Compensation Cess under GST

Compensation Cess under GST

The Goods and Services Tax (GST) Act, 2017 provides for a mechanism to compensate the states for the revenue loss on account of the rollout of GST. Such compensation is to be provided by the Centre to the States. An Act namely the Goods and Services Tax (Compensation to States) Act, 2017 has been enacted to seamlessly payout such compensation to states. 


Salient features of the Compensation Cess Act, 2017

The salient features of the Compensation Cess Act, 2017 (the Act) are the following: 

  • Compensation cess would be paid for a period of five years. 
  • The base year during the transition period is financial year 2015-16 which is being used for the purpose of computing compensation cess payable to states. 
  • The revenue to be compensated is determined basis the revenue of states arising from taxes subsumed under GST. The accounts were audited by the CAG for determining the same.  
  • The growth rate of revenue subsumed under GST was determined at 14% per annum. 
  • It was decided that the Compensation cess will be released bi-monthly on the basis of the provisional numbers furnished by the Central Accounting Authorities and the final adjustment to be done after the accounts are subjected to audit by CAG. 
  • For 11 special category states, it was decided that the revenue foregone on account of exemption would also be considered for the purpose of determining the revenue for the base year i.e., 2015-16.  
  • The revenue of the states which directly transfers to mandi/ municipalities was considered as revenue subsumed. 
  • A cess would be notified on specified goods for a period of 5 years, the revenue of which will be used to compensate states for loss of revenue. 
  • 50% of the amount which remains unutilized in the fund at the end of the fifth year would be transferred to the Centre and the balance 50% would be distributed amongst the States and Union Territories in the ratio of total revenues from SGST/ UTGST of the fifth year.   
  • The provision of the GST law and the rules made thereunder including the provisions relating to assessments, input tax credit, non-levy, short-levy, interest, appeals, offences and penalties, would also apply to the Compensation cess so levied. 
  • The input tax credit of Compensation cess shall be utilised only towards payment of said Cess on supply of goods and services leviable under the said Section.  
  • Compensation cess would not be leviable on supplies made by a person who has opted for composition levy.  
  • The Cess is to be levied on taxable value and would be payable over and above the CGST, SGST, IGST. Taxable value means transaction value exclusive of GST leviable.  
  • An exporter is permitted to avail credit of cess paid on export of goods similar to IGST paid on exports. Similarly, Cess is not charged if goods are exported under LUT. 

Items on which Compensation cess is applicable

  • Pan Masala  
  • Tobacco and Tobacco products  
  • Coal, briquettes and similar solid fuels  
  • Aerated Water  
  • Used and old Motor vehicles, Ambulance, Cars for physically handicapped persons, electrically operated vehicles, three wheeled vehicles, Motor vehicles of engine capacity not exceeding 1500cc and of length not exceeding 4000 mm  
  • Motor cars and passenger motor vehicles, SUVs  
  • Caffeinated Beverages  

How is Compensation cess computed?

The Compensation cess to eb distributed to states is calculated as under: 

  1. Determine the base revenue of a particular state for FY 2016-17. 
  2. Add 14% growth rate per annum to the base revenue (for the first year) and the previous year’s projected revenue (for subsequent years) to arrive at the projected revenue. 
  3. The differential between projected revenue and actual revenue is the amount of compensation cess that is payable to the state.  
  4. The amount computed is required to be paid bi-monthly to each state. 

Key Rulings

In a petition filed before the Supreme Court in the case of Mohit Minerals vs UOI [Review Petition (C) NO.2718 OF 2019 In Civil Appeal No. 10177 OF 2018], the Supreme Court held that the Compensation to States Act, 2017 does not go beyond the legislative competence of the Parliament. It does not violate the Constitution, nor it is against the objective of Constitution. The Supreme Court opined that the principle is well settled, two taxes/imposts which are separate and distinct imposts and on two different aspects of a transaction are permissible as “in-law there is no overlapping – Levy of Compensation to States Cess is an increment to goods and services tax which is permissible in law.”

Challenges faced by the Government

The Compensation cess has been driving a wedge between the Centre and State for more than a year now. The Centre has not been able to match the promised 14% growth to the States. This is because of reduced GDP and consequently reduced GST revenue collection. Therefore, the problem arose as the Centre did not have sufficient funds to pay the States. The items which attract Compensation cess (mentioned above) witnessed a slowdown resulting in the lowered collection of Compensation cess. Moreover, the pandemic and the repeated waves have washed any hopes of an early revival for the compensation fund. The Centre was thus left with an important question – How to fill the pit which is only getting deeper? 

To answer this, the GST Council in 2020 gave borrowing options to the states, wherein the states could borrow funds which could make up for the shortfall. Another option that was suggested was an increase in the tenure of compensation cess beyond five years. 

As expected, few states did not accept the proposal of accepting the borrowing option as it shall give rise to a fiscal deficit.  

Since then, the Centre and States have not been able to reach an amicable solution on the issue. However, the Centre in the last GST Council meeting held in May 2021 promised to hold an exclusive agenda meet in July 2021 to discuss the close of the issue. 

It is to be seen whether the issue finally reaches a conclusion or not; even if does, whose pocket will be emptied – Centre, States or the Consumers of the country is something which awaits clarity. 

Sharing is caring!