A committee comprising representatives of both Union and state governments has been set up to iron out the differences over the states' demands of compensation for reduction in Central Sales Tax (CST) rate.

"After a meeting with the Chairman, EC (Empowered Committee of state FMs), a committee, comprising representatives of both the Union and State governments, has been formed to examine ... CST related issues," Finance Minister Pranab Mukherjee said in a written reply to the Lok Sabha today.

Central Sales Tax (CST) is payable on inter-state sales at two per cent. Although CST is levied by the Centre, the revenue goes to the state government and the state from which movement of goods commences gets revenue.

The Centre had earlier promised to compensate states for loss of revenue due to reduction in CST rate to 2 per cent from 4 per cent.

The Empowered Committee of State Finance Ministers has recommended to the Centre not to link release of CST compensation with the increase in revenue due to increase in the rate of Value Added Tax (VAT).

A few states had earlier hiked VAT rates to 5 per cent, from 4 per cent, and Centre had reduced the allocation for CST compensation for those states.

The state governments had expressed dissent over the Rs 300 crore CST compensation proposed in Budget 2012-13. This was against their overall demand of over 19,000 crore.

The states have demanded that either the Centre should pay the compensation in full or restore the levy to original level of 4 per cent.

In 2006, states and the Centre had reached an agreement to cut CST by 1 per cent every year beginning April 1, 2007 and eliminate it by April 1, 2010 to coincide with launch of GST.

The GST regime is now expected to come into force from April 1, 2013.

CST phase-out is part of the introduction of the new GST regime under which various levies like excise, service tax and states tax, like value-added tax, entry tax and purchase tax would be subsumed in a single tax.