The GST Compensation Cess Issue - All you need to know.


On 5th October, all eyes were focused on the 42nd Goods and Services Tax (GST) Council meeting. An important decision had to be made with respect to the ‘compensation cess issue’. There always seems to be a lot of complicated terms and facts surrounding this topic. Let us understand with clarity, how this issue came about. When it comes to a matter of such great importance, why are the Central government and states facing difficulties in reaching an agreement?

What is the GST Compensation Cess?

Taxes collected by the Government can be divided into Direct Taxes and Indirect Taxes. The Goods and Services Tax (GST), which was introduced in India on 1st July 2017, has replaced the indirect tax structure for the entire country. It is based on the slogan 'One Nation, One Tax, One Market'. One of the advantages of GST is that it integrates different taxes like Central Excise, Service Tax, Sales Tax, Luxury Tax etc. into one consolidated tax. It prevents multiple taxes being imposed on goods and services.

GST is further divided into three parts- Central GST, State GST, and Integrated GST. These are taxes that can be passed on to another entity or individual. For example, when a particular product is manufactured in Tamil Nadu but is consumed in Kerala, then the revenue from GST collection is given to Kerala (the state where the product was consumed). Due to this feature of GST, certain manufacturing states of India believed that they would suffer from losses in revenue. Thus, the GST Compensation Cess was launched by the Central Government to compensate for any revenue loss that would come up in these manufacturing states. Cess is nothing but a tax imposed on a tax amount. You may have seen GST Cess in the bills you get from the your petrol pump. Anyway, when this relief for states was introduced, the GST Bill stated that the cess would be imposed for a period of 5 years, ie, till 1st July 2022.

It might be interesting to know that GST Compensation Cess is applicable to certain specified products such as Pan Masala, Cigars, Tobacco, Cigarettes, Petrol, LPG, Motor Cars and Vehicles. These products can be categorized as luxury, sin, and demerit goods. So products which the governments think you should not use or use less or ones which are used only by the rich are included in these lists.

How is GST Compensation Cess amount calculated?

While calculating the amount for GST Compensation Cess, the growth rate of a state is assumed to be at 14% per year. Based on this information, a state's projected revenue that they could have earned in absence of GST, is calculated. The total compensation cess payable to a state will be the difference between the projected revenue (for the financial year) and actual revenue collected by the state.

States vs the Centre

Now that we have an idea about GST and GST Compensation cess, let us know why there has been a ‘GST compensation row’ and why states are not happy with certain decisions.

As we all know, revenues of state governments have dried up due to the ongoing Covid-19 pandemic. The states have high expenses, and GST collections have gone down. As a relief measure, the Central Government assured that all states would be compensated, and that they will not face a shortage of tax money. The amount calculated as the total of GST revenue shortage and revenue shortage due to Covid-19 (these are separate estimates calculated by the Centre) was Rs 2.35 lakh crore. With this new estimate, the Centre established two options during the previous GST Council meeting, which was held on 27th August:

  1. In consultation with the Reserve Bank of India (RBI), the Centre would give states a special window to borrow Rs 97,000 crore, that could be paid back after 5 years. This amount was calculated as the GST revenue shortage.
  2. States could directly borrow Rs 2.35 lakh crore from the market, but this would come at a higher cost.

Things have been tense since this announcement took place. A majority of the states have already opted for the first option. However, ten states and union territories, which include Kerala, West Bengal, Delhi, Tamil Nadu, Punjab, and Chattisgarh have completely refused to accept both options and started protests. In both the cases, the states are responsible of borrowing and paying back this allocated 'funds'. What these states have demanded is that the Centre should borrow the required funds, not the states, and that it should be allocated to them. 

What happened at the 42nd GST Council meeting?

After the 42nd GST Council Meeting on 5th October, the Centre and States governments have not yet reached an agreement on the compensation borrowing options. However, major new updates were given by Finance Minister Smt. Nirmala Sitharaman:

  • The borrowing limit has been increased to Rs 1.1 lakh crore, instead of the first option that was mentioned earlier. This would be the new amount for the GST revenue shortage.
  • The Centre would release a compensation of Rs 20,000 crore to all the States, which would help cover the revenue loss during 2020-2021.
  • Another amount of Rs 25,000 crore will be released for Integrated GST (or IGST). IGST is charged when there is movement of goods from one state to another.
  • The GST Compensation Cess would be applicable even after the specified 5 year period, ie, it would go beyond June 2022 to meet the revenue gap.
  • From 1st January, small businesesses whose annual turnover is less than Rs 5 crore will not have to file monthly tax returns, need to file it only quarterly. And payment of taxes can be made using a challan. This would give relief to a lot of small taxpayers

Since the beginning of this financial year, no compensation cess has been given to the states. An important factor we must understand is that states are now at the forefront of fighting Covid-19, and they need much more resources than the Centre. Finance Ministers of states have already asked the Government to reverse its decision of making the states borrow. But the Centre has suggested that they are not willing to change the options. The next GST Council meeting is scheduled for 12th October. 

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