The Union Budget 2012-13 is likely to witness a revolutionary shift in taxation of services in India with the introduction of the negative list of services.

All non-considered biases caused by the present tax system of services, which plays favourites by taxing some services and leaving others out of the tax net, could be done away with the introduction of this list. The present list is of over 125 taxable services.

In the beginning, the State Governments had reservations towards implementation of a negative list. The resentment was primarily due to the fact that the Centre may also levy tax on services which formed part of the State's taxable jurisdiction.

However, with many discussions and round tables, the Empowered Committee of the State Finance Ministers has given a go-ahead to the negative-list approach, with conditions, by way of an in-principle approval. This is being seen as a significant move paving the way for a simplified design of the goods and services tax (GST).

The Empowered Committee is understood to have proposed a rider that the Centre will exclude areas or activities which fall within the State's jurisdiction, such as construction, entertainment, restaurants, transport of goods and inland waterways, beauty parlours, health and fitness, etc.

They argued that if States are taxing certain activities or propose to charge such services to tax under the GST regime then the Centre should not cover those services for levy of service tax under the negative list, as it would not provide an additional tax base to State Governments in the GST regime.

Tackling overlaps

Now, it would be interesting to observe the Centre's reaction to the wish list of the State Governments. Given the current constitutional framework vis-à-vis power of the Centre and the State to levy service tax, the Centre may find it difficult to give in to the State Governments' demand for exclusion of those services.

In case the Centre waves the green flag, it may pave the way for the announcement of the negative list in the Budget 2012-13.

The arguments of the state governments to support their stand on carving out certain activities from the Centre's ambit may sound reasonable. However, to what extent it gains support under the present constitutional framework needs to be looked at. The State governments' proposal targets the fundamental issue of overlap in taxation by the Centre and the States, which has been a subject matter of intense debate and litigation for a long time.

Given the way these taxes are computed, the taxable value of the contract across the two taxes exceeds the value of the contract. This is a typical example of double taxation due to overlapping jurisdictions.

Similarly, in case of restaurant meals, the Constitution empowers the State Government to levy sales tax as a sale of goods. However, the Centre has been aggressive to extend its claim in this respect as well to the extent of 30 per cent of the amount charged for the meal in an air-conditioned restaurant (licensed to serve alcohol) on the pretext that such meals served have an element of service to it.

As far as entertainment services are concerned, the state governments have proposed its introduction in the negative list on the premise that it is a State subject, and recently Madhya Pradesh also introduced levy of entertainment tax on various telecommunication services which are a medium of entertainment: for instance, DTH services, SMS services used for advertising and entertainment and even Internet connectivity service.

Another classic example is the issue of taxability of software, which has been a subject of on-going dispute across courts. Arguably, transactions involving transfer of rights in goods should constitutionally fall within the taxing domain of the States, but the Centre has chosen to consider these as a taxable service in case where software is electronically supplied.

COSTLY AFFAIR

Given the history of conflict between the Centre's and the State's power to levy tax and the present proposal by the state governments vis-à-vis introduction of the negative list, it may seem difficult for both the parties to arrive at a consensus on the final list prior to the Budget.

The negative list, if introduced in the Budget, without consensus and the accompanying challenges, would require humongous effort and a long time frame at a later date to guide the legislation and taxation of service on to the right path and prove a costly affair both to the assessee and the administrator.

The implementation of point of taxation rules, proposed introduction of negative list with parallel changes to the existing legislations and eventually the implementation of GST are right steps in the direction of reshaping the indirect tax regime in India.

However, a clear consensus on the scope of taxation between the Centre and State is a must before we embark on this journey.

(The author is Tax Partner, Ernst & Young.)

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