Companies located in states that do not implement the proposed Goods and Services Tax (GST) from April 1, 2010, would not be able to claim input tax credit, said a senior finance ministry official.

Thus, firms in non-GST states would have to pay higher taxes, which will make them uncompetitive with those in states where the tax is implemented.

This is an incentive system for states to join the proposed GST, said the same official, who declined to be named.

The concept of input tax credit is essential to ensure that producers pay tax only on their value addition part, and not pay tax on tax. For example, if a company A buys inputs for Rs 1,000, which includes a tax component of Rs 100, then assuming that this company sells a product after adding value to the inputs at Rs 2,000, with a tax liability of Rs 200, the input tax credit will ensure that the net tax payable by the firm is only Rs 100 (that is Rs 200 less Rs 100).

If the company A is located in a non-GST state, it would pay a total tax of Rs 300 (Rs 200 on finished product and Rs 100 on input), compared to Rs 200 paid by other producers in a GST state.

The Centre is hoping that in such a scenario companies in GST states would lobby for introduction of the pan-India tax, which will subsume most state and Centre-level taxes.

Finance Minister Pranab Mukherjee, in an address to industry representatives last week, said that some states might decide to stay out of GST in the beginning like in the case when the Value Added Tax (VAT) was implemented four years back.

A few states like Tamil Nadu, Madhya Pradesh and Chhattisgarh have opposed or expressed reservation on implementing this pan-India consumption-based tax as many of their concerns were not resolved.

When the VAT was introduced in 2005, some states like Tamil Nadu did not join initially. But later, all the states introduced the VAT. The finance minister hinted this route could be one way to resolve the current deadlock on rolling out the GST.

If the input tax credit is not permitted, states that are implementing the GST will get extra tax revenue on sales made to buyers in non-GST states, the official said. This is because buyers in non-GST states wont be able to claim credit on taxes already paid.