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Centre clears biggest hurdle in VAT route

Anil Sasi in New Delhi

The biggest stumbling block to the value-added tax has been sorted out, with the Centre agreeing to provide full compensation for the "notional losses" of the states in the first year.

According to government officials, the Union finance ministry has further agreed to compensate the states to the tune of 66 per cent and 25 per cent of the losses suffered by them during the second and the third year, respectively, following their transition to the VAT regime from April 1, 2003.

The Centre had earlier proposed a compensation scale of 75 per cent, 50 per cent and 25 per cent for notional losses incurred by the states during the first three years.

The states had, however, unanimously rejected this compensation formula and instead pressed for higher compensation in the first two years as a precondition for shifting to the VAT regime.

Government officials involved in the exercise told Business Standard Finance Minister Jaswant Singh had acceded to the demand of the states for higher compensation.

The Union finance ministry had maintained that there would be no revenue loss to the states on account of the switchover (from the present sales/commercial tax structure), and the Centre had been reluctant to agree to the demand of the states for full compensation because it wanted them to make "sincere" efforts towards ensuring optimum revenue collection.

"The Centre had earlier declined to guarantee full compensation so that the revenue departments of the states made sincere efforts at tax collection," a finance ministry official said.

Since the transition to the VAT regime has been postponed twice during the past two years, mainly due to differences between the Centre and the states on the compensation issue, the Union finance ministry had acceded to the demand to clear the roadblocks in the way of the states' transition to the VAT regime this time around, officials said.

The Centre's compensation will largely cover the "notional revenue loss" to the states because of the complete phase-out of the central sales tax over three years.

Apart from discrepancies on the compensation issue, another grey area relates to the states' demand for allowing them to impose an entry tax to partly compensate them for the loss of revenue, which is being opposed by the Centre.

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