The empowered committee of the state finance ministers and the finance ministry reached a broad consensus on the issue of phasing out of the central sales tax on January 3, 2007.

The compensation package consists, inter alia, of (i) Legislative measures that are required to be taken in this regard; (ii) The transfer to the states of the total service tax revenues on certain identified services. It is reported that 77 services have been identified for this purpose.

However, the fact that legislative measures have been thought of, proves that there will be a transfer of power to the states to collect service tax. The power to levy the service tax is only with the Union as per Entry 92C of List 1-Union List, Schedule-VII but the collection can be authorised to the states under Article 268A(2) if such is passed by the Parliament.

If the central government merely collects the service tax and dispenses it to the states, no legislative empowerment is necessary. So, it is clear from the above consensus that the central government is thinking of empowering the states to collect the 77 service taxes.

I wish to stress that it is not a good idea to allow the states to collect and appropriate the service tax. The central government should levy, collect and thereafter distribute the revenue to the states.

There are several reasons why the collection of service tax by the states is not desirable:

(a) At present, the Cenvat for goods and service tax paid for input services can be combined and taken credit against the tax payable on services and goods by companies on an all-India basis irrespective of the state where the purchase or sale takes place.

For instance, an all-India company buying services in Maharashtra can get an input credit for the service tax against the tax payable for goods cleared at West Bengal. This all-India character of the combination of service tax and goods tax (Cenvat) is what makes an Indian common market where business is conducted smoothly.

The path to GST (goods and services tax) at the Central level is possible in this way. Presently, the interchangeability between service tax and goods tax is not complete but it is moving in that direction. It will be complete with the service tax rate going up from 12 per cent to, say, 14 per cent and the goods tax (Cenvat) coming down from 16 per cent to 14 per cent. Such interchangeability will not be possible in case the service taxes are collected by the states

A service tax collected in Maharashtra will not be allowed to be adjusted as input credit against the sale of goods in West Bengal though the company may be one and the same. The company will have to bifurcate and trifurcate the corporate accounts for different states making accounting procedure unnatural and creating hurdles in business. This may hinder the free flow within a common Indian market.

(b) The 77 services, which have been chosen, are quite obviously the state-based ones, which do not have all-India ramifications. But there is no reason why some of them cannot develop into all-India businesses. If they do, then they will face the same problem as has been discussed above.

(c) To ensure that all states have the same rates for service tax is not possible. This will cause complications.

(d) The administrative machinery in place at the Centre is well-experienced and established and can collect service tax for 77 items without much extra cost. The state governments, on the other hand, will have to spend substantially on fresh administrative set-ups.

(e) The interchangeability of input credit for goods and services is a complicated system, which has developed over a period of time at the Central government level. It will not be practicable for the states to introduce it straightaway. It may create enormous confusion leading to loss of duty. Establishing a new system of administration for service tax alone is difficult.

Doing it for introducing interchangeability will be even more so. There are several states which are administratively not well-developed, like in the north-east, Jharkhand, Chhattishgarh, Uttaranchal, Himachal Pradesh and so on. In fact, some states are still employing international consulting firms to straighten up the VAT system.

(f) There is no reason to believe that the collection of service tax by the states will be as efficient as that by the Centre, which has an experience of nearly 20 years in the case of goods and 12 years for services.

It will, therefore, be a much more effective system if the service tax is collected by the Centre and the revenue is dispensed to the states as per a devolution formula, which can be worked out suitably between the parties involved.

In this connection, it is relevant to dwell upon the idea of some economists that the states should be allowed to levy service tax on all the services so that the states and the Centre have the same base for a complete dual VAT. This idea is also not good enough for the reason that in a federal country like ours, where several services are spread throughout the country such as railways, air and road transport, communication and others, a service tax regime under different states will create dichotomy as the same service provider will have to pay service tax in different states.

This would make business unduly complicated and burdensome. In Canada, which is a federal country and is therefore comparable to India, GST is levied only by the Union and the states only collect sales tax. There is also a possibility of excessive taxation on services because the tax base is the same both for the Centre and the states.

At present, all taxes by the Centre and the states have different bases. For example, for central excise, the base, that is, the taxable event is the act of manufacture while for sales tax or VAT, the base is the act of sale, though the goods are the same.

Thus, both from the practical and economic point of view, a more appropriate policy for service tax will be for the Union to levy, collect and thereafter dispense the revenue to the states rather than allowing the States to collect and appropriate the service tax.

The author retired as Member, Central Board of Excise & Customs.