Understanding GST Compensation Cess

Several manufacturing states, including Gujarat, Maharashtra, Karnataka, Haryana, and Tamil Nadu, were concerned about potential revenue loss due to the consumption-based nature of the GST.

• To address these concerns, the government introduced the GST Compensation Cess, designed to offset any potential revenue losses incurred by these manufacturing states.
• Under the GST (Compensation to States) Act of 2017, a compensation cess is levied on five items considered to be "sin" or "luxury," such as Pan Masala, Tobacco, and Automobiles.
• The compensation cess fund was established to compensate states for any revenue loss. The additional cess collected on certain goods was decided to be used for this compensation.
• Compensation Cess on Exported Goods: Compensation Cess is not applicable on goods exported by an exporter under bond/LUT, and the exporter can claim a refund of the input tax credit of Compensation Cess related to the exported goods.
  • If the goods have been exported after paying the Compensation Cess, the exporter is eligible for a refund of the Compensation Cess paid on the exported goods.

How is the GST compensation cess calculated?

Understanding Cess

Cess is a tax that is levied for a specific purpose and can only be used for that particular purpose.

• A cess can only be levied by the Union Government after the Parliament of India passes the necessary legislation.
• The legislation must clearly state the purpose of the fund collection.
• While the Union Government is required to share taxes with the State Government, a cess can be excluded from the pool of revenues that can be shared according to Article 270 of the Indian Constitution.

Why was the Compensation Cess Necessary?

With the implementation of the Goods & Services Tax (GST), States and Union Territories (with legislatures) had to relinquish their fiscal authority to a GST Council.

• The transition from sales tax or value-added tax to GST could lead to a decrease in a State's total revenue.
• To address this, it was decided that any revenue shortfalls resulting from the transition to the new indirect tax system would be compensated for a five-year period through a pooled GST Compensation Fund.
• According to the GST law, the financial year 2015–16 should be used as the base year for calculating compensation, and States were guaranteed an annual income growth of 14%.
• The Government of India has recently extended the compensation cess until 31st March 2026, which was initially set to end on June 30, 2022, five years after the GST roll-out on July 1, 2017.
  • This extension is to repay the loans taken in 2020-21 and 2021-22 to compensate States for the GST revenue loss.