GST compensation cess – will it become a permanent feature?

Realising that the compensation cess on GST collection is unlikely to grow @14% y-o-y after June 2022, some states have expressed a desire to continue with the GST Compensation Cess for further period.

By Sachin Menon

With a view to ushering in the mother of all economic reforms in India, that is Goods and Services Tax, the then finance minister Arun Jaitley, had agreed to what certain sections of the society may view as an unreasonable demand from the states. A promise was made to compensate loss of revenue due to introduction of GST that may be suffered by the states, considering the tax collection of 2015-16 as the base year and an assured growth of tax collection year on year at 14% for the next five years which ends on June 30, 2022. To which, the states wanted an assurance, basis suitable provisions as per the Constitution of India. This request was eventually met. Subsequently, the GST (Compensation) Act, 2017 was introduced with effect from July 1, 2017 primarily levying additional cess on luxury and demerit goods to fund the gap between the actual and promised revenue as compensation.

It was a fact that in most cases, under the erstwhile VAT regime, the state revenues rarely grew consistently at 14%. However, things worked out as planned during the years 2017-18 and 2018-19 as the net compensation cess collected was more than compensation which was required to be released to the states. However, since 2019-20 onwards, there has been a reverse trend which is attributable to falling revenues that resulted in increase in compensation requirement due to the fact that projected growth rate of 14% y-o-y was unrealistic.

The GST Council had to deliberate if compensation would have to be paid to the states due to fall in revenue because of Covid-19 since the enactment provided for compensation for loss arising from implementation of GST and not due to ‘Act of God’. Covid-19 was a bolt from the blue. After detailed deliberation and evaluation of various options, the GST Council, in its 41st meeting, recommended that the part of the shortfall that is attributable to Covid-19 can be bridged with borrowing of approximately Rs 1.59 lakh crore with the support of the central government.

Realising that the compensation cess on GST collection is unlikely to grow @14% y-o-y after June 2022, some states have expressed a desire to continue with the GST Compensation Cess for further period. This raises the question as to whether the GST Compensation Cess will become a permanent feature in the scheme of GST or it should be discontinued after its initial period of five years?

In this context, it is important to note that Section 18 of the Constitution (One Hundred and First Amendment) Act, 2016 provides for grant of compensation to states for loss of revenue on account of GST introduction for a period of five years; whereas GST Cess Act provides for compensation for a period of five years or for such period as may be prescribed on the recommendations of the Council. Thus, in order for the abovesaid transition period to be extended, it seems an amendment would be necessary both in the Constitution as also in Cess Act, 2017.

However, Article 270 which deals with ‘Taxes levied and distributed between the Union and the States’ empowers the Parliament to levy cess for a specific purpose under a law made by it. Hence, going by the language of the article, it may be construed that even in the absence of any provision for the extension of the period of five years (as per the Constitution Amendment Act), the Parliament can still enact a law for the levy and collection of the cess independent of the constitutional provision. It will be critical to see the route, if adopted by the government, will end up in collection of a pseudo GST forever in the form of cess.

After the recently held 45th GST Council meeting, the finance minister has clarified that the Compensation Cess collection beyond June 2022 till April 2026 would be exhausted in repayment of borrowings for the FY 2020-21 and 2021-22. Thus, it is possible that the levy of cess could be extended to cover not only the shortfall of revenue but also the interest cost of borrowings which was not envisaged earlier.

However, an act which is introduced with a specific purpose for a limited period under a constitutional provision, should not become a permanent fixture of the GST system and the states should explore other avenues for generating revenue without resorting to a pillion ride on the GST law.

The author is Partner and National Head — Indirect Tax, KPMG in India Supported by Santosh Sonar, Chartered Accountant.

Views expressed are personal