The government today announced a reduction in the central sales tax (CST) rate to two per cent from the current three per cent effective 1 June.

The new rate will replace the current sales tax rate on inter-state sale of goods, in line with the finance minister's February budget announcement.

It said the new CST on inter-state sale of goods to registered dealers would now be the lower two per cent plus the rate of value-added tax or state sale taxes as applicable.

The reduction forms part of the roadmap for phasing out CST completely by 31 March 2010.

The government had, yesterday, withdrawn a statement about cut in central sales tax rate on inter-state sales from three per cent to two per cent, effective 1 June.

The finance ministry notification came after much bickering with states and the differences with the states persisted on how to compensate them for revenue loss of about Rs13,000 crore in 2008-09.

CST was cut to three per cent on 1 April 2007 from four per cent and it was to be reduced to two per cent on 1 April 2008, before being phased out by March 2010.

However, an agreement on reduction to two per cent got delayed after states refused to increase value added tax (VAT) rate from four per cent to five per cent and bring textiles under its ambit.

"The empowered committee of state finance ministers will make every effort to prevail upon the state governments to impose VAT on textiles as also to increase the general VAT rate from four per cent to five per cent within the financial year 2008-09 as per agreement reached earlier," finance ministry had said in a statement acknowledging the differences with states on compensation.

While states will get some revenue from certain services, VAT on tobacco and removal of Form D, there was a dispute how the remaining Rs9,600 crore will be paid to states.

Finance ministry sources said states are refusing to raise VAT from four per cent to five per cent sighting inflation and assembly elections. States are also demanding cash compensation for Rs9,600 crore from the central government.

With no immediate solution in sight, the central government decided to withdraw the notification. The empowered committee, which will meet in the last week of June, is expected to further discuss the issue.