Excise Act Review: 3
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Part III
Production Levy Versus Sales Levy

Range of Options

The review was undertaken with a view to considering all options for a revised excise framework, ranging from a production levy to a sales levy. For purposes of the review, these levies may be defined as follows:

Production levy -- point of imposition up to and including finished-goods storage; and

Sales or post-production levy -- point of imposition subsequent to finished-goods storage, including removal from manufacturing premises or warehouse, point of sale by the manufacturer, or delivery to the wholesaler/retailer/ consumer.

These options were evaluated against the criteria for reform outlined earlier and with reference to both domestic and international considerations.

International Comparisons

The taxation of alcohol and tobacco products is one of the oldest forms of taxation in the world. The broad base of global experience allows domestic reform efforts to consider the excise frameworks of other countries having similar industrial and social characteristics -- the United States, the countries of the European Community, Australia and New Zealand.

All the countries surveyed continue to impose specific taxation on alcohol and tobacco products at the level of the manufacturer, either at some point during the production process or on the first sale of the goods for wholesale distribution. This structure continues even in countries with a greater reliance on a comprehensive value-added taxation structure.

There is general consensus among the surveyed countries that manufacturers should be licensed or registered and, in many cases, subject to some basic disclosure requirements in respect of premises and equipment. Beyond these basic requirements, the range of production controls and compliance mechanisms extends from on-site presence of revenue control officers, to modern audit systems implemented for extended time periods through a comprehensive systems-based investigation of the manufacturer.

Point of imposition and time of payment are largely integrated. Where point of imposition occurs at an early stage in the production process, time of payment can be delayed for several months to allow for production and distribution cycles. Where point of imposition occurs at a later stage, payment may be required with less delay, reflecting the shorter time to market.

There is a recognition that control and compliance techniques should reflect the use of automated production processes. The greater the degree of automation, the greater the need to test the system as opposed to individual transactions, and to perform accounting reconciliations over time. As manufacturers implement automated processes, excise frameworks around the world have been revised to meet this changing environment.

This brief survey of international excise structures, while not intended to be exhaustive or conclusive, highlights certain considerations that are useful for the development of a revised domestic framework.

At the most basic level, specific taxation of alcohol and tobacco products at the level of the manufacturer continues to be a prominent feature of the commodity taxation system in all the surveyed countries. While a variety of legislative and administrative structures are currently in use, the differences across concept, design and implementation tend to be attributable more to evolution than revolution, as each country attempts to balance the interests of protecting government revenue, reducing the administrative burden, and allowing businesses the opportunity to implement competitive practices.

Domestic Considerations

It is important to remember that alcohol and tobacco are not like other products. Specific taxation and the potential for diversion act as powerful incentives for contraband activity and demand special consideration in the formulation of an excise framework that will protect the integrity of the domestic market and government revenues. In fact, over the time frame of the review, the domestic markets for alcohol and tobacco products were subject to considerable contraband pressure.

Tobacco

Significant amounts of contraband tobacco first appeared in the early 1990s with the diversion of untaxed product intended for duty-free sale in Canada and for export. To combat this activity, the stamping and marking requirements that accompany imposition of excise duty for tobacco products, and the controls on the sale of duty-free tobacco products in Canada, were revamped and strengthened in 1992.

Continued growth in Canadian tobacco products exported on a duty- and tax-free basis and smuggled back into the country, however, led to the implementation of further measures, including tax cuts, in 1994. Again, the stamping and marking requirements that accompany imposition of excise duty were fundamental to establishing differential excise rates by province and to successful prosecution of smuggling networks.

Spirits

In the case of spirits, control measures that accompany the imposition of excise duty at time of production have been largely effective in preventing illegal production and diversion of domestic production. Contraband activity has focused on the smuggling of low-cost U.S. product for distribution through black market channels to consumers and commercial venues.

More recently, however, there has been some evidence of limited diversion of domestic production intended for export as contraband operators continue to put pressure on the control measures contained in the Excise Act.

Beer

With respect to beer, its mass and perishability form an effective physical barrier to the diversion or smuggling of bulk product, while imposition of excise duty at the time of packaging ensures that packaged goods, which can be more easily diverted, have liability for duty attached.

Wine

Wine is taxed under the Excise Tax Act and is subject to few controls over production and distribution. Against this backdrop, the contraband problem includes unlicensed production in Canada with illicit distribution to consumers and commercial venues. In addition, bulk wine fraudulently enters Canada and is bottled to supply the underground market. The Excise Tax Act, imposing liability only at the point of sale, does not provide the tools necessary to control this contraband activity.

Weaknesses of a Sales Levy

These developments have plainly demonstrated the need for a legislative structure that protects government revenues and secures the integrity of the domestic market. Shifting the point of imposition away from production would only exacerbate contraband pressures, reduce the potential for constructive federal involvement at the manufacturing level, and limit the tools available to enforcement agencies. Consider the following factors associated with a post-production levy:

• Packaged goods would be stored without imposition of duty, often at off-site private and public warehouses, increasing the number of participants and risk of diversion while reducing the manufacturers' incentive to safeguard production;
• Moving the point of imposition away from production would reduce the certainty of accounting reconciliations of production with amount shipped or sold; and
• Application of legal concepts to the determination of sale, delivery and purchaser would reduce the certainty of taxation assessment and collection, and create the potential for uneven application of the tax between and within provinces depending on the extent to which various wholesale and retail undertakings are available.

For these reasons, a sales levy does not provide the level of protection and enforcement required for specific taxation of alcohol and tobacco products. Moreover, any attempt to address the concerns surrounding a sales levy could result in an excise framework that is more complex and costly to administer than a production levy.

Strengths of a Production Levy

Work on the review has demonstrated that a production levy is essential to control and protect revenue, and that such a levy should include wine. Imposition of excise duty during the production process:

• Minimizes the risk of diversion of duty-free product by imposing a liability at a stage prior to the point where product can be easily redirected;
• Provides the opportunity for the federal government to maintain a constructive presence in production, packaging, storage and distribution;
• Ensures that manufacturers have a strong incentive to safeguard their production;
• Allows for a more effective enforcement function where goods are charged with excise duty at an early stage in the production process; and
• Complements provincial control over wholesale distribution and retail sale, effectively providing regulatory vigilance and enforcement capacity at all points along the production and distribution chain.

Revising the Production Levy

The retention of production-based excise charges does not, however, require the type of archaic structure and onerous regulation that comprise the current Excise Act. Many of the intrusive controls of the current legislation can be replaced with a modern production levy based on self-assessment and after-the-fact verification, while including the tools necessary to protect government revenues.

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