States Seek Revamp Of Sales Tax Law To End Tax Arbitrage By Oil Firms

States have asked the central government to amend the Central Sales Tax Act to avoid tax arbitration by oil companies on inter-state sales, according to a senior official privy to the development, as they look to shore up sagging revenue.

Oil companies pay 2 percent CST on inter-state sale of petrol and diesel instead of a value-added tax at an average of 25 percent. Unlike VAT, companies don’t get credits against CST payments. Manufacturers and fuel resellers, among other businesses, are allowed to buy petroleum products across state borders at a concessional tax rate.

But the structure leads to tax arbitrage and a loss in revenue for the consuming states, two state officials told BloombergQuint on the condition of anonymity. It causes an annual revenue loss of at least Rs 15,000 crore for all states and is against the principle followed under the new indirect tax regime of levying tax at the point of consumption of goods and services, the states said in a representation to Union Finance Minister Nirmala Sitharaman. To be sure, fuels are out of the GST ambit.

While the provision is not new, states called for plugging this gap to augment revenues as losses after the implementation of GST rise. The central government is finding it difficult to compensate them for less-than-expected indirect tax collections as the economy sputters, with the GDP growth estimated to fall to its lowest in more than a decade this fiscal.

The central government is of the view that these issues will be taken care of once petroleum and diesel are brought under the ambit of GST, said a fourth government official who didn’t want to be identified. But the states are unlikely to give up their rights to tax fuel as it’s one of their highest sources of revenue, he said.

The promised relief after GST rollout ends in 2022 after which the states won’t be compensated for any shortfall in revenue. States want the central government to make necessary amendments in the CST Act, 1956, to end this benefit enjoyed by oil companies, the first person said.

Tax experts, however, said it won’t be that simple.

The principles of VAT and CST don’t allow tax at point of consumption and consuming states don’t get any revenue for inter-state procurement of petroleum products in the current VAT regime, said Krishan Arora, a partner at Grant Thornton India LLP. If CST is withdrawn or a new levy is imposed on inter-state procurement in consuming states, there would be no revenue benefit for consuming states, Arora said.

To pass revenue to consuming states, a constitutional amendment would be needed to allow taxation on consumption for goods not covered under GST, he said.

Agreed Niraj Bagri, partner at Dhruva Advisors LLP. Enabling the consuming state to retain taxes charged on petroleum products would require significant changes to central sales tax laws. It requires a destination-based consumption tax, and VAT and CST laws would then mirror GST, Bagri told BloombergQuint.

Consumers To Bear Higher Costs?

The move will also have substantial implications as current practice of paying CST at 2 percent by manufacturers would be discontinued, and they would end up paying VAT rates of 18 percent to 20 percent, said Bagri. That could increase production costs and eventually prices of final products, he said.

If oil companies will be required to pay VAT instead of a 2 percent CST, the price increase will be passed on to consumers, an official from a state-run oil company said on condition of anonymity as he is not authorised to speak to the media. With companies’ tax liability increasing by 18-20 percent even after factoring in tax credits, this would translate into an equivalent increase in prices for customers, the official said.

Indian Oil Corporation Ltd. and Bharat Petroleum Corporation Ltd. have yet to respond to BloombergQuint’s queries on CST and VAT.