Pan Masala and Indirect Tax Leakage: Where Enforcement Still Fails

Abstract

Pan masala presents an unusually difficult indirect-tax problem. High volumes, low unit prices, fragmented production and cash-based distribution make output easy to conceal and difficult to audit. The industry therefore provides a useful test of whether capacity-based levies, machine registration and surveillance can close persistent enforcement gaps.

This article delves deep into changes reforms happened in past years, how acts are governing and restricting exploitation and how people are envisioning taxing for their own profit in this market

Introduction

Pan masala is a mix of betel nut, tobacco with other essences and ingredients and is said to be "sin good" and "demerit". It is found in abundance in the areas of Uttar Pradesh, Madya Pradesh, Gujarat, Delhi it makes crores of revenue annually but even thou this industry has always marked itself highest number of tax evasion under Indian Taxes Laws.

Pan masala is inexpensive, widely consumed and produced through packaging systems whose real output can be difficult to verify. Those characteristics create opportunities for suppressed production, undervalued invoices, false exports and fraudulent input-tax-credit claims.

Road from Excise to GST CESS

Central Excise Act,1944.

Before Good and Services Act took place in 2017, These pan masala and tobacco were regulated under central excise act,1944. The main feature which was introduced was the capacity- based levy introduced in 2008 under Pan masala Packing Machine rules. The duty was imposed on the number of packaging per month based on machine, speed and its retail price which led to high litigation issues on production, sealing and de-sealing of these machines.

GST Transition and Compensation Cess

GST was introduced in 2017 which shifted the whole focus on the invoice-based GST and compensation cess. The GST act levied cess on the stated 'sin goods' which included pan masala contributing as a compensation to the states for the losses during the transition period.

In this period the masala secured 28 percent of GST + ad valorem (it is the way where cess was calculated on the basis of the percentage of transaction s written in the invoice). After this the GST council found out the loophole and accepted the recommendation for the cess mechanism to change from ad valorem to specific rate-based levy.

The Finance Act 2023 required manufacturers of pan masala, tobacco and gutkha to register packing machines with the GST authorities. Failure to register could attract a penalty of INR 1 lakh per machine and possible confiscation.

Main Analysis

Loopholes and Tax Evasion Techniques Used by Manufacturers to Escape Taxes

Pan masala manufacturing without registration- these usually happens in the industrial, warehouses owned by the people or even in some residential area, they produce goods through unregistered machines. The raw materials are cultivated and produced secretly and then used to make the finished products. The government does not know the existence of the factory as it is unregistered so they are not taxed by the authorities.

Under-reporting production: a registered factory may conceal raw-material use or actual output while reporting lower quantities in its records. Because invoice value and declared quantity shape the tax assessment, false documentation can significantly reduce the liability shown on paper.

A capacity-based levy shifts attention from invoices to the productive capacity of packing machines. Fraudulent input tax credit presents a separate risk: manufacturers may use false invoices or shell suppliers to claim credit for tax that was never paid.

The fraud commonly involves shell suppliers, fabricated purchases and invoices unsupported by any genuine movement of goods. The paperwork creates the appearance of tax-paid inputs while the underlying transaction is fictitious.

E-way-bill and transport fraud: consignments may move without valid documentation or with quantities and values deliberately understated. The scale and speed of road transport make consistent physical verification difficult.

Exploitation in the name of small manufacturers- This fraud takes place when a large manufacturer plays role of small manufactures to attain benefits which are given by the government such as schemes to promote small manufacturers. The larger manufacturer divides its company into small company and thus the turnover for each company is less and thus less tax is allotted by the authorities

Constitutional Validity of Taxation Laws

Godfrey Philips India Ltd vs Commissioner of Central Excise,2017.

In this case the tribunal handling the case had affirmed the capacity-based tax levy in its final order under Section 3A of Central Excise Act,1944 and the Pan Masala Packing Machines. It is held that duty applied on the basis of production capacity of the machine rather than the actual production figures. This decision is crucial as its main objective was to combat large scale tax evasion by suppression of production and underreporting, This judgement emphasis on the strict compliance with the machine capacity determination requirements. The case is significant for showing judicial support for capacity-based tax levy as an anti-evasion mechanism in the pan masala industry.

Reinforcing the principle that industries with a history of widespread tax evasion the lawmaking authorities support the activities which would be helpful for the taxing authorities and to prevent tax evasion.

Legislative Reforms of 2025-2026

Health Security se National cess Act,2025.

This act was present in the Lok Sabha by finance minister Nirmala Sitaraman and was passed by the both legislative houses. This act aims to put up a special tax on machines installed or any activities take are taken place for the manufacturer or production of pan masala or any other goods as per the central government.

The reforms introduced capacity-based taxation for packing machines and widened responsibility to persons who operate or control those machines, directly or through contractors. They also required self-declaration and CCTV coverage of production areas, with footage retained for at least forty-eight months.

The legislation also strengthens criminal consequences for deliberate tax evasion. The Central Excise (Amendment) Act, 2025 complements the new cess framework by revising excise treatment for specified tobacco products.

New Composite Tax Framework from 1 February 2026

Acc. to the new framework a uniform GST slab s provided that is 40%, tobacco products including pan masala straight forward attract 40 percent GST on RSP basis (Retail Sale Price) under Rule 31D of the CGST Rules.

Health Security to National Security Cess

HSNS Cess is a capacity-based excise tax implemented by the government of India for specific goods like pan masala which is charged by per machine per month computed on machine speed and pouch weight.

The composite framework marks a structural shift from invoice-led enforcement towards production verification. Capacity-based liability, compulsory machine registration and CCTV records are intended to reduce output suppression and invoice undervaluation.

Early enforcement actions indicate a willingness to use criminal liability, not merely civil penalties, against deliberate evasion. A remaining risk is displacement: misconduct may move from the factory floor to transport, warehousing or false reporting elsewhere in the supply chain.

While the government cured the legislative flaws, it would not stop the informal sector for tax evasion. A large portion of production and consumption occurs through the corner shops, small shops, traders and hand to hand cash inflow in rural or semi urban areas or markets. To cure this we need stricter reforms, arrangements and surveillance over every seller manufacturer etc. The HSNS cess is on the premise that the manufacturers are identified, machines are registered with their capacity declared.

Conclusion

Tax evasion n pan masala industry still remains one of the most challenging in the Indian taxation system, As the problem is deeply rooted in the informal as well as formal sector in the industry. Persistent challenges come to surface such as unaccounted production, fragmented manufacturing units and cash transaction which are not noted down formally which creates loopholes in the tax transaction allowing high leakage of revenue on a large scale over the years despite heavy legislative and administrative reforms. The regulation is aimed to strengthened tax compliance and improving enforcement mechanisms.

The reforms show governments effort to reduce invasion, starting with capacity-based levy and then in 2008 curbed under reporting of production by linking tax to the manufacturing capacity, The transition to GST framework 2017 was to modernize the structure of taxation and to improve transparency through input credit mechanisms.

Judicial decisions have reinforced capacity-based taxation and the authority of officials to recover deliberate evasion. Enforcement must now become consistent across production, transport and distribution. Strong penalties will work only when they are supported by reliable evidence, transparent procedure and meaningful protection for compliant firms.

Consistent examination and surveillance with stricter enforcement and implementation of rules and regulation, these measures will be effective and has potential to reduce the tax evasion and promote fairer practice and competition in the industry, strengthening public confidence on government and India's taxation system.

Primary materials

Key primary materials: CBIC GST Acts; Supreme Court of India judgments.