Finmin divided over CBDT proposal to cut service tax

Written by Gireesh Chandra Prasad | Gireesh Chandra Prasad | New Delhi | Updated: Dec 3 2012, 08:52am hrs
The Central Board of Direct Taxes (CBDT) has made a strong case before the Service Tax Administration to slash the 12% levy only for the final consumer so as to help boost consumption and, consequently, corporate tax revenue. The board's proposal has, however, created divisions within the finance ministry, with the Service Tax Administration flatly rejecting a cut in the tax, proceeds from which has grown at a spectacular 34% this year. The service tax should be allowed to stabilise and attain its full revenue potential, the administration reckons.

The CBDT also feels the need to cut the service tax rate to 8% to introduce the proposed goods and services tax (GST), the combined (Centre-state) rate of which could be 16% or 18%. On the other hand, there is a demand from the Kelkar panel that looked into government's fiscal health to further prune the negative list of services that are outside the tax net now in order to maximise revenue. The question, therefore, is a fundamental one: Whether to use direct taxes to boost revenue or indirect taxes.

Experts said that unlike in high-income countries, where the effect of a tax rate change on purchases may be short-lived, the same in India may be more pronounced and long-lasting. The impact of a change in tax rate on consumption depends on price elasticity of demand. In a country like India, we have seen a demonstrable evidence of impact on consumption arising from a change in tax rate, said Prashant Deshpande, senior director, Deloitte.

Only robust service tax collection will strengthen the government's hands to introduce the proposed new Direct Taxes Code (DTC) with an income tax exemption limit of Rs 5 lakh, as against to the current exemption limit of Rs 1.8 lakh, said a senior government official, who asked not to be named. Globally, service tax has helped many economies to keep income taxes low, the official added.

While there is no hard and fast rule about the right balance between direct and indirect taxes, some economists believe that in developed countries, where services account for a larger share, indirect taxes surpass direct taxes. Many also believe indirect taxes are distortionary in nature. India hopes to collect Rs 5.6 lakh crore by way of direct taxes and Rs 5.1 lakh crore from indirect taxes this fiscal, suggesting a direct-indirect tax ratio of 52:48.

There is another strong argument with the Service Tax Administration to guard against a rate cut. Unlike direct taxes, indirect taxes including service tax is unaffected by the tax residency of the individual or the company that consumes the service and, therefore, is a more reliable source of revenue to the exchequer. An individual consuming a service here needs to pay service tax irrespective of whether he had stayed 182 days in India or not in the previous year.

But the call for a reduction in the service tax for the final consumer is getting louder within the finance ministry as such a step may leave more money in the hands of the common man to consume more, thus boosting the economy. The common man bears the impact of all indirect taxes including excise, customs and service tax that gets built into a purchase. Since he does not get input tax credit, there is a case for moderation in the rates, goes the thinking. It is not fair to burden one class of assessees too much, according to some in the government.

Service tax, which accounted for only 5.3% of the total indirect taxes in 2003-04, has now grown to be 23.5% of the indirect tax receipts in 2011-12 at Rs 95,000 crore. The ministry expects it to touch Rs 1,24,000 crore this fiscal.

Direct contest over indirect tax

* CBDT proposes to slash 12% levy for final consumer to help boost consumption

* CBDT also feels need to cut service tax rate to 8% to introduce the proposed GST

* In FY13, India may collect R5.6 L cr from direct taxes & Rs.5.1 L cr from indirect taxes