Tobacco stocks took a sharp tumble on the bourses on February 20, as reports suggested that the Goods and Services Tax (GST) Council might consider hiking the GST applicable on cigarettes and other tobacco products.

This hike would be implemented once the compensation cess on these items is discontinued, the Economic Times reported.

The shares of diversified conglomerate ITC, Four Square-maker Godfrey Phillips, and Charminar manufacturer VST Industries slipped sharply. At 9.55 am, ITC's stock was down 1.6 percent to trade at Rs 400, while Godfrey Phillips was lower by 3 percent at Rs 6,364.4 and VST Industries shares cracked 3.7 percent to quote Rs 288.3 apiece.

However, higher taxes on cigarettes will result in a sharp decline in cigarette volumes for firms, as consumers tighten their pockets, causing sales to see a sharp decline. Further, consumers will switch to downtrading, purchasing counterfeit goods at a lower price point.

In the Union Budget 2025, the Finance Minister Nirmala Sitharaman did not announce any changes to tobacco taxation. A stable taxation regime augurs well for sustained momentum in the cigarette business and the last tobacco tax hike was 2 percent in February 2023.

Cigarettes and other tobacco products currently fall under the 28 percent GST slab, but additional levies, including a compensation cess, push the total indirect tax burden to 53 percent. A proposal under consideration suggests increasing the GST rate to the highest allowable 40 percent while introducing an extra excise duty.

The idea is to maintain steady tax revenues from tobacco products once the compensation cess is phased out, which is set to end by March 31, 2026. Government officials have indicated that introducing a replacement cess is not being considered as a preferred option.

Currently, the excise duty on cigarettes up to 65 mm in length is Rs 5 per 1,000 sticks, extending to filter cigarettes between 70 mm and 75 mm. Additionally, the National Calamity Contingent Duty (NCCD), in place since 2023, ranges from Rs 230 to Rs 850 per 1,000 sticks, depending on factors such as size, filter type, and flavor.

A ministerial panel within the GST Council, responsible for determining the future of the compensation cess, is expected to review these proposals before submitting its recommendations. However, the final decision will rest with the GST Council.

Categorized as ‘sin goods,’ tobacco products are subject to multiple taxes, including GST, basic excise duty, the compensation cess, and the National Calamity Contingent Duty. Even with the current 53 percent tax rate, it falls short of the World Health Organization’s (WHO) recommendation of 75 percent.

Tobacco-related products, including cigarettes and pan masala, generate substantial revenue for the government, contributing Rs 72,788 crore in the 2022-23 financial year, according to ET.