Extension of compensation cess fund to hit Centre’s revenue

During the initial meetings of the Council, it was decided that after five years, the cess rates would be subsumed into the GST rates itself.

The extension of compensation cess fund beyond the transition period of five years would affect the revenue potential of the central government from June 2022 because in the absence of the fund, the cess rates were to be merged into the goods and services tax (GST). The proceeds of this tax could then be claimed by the central government as central GST component as opposed to compensation cess proceeds which are reserved solely for states, sources said.

“During the initial meetings of the Council, it was decided that after five years, the cess rates would be subsumed into the GST rates itself. So, while the fund won’t exist, the cess rates would continue but in a different form,” the source said. He added that doing away with the fund doesn’t mean the items currently attracting cess would suddenly become cheaper.

For instance, if a certain type of automobile attracts a total of 53% tax (28% of peak GST rate plus 25% cess), the total tax on it would remain the same even after the compensation fund is dismantled. However, the 25% of cess would then be converted into GST itself. The new rate would mean that half of the proceeds would go to the Centre.

The GST Council on Thursday decided that the compensation cess fund would continue beyond the mandated period between July 2017 to June 2022, which would then be used to pay for the loans taken by the states meet their protected revenue target.

In the 4th GST Council meeting in November 2016, the then union finance minister Arun Jaitley is recorded as having said in the minutes of the meeting: “Any surplus left in the cess compensation fund (after five years) would be shared between the Centre and the states and that there would be a sunset clause for imposition of cess after five years. He further suggested that there could be a review every year by the Council to examine what cesses could be subsumed into GST tax.”

In the 3rd meeting a month earlier, the secretary to the Council had summarised the decision on way forward for cess once the compensation cess fund ceases to exist after five years. He said that the modality of converting cess into GST could be decided in the GST Council and, if needed, a separate GST rate subsuming the rate of cess could be adopted. In the same meeting, chief economic advisor had also suggested the same mechanism: “Cess was also an indirect tax and if after two years, no compensation was needed, cess could be rolled into tax, but, according to him, the general rate of tax should come down.”

A constitutional amendment guarantees states compensation for revenue shortfall arising out of GST implementation for a period of five years. Another law – Compensation to states Act – lays down that such payment would be made from a fund made of cess proceeds.