Days before stepping down as finance minister to become the UPA's Presidential candidate, Pranab Mukherjee paved the way for a far reaching indirect tax reform - the introduction of a new service tax regime in India.
On June 20, Mukherjee announced the revised 'negative list' of services to be exempt from tax, starting July 1. All other services, which fall within the definition of 'supply of services', became taxable at a flat rate of 12 per cent. The government hopes that the new system will be easier to implement and will widen the tax base.
The previous method of taxation was based on a 'positive list' - it had a detailed description of each taxable service.
This approach, introduced in 1994, became prone to abuse and litigation. The scope of the definition of taxable services was wide and led to unintended taxation requiring further clarifications.
"The negative list approach will keep the possible areas of conflict to the minimum and lay down a more lucid and hassle-free legislation," says Sachin Menon, head of indirect tax at KPMG.
The 'positive list' included 119 services whereas the 'negative list' has 17 items. Another 38 would also be outside the service tax net as part of a separate exemption list.
Services such as transport of goods or passengers, electricity transmission or distribution, metered taxis, auto rickshaws, betting, gambling, lottery and entry to amusement parks have been included in the negative list.
Conversely, services such as coaching classes and training institutions will come under the tax net, though it will not be levied on school, university education and approved vocational courses. Bollywood and television actors have also been kept out of the negative list and they will have to pay service tax under the new guidelines.
The new tax system is expected to swell the government coffers by Rs 27,000 crore, according to the Ministry of Finance. However, there are plenty of grey areas.
For instance, a lot of transactions would now be subject to both sales tax and service tax, which will raise the issue of double taxation. Besides, the move is expected to create market distortions. For example, the government has exempted the core services provided by the Indian Railways, namely transportation of goods and passengers, from the levy of service tax but road transportation is still being taxed.
Ashok Dhingra, Partner at law firm J. Sagar Associates, says that the devil is in the detail. "For certain services, only the supplier was liable to pay the service tax previously. But under the new mechanism, both the service provider and service receiver will be considered liable. This will create hassles for service recipients," he explains.
Most experts though agree that it was a long-awaited decision and will take the economy a step closer to a goods and service tax (GST) regime.