By this innovative suggestion made to states recently, the Centre intends to not only overcome the states resistance to inclusion of petroleum products in the GST, but also address their concern over the imminent removal of the central sales tax (CST). CST is a major revenue source for states at present.
Since CST is an origin-based tax benefiting the exporting or producing state, it goes against the destination-based taxation principle followed worldwide in GST, under which consuming states get the tax revenue.
If states agree to the proposal, in what is seen as a last-ditch effort to implement GST during the current government's tenure, it would bring an instant solution to the two most thorny issues that have so far hampered progress in introducing a unified indirect tax regime in India.
Zero rate for inter-state transactions is based on the EU model of zero tax on inter-country sales.
Inter-state transactions are at present taxed through CST at the rate of 2% and the proceeds are appropriated to states. The states have been very reluctant to replace it with inter-state GST (i-GST), the collection of which was originally meant to go to the Union government exclusively. The second benefit of the new proposal, according to official sources, is that it may help secure the states' consent to keeping petroleum products within GST with input tax credit facility (ITC). This will help reduce the tax burden on a host of products as petroleum by-products are building blocks in a large number of industries.
The Union governments proposal to keep i-GST zero rated is based on the fact that it is actually not meant to be a tax but a two-way settlement system. The tax paid by a businessperson on purchase of goods or service from a neighbouring state will be claimed by him as an input tax credit when he has to meet his tax liability, said an official source.
IGST is not a tax per se, but a T+2 clearing system. Eventually, the iGST pool will have nothing but the unpaid input tax credit, the source explained.
"We will allow states to levy a narrow band on the state component of GST on petroleum products to make up for loss of revenue from removal of CST, said another person familiar with the matter. States now levy sales tax on sale of petroleum products in two stages that yield them nearly 30% of their overall tax revenues. For example, Indian Oil Corporation has to pay sales tax to a state when its products enter its depot in that state and dealers subsequently pay sales tax when they get the fuel from the refiner.
Besides, the central government will give an assurance to states that their CST revenue from products like petroleum (on which the ITC facility is currently not available and hence has a high tax incidence) will be protected. States, however, have been demanding a constitutional mechanism for compensation of loss of revenue, which has not been favoured by the Centre.
According to David Raistrick, global managing director, indirect taxes, Deloitte, a nation need not necessarily tax inter-state transactions under GST, although it can be done. You could look at the EU model. If you really want to simplify GST, inter-state tax can be zero, Raistrick told FE recently.
Sources also said that if states agree to the new proposal, GST could be introduced inclusive of petroleum products from day one, which would benefit industry.