Now that the Centre and states have agreed to divide the power to tax services, an intangible property, between them as part of the indirect tax reforms, a key issue that would emerge is how much (revenue) to whom. Service tax is the ‘tax of the future’ being the most rapidly growing tax in India, with bulk of its (growing) potential yet to be tapped.

A senior tax official was recently quoted in the media saying that if the growth rate so far this fiscal of over 37% is merely kept, this year’s service tax collection target of Rs. 50,200 crore could be beaten by a good Rs. 5,000 crore. Also, reasonable assumptions have been made of revenue from this tax touching a staggering Rs. 8 lakh crore by 2020. So, the stakes are really high.

Since there would be two separate lists of services for the Centre and states to tax, no major policy or administrative issues are envisaged in the absence of crossborder (inter-State) delivery of services. Again, as for the services that the Centre would tax, no issues are seen, even if rendered from one State and consumed in another.

In this case, the Centre would levy, collect and appropriate the tax and allow input tax credit for those in the Central VAT chain. Similarly, if a service in the State list of taxation is rendered and consumed within a State, that State would have the sole jurisdiction. It may be noted that the proposed goods and services tax (GST) would comprise parallel VATs at the Central and State levels.

However, policy and administrative issues would arise in the event of inter-State sale of taxable services in the State list. A major part of the problem is generic with respect to all inter-State sales (both goods and services) in the twin VAT regime. The question is whether to allocate the revenue to the jurisdiction of production (rendering) of the services (origin principle) or to the jurisdiction of consumption (destination principle).

The policy managers seem to have decided in favour of the destination principle and are weighing the options for operationalising the same. The idea is to facilitate the seller in the exporting state to collect the tax from the purchasing dealer in the importing State and deposit in the designated bank to the credit of the importing State/Centre. This principle is being adopted in view of the fact that all countries follow the destination principle to tax international transactions with VAT imposed on imports and rebated on exports.

But there are additional issues in this context when it comes to taxation of services transferred from one State to another. One pertinent question is how to determine the State which can collect the service tax as, unlike goods, it is sometimes difficult to determine the actual place of effective use of the service to give effect to the ‘destination principle’. Even with the help of internationally accepted rules for identifying the ‘place of supply’ of services, it would be difficult to determine the place of enjoyment of the service.

In tune with the global practices, India now follows the practice of taxing services at the receiver’s end with respect to import of services. However, it belies this principle in the case of taxation of work contracts, where the contractor is required to register with tax authority of each State where he actually renders the service and pay the tax himself.

Co-existence of the Central and State service taxes, without the integration of Central and State VATs, could lead to cascading of taxes, frustrating the very principle of VAT. In such a system, the taxpayer might not always get the set-off of the input tax paid on goods and services, even as he is not the final consumer. If the service provider and the recipient are located in different States, there would be greater possibility of such credit accumulation/cascading of tax.