Several states have opposed provisions in finance minister P. Chidambaram’s budget that would boost federal revenue at the cost of the states, in a move that could further strain ties between the Centre and the states, and halt progress towards a goods and services tax (GST).

At issue are budget proposals that make certain levies such as royalties, licence fees and privilege fees paid by state government undertakings to state governments non-deductible from the income of state-owned units.
This would in effect increase the tax payout of these state government units.

While Tamil Nadu chief minister J. Jayalalithaa has already objected to the provisions, several other states are also likely to take up the issue with the Union government.

“It is an attack on the state government and is anti-constitutional. We are looking into the provisions. We will inform the central government about our opposition before the Finance Bill is taken up,” said Raghavji, finance minister of Madhya Pradesh, who uses only one name.

Jayalalithaa, in a letter to Prime Minister Manmohan Singh, has sought the deletion of the clause and said states have the powers to levy such fees and royalties under Article 265 of the Constitution, according to a report by PTI. She added that the provision would boost the income of the Union government to the detriment of the legitimate tax and non-tax revenue of the state governments.

“This amounts to an indirect taxation of the income of state governments and hence is violative of the spirit of Article 289 of the Constitution, which exempts the property and income of a state from Union taxation,” she said, adding that the move would distort the federal structure of the country.

The budget proposals have opened another front in the uneasy relationship between the Centre and the states at a time when the Union government needs the agreement of the states to implement GST aimed at creating a common market. This is widely seen as a step that will boost flagging economic growth.

After much toing and froing, the states turned amenable to the single tax after the Union government conceded some of their demands with regard the design of the levy and the issue of central sales tax (CST) compensation. In its effort to move towards the unified tax, the Union government had cut the quantum of CST from 4% to 2%. This tax, levied on the movement of goods across state borders, is a major source of revenue for states. Chidambaram made a provision of Rs.9,000 crore towards CST compensation in the budget for 2013-14 that he presented in Parliament on 28 February.
“The states will oppose the Centre’s move,” said a state finance minister of an opposition party-ruled state, who did not want to be identified, commenting on the budget proposals. “It will be taken up by the respective parties in Parliament or directly by the state governments. Such unilateral steps by the central government reinforces fears of states about their autonomy in the post-GST regime.”

The Finance Bill, 2013, proposes to insert a clause that says that any amount paid by way of royalties, licence fees, service fees, privilege fees, service charges or other items levied exclusively by a state government on a state government unit will not be considered eligible expenditure while computing income.

“From last many years, the central government is trying to take away revenues from the state,” said Saurabh Patel, Gujarat’s energy and petrochemicals minister. “Gujarat government-owned companies have been performing very well, and the turnaround of many state owned-companies has happened in the last decade and the state has invested heavily in them. The state invests money in infrastructure and other facilities and the Centre wants to take away all the revenues. This is harmful for the state in the long run.”

State government units have been defined as entities set up under any Act of the state government, or a company in which the state government holds a majority stake. There are around 850 such entities. Mint couldn’t immediately ascertain the quantum of royalties, licence fees and privilege fees paid by these companies to their respective owners.
The memorandum explaining the provisions says this clause has been inserted to protect the tax base and prevent disputes that have arisen over allowing such expenditure to be deducted from the income of these units.

Analysts said states would argue that the scope of these units is a state function. Also, the states provide these state-run firms assets by way of land and other infrastructure, and these units are required to pay such amounts though various Acts.

“The state government has delegated a sovereign function to these undertakings and recovers royalty or fee from them. But the central government is of the view that such royalty is charged to reduce the payout of tax,” said Ved Jain, a former president of the Institute of Chartered Accountants of India.