The proposal comes just days before the Centre and states discuss a model for taxation of interstate movement of goods (IGST).
Gujarat has told the Centre that it should be allowed to deduct the 2 per cent tax levied on all goods that leave state borders to be sold elsewhere. For instance, cars manufactured at Maruti and Tata factories in Sanand, but sold in Delhi.
Currently, the Centre collects this inter-state tax on behalf of all the states and distributes it among them. The GST structure which is being finalised is meant to abolish this origin-based tax for a destination-based tax. To make the switchover easy, all states are supposed to get a compensation amount over the next few years.
But the Gujarat model placed before the empowered committee of state finance ministers puts a spanner in the works as it ensures that the origin-based tax, biased in favour of manufacturing heavy states, will continue in perpetuity.
For instance, it will force a recalculation of the rates for the GST in the bills that are to be placed in the winter session of Parliament. Equally important, if this model is adopted, one more constitution amendment bill will be necessary to redraw the powers of taxation for the Centre and the states.
State Finance Minister Saurabh Patel, in his note, has demanded that Gujarat be allowed to levy the central sales tax at the source. In return, the state will ask the Centre to recalibrate the compensation amount it would have got. Manufacturers will be given credit by the state, independent of the central governments GST machinery for the sales they make outside the province.
Crucially, the right to phase out the inter-state tax will pass from the Centre to the states under the Gujarat model.
This is now the biggest obstacle we have on the GST issue. It will entirely damage the model, a source said. In last years budget, the Centre had provided Rs 9,300 crore as compensation to states, though only Rs 1,940 crore was disbursed.
Central government sources said that the proposal, which is totally at variance with the Maharashtra model, has drawn interest from some other manufacturing rich states such as Tamil Nadu, and may force the GST plans back to the drawing board.
Gujarat has argued that it is not convinced that the compensation mechanism being drawn up by the Centre will be adequate for the tax it will forgo on interstate movement of goods.
Indirect tax expert and consultant to the Finance Ministry on GST issues, S Madhavan, described the Gujarat plan as a bad idea. It will lead to perpetuation of origin-based tax from which we are trying to move away. The finance minister and his team must stand firm against it.
In the Budget for 2014-15, Finance Minister Arun Jaitley had referred to the apprehension among some states to surrender their taxation jurisdiction. I assure all states that the (central) government will be fair in dealing with them, he had said.
But despite the assurance, Patel has made the fresh demand, taking away the right of the Centre to determine the end of the most important bottleneck for the GST to become a reality. The budget has not drawn up any amount as CST compensation since the mechanism is still in the works.
Phasing out this tax has been highly controversial as the manufacturing states have demanded higher compensation while consuming states have objected to it. The Gujarat model, by seeking to take away the Centres rights on the tax, could make the GST almost impossible to reach.