The Indian federal system empowers both the Centre and State to be independent in their respective spheres of governance.

Both derive their powers for taxation from the Constitution, and tax policies play a crucial role in the development and growth of an economy. Over the years, State governments have been recognising the need for a constructive long-term industrial policy with various benefits, incentives and exemptions to attract investment from various sectors of the economy.

Further, the current economic meltdown has resulted in global investors seeking newer investment destinations that promise safety and assured returns. In such a situation, the States vie with each other for investment and offer various tax and non-tax incentives to promote their respective regions.

State industrial policies, through their packages of incentives and benefits, not only encourage investment and generate employment but also improve the State’s infrastructure including business facilities, roads, power, transportation, communication facilities and so on. In certain States, the government goes the extra mile by offering corporates tailor-made incentives to set up shop locally and deploys the required administrative machinery to support the corporates. Government initiatives in States such as Karnataka, Gujarat, Goa and Tamil Nadu have helped ensure uniform spread of industries and economic activity across the State and accelerated the pace of development.

In general, State governments have been routinely offering benefits, concessions and incentives based on the location of the industrial facility and the investment portfolio.

The incentives, by and large, include fiscal benefits such as capital investment subsidy, interest subsidy, land at concessional rates and so on; policy benefits such as industrial parks, equity/ loan contribution from the State government, customised and sector specific incentives; and indirect tax benefits such as exemption/ deferment of VAT, exemption from entry tax, stamp duty, electricity duty, entertainment tax and so on.

However, with the political agenda increasingly centring around the State’s growth and development, the scale and magnitude of the incentives offered have touched new levels in the recent past and investors planning for large/ mega projects can expect a plethora of incentives.

So far, State industrial policies have been a blessing both to the State governments and the investors.

However, given that the biggest tax reform under indirect taxes — the Goods and Services Tax (GST) — is on the anvil, it would be interesting to see what shape the incentives doled out by the States take.

The GST by its very design would envisage doing away with most of the incentives/ benefits and taxing all or substantial economic activities in the country in relation to goods and services. Though the States may retain the authority to offer incentives/ benefits in non-tax related areas, the unilateral power to offer incentives/ benefits on taxation-related matters may be significantly curtailed and any such incentive/ benefits would be based on a collective decision of the Centre and the States.

The overall growth and development of States and industries is of critical concern; tax reforms should not become an impediment to such progress and instead prompt the States to announce new and innovative incentives.

As the world moves into a tougher economic environment, investment will flow to those States that can provide the best infrastructure, minimum bureaucracy and quick decision-making, apart from other possible short- and long-term fiscal incentives.

Bipin Sapra is Tax Partner, Ernst & Young.

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