The empowered committee (EC) of state finance ministers has decided to levy value added tax (VAT) on sugar and textiles at 4% -5% from April next year, a move that could lead to an increase in the prices of these commodities. The decision has been taken as states have now been empowered to tax these two commodities.

Speaking to reporters, EC chairman Sushil Kumar Modi said there is consensus among states to impose VAT on sugar and textiles from next fiscal. He further said the VAT would be levied at the floor rate, which varies from 4% to 5% across various states. Currently, only Tamil Nadu, Orissa and Andhra Pradesh impose VAT on these items and now it is likely to be replicated in other states.

Exporters of textile products won’t be impacted by the new VAT levy as they get refunds. As for domestic sales, textile and apparel companies might have to pass the burden to consumers.

Until 2006, the Centre used to impose additional excise duty in lieu of sales tax (the rate was originally 4% but was subsequently reduced to 2%) under a central Act on these commodities. The states used to get one percentage point additional share from the Centre from the divisible pool of its tax proceeds on account of this central tax. The tax rate was reduced to nil at a point and subsequently, the Act itself was abolished. The Thirteenth Finance Commission, meanwhile, has proposed a one and half percentage point increase in states’ share of Centre’s tax revenue to 32%.

Since textiles and sugar were in Centre’s tax schedule, the states did not have the power to levy tax on these items until they were moved out from the schedule in this year’s Budget. Experts say that levying VAT on sugar in its producing states like Uttar Pradesh will lead to increase in prices. “If the VAT is levied, the price of the commodity will rise,” Deloitte indirect tax leader Prashant Deshpande said.

Modi also said VAT and non-VAT revenue of the states grew by 20% in the first half of the current financial year. However, the growth is not robust as compared to last year and so it seems that states are entering into recession. The moderate growth is due to muted performance of sectors like auto, transport, cement and construction. “This is due to high interest rate scenerio and increase in petrol prices,” he said.

The Bihar deputy chief minister and finance minister also added that there was resentment among the states as the Centre is not abiding by its promise to compensate states on loss of revenue due to phasing out of Central Sales Tax (CST). “The CST was reduced to 2% from 4 % about three years back. For two years, 2010-11 and 2011-12, many states have not received compensation. Strongly worded letter will be written to Union Finance Minister on the issue,” Modi said.

CST, a tax on inter-State movement of goods, was reduced from 4% to 3% in 2007-08, and further to 2 per cent in 2008-09 after the introduction of Value Added Tax (VAT).

He added that PMO has written to the empowered committee to keep natural gas and regassified LNG in the declared goods category so that 5% VAT could be levied in this category. However, states have opposed the move initially as it would lose revenue, since states impose up to 12% tax on these items. Items used by large public are kept in declared goods category.

In the meeting of EC, the European model of GST was also discussed. Recently, the state finance ministers were on the trip to Europe to study their tax structure.