The prices of rice and cotton that's ginned and baled are likely to rise as their transport and storage have been deemed ineligible for exemption from service tax by the finance ministry.

They are not on the negative list of items on which 12.36% service tax doesn't have to be paid, finance minister P Chidambaram told junior consumer affairs minister KV Thomas in a November 8 letter, a copy of which ET has reviewed. Consumer affairs ministry officials said that they are yet to review the clarification. "We are concerned for cotton as it will have a larger impact and we are still working on it with the finance ministry," one of them said.

Thomas had sought a clarification because of the ambiguity regarding service tax on the transport and storage of the two commodities.

The finance ministry is of the opinion that paddy is an agricultural produce but rice is not since it has been processed and de-husked in a mill, thus excluding them from being classified under "agricultural produce" and exempted from paying service tax.

Agricultural produce, as per the service tax negative list, means anything that hasn't been processed at all or has only been subjected to treatment as is typical by a cultivator or producer that doesn't alter the essential characteristics but makes the commodity ready for sale in the primary market.

"The clarification means farmers or merchants will have to pay 12.36% service tax on storage, loading, stacking, transportation etc of rice and ginned/baled cotton," said Pritam Mahure of Pune-based tax advisory firm Lawgical Consultants. "When there is no service tax levied on other essential agriculture products (such as wheat), this step is very strange" as consumers "are already feeling pinch due to inflation."

After a long battle with prices, inflation has only just slowed, giving the central bank some breathing space on interest rates amid a prolonged slump. High inflation and the state of the economy have been partly responsible for the erosion in the popularity of the United Progressive Alliance government, which is preparing for elections in a few months.

According to Chidambaram's letter, the finance ministry told Thomas that services related to agricultural produce that are in the service tax negative list, according to section 66D(d) of the Finance Act, can't be expanded.

"Certain specified services relating to agriculture or agricultural produce are kept in the negative list. Rice and ginned/baled cotton are not covered by the definition of 'agricultural produce' found in section 65 B (5)," according to the letter. Following the finance ministry's clarification,

the Central Warehousing Corporation has instructed customers about the additional levy, with retrospective effect. "The storage and cargo-handling charges on rice are subject to service tax from July 1, 2012, for all the depositors including Food Corporation of India (FCI) and other central or state government agencies or the department," CWC said in a statement.