Octroi Phenomenon:
Octroi taxes enjoy a respectable antiquity. The Romans called them ‘vectigalia’, a tax which was levied primarily on wine and certain articles of food.

About Octroi:
The dictionary definition of Octroi terms it to be “a local tax collected on various articles brought into a district for consumption.”

A sketch:
Octroi has been in force in Maharashtra for many years and all municipalities levy it on entry of goods. It is a major source of revenue for municipalities. The Municipal Corporation of Greater Mumbai (MCGM) alone collected Rs 2,504 crore as octroi in 2004-05, up from Rs 2,240 in 2003- 04.

Octroi has clearly contributed to the tune of 33 per cent of MCGM's annual budget and it has been enjoying a 4,500-strong assessment and collection department.

Many Governments had abolished octroi in Municipal Councils in the year 1999. The financial implications of abolishing octroi in the Municipal Corporations are however, much more substantial since their projected net revenue from octroi during 2005-06 was Rs. 4962 crores.

Since municipal finances depend heavily on octroi income, it will not be possible for them to discharge their responsibilities unless they are given an equally potent alternative revenue source or, are compensated in perpetuity from the State budget.

The latter is not possible due to State’s own developmental commitments and the heavy debt burden. One merit in octroi tax is that its incidence falls largely on the residents of the very city. Any alternative to octroi should, therefore, ideally be such that its burden falls on the residents of that city alone.

The details of the present revenue from octroi, the per capita octroi income of the municipal corporations and the growth rates of octroi are given in the table below.

In case octroi is to be abolished, or is halved to begin with, the compensatory resource to the ULB’s (Urban Local Bodies) should, to the full extent, match the octroi revenue lost by each ULB.

Net Octroi Receipts : CAGR : Per Capita Receipts : Projections (Figures in Rs. Lakh)

Almost a decade has passed since the ongoing tussle between the industries and the municipal corporations of Maharashtra over the Octroi levy. If we look at the India story as a whole, except for Gujarat and Maharashtra most other States in India have either done away with or are into the stages of phasing out Octroi.

It is essential to note that octroi as a tax in the BMC was introduced in 1965. Prior to that only 'town duty' was being levied on a very few items. At that time yield from property tax was the mainstay of municipal tax revenue for Mumbai. For example, in 1964, total revenue of BMC was Rs.23.64 Crore, out of which Rs. 18.59 Crore were from property tax while Rs. 1.54 Crore only were from 'town duty'. Property taxes accounted for 78.61% of total municipal revenue while town duty accounted for only
6.53%.

Nevertheless, in Maharashtra, despite the continual assurances and diverse committees created by the Government of Maharashtra in the same direction, things seem to be moving at a sluggish rate today with respect to abolition of Octroi. This brings us to the vital question of ‘What is it that is holding the government back, to reduce this ‘inter state tariff’, if one may call it so in the era of plummeting global tariffs’?

On the one hand, the municipalities seem to be opposing the abolition of their main source of income-Octroi, given that it contributes nearly 60% to their revenue. On the other hand is the industry. The Industry seems to echo the idea that Octroi must be abolished due to its various ill effects including the final distribution price.

Given the milieu that even an agriculturally rich state like Punjab, is in the process of gradually abolishing the levy, the answer to “Why then is Maharashtra not doing as ‘Romans do’ “? seems to be the crying need of the hour.

This paper attempts to analyse the role of Octroi in the state of Maharashtra. Alternatively, the paper attempts to provide diverse sources of revenue which Maharahstra could tap instead of harping on Octroi.

Octroi in Maharasthra – An Overview:

Maharashtra has 21 municipal corporations spread across the State. Going by the statistics provided by the Municipal Corporation of Greater Mumbai, the development plan for the city of Mumbai for the period 2005-2025, is to be financed in the following manner:


The position and weightage of Octroi can be judged by the figures given above. It is thus imperative to find alternative sources for funding the municipalities.

Current scenario:

The Economic Survey of India 2006-2007 states that the net state domestic product at current prices for 2005-06 stands at Rs.3, 86,241cr up 14.2% more than the previous yr. The State’s own tax revenue is estimated at Rs.40,323cr for 2006-07 ie.20.23 % up than the previous year and states own tax revenue receipts as percentage of gross state domestic product is up from 7.76% in 2005-06 to 8.11% for 2006-07.

The average growth rate of VAT has been estimated at 13% for the state. In order to source in more revenue from the Profession Tax, the state government introduced an amnesty scheme wherein an individual paying tax after April 1, 2002 would be exempted from any prior tax dues. The state’s Stamp Duty cashed in an amount equivalent to Rs 5000cr in the year 2005- 2006, marking an increase of 23% over the previous year.

However, this year the state government seems to be going slow on this tax. The entertainment Tax on Cable TV has been increased by 50%. The Motor Vehicle Tax has been increased from 4 to 7% on four wheeler vehicles and the tax on goods vehicles is already at the maximum level. Further, there has been a reduction in the CST from 4 to 3% that will result in an estimated loss of Rs1000cr for the year 2007.

Two contradictory findings emerge from the above. On one hand, the government has earned more revenue that can be utilized to a certain extent to compensate the municipal corporations. On the other, one would find that the government has already exhausted some alternative sources of revenue in the form of Entertainment and Motor Vehicles Tax.

In addition to this the government also has to consider the development of the state. Nevertheless, these findings in no way imply that the government should not abolish Octroi.

Although computerization of the entire process has been considered to help in resolving the problems with Octroi such as theft and mishandling to an extent by some experts the fact that malpractices exist even in computerized systems.

Because of the above shortcomings of the octroi system, it is often termed to be ‘obnoxious’ ‘vexatious’ ‘wasteful’ and ‘distorting’. The abolition of Octroi will not only help to attain economies on logistics and warehousing but will also make India one unified market.

Some alternative sources of Octroi:

Some of the alternative sources which can be looked at in order to raise revenues for the municipalities include:
Ø Increased Property Tax
Ø Increased Value Added Tax (VAT)
Ø Increased Profession Tax
Ø Imposition of Entry Tax
Ø Levy of Cess
Ø Revision in User Charges
Ø Issuance of Municipal Bonds
Ø Creation of a Municipal Development Fund
Ø Tax on Vacant Land
Ø Imposition of Pollution Tax
Ø Roof top tax as in Nepal

In the past, there has been a huge debate over finding alternate revenue sources for Octroi.
One school of thought emphasized that replacement of Octroi by any other form of levy amounts to the same thing and that it was in no way a step towards reformation of the tax structure in India.

The other school of thought advocated the demand for greater grants by the central government in the form of large state funds. Further, some others advocated the need for fiscal reforms and budget management by the local bodies. Some experts have also believed that the introduction of Goods and Services Tax (GST) by 2010 will itself result in abolition of Octroi.

Another proposal was to ear mark certain proportion say 10% of the existing state levies like VAT, Stamp Duty, Motor Vehicle Tax, Entertainment Tax etc. for the Panchayati Raj Institutions, Urban Local Bodies and Local Bodies. Some experts opined have opined that VAT revenues have grown all over India by more than 26%. So estimating the growth figures of all these taxes and their contribution to local bodies will without doubt compensate the current Octroi revenue.

We shall now try to benchmark Octroi against some of the alternative sources of taxation:

Ø Octroi v/s Levy of Cess

Levy of Cess will not only reduce the paper work but also remove all the octroi check posts
which will result in reduced transit time leading to savings in freight cost for the companies. It
has been successful in Navi Mumbai, an area that has a large industrial belt. There are no check posts in the area and hence no stoppage of vehicles.

Also, it saves manpower and administration expenses. Further, only the registered dealers are
required to pay the cess on the entry of goods under the Bombay Provincial Municipal Corporation Rules 1996 and no unregistered dealer is required to pay it. Also, cess reduces the costs of importers who are required to unload and reload goods under octroi for evaluation of weight and sealing. However, no such complications are involved in case of cess.

Replacement of Octroi with Cess could be a possible solution as cess would contribute to the tune of 80% of the Octroi revenue. This implementation could be carried out in two phases, starting with the metros and class one cities in the first phase and slowly spanning across the remaining cities in the second phase.

Ø Octroi v/s Entry Tax

In case of an Entry Tax, states such as Karnataka and Madhya Pradesh have replaced Octroi with an Entry Tax in the past. Some of the merits of the tax over Octroi include its account based system in contrast to the checking system under Octroi that reduces the hindrances, delays and harassment arising from the checkpoints and physical verification can be avoided, if the administration is backed by an adequate information system.

However, the tax is not adequate enough to offset the octroi tax. Many times it has shifted the production and distribution centres outside municipal limits resulting in unnecessary movement of consumers to these centres. However looking at the view point that both entry and Octroi are entry taxes, the difference should not be much.

Ø Octroi v/s VAT
Another suggestion has been the increased VAT or surcharge on VAT. This alternative has been recommended by the majority as it overcomes the problems of earlier taxes of double counting and the cascading effects. Infact, it is considered as a transparent system of levying taxes. Since VAT and Octroi, are both different forms of sales tax, it is considered judicious to levy the reformed tax-VAT, instead of the age old Octroi.

Ø Octroi v/s Profession Tax

Considering Profession Tax as another alternative to offset the losses resulting from the abolition of Octroi, it is observed that the tax initially fell under the purview of the state governments but now the same may also fall under the local bodies. In fact many consider it better, over the state government jurisdiction as the local bodies are better placed in deriving information from the people.

This form of taxation has a lot of scope to grow but has fallen short only due to negligence in comparison to the focus attained by other high yielding taxes. Also those who are not registered for sales tax are not registered for profession tax either. Therefore, registration poses a big problem here.

Ø Octroi v/s Property Tax

Considering the Property Tax, octroi and the property tax are both collected by the same system of machinery. So if one is removed, the other should be made good by the same machinery. Going back to the era of 1960’s, property tax accounted for over 70% of the municipal corporations revenue. Since then there has been an appreciation in the value of land, commonly called capital gain.

Hence, there is broader scope for the tax to grow. However, there are some problems involved in this form of taxation. One must keep in mind issues such as progression rates, poor levels of collection and the various exemptions given to government buildings. Further, what one finds in case of Mumbai is the frozen land rates in the city area where the rent paid is only about 10paise to Rs.1 per sq foot unlike the suburban areas where the rates paid are close to Rs.3.5 to Rs.4 per sq foot. Infact, if the land rates are revised in the city area, much more revenue can be generated.

Ø Octroi v/s Tax on Vacant Land
Apart from considering all the above mentioned alternative sources, the government of Maharashtra must levy a tax on vacant land. Such a mechanism would not only serve the purpose of revenue generation for the government, but also look into the problem of land scarcity. A similar source of revenue could be the Pollution Tax. Again, besides generating revenue for the government, it will help to tie over the pollution problem in the city.

Ø Octroi v/s Municipal Development Fund and Municipal Bonds

The Creation of a Municipal Development Fund and issuing of Municipal Bonds could also be considered. This will not only impart more credibility to the corporation but will also give them liquid cash for a start. Also, in the current scenario of rising interest rates, it appears to be a good option for the government.

Learning Lessons (Inter State Comparison) :

Of the 28 states and 7 Union Territories in India, Maharashtra and Gujarat are the only two states that are still continuing with the obsolete tax-Octroi. It’s time the two states take some learning lessons from those who have done away with this form of taxation.

Although in the case of Maharashtra, parameters like the size of the state, the size of the industry and the number of people getting affected by the removal of octroi (including the municipalities and the industry) play a decisive role in the issue, it should stall the consideration of alternative and desirable sources of taxation.

Ways and Means adopted by the states of Tamil Nadu, Kerala, Rajasthan, Punjab:

Different states have adopted different methodologies to find alternative solutions to the problem at hand. States like Tamil Nadu and Rajasthan have introduced a flat entry tax of 2 percent and an additional Land and Building Tax, while Kerala had levied only Land and Building Tax. Punjab has done away with Octroi completely without imposing any additional levy.

The municipal corporations of Chennai and Trivandrum had relied only on two forms of taxes- Entertainment and Property for the bulk of their revenue and Octroi was far from sight.

Methodology adopted by Calcutta:

In case of Calcutta, the loss from abolition of Octroi was compensated by transferring the entire state Entertainment Tax to the local bodies apart from 16% of Sales Tax and the Development Grant. Also, the municipal corporations were empowered to issue trade licenses and levy higher tolls on heavy vehicles. Further, the cost of living allowance was to cover 100% of Calcutta Municipal Corporation’s liability and the grant was expected to rise by 3.35% every yr accounting for the inflation.

Steps undertaken by the Government of Rajasthan:

Taking the example of the Government of Rajasthan, the Octroi leviable under section 65(b) of
the Rajasthan Panchayati Raj Act, 1994, was abolished in August 1998. The government in order to compensate the local bodies had levied surcharge on the sales tax. (source- www.tribuneindia.com 1999). The compensation given was on the basis of 1997-1998 prices.

Broadly, compensation was to be of the value, equivalent to Octroi plus 10% increase per annum. However, for the year 1998-1999, the compensation was to be 2/3rd more than the Octroi received during 1997-1998.

In line with the Rajasthan Government Industrial Policy 1998, the process was gradually adopted beginning with exemption of Octroi in scientific instruments and those equipments required by technical institutions.

Another industry to get exemption from Octroi was the Automobile Industry, although the exemption limit specified in the policy has a short span of ten years. For industries making use of fly ash and stone slurry, 100% exemption would be given and finally in case of small scale industries under the rehabilitation plan, exemption from octroi would be given to boost the major employers in the industry. Further, to boost the agricultural sector, the Purchase Tax and the Octroi Tax was rationed for specific commodities.

Octroi versus Non- Octroi States:


The above table clearly indicates that in case of non Octroi states West Bengal is the only state
that gets state financing to the tune of 70% despite being a better industrial state than Assam
that gets funds worth only 20% from the state government.

Both the states show contradictory findings. On the other hand, all Octroi levying states show higher percentage of the expenditure being self financed. The question that arises is not of obtaining larger grants from the state governments but also of self dependence without the Octroi Levy in the high per capita income states than Assam.

Secondly, when it comes to levying taxes, Maharashtra levies the maximum percentage of taxes in India. In this milieu, the pendulum certainly dangles towards the abolition of Octroi. This can be quantified by taking an example of the local taxes on the Road transport industry levied by a few states.

Major States and Local Taxes on Road Transport Industry (%) 2001-02 :

The table also brings to the fore the double edged knife of taxation for Maharashtra, the other
end spelling burden on the consumers.

Consequences of Octroi Abolition
There are no two opinions on the fact that Octroi abolition implies huge losses for the municipalities. So, devising alternative sources of revenue becomes imperative.

Another problem faced in case of Octroi levying state would be hindrance in implementation of development plans. A similar situation was seen in Haryana where road construction was stopped fearing the inability of the municipalities in making timely payments.

Octroi abolition would also pose a problem for the employees involved in the task, since they will have to be put in alternative divisions for work.

Besides, the problem of this direct employment, there are many others who earn a living because of the Octroi Nakas as, tea stalls, dhabas, motor workshops etc

Another very important point to be kept in mind is that the municipal bodies should not go bankrupt to the extent that they do not have sufficient funds to pay their employees. Such a situation was found in Punjab where the state high court had questioned the abolition of octroi.

Also, there is no guarantee that after octroi abolition, the prices of various commodities will come down. A similar situation was found in Punjab, where the municipal corporations of Ludhiana, Jalandhar, Patiala and Amritsar had not seen much reduction in commodity prices.

Word of caution

As mentioned above, one of the inhibiting factors for the abolition of Octroi is the largesse earned by the Municipal Corporations of Maharashtra and Gujarat. Although both the governments have listed a few alternatives for the same, yet the phasing out will take time as such a move involves amendment of the Municipal Act and the related laws.

Gujarat is already in the process of phasing out Octroi by November 2007 and as per the suggestions given by the state finance commission, village panchayats would be given a grant equivalent to the average of the past three years octroi revenue apart from an annual increase of 7%. This has resulted in additional loss for state governments worth Rs.47.39cr for rural bodies and Rs.168cr for the urban bodies for the year 2002-2003. Therefore, the government is being cautious taking into account full weight of its actions.

Recommendations:

The present system of levy and collection of octroi needs to be abolished. The loss due to full abolition of octroi in the year 2006-07 is of Rs. 5572 crore. It is possible to compensate the ULBs fully for loss due to abolition of octroi.

Abolition of octroi will require imposition of Municipal Profession Tax by ULB’s; imposition of Additional VAT; reform of property taxes, coupled with revision in user charges. Imposition of a general entry tax can be considered at a later date.

The municipal bodies can be permitted to impose and collect their own independent professional tax.
The job of registration under the Shop and Establishments Act should also be given back to the ULB’s
to facilitate imposition of professional tax by municipal corporations / councils.

Octroi should be eliminated in two phases. After all legislative changes are in place, a date should be notified to bring into effect the profession tax and Additional VAT levies. Octroi rates should be halved from a date 3 months hence. The Government should simultaneously notify a date for the full and final abolition of Octroi which should be a date 12 to 18 months away from the date of octroi reduction
to half.

The State Government should give guarantee on a tapering basis for three years starting from the first
reduction in octroi rates, for the loss, if any, incurred by the ULB’s in case the additional VAT does not yield the anticipated revenue.

Within these twelve to eighteen months municipal corporations should complete restructuring of the property tax according to a capital value/area based system. Simultaneously, they could revise the user charges for water and sanitation services to ensure full cost recovery.

Conclusion:
The state of Maharashtra with Mumbai as the financial capital is one of the wealthiest States in
India housing some of the most important industries including Textiles, Electronics, Petrochemicals etc. It is evident that the contribution of Maharashtra’s Industrial sector can grow further, especially when all hindrances to trade get abolished, including Octroi.

The government must act before it’s too late. Although abolition of Octroi might result in some initial losses, it will be beneficial in the long run. This will not only ease inter state trade and generate more revenue but also impart some degree of uniformity to the tax system.