Sri Lankan government's proposals to impose a minimum excise tax on liquor and beer manufacturers and tighten issuance of liquor licenses are positive for larger spirit manufacturers, including Distilleries Company of Sri Lanka, Fitch Ratings said.
The impact is likely to be neutral for beer manufactures, including the market leader Lion Brewery PLC, the rating agency said Wednesday in a release.
According to the rating agency, the proposals, which target manufacturers and retailers of alcoholic beverages to address problems of tax evasion, will reduce the number of players and act as barriers to entry. The proposed changes were set out in the government's interim budget on 7 February 2015.
The new minimum excise tax of Rs. 200 million is aimed at reducing the number of smaller players, especially in the spirits market. Based on the latest reported data, the majority of licensed liquor manufacturers do not produce enough to meet the minimum monthly excise tax of Rs. 200 million. The four bigger companies in the spirits market, however, already pay more than Rs. 200 million in excise tax monthly and they are likely to dominate the market as smaller players exit. Fitch estimates the exit of small players could lead to potential market share gains of close to 10% in aggregate for surviving players, based on Excise Department statistics.
For the beer market, the impact of the proposed excise tax will likely be neutral because of a duopoly structure in the malt beverage segment, with Lion already paying more than the minimum tax while the other player almost meets the minimum amount based on latest published data by the Excise Department.
With fewer industry participants, the volume of undisclosed and/or untaxed production will likely fall, which would lead to a more level playing field in terms of pricing. Industry participants that evaded taxes on production by reporting lower production volumes were able to price their beverages at 30%-35% less than prices quoted by DIST.
The new budget proposes limiting the number of liquor licenses each person can hold to three, with licenses up for renewal annually through an open tender process that will start in 2016. In the interim, pending implementation of the tendering process, the government will double license fees. The proposals also include a one-off special levy of Rs. 250,000 on each tavern/liquor sales outlet. Fitch expects the restriction on ownership and higher licensing fees to have minimum impact on alcohol beverage distribution due to the retailers' ability to absorb the higher taxes and fees, and significant demand for licenses in the market.
However, the annual renewal of licenses could deter extensive investment and refurbishment of retail points. The impact of the proposal on modern trade, hotels, and restaurants with more than three licenses is not yet clear because the terms of the proposal have not yet been determined.
Other budgetary proposals include a one-off super-gains tax of 25% on companies with profits over Rs.2 billion, which Fitch does not expect to have a material impact on the industry players, given the cash generative nature of the sector and the tax being a one-off event.