories, MKD’s practice and lawyers have been consistently recognized as one of the leaders in Georgia.

By David Archvadze, lawyer at Mgaloblishvili Kipiani Dzidziguri (MKD) law firm
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