In a move that could further fuel inflation, the finance ministry is considering a proposal to levy service tax on transport of goods by the railways. The proposal, which got deferred four times earlier due to stiff resistance from railway minister Mamata Banerjee, is now being given a fresh lease as it would help meet the tax collection targets for current fiscal. The move is also in line with governments intent of bringing more and more services under the tax net as it inches closer to implement indirect tax reforms by way of goods and services tax (GST) next year.

The revenue department proposes re-consider imposition of the levy (service tax) on railway freight from next month. A decision on this was earlier deferred to June 30, said a finance ministry official.

The duty is unlikely to be deferred again as we expect less opposition to the proposal now with the imminent changes in the Railway ministry. Besides, the levy has significant revenue potential that would come handy to meet the tax collection targets, ther official added.

It is expected that the service tax will be imposed on transport of bulk of railway freight comprising items such as coal, steel, iron ore, cement and gypsum. These constitute 70% of the freight revenue of the Railways. The total revenue potantial of the move is estimated to around Rs 1,000 crore in a financial year.

However, foodgrain and other essential commodities will continue to be exempted from the tax. An abatement of 70% of the gross value of freight charged on goods would also be given, leading to a slightly lesser tax burden.

On the 10% service tax, cenvat credit would be given, so effectively the tax rate would come to 3 to 4%, another government source said.

The move will be inflationary as it will impact the prices of key items used by the infrastructure sector. Coal and iron ore prices are already strong in the global markets and the governments move would mean that steel prices will go up by at least 10% and electricity tariff may need to be revised upwards marginally, said a metal sector analyst asking not to be named.

The the headline inflation, as measured by wholesale price index (WPI), declined by 0.38 percentage point from 9.04% to 8.66% in April. The service tax is expected to put further pressure on non-food that has kept overall inflation levels well above the governments confort zone.

The decision will come at a time when government has already increased petrol pruices sharply by Rs 5 per litre from May 14 mid-night. Prices of diesel and LPG, which are now regulated, are also expected to go up soon.

The revenue collection is important for the Finance Ministry as growth forecast already is being projected lower due to high crude prices, the source said justifying the levy.

Under pressure from Mamata Banerjee, the government had deferred a decision on levying service tax on transport of goods by rail by 3 months to July 1 in the beginning of the current fiscal. This was the fourth time that the government decided to postpone the imposition of service tax on rail freight, which was to be implemented from April 1, 2010.

In Budget 2009-10, the government had proposed 10% service tax on goods carried by the Railways, to provide a level-playing field to transport of goods by roads. It, however, exempted rail freight from service tax in September 2009.

Withdrawing this exemption, the Union Budget 2010-11 has proposed to levy service tax at 10% on service provided in relation to transport of goods by rail with effect from April 1, 2010. However, Banerjee was upset over Finance Minister Pranab Mukherjees Budget proposal to bring railways under the service tax net. Railway ministry officials had also written to the finance ministry seeking withdrawal of service tax on rail freight.They argued that the tax would result in an increase in freight rates between six and seven per cent in case the railways decides to pass it on to the consumers.

The exchequer had estimated to lose around R800 crore in 2010-11 as the finance ministry decided not to levy service tax on transport of goods through rail in the last fiscal.