Killing the goods and services tax
Sukumar Mukhopadhyay
January 13, 2007

If states are to levy service tax, a combined GST will become a
nightmare since a host of tax departments in each state will also have
to be dealt with.
The empowered committee of the state finance ministers and the finance
ministry reached a broad consensus on the issue of phasing out of the
central sales tax on January 3, 2007. The compensation package
consists, /inter alia/, of (i) Legislative measures that are required
to be taken in this regard; (ii) The transfer to the states of the
total service tax revenues on certain identified services. It is
reported that 77 services have been identified for this
purpose. However, the fact that legislative measures have been thought
of, proves that there will be a transfer of power to the states to
collect service tax. The power to levy the service tax is only with
the Union as per Entry 92C of List 1-Union List, Schedule-VII but the
collection can be authorised to the states under Article 268A(2) if
such is passed by the Parliament. If the central government merely
collects the service tax and dispenses it to the states, no
legislative empowerment is necessary. So, it is clear from the above
consensus that the central government is thinking of empowering the
states to collect the 77 service taxes. I wish to stress that it is
not a good idea to allow the states to collect and appropriate the
service tax. The central government should levy, collect and
thereafter distribute the revenue to the states.
There are several reasons why the collection of service tax by the
states is not desirable:
(a) At present, the Cenvat for goods and service tax paid for input
services can be combined and taken credit against the tax payable on
services and goods by companies on an all-India basis irrespective of
the state where the purchase or sale takes place. For instance, an
all-India company buying services in Maharashtra can get an input
credit for the service tax against the tax payable for goods cleared
at West Bengal. This all-India character of the combination of service
tax and goods tax (Cenvat) is what makes an Indian common market where
business is conducted smoothly. The path to GST (goods and services
tax) at the Central level is possible in this way. Presently, the
interchangeability between service tax and goods tax is not complete
but it is moving in that direction. It will be complete with the
service tax rate going up from 12 per cent to, say, 14 per cent and
the goods tax (Cenvat) coming down from 16 per cent to 14 per
cent. Such interchangeability will not be possible in case the service
taxes are collected by the states. A service tax collected in
Maharashtra will not be allowed to be adjusted as input credit against
the sale of goods in West Bengal though the company may be one and the
same. The company will have to bifurcate and trifurcate the corporate
accounts for different states making accounting procedure unnatural
and creating hurdles in business. This may hinder the free flow within
a common Indian market.
(b) The 77 services, which have been chosen, are quite obviously the
state-based ones, which do not have all-India ramifications. But there
is no reason why some of them cannot develop into all-India
businesses.  If they do, then they will face the same problem as has
been discussed above.
(c) To ensure that all states have the same rates for service tax is
not possible. This will cause complications.
(d) The administrative machinery in place at the Centre is
well-experienced and established and can collect service tax for 77
items without much extra cost. The state governments, on the other
hand, will have to spend substantially on fresh administrative
(e) The interchangeability of input credit for goods and services is a
complicated system, which has developed over a period of time at the
Central government level. It will not be practicable for the states to
introduce it straightaway. It may create enormous confusion leading to
loss of duty. Establishing a new system of administration for service
tax alone is difficult. Doing it for introducing interchangeability
will be even more so. There are several states which are
administratively not well-developed, like in the north-east,
Jharkhand, Chattishgarh, Uttaranchal, Himachal Pradesh and so on. In
fact, some states are still employing international consulting firms
to straighten up the VAT system.
(f) There is no reason to believe that the collection of service tax
by the states will be as efficient as that by the Centre, which has an
experience of nearly 20 years in the case of goods and 12 years for
It will, therefore, be a much more effective system if the service tax
is collected by the Centre and the revenue is dispensed to the states
as per a devolution formula, which can be worked out suitably between
the parties involved.
In this connection, it is relevant to dwell upon the idea of some
economists that the states should be allowed to levy service tax on
all the services so that the states and the Centre have the same base
for a complete dual VAT. This idea is also not good enough for the
reason that in a federal country like ours, where several services are
spread throughout the country such as railways, air and road
transport, communication and others, a service tax regime under
different states will create dichotomy as the same service provider
will have to pay service tax in different states. This would make
business unduly complicated and burdensome. In Canada, which is a
federal country and is therefore comparable to India, GST is levied
only by the Union and the states only collect sales tax. There is also
a possibility of excessive taxation on services because the tax base
is the same both for the Centre and the states. At present, all taxes
by the Centre and the states have different bases. For example, for
central excise, the base, that is, the taxable event is the act of
manufacture while for sales tax or VAT, the base is the act of sale,
though the goods are the same.
Thus, both from the practical and economic point of view, a more
appropriate policy for service tax will be for the Union to levy,
collect and thereafter dispense the revenue to the states rather than
allowing the States to collect and appropriate the service tax.
/* The author retired as Member, Central Board of Excise & Customs */