Published Editorial

Time for states to exit from entry tax

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Business Standard

by

Satya Poddar
Tax Partner
EY

Contributed by:

SB Singh
Senior Policy Advisor
EY

The decision of the Empowered Committee (EC) of state finance ministers to not subsume "entry tax in lieu of octroi" (ETILOO) under the GST requires a rethink. It is a tiny tax, but difficult to comply with and inflicts enormous pain on the economy. It divides the Indian common market and acts like a tariff on import of goods into a local/municipal area from the rest of the country.

It has been a subject of protracted litigation and the courts have ruled it to be ultra vires of the Constitution, as it violates the condition of non-discrimination under Article 304 (a). It applies to goods brought into the local area, but not to goods produced within the local area. Such discrimination is not permissible at the national level under our WTO obligations, and is objectionable at the state or local level also under the Constitution. At present, the issue of its legality stands referred to a larger bench of the Supreme Court.

During his introductory press conference, the newly elected Chair of the Empowered Committee, Abdul Rahim Rather, indicated that a general entry tax will be subsumed under the GST, but not ETILOO. The distinction between the two is not based on any law, as they are both levied under the same provision in the Constitution empowering states to levy "Taxes on entry of goods into a local area for consumption, use or sale therein" (Entry 52 in the list of State taxation powers). In policy discussions, a general entry tax is taken to mean an entry tax that is levied on goods brought into a state, while an ETILOO is applied on goods brought into a local/municipal area. Both types are levied by state governments. However, revenues from ETILOO are earmarked for compensation to local/municipal bodies for replacement of octroi that they previously levied. It is the latter type that accounts for the vast bulk of revenues from this tax.

Previously, this tax was levied by local civic bodies on mere entry of goods into its local area, and collected in cash at check-posts by the road side.

There was no mechanism for collecting the tax on train or air cargo. Given the inefficiencies of collecting it at the entry point, the tax is now levied on the basis information in the accounts of the dealers.

As an example, Maharashtra is in the process of replacing octroi by the Llcal body tax (LBT). It has encountered significant opposition from the SME sector, forcing the government to delay its implementation in Mumbai.

One of the main difficulties with the tax is that it requires accounts to be kept for each local area, segregation of inventory of goods procured within the local area and elsewhere. Questions are also being asked whether electronic downloads (e.g., of software, and other digital products) are subject to LBT. Are they goods, and does an online download from the virtual cyberspace constitute entry into a local area?

One of the major objectives of GST is allowing free flow of goods and services within the common market of India. The entry tax is an impediment to free flow of trade and is a source of competitive distortions and inefficiencies in the supply chain.

Its impact is similar to that of the CST which acts as an exit tax on goods shipped to other states. The same goods are then subjected to entry tax in the state to which they are shipped. If these goods happen to be parts or materials used in further manufacturing, then any sale of the manufactured goods to other states is subjected to the CST again. These taxes are over and above the VAT at the time of final sale of the goods in the local area.

To remove such cascading and compounding of taxes, the 13th Finance Commission (chaired by Dr Vijay Kelkar), recommended that they be fully subsumed under the GST.

The Centre also considered this option, but, at the insistence of Maharashtra, made an exception for entry taxes levied and collected by local bodies (i.e., an octroi). Now that the octroi is being replaced by LBT, the EC is proposing that the exception be broadened for any ETILOO regardless of whether it is levied by the state or a local body.

As most entry taxes are of this type, this would amount to a status quo for them. If the GST is to be a game changer, it is essential they be fully subsumed under the GST.

It is ironic that Gujarat, which has been opposed to the GST, has already taken the progressive step of getting rid of this tax. In 2008, it replaced its local entry tax by an increase in its VAT rates (to five per cent and 15 per cent from four per cent and 12.5 per cent). It has a general entry tax on a few commodities, which is fully rebatable under the VAT.

Might it be that that Gujarat's opposition to the GST is rooted in its flawed design, which could be turned around if the governments embrace the flawless model? Pending consensus on the flawless model, states should consider taking a leaf out of Gujarat's reform book and subsume their entry taxes within the current VAT.