Inter-State Problems of Sales Tax in India

THE ECONOMIC WEEKLY November 12, 1955 Inter-State Problems of Sales Tax in India L C Gupta IN a federal constitution, taxes levied by one state are not always confined In their effects to the boundaries of the taxing state. They may give rise to inter-state complications -fiscal, legal and administrative. The operation of the sales tax in India illustrates some of these. The situation was summed up by the Taxation Enquiry Commission as follows: "From the point of view of industry, the main problem arises from the need to produce and sell at competitive prices. To the extent that the rates vary much between different States if raw material, for instance, is not taxed at all in one State, but is taxed high in another this competition may he materially affected. Since the organised industries tend individually to be made tip of different concerns specialising in different processes, the total might well turn out to be high of a tax that is collected at each of the stages. Also, many Industries, especially the bigger ones, are interested in buyers all over India; their special grievance is the lack of an all-india uniformity in rates and regulation. The Stare Governments face a problem of evasion which is seemingly intractable. The interests of States often clash and co-ordination, as we have pointed out, has become difficult. This in turn has meant new hardships for trade and industry." Article 286 of the Constitution aimed at solving some of these problems. A legal battle has raged over the interpretation of the Article almost from the very beginning and so vague and ambiguous is its language that it has been subjected to two varying interpretations by the Supreme Court. The actual working of the Article during this shore period has revealed the inadequate and unsatisfactory character of the present provisions and it has become urgently necessary to bring about a change in them. The issue is under the active consideration of the Government of India at present. Freedom of Inter-State Trade We propose to examine the various suggestions made in this connection, Including those made by the Taxation Enquiry Commission, and to see how far they satisfy such diverse interests as those of the State governments who are interested in these own revenues, those of the dealers who are the tax-payers, the consumers, the trade and commerce etc., etc. Before undertaking this examination, it is necessary to set out some general principles. The first, as also the most important, is the principle of freedom of inter-state trade and commerce. The expansion of our economy has in no small degree resulted from the free flow of inter-state trade and the development of a great nation-wide market for our industries. Moreover, inter-state economic ties are the strongest bonds of unity and ought to be fostered rather than weakened. The principle of freedom of trade which is accepted in all federal constitutions is laid down in Article 301 of our Constitution, It implies that the States are to be prohibited from levying taxes which burden trade and commerce in such manner as to cause obstruction in its flow. Clause (2) of Article Constitution states: 28G of the "Except in so far as Parliament may by law otherwise provide, no law of a State shall impose, or authorise the imposition of, a tax on the sale or purchase of any goods where such sale or purchase takes place in the course of interstate trade or commerce." The Clause was, however, rendered entirely inoperative as a result of the judgment of the Constitutional Bench of the Supreme Court In the case of the State of Bombay vs. the United Motors (India) Ltd., delivered on March 30, 1953. The majority of the judges held that Article 286(1) (a), read with the Explanation thereto and construed in the light of Articles 301 and 304, prohibited the taxation of sales or purchases involving interstate elements by all states except the state in which the goods were delivered for the purpose of consumption therein. The latter state was left free to tax such sales or purchases. The effect of the Explanation in regard to interstate dealings was to convert such inter-state transactions into intra-state transactions and to take them out of the operation of Clause (2) of that Article. This interpretation gave to the importing state the right of imposing 1339. a tax in respect of goods delivered in that state. It could collect either a purchase tax from the resident purchaser, or a sales tax from the out-of-state seller. Thus this interpretation not only infringed the principle of freedom of inter-state trade but also gave extra-territorial operation to the sales tax laws of the states. If the states had chosen to collect a purchase tax, it would not have affected inter-state trade so badly and would not have produced such an intolerable situation, as the collection of a sales tax from out-ofstate dealers which the states found to be more profitable for them, The levy of sales tax on out-ofstate dealers involved, besides the direct burden of the tax, an added burden or an invisible tax, on account of the inconvenience and costs of compliance with the sales tax laws of many states. The costs of compliance are specially heavy for the outof-state dealers. The hardest hit were dealers who sold their goods in a number of states and who had, therefore, to be conversant with the different sales tax laws of all those states, to keep separate accounts of transactions with dealers of different states, and to submit books of accounts and sometimes to appear before Sales Tax authorities in a number of states. This would have paralysed the flow of interstate trade. The Central Government had, therefore, to call a Conference of Officials in November 1953 to devise interim relief measures for the trade. Earlier Decision Revised Recently, the Supreme Court, in the case of the Bengal Immunity Co. Ltd. vs. the State of Bihar, reexamined the earlier decision of the Court in the Bombay appeal. In its judgment, delivered in September 1955, it gave a new and different meaning to Article 286. The majority decision was: "We are definitely of the opinion that, until Parliament by law. made in exercise of the powers vested in it by clause (2) provides otherwise, no State can impose or authorise the imposition of any tax on sales or purchases of goods when such sales or purchases take place in the course of inter-state trade or commerce, and

THE ECONOMIC WEEKLY November 12. 1955 the majority decision in the State of Bombay vs. the United Motors (India) Ltd., in so far as it decides to the contrary, cannot be accepted as well-founded on principle or authority." In view of this Interpretation, the Court held that the Bihar Bales Tax Act, "in so far as it purports to tax sales or purchases that take place in the course of Inter-state trade or commerce, is unconstitutional, illegal and void.'' This new interpretation of Article 286 by the Supreme Court ensures complete freedom of inter-state sales or purchases. The principle of freedom of trade is thus restored. At the same time, it puts an end to the irrational system of taxing out-ofstate dealers. Scope for Evasion The Immunity of inter-state trade and commerce from state sales taxes, however, gives rise to another problem. It opens the door to avoidance of tax if consumers and unregistered dealers residing in one.state are permitted to enter into direct dealings with out-of-state sellers. The possibilities of such avoidance are greater in the case of persons residing in border towns and in the case of mail-order-business. The new interpretation of Article 286 by the Supreme Court enlarges the scope for such avoidance by taking away the right to collect a tax on transactions in the course of inter-state trade or commerce from the exporting state as well as the importing state. Even before, when the prohibition operated only on the exporting state, the importing state being allowed to impose a tax on inter-state dealings, there was considerable room for avoidance and evasion of sales tax. The Taxation Enquiry Commission refer in their report to such avoidance which arose out of restrictions contained in Article 286. They observe: " because of these restrictions there was greater scope for avoidance of tax, entailing an indirect loss of revenue on almost all States. Traders in one State started to sell direct to unregistered dealers and consumers in another. Similarly, consumers of valuable commodities tried to get these from dealers in another State rather than buy the articles from their local dealers. The practice grew for sales of goods within a State itself to be shown in the books of accounts as having been made to fictitious dealers outside the State and these goods having been resold by those dealers to consumers within the State. For valuable commodities, like motorvehcles, jewellery, watches, etc., this practice became very common. On transactions that could be shown to be in the course of inter-state trade, the exporting State was prohibited under Article 286 from levying the sales tax, and if goods delivered as a result of these transactions were shown to be received by individual consumers or unregistered dealers, neither could any tax be levied on them by the Importing State. Thus many of these transactions escaped sales tax altogether." Lack of Uniformity Some difficulties also arise on account of the lack of uniformity of rates and exemptions in different states. Differences in the treatment of raw materials in different states are especially open to objection. If rates of tax on raw materials are not uniform and some of the states exempt them altogether, the competitive capacity of manufacturers in different states, is affected materially. This may create an artificial advantage for industries in some states, and hence, cause diversion of industry from the most economical locations. The Essential Goods Act, 1952, enacted by the Parliament under Clause (3) of Article 286 of the Constitution, does not eliminate this lack of uniformity though almost all the important raw materials are included in the list of 'essential goods'. One reason is that the Act does not apply to rates in force in the various states before the passing of the Act. Moreover, it cannot eliminate an advantage arising to an industry located in a state which exempts raw materials from taxation altogether. Central regulation of rates levied on raw materials is important for another reason also. The raw material may be sold within a state to the manufacturers but the manufactured product may be exported to other states. By levying a tax on the local sales or purchases of the raw material, the state will be able to transfer the fiscal burden of the tax to the residents of other states. This is undemocratic inasmuch as the residents of other states who ultimately bear the tax in this case have no voice in the legislature of the taxing state. 1341 Finally, there is also the problem of bringing about co-ordination in the sales tax laws and administrations of different states. This is necessary so that there is no inconsistency in the sales tax laws of different states and there is a coordinated approach to the various inter-state problems* We must now look for a satisfactory solution. One of the suggestions which, no doubt, has the merit of resolving all the problems d'scussed above, but which must, nevertheless, be dismissed, is that sales tax should be altogether abolished or replaced by other taxes such as excises, customs and octroi. Sales tax has come to occupy a place for itself from which it cannot toe dislodged. Arguments against Centralisation Another suggestion which has been very popular among the business community is the centralisation of the tax. Perhaps the enthusiasm of the business community for centralisation has waned after the Supreme Court's new interpretation of Article 286 of the Constitution, As interstate complications arise because the right of sales tax levy belongs to the states, they would automatically disappear on centralisation. But centralisation cannot be accepted without looking to other aspects of the levy as well. On account of the very great regional diversity of economic and social conditions in India, the patern of production, consumption and trade differs widely from state to state. This means that the rates of tax on different articles, the list of exemptions, the class of dealers liable to pay tax, may have to be different in different states. Now, centralisation of the tax would mean uniformity of levy in all respects and this would clearly be undesirable in the conditions obtaining in the states. A sales tax which is not adapted to the local conditions of production, consumption and trade would become burdensome to the producers, consumers and traders. Moreover, a change in the local conditions of trade requires a prompt adjustment in sales tax, but such adjustment cannot be carried out if the tax is centralised. The Taxation Enquiry Commission found that the sales tax possesses 'strong local moorings'.. If one analyses the circumstances in which sales tax has developed differently in different States in India, "there can be discerned in each State a definite degree of relationship between the tax system initially adopted and certain relevant characteri-

THE ECONOMIC WEEKLY November 12, 1955 stics of the economy of the State." It is true that In some federations such as Australia and Canada, the sales tax is levied by the federal or central government in the form of a single point levy at the first point of sale but the same system cannot be applied to India because of the very great diversity of eco nomic and social conditions in different states. Apart from this, there is another ground for rejecting centralisation. Sales tax is now a major source of revenue in most of the states and has become an integral part of their revenue systems, which would be dislocated if the tax is taken out of the states' jurisdiction. It may be argued that this need not be so, because the proceeds of the tax can be allocated to the states. This view ignores that the sales tax has made the state revenue systems more flexible and elastic to meet changing revenue needs and centralisation would take away this advantage. All the state governments are, therefore, opposed to centralisation. Purchase Tax as Alternative A simple solution which has often been suggested, especially to check avoidance of the tax without interfering seriously with freedom of inter-state trade, is a purchase tax levied by the importing state on local purchasers of outside goods. In the USA, some states levy a 'usetax' on out-of-state purchases of goods on which a sales tax is not payable in the state. At the Conference of Officials, called by the Government of India in November 1953, to consider the difficulties of trade on account of taxing of nonresident dealers, a purchase tax was proposed as a long-term solution The state governments, however, were not prepared to replace a sales tax on non-resident dealers by a purchase tax on local purchasers on account of the meagre revenue possibilities of the latter. It should be noted that after the decision of the Supreme Court in the Bengal Immunity Cols case, the states cannot levy a purchase tax even on consumers and unregistered dealers on their out-of-state purchases unless the Constitution is amended. The collection of a purchase tax is administratively feasible only in the case of a few important commodities whose purchasers or users can be easily traced, such as motor-cars, radios etc. The purchase tax would, therefore, provide a solution which would be incomplete and not very attractive from the point of revenue. Matthai Commission Proposals We come now to the proposals of the Taxation Enquiry Commission. The salient features of their proposals are as follows: (1) The sphere of inter-state trade should be taken out of the purview of state taxation and placed in that of the Centre. (2) The Central government should levy a sales tax on inter-state transactions, but the collection of, the tax should be entrusted to the exporting states in order to avoid duplication of administrative machinery. Receipts should be approprinted by the exporting states. (3) The rate of sales tax on interstate transactions should be low. The Commission suggest a one per cent fax but when the goods have been sold to an unregistered dealer or consumer of another state, the rate of tax should be the same as for internal transactions in the exporting state. A higher rate on direct sales to consumers and unregistered dealers is necessary to check avoidance and evasion. (4 ) The Central government should have the power to regulate state's soles tax on "goods of special importance in inter-state trade'" which would comprise the important raw materials viz., coal, iron and steel, cotton, hides and skins, oilseeds and jute. On these goods, the states can have only a single point levy at the last, stage of sale or purchase by a registered dealer or at the point of export to other states arid the maximum rate would be 3 pies per rupee or nearly 1½ per cent. No other sales tax shall be levied on them either by the exporting or the importing state. Conflicting Demands Reconciled It would at once be seen that the Commission's proposals are aimed at solving more than one problem. They try to secure not only that the burden of tax on inter-state trade is kept within reasonable Pmits. but also that there is maximum possible uniformity among states in the matter of inter-state trade. At the same time, they are calculated to combat avoidance of tax by the method of out-of-state sales or purchases. The collection of the tax at the exporting end by the exporting state is likely to prove economical in practice as it would also be convenient from the point of view of the traders. The proposals are likely to prove satisfying from another point of view also. viz.. that of revenue. The proposals 1343 seem to reconcile the interests of the States as well as the dealers. Moreover, the regulation of tax on raw materials so as to secure uniformity of their tax treatment in alll the states, would eliminate difficulties due to lack of uniformity. The Commission have also considered the question of co-ordination among the states in regard to their sales tax laws and administrative organisations. They recommend that the principles for determining whether a sale or purchase of goods takes place (1) outside the state (ii) outside the territory of India and ( iii) in the coarse of inter-state trade and commerce, should be embodied in an all-india law enacted by the Parliament. This would remove difficulties arising from lack of consistency in the present sales tax laws. On the other hand, the Inter-State Taxation Council, proposed by them, would help to bring about greater administrative coordination by arranging periodical meetings of the heads of sales tax departments of all the states at least once a year to discuss questions of mutual interest. The Rate of Tax The proposals need modification in one respect, viz., the rate of tax proposed on inter-state transactions. The Commission propose that the rate of tax on inter-state transactions should be one per cent when the transaction is between two registered dealers. This one per cent central tax on inter-state trade is likely to prove somewhat burdensome on trade because this tax would be in addition to any single or multiple point tax leviable within the states. The Commission have recommended a rate of half per cent only for multipoint sales tax within a state. The rate at the stage of inter-state sale should not exceed fralf per cent because these goods would have to pay tax again at a later stage when they are finally sold to the consumer. When, according to the recommendations of the Commission, only one-half per cent should be payable at each stage of sale within a state, it is difficult to understand what prompted the Commission to recommend one per cent on interstate sale which is in fact just one of the stages of sale till the goods reach the final consumer. However, in order to check avoidance of tax, when the purchaser in one state Is a consumer or an unregistered dealer, the rate of tax should be the same as is leviable on Internal transactions in the exporting state.

November 12, 1955 Constitutional Amendment Necessary The Implementation of the proposals will require amendment of the Constitution and vesting of greater powers in the Central Government As the Commission observe; "In the absence of more powers for the Union than now vest in it that is to say in Parliament and in the Central government the inter-state sphere of sales taxation is occupied by constitutional regidities, occasionally diversified by judicial interpretation, instead of by law and administration that can adapt themselves to changing needs." THE ECONOMIC WEEKLY It is to be hoped that the proposals of the Taxation Enquiry Commission can be operated with simplicity. However, the subject is such that only actual experience will show how far the proposals can solve the present problems without giving rise to new ones. 1244