It is an acknowledged deficiency in our tax system that our system operates on the principle of origin based taxation, whereas the world over the taxation under value added tax regimes has been by destination principle. The levy of central sales Tax (‘CST’) has been criticized for distorting the supply chain, taking away focus from operational efficiencies to tax mitigation oriented supply chain. The elimination of CST was one highlighted as one of the features of Goods and Services Tax (‘GST’).
There have been continuous deliberations of the Central and the State Governments on implementation of GST. However, in spite of negotiations which have stretched for a number of years, there is a clear lack of consensus. The resistance of the States is on various fronts and most notable one is reflected in their demand to compensate for losses which could arise on losing revenue from CST, currently levied on inter-State sales.
Constitutionally, levy of CST is within the legislative jurisdiction of the Central Government. However, the same is collected, administered and retained by the State from where the movement of goods originates. Since the entire tax revenue arising out of inter-State sale of goods goes to the coffers of the originating State, the destination State does not allow the credit of CST component when the said goods are subsequently resold or used in manufacture etc. within its borders. This results in cascading effect of tax and thereby creating a barrier towards the free trade between the States. To prevent the CST from being levied the Trade started moving the goods without the movement being pursuant to sale of goods, commonly known as stock transfer. However, the States partially negated the benefits by specific provisions in the VAT laws which disentitles full input tax credit when the goods move to other State otherwise than in pursuance of a transaction of sale, commonly known as retention of credit. The provisions specify deduction of specified percentage from the amount of set-off otherwise available when a dealer undertakes an inter-State stock transfer. These provisions aim to bring parity in movement of goods across States, whether by way of sale or without. In a complete mockery of the intent, some States like Gujarat and Tamil Nadu also requires partial reversal of input tax credit when the goods are sold on inter-State basis.
The rate of CST when it was first introduced six decades ago was 1%. However over the years, CST became one of the tool to generate revenue and the rate gradually increased to 2%, 3% and then to 4% with effect from 1 July 1975. In case where the goods were sold to an unregistered dealer or without exchange of C Form, rate of CST used to be 10% or VAT rate applicable on the goods in the originating States, whichever was higher. Later the provision was amended to make the CST rate for sale to unregistered dealer or without the concessional Form, equal to the VAT rate; in effect relieving the goods chargeable to lower than 10 per cent from penal rate of 10 percent in absence of Form. The high rate of CST created an adverse effect on cost and relative prices of the goods. Since CST component sticks with the value of goods purchased on inter-State basis, there was incentive to minimize the inter-State transactions of sale of goods. As a result, several manufacturers and dealers were attracted towards realigning their supply chain to set up stock depots and warehouses in various States where they could transfer and sell the goods in the consuming State on paying the local sales tax. Thus, CST becomes an influential factor in the location of the warehousing.
CST, being an origin based tax did not carry any set off benefit. After the successful implementation of VAT, there were deliberation for abolition CST. In fact, the Union Finance Minister in his budget speech of 2007-08 had specifically stated that the both Central and State Government had reached to an agreement to phase out CST. Consequently, the CST rate was reduced from 4% to 3% with effect from 1 April 2007 and was further reduced to 2% from 1 June 2008. The issue regarding the further reduction of CST rate from 2% to 1% with effect from 1 April 2009 was considered by Empowered Committee in its meeting held on 21 January 2009 and after due consideration it was decided to retain the 2% CST rate till GST is introduced. In fact, the First Discussion Paper on GST had also emphasized about phasing out of CST on introduction of GST. However, with delays in introduction of GST, the phasing out of CST has always remained a distant dream.
GST is perceived as a panacea to most of the indirect tax challenges faced by industry including the one in relation to levy of CST. Just when one thought that end of CST could become reality, Serial No. 18 of Constitution (One Hundred and Twenty-Second Amendment) Bill, 2014 was inserted which allows the Central Government to levy and collect 1% additional tax on inter-State trade and assign the tax so collected to the State from where the supply originates.
The purpose and intention of this enabling provision in the constitution appears to be for dealing with shortfall in revenue of producer States post implementation of GST. However, the levy of this origin-based additional tax looks like a levy of CST in a different form and nomenclature which is completely opposed to the principle of destination-based taxation under GST. As per the Press Release by Ministry of Finance on 19 December 2014, such additional tax would be non-creditable. Thus, like CST, this one per cent additional tax will not form part of the GST credit chain and will certainly prove to be an additional burden on the trade and industry.
The broad objective of GST is to dismantle the fiscal barrier between the States and elimination of CST was expected to pave way for an overhaul in the distribution network. However, due to this additional tax, barrier of carrying out inter-state transactions is expected to continue for the time being. But the worries do not end here for tax payers. The manner in which the Constitution Amendment Bill is worded suggests that the additional tax will apply on supply of goods on inter-State basis which includes stock transfer as well. However, per the Report of Select Committee of Rajya Sabha, it was suggested that such additional tax should be levied only on the supply for consideration. It is understood that the said recommendation is to be accepted while passing the Constitutional bill.
As we are moving in the direction of GST, it is essential that the changes carried out today are an indicator of what is to be in store in the GST regime. Certain changes in the previous Budget like enhancement of service tax rate, correction of inverted duty structure, subsuming of Cess were introduced with an intent of smooth transition towards GST. On a similar line, with the Union Budget 2016 round the corner, there is a general expectation that CST rates should be reduced to 1% in order to align it with additional tax to be levied once GST is introduced. In an ideal scenario, keeping the initiatives like Make in India in mind, it would be best to remove the levy of CST and not introduce the burden of additional tax of 1% under the GST regime, since such taxes would become a burden on the manufacturers. If that is not to happen, at least a small reduction of 1 per cent from the CST rate would provide a big relief to the trade.
Prashant Deshpande, Partner, Deloitte Haskins and Sells LLP
Shrenik Shah, Senior Manager
Parth S Shah, Deputy Manager