Modi Government rejects states’ demand

Dated 9th October, 2014

While the Narendra Modi government is keen to bring the states on board for the proposed comprehensive goods and services tax (GST) given its economy-wide benefits, it won’t yield to the sates’ strategy to use the grand bargain for unreasonable revenue gains and unhindered fiscal freedom.

The Centre is learnt to have turned down a key demand from mineral-rich, grain-producing and manufacturing states that they must be given a portion of the Centre’s revenue from GST on interstate trade to offset their perceived revenue loss to “consumption states” in the GST regime. It has also rejected a proposal from all states that the mandate of dispute resolution should not be given to the proposed GST Council, which is meant to have a constitutional role. These demands were made by respective states as a precondition for their adoption of the superior tax system that would avoid cascading of taxes and reduce the multiplicity of indirect taxes.

Financial Express had earlier reported that states like Gujarat and Tamil Nadu that export goods to other states demanded an upfront share of Centre’s revenue from interstate trade. Their contention is that GST, being a destination-based tax on consumption, shifts the tax base away from investment and production and hence could be detrimental to their revenue interests. Mineral-rich states like Odisha and those with big oil refining capacities have also raised similar concerns.

Sources privy to discussions between central and state finance ministers said that transferring proceeds from 2 percentage points of the central government’s component of GST on interstate commerce to the exporting state would reduce the Centre’s revenue, unless the revenue-neutral rate (RNR) for it is raised.

The GST has two components — central (CGST) and state (SGST) — that roughly apply on the same base.

While the combined RNR is yet to be determined, it is widely expected to be between 16% and 20%. As per the current thinking, GST on interstate transactions or IGST will be levied at the same rate as the combined RNR (initially, IGST was proposed to be zero-rated). The state component of IGST would go to the importing state, in contrast to the present system of the exporting state getting the proceeds of the central sales tax on cross-border commerce.

“Although theoretically it is possible for the central tax rate on interstate sales to be higher than the state tax rate, it is generally desirable to have a common rate for both. This would make the design and implementation of IGST simple,” said the source, who asked not to be named considering the sensitive nature of the talks. Cross-utilisation of credit between central and state taxes would be available on interstate transactions.

The finance ministry has also taken a view that the mandate of the proposed GST Council to settle tax disputes between states and between states and the Centre need not be taken away. States recently objected to the idea of an executive body of central and state ministers having the final say on taxation, as it would be compromising state legislative assemblies' taxation and lawmaking powers.

The finance ministry believes that a similar give and take has been made when India joined the WTO for the larger goal of economic benefits although there was criticism of compromising the state's sovereignty. “In the case of GST, we are talking about making compromises within the country for a common economic goal,” said the official.

The ministry recently conceded to state finance ministers demand for not levying GST on petroleum products in the initial years of the new indirect tax regime expected from 2016. It believes GST won't be worthwhile if too many adjustments on its design are made and it carries forward the very anomalies it seeks to address. Exporting states retaining a share of tax meant for the importing state amounts to retaining the present origin based tax system on interstate sales.

The government is expected to table in Parliament a revised the Constitution (115th Amendment) Bill in the coming winter session of Parliament. The Bill seeks to redefine the taxation powers of the Centre and the states and lay the framework for creation of a single market across the country that is believed to add another 1.5 percentage points to its economic growth rate.