Inter-State Transactions

The Central Sales Tax Act, 1956 was enacted by the Parliament under the powers vested in it in terms of Article 286 and Entry 92A of List-I of the Seventh Schedule to the Constitution. The tax collected under the Central Sales Tax Act, 1956 is retained by the State in terms of Article 269 read with Section 9(3) of the CST Act.

The State cannot levy any tax on inter-State sale transactions and it is only the Parliament which is empowered to make law. Therefore the co-existence of VAT and CST creates certain specific problems both for industry and Government.

Federal Structure

In the White Paper it is expressly mentioned that VAT has been introduced in about 130 countries including several federal countries. VAT is not an easy system to implement in a federal structure where States have their own freedom to identify sources of revenue within the broad limits laid down by the Constitution. In fact the very purpose of enacting the Central Sales Tax Act 1956 was to formulate principles for determining when a sale or purchase of goods takes place in the course of inter-state trade or commerce or outside a State.

Canada is a country, which has a federal structure and has GST within the domain of the federal government with the provinces being allowed to have their own system of consumption tax. Canada today has separate federal and provincial VAT, joint federal and provincial VAT as well as separate federal VAT. When goods are moving from one province to another province within Canada, the transaction is zero-rated.

In India the Central Sales Tax Law is an origin-based tax whereby the revenue goes to the originating State whereas VAT is a consumption-based tax. This inherent conflict between CST and VAT creates further complications. Originally when CST was introduced the rate of tax was only 1% subject to production of applicable declaration forms. This was increased to 2% w.e.f. 1st April 1963 and 3% w.e.f. 1st July 1966 and 4% w.e.f. 1st July 1975. The current rate of CST is 2% subject to production of C-Forms.

CST Revenues

CST has become a significant source of revenue for certain States whereas for some States the revenue is not that relevant. An analysis of CST collection data indicates that the States such as Tamil Nadu, Karnataka, Maharashtra, Andhra Pradesh, Delhi, Gujarat, Haryana would lose significant revenue if CST is abolished. Further, the rationale indicated for the continuance of CST is that data is required to be collected about CST transactions before any decision is being taken for its phase out.

CST purchases are not eligible for credit under the State VAT Law

The revenue in a CST transaction goes to the Originating State and therefore the Destination State is not willing to grant input tax credit. The White Paper has made it very clear that CST purchases would not qualify for input tax credit. The provisions of various State VAT Laws provide that CST purchases would not qualify for a credit. Unfortunately this distorts the supply chain mechanism and indirectly increases the cost. The complications and the cascading effect are brought out through this illustration.


Components Ltd. manufactures automobile components in a factory located in Tamil Nadu. Components Ltd. purchases iron and steel, aluminium and other raw materials from Maharashtra and Bihar. Since these are in the nature of CST purchases, Components Ltd. will not qualify for VAT credit in respect of the 2% (assuming C-Form is issued) on the materials. The automobile components, which are manufactured, are sold to Car Ltd. in Maharashtra in the course of inter-State trade. Car Ltd. will not be able to take credit in respect of the purchase of automobile components, as they are CST purchases. Car Ltd. manufactures cars and sells the same to Car Dealer Limited in Tamil Nadu charging CST. The dealer in Tamil Nadu will not be able to avail any credit since the car is being purchased under CST. When Car Dealer Limited sells the car in Tamil Nadu it would attract VAT in the hands of the dealer without any corresponding credit. The cascading effect of loss of credit in this simple transaction is significant and arises mainly because of the continuing of CST and the non-vattability of CST.

Impact on Industry

The non-availability of input tax credit on CST purchases has altered existing business models and has also affected market shares of a number of companies. To illustrate assuming a company from Tamil Nadu has been supplying certain goods to a company in Andhra Pradesh under CST, the existence of competitors for the Tamil Nadu company in Andhra Pradesh would affect the business of the Tamil Nadu company. The buyer in Andhra Pradesh would prefer to purchase from a local vendor who can charge VAT which would be available as a credit instead of purchasing under CST which would not qualify for credit. The buyer would gain in terms of cash flow and further savings on account of freight. However, where the market is monopolistic in nature and there are no local sources for supply, the buyer would continue to purchase under CST or request the outstation vendor to open a branch in his State and effect local supplies charging VAT which can be taken as a credit.

Non-availability of credit for CST purchases has created artificial supply patterns for the sake of tax credit provided all other factors are neutral. In other words, the purchase pattern is increasingly becoming regionalized unless there is no other source except the vendor from another State. In the long run this will also affect States where some States would flourish and gain whereas some States would dwindle further.

The solution that is contemplated is GST and specifically IGST. A clear picture would emerge after the Constitutional Amendments take shape and paves way for a seamless and smooth GST regime.