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Indirect tax provisions: The key issues
March, 05th 2007

The finance minister, while holding the line on indirect taxes in general, has introduced several incremental technical changes in the Union Budget 2007. A few of the recommendations made by various industry groups in their pre-budget submissions to the government for substantive reforms or restructuring of tax provisions (for example, those relating to the definition of exports of services) have been addressed in the budget. But these may now become a distant reality.

A major reform proposal was the introduction of a goods and services tax (GST), which the FM himself had promised in his last year's budget to introduce by April 1, 2010. The Union Budget 2007 reconfirms this proposal, but does not provide any additional information on its design or steps for implementation. Will it be a single national tax or dual tax consisting of a central and a state GST? What will be its scope and the rates? How will it be administered? What flexibility will the Centre and the states have in making changes to the tax in future? Will the Constitution need to be amended to empower the Centre or the states to levy a comprehensive tax on all goods and services?
The GST will be the single most significant fiscal initiative of independent India. If designed and implemented properly, it can yield significant dividends not only to the government in additional revenue, but also to the economy in the form of additional investment and economic growth. An initiative of this nature requires significant inputs from both the Centre and the states and also, resolution of several issues ranging from political to technical ones. The only information provided is that the empowered committee of state finance ministers has agreed to work with the Central government to prepare a roadmap for introducing the GST. The road to the GST is likely to be long and tortuous. The sooner the governments commence the discussions, the better.

Among the changes of incremental or technical nature announced in the Budget, there are several that are significant in terms of revenues or the impact on those affected. These include:

* Reduction in the peak rate of basic customs duty reduced from 12.5% to 10%.

* Increase in the turnover ceiling for small scale exemption under central excise from Rs 1 crore to Rs 1.5 crore.

* Extension of the service tax to new services including services related to mining and oil and gas, renting of immovable property, specified works contract, development and supply of contents and design services.

* Reduction in the central sales tax rate from 4% to 3% with effect from April 1, 2007.

The biggest surprise in the above list is the introduction of service tax on renting of immovable property for use in commerce or business. This could prove to be controversial because taxes on land and buildings are the exclusive domain of the states under the Constitution. Questions are being raised whether levy of the service tax by the Centre on rental of immovable property would be ultra vires of the Constitution.

From an economic perspective, taxation of rentals of immovable property would be discriminatory as it would create a bias in favour of owning property, as opposed to taking on rent. People renting properties would be penalised with the additional service tax liability, but not those buying them. This would be an unnecessary and undesirable distortion in the real estate market.

Rental arrangements for commercial properties are of several kinds and the tax may thus, not be applicable in a neutral fashion. In certain arrangements, the expenses such as for electricity and water are included in the rent, in which case, service tax would be chargeable on the gross amount, including the charge for utilities.

In many situations, a property may be used for commercial, as well as for residential purposes, eg, doctors or lawyers using a part of their residential property as consultation office. For such situations, the Finance Bill 2007 provides that the total amount must be taxed, which is unfair and may force people to alter their arrangements so as to avoid service tax on residential leases.

These aspects make this budget a 'wait and watch' budget to see the impact only after the proposed changes are implemented and the mysteries, particularly on GST, are unfolded.

The authors are senior tax professionals with Ernst & Young

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