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Separate act for service tax may take a year more
February, 27th 2007

A comprehensive law on taxation of services, or a separate service tax act, could take at least one more year to come into force. The Centre is not keen at this juncture to have a separate legislation for service tax though a consensus has been reached on compensating states for revenue losses on account of CST phaseout. The compensation package will enable states to tax 33 out of 99 services that are now taxed by the Centre and another 44 services of local nature.

The finance ministry reckons that there is no need to rush through the process of having a separate service tax legislation. Power to tax services was taken by the Centre through the Finance Act 1994. The act sourced the power from Entry 97 of the Union List (residuary clause). However, for administrative purpose, service tax is regulated by relevant provisions of the Central Excise Act, separate rules notified for import and export of services and many clarificatory circulars issued by CBEC since the impost was introduced.

According to official sources, the Centre may retain power to levy and collect service tax in 2007-08. It could bring many services of local nature, among the identified 44, under tax net in this Budget.

The proceeds would go to states, instead of the 12th Finance Commission-mandated 31.5%. Budget will include a monetary component as grant-in-aid for the proposed additional resource transfer to states on account of CST phaseout.

Other components of CST compensation include abolition of Form D, which entails the Centre to enjoy concessional sales tax of 4% for inter-state purchases and state VAT on imports and tobacco.

While Form D abolition would be effected through an amendment to the CST Act in the Budget session, VAT on imports may have to wait. States may, however, start levying VAT on tobacco in 2007-08 and in the coming years, fabrics and sugar, the other two items under additional excise duty in lieu of sales tax (AED-ST), may attract state VAT.

There are various administrative issues that the Centre and states will confront as states actually start levying tax on services. As for services taxed by states, the Centre will have no obligation to give credit.

As for services of inter-state nature (service provided fully, or partly in one state and consumed fully, or partly in another), questions of identifying the tax providers end (which determines which state has the jurisdiction) and providing input tax credit will have to addressed. The legal and administrative systems for availing input tax credit on inter-state services will have to be evolved and set up. One option could be that states give credit on service tax from VAT.
One view is that the practice of administering service tax through the excise act has not had major glitches the plus points are that compliance among service providers has improved. There are apprehensions that if a separate act is legislated, it would give sweeping powers to revenue authorities which may not be warranted at this stage.

Services in general are excluded from state taxation. Only a few services are taxable by states under some specific provisions under the constitution taxes on goods and passengers carried by road and inland ways, taxes on amusements and taxes on betting and gambling. Under the constitution, the Centre has powers to levy taxes only on railway fares and freights and on airway services.

However, Entry 97 of the Union List (residuary clause) empowers the Centre to levy taxes on all items not mentioned either in the State or Central lists.

By virtue of this entry, the Centre has been levying taxes on select services since 1994. Service tax has not been merged yet with cenvat. Expert committees on reforms in inter-state taxation had made out a case for having a suitable mechanism to provide input tax relief on the tax paid on services. Such a system is already in place.

However, a constitutional amendment would be needed to allow states to levy tax on services. It would take at least a year for such an amendment to be passed by Parliament. Till then, the government need not have a separate service tax legislation.

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