One has to applaud the endorsement of the ‘negative list’ concept for the taxation of services by the Empowered Committee of State Finance Ministers. It paves the way for simplified design of the goods and services tax (GST), as it would obviate the need for defining individual services being taxable.
However, the condition imposed by the states to exempt from the service tax the services currently within the domain of state taxation (construction, meals in air-conditioned restaurants, and entertainment) is highly contentious, the Centre may find hard to swallow.
It hits upon a most fundamental issue of overlap in the taxation by the Centre and the states. It is caused by the vague and archaic division of taxation powers under the Constitution, and has been the subject of numerous controversies and litigation. Pending the Constitutional amendment empowering both levels of governments to levy GST concurrently on all services, the Centre has been aggressive in staking its right to tax items that are arguably in the state domain.
For example, the Constitution defines the sale of prepared meals, with or without service, to be wholly a sale of goods which can be taxed only by the states. However, the Centre has extended service tax to 30 per cent of the amount charged for meals served in an air-conditioned restaurant (and licensed to serve alcohol) on the grounds that such meals contain an ‘aspect’ of service.
In the case of construction, the Constitution empowers the states to tax the goods portion of a works contracts.
The Centre has staked its claims on the balance, calling it a construction service. However, the way the two taxes are computed, the two parts add up to more than 100 per cent of the contract. This results in double taxation.
The states’ demand for classifying entertainment services in the negative list is based on the premise that entertainment tax is a state subject under the Constitution. Recently, Madhya Pradesh extended its entertainment tax to a variety of telecommunication services which are only a medium for entertainment.
These include DTH (direct-to-home) services, SMS services used for advertising or entertainment and, even, internet connectivity.
Historically, the states have argued that the telecommunication connectivity was in fact taxable as a sale of goods. However, after the constitutional bench of the Supreme Court came up with a landmark decision holding, telecommunication to be only a service, the states are now aggressively staking their claim on this base in the form of entertainment tax.
The Centre has been applying its service tax to these items, calling them a service or having an ‘aspect’ of service. In its concept paper on negative list, the Centre is proposing tax cinema admissions also, which have historically been a state domain.
This turf fight has been costly for taxpayers, both in terms of overall tax burden and the costs of compliance. They have suffered considerable harassment by the tax authorities and sleepless nights in determining their obligations. Pending the outcome of litigation, they have had to suffer double taxation by the two governments.
Both governments are responsible for this mess — and neither is likely to concede. If so, the condition placed by the states for their endorsement of the negative list concept may, in effect, turn out to be a subtle rejection of the concept.
It is for this reason that some of the business chambers have questioned the merit of proceeding with this change outside the context of GST. If the overlap between Centre and state taxation continues, then it is best for the governments to divert their energies to an early implementation of a flawless GST.
The author is tax partner, Ernst & Young. The views expressed are personal. (S B Singh, senior advisor, Ernst & Young, also contributed to the article.)
