GST Compensation Cess: A Temporary Levy to Support the States in the GST Regime
The primary purpose of the GST Compensation Cess is to offer financial assistance to states experiencing a decline in revenue due to the GST implementation. As recapped in the GST (Compensation to States) Act 2017, this compensation is scheduled to extend for a five-year period from the transition date, which is July 1, 2017.
Therefore, the cess is planned to be imposed until June 30, 2022, unless the GST Council decides to extend or shorten this duration. The GST Council, comprised of the Union Finance Minister, the Union Minister of State overseeing Revenue or Finance, and the Finance or Taxation Ministers from all states and union territories, holds the authority to determine cess rates, exemptions, and related parameters.
Further, the council formulates the methodology and formula for computing the compensation amount disbursed to the states. Authorized to make recommendations on various GST-related matters, including the cess, the GST Council plays a crucial role in ensuring the balanced and sustainable implementation of GST throughout India.
GST Compensation Cess Rates for Goods and Services
The GST (Compensation to States) Act, 2017, which has been amended over time, specifies the cess rates for different goods. The following table shows some of the goods and their cess rates:
| Goods |
GST Compensation Cess |
| Cut Tobacco |
0.14R per unit |
| Unmanufactured tobacco (with lime tube) |
0.36R per unit |
| Unmanufactured tobacco (without lime tube) |
0.36R per unit |
| Branded tobacco refuse |
0.32R per unit |
| Tobacco extracts and essences bearing a brand name |
0.36R per unit |
| Tobacco extracts and essences without a brand name |
0.36R per unit |
| Jarda scented tobacco |
0.56R per unit |
| Filter khaini |
0.56R per unit |
| Cigarillos |
21% or Rs. 4170 per thousand, whichever is higher |
| Cheroots and Cigar |
21% or 4170 per thousand, whichever higher |
| Cigarettes containing tobacco, except filter cigarettes, of length not more than 65mm |
5% + 2076 per thousand |
| Cigarettes that include tobacco, excluding filtered ones, with a length ranging from over 65mm to 75mm. |
5% + 3668 per thousand |
| Filtered cigarettes with a total length, including the filter (which is either 11 millimeters or its actual length, whichever is greater), that does not surpass 65 millimeters. |
5% + Rs.2076 per thousand |
| Filter cigarettes with a total length, inclusive of the filter (which has a minimum length of 11 millimeters or its actual length, whichever is greater), that surpass 65 millimeters but do not exceed 70 millimeters. |
5% + Rs.2747 per thousand |
| Filter cigarettes with a combined length, encompassing the filter (with a minimum length of 11 millimeters or its actual length, whichever is greater), within the bracket of 70 to 75 millimeters. |
5% + Rs.3668 per thousand |
| Cigarillos of tobacco substitutes |
12.5% or Rs. 4,006 per thousand, whichever is higher |
| Cigarettes of tobacco substitutes |
Rs.4006 per thousand |
| Branded ‘hookah’ or ‘gudaku’ tobacco |
0.36R per unit |
| Smoking mixtures for pipes and cigarettes |
290% |
| Tobacco used for smoking ‘chilam’ or ‘hookah’ commonly known as ‘hookah’ tobacco or ‘gudaku’, without a brand name |
0.12R per unit |
| Other water pipe smoking tobacco without a brand name |
0.08R per unit |
| Other smoking tobacco having a brand name |
0.28R per unit |
| Other smoking tobacco without a brand name |
0.08R per unit |
| Homogenized or reconstituted tobacco bearing a brand name |
0.36R per unit |
| Chewing tobacco (with or without lime tube) |
0.56R per unit |
| Preparations having chewing tobacco |
0.36R per unit |
| Pan masala (gutkha) having tobacco |
0.61R per unit |
| All goods, except pan masala having tobacco ‘gutkha’, with or without a brand name |
0.43R per unit |
| Snuff, Preparations containing snuff |
0.36R per unit |
| Solid fuels derived from lignite or coal, such as ovoids and briquettes, whether agglomerated or not, excluding jet and peat (including peat litter), whether or not agglomerated. |
Rs.400 per tonne |
| Lemonade, Aerated waters, and Others |
12% |
| Motorcycles with engine capacity exceeding 350 cc |
3% |
| Aircraft (including helicopters, etc.) for personal use |
3% |
| Yacht and other vessels for amusement or sports |
3% |
| Motor vehicles for transport not having a capacity of more than 13 passengers, including the driver. |
15% |
Benefits, Impact, And Effects Of The Cess On The States And The Consumers
The cess links the expected revenue and the actual collections of states post-GST implementation. The GST Council initially projected a 14% annual growth rate in state revenues based on the 2015-16 collection figures. However, factors like economic slowdown, compliance issues, rate adjustments, and technical glitches have led to GST collections falling short of the projected rate. This revenue shortfall particularly affects states with a significant manufacturing sector.
To address this gap, the cess acts as a compensatory mechanism, providing financial relief to states for a duration of five years or until they achieve the predicted growth rate. This interpretation positively impacts states' fiscal stability and economic development, especially those with a substantial manufacturing presence. By preventing fiscal strain during the GST transition, the cess ensures that states can continue investing in essential public services like healthcare, education, infrastructure, and social welfare.
Moreover, the cess upholds the fiscal autonomy of states, allowing them to allocate compensation funds based on their unique priorities and requirements. This flexibility authorizes states to make informed decisions, enhancing their ability to implement development policies effectively.
The cess also influences consumer behavior by affecting the demand for goods and services subject to it. Typically applied to items like luxury, sin, or demerit goods, as well as those with adverse environmental or health impacts, the cess aims to discourage consumption of such products. Examples include tobacco products, aerated beverages, motor vehicles, and coal. By increasing the prices of these items, the cess reduces their demand, thereby promoting social welfare and environmental sustainability. This strategy encourages consumers to opt for environmentally friendly alternatives, such as renewable energy and electric vehicles, contributing to a healthier and more sustainable future.
Challenges of Cess Implementation in India
Complexity of Calculation: The cess is levied on the tax amount, which may vary depending on the tax rate, the tax base, the exemptions, the deductions, and the rebates applicable to different taxpayers and transactions. This makes the calculation of the cess complicated and prone to errors. Moreover, the cess rates may change from time to time, requiring frequent adjustments and revisions in the tax returns and payments.
Compliance Burden: The cess imposes an additional compliance burden on the taxpayers, who have to maintain separate records, file separate returns, and pay separate dues for the cess. The compliance cost may be higher for the taxpayers who are subject to multiple cesses, such as the health and education cess, the road and infrastructure cess, the coal cess, etc. The compliance burden may also affect the tax authorities, who have to administer and monitor the cess collections and transfers.
Refund Mechanism: The cess is not refundable, unlike the tax, which can be claimed as a refund or a credit in case of excess payment or input tax credit. This may create a cash flow problem for the taxpayers, especially the exporters, who have to pay the cess upfront and cannot claim it back. The non-refundability of the cess may also lead to a cascading effect, where the cess is levied at multiple stages of the production and distribution chain, increasing the effective tax burden on the final product or service.
Recent Changes in the Cess and its Implications
The government has officially announced the extension of the GST compensation cess until March 31, 2026. Originally scheduled to conclude on June 30, 2022, marking five years since the introduction of GST on July 1, 2017, this extension aims to offer continued financial assistance to states grappling with revenue losses resulting from the GST implementation.
In the Budget 2023-24, the government has also made adjustments to the cess rates for specific products, including motor vehicles, tobacco, and liquor. In particular, the cess on mid-sized cars has risen by 2% to reach 17%, large cars face a 5% increase to 22%, and SUVs experience a 7% hike to reach 25%. Further, the cess on tobacco and tobacco products has seen a 10% increase, now standing at 20%, while the cess on liquor has been raised by 5% to reach 15%. The government anticipates generating an additional revenue of ₹50,000 crore through these revised cess rates.
The rationale and implications of the changes
The decision to extend the GST compensation cess is grounded in the ongoing challenges faced by states, arising from both the GST implementation and the lasting effects of the COVID-19 pandemic. In adherence to the GST Council's directive, the Centre has committed to borrowing and channeling funds to the states. However, this commitment places a financial burden on the Centre, containing both interest and principal repayment responsibilities, i.e., impacting its fiscal capacity and borrowing capabilities.
The adjustment of cess rates for specific products is driven by the necessity to mobilize additional resources for the Centre, particularly to support the health and infrastructure sectors. The government has presented a new Agriculture Infrastructure and Development Cess (AIDC) on petrol, diesel, gold, and silver items dedicated to funding agricultural infrastructure and development initiatives. Nevertheless, this move also implies an increase in prices and demand for the affected goods and services, exerting an influence on consumer inflation and consumption patterns.
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