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February 17, 2021

GST compensation cess on vehicles and tobacco could extend till 2025-26

by CA Shivam Jaiswal in GST

GST compensation cess on vehicles and tobacco could extend till 2025-26

The GST Compensation Cess Act, 2017 provides for levy of a cess for the purpose of providing compensation to the States for loss of revenue arising due to implementation of GST for a period specified in the Act. As per the Act and the accounting procedure, the entire cess collected during the year is required to be credited to a non-lapsable Fund (the GST Compensation Cess Fund) which shall form part of the Public Account and shall be used for the purpose mentioned i.e., for providing compensation to the States for loss of revenue.

Consumers of automobiles, aerated water and tobacco products may have to bear the burden of the GST compensation cess on their purchases till the end of 2025-26 to help the Union government raise resources to pay states the committed compensation required to make good a shortfall in their GST collection.

Why is the Compensation Cess proposed to be continued?

  • The Fifteenth Finance Commission has estimated that the shortfall in the collection of state GST (SGST) vis-a-vis the assured collection will be in the order of Rs 7.1 lakh crore for the period April 2020 to June 2022.
  • Their calculations showed that the estimated collection from the compensation cess, if extended till 2025-26, would be just enough to clear the liabilities towards the States.
  • A shortfall in revenue collection arises when the actual collection of SGST in a year is lower than the protected revenue, which was based on an assured annualised 14% growth on the 2015-16 revenues of individual states from the value added tax, central sales tax and other minor taxes that got subsumed into SGST.
  • The Centre is obliged by an amendment to the Constitution to provide compensation to states for any shortfall in their revenue arising from the implementation of GST for five years from the date of implementation of the tax regime.
  • The resources to pay this compensation were to be raised by the Centre through a levy of GST compensation cess on select demerit goods.
  • Therefore, the compensation cess was to be levied on select goods during these five years (from July 2017 to June 2022).
  • The assurance for revenue protection ends in June 2022 but the Centre is in no position to fully pay the committed compensation by that date.
  • Therefore, it was suggested extending the compensation cess beyond the June 2022 deadline.

Audit Observation on GST Compensation Cess

CAG conducted audit on the Accounts of the Union Government for FY 2018-19. The audit report gave an overview on Union Government Finances for the year 2018-19 and consisted of observations of the CAG. Audit examination with regard to collection of the cess and its transfer to the GST Compensation Cess Fund, showed that there was short crediting to the Fund of the GST Compensation Cess collections totalling to Rs 47,272 crore during 2017-18 and 2018-19. The short-crediting was a violation of the GST Compensation Cess Act, 2017. Details are given in the Table below:

YearTotal CollectedTotal Transferred to FundShort Transfer
2017-1862,612 crores56,146 crores6,466 crores
2018-1995,081 crores54,275 crores40,806 crores
  • The amount by which the cess was short credited was also retained in the Consolidated Fund of India (CFI) and became available for use for purposes other than what was provided in the Act.
  • Ministry accepted the audit observation and stated that the proceeds of cess collected and not transferred to Public Account would be transferred in subsequent year.
  • Short crediting of cess collected during the year led to overstatement of revenue receipts and understatement of fiscal deficit for the year.
  • Also, as per the approved accounting procedure, GST Compensation cess was to be transferred to the Public Account by debit to Major Head ‘2047-Other fiscal services’.
  • Instead, Ministry of Finance operated the Major Head ‘3601-Transfer of Grants in aid to States’.
  • The wrongful operation had implications on the reporting of Grants in aid, since the GST Compensation Cess was the right of the States and was not a Grant in aid. It was recommended that Ministry of Finance take immediate corrective action.
  • During 2018-19, there was budget provision of Rs 90,000 crore for transfer to the Fund and an equal amount was budgeted for release to States as compensation.
  • However, though Rs 95,081 crore was collected during the year as GST compensation cess, Department of Revenue transferred only Rs 54,275 crore to the Fund.
  • From the Fund it paid out Rs 69,275 crore (inclusive of an opening balance of Rs 15,000 crore in the Fund) as compensation to the States/ UT.
  • This resulted in savings of Rs 35,725 crore on account of short transfer to the Fund and of Rs 20,725 crore on account of payment of compensation to the States/ UTs as against BEs of Rs 90,000 crore each for transfer and payment of compensation.

Fall in tax collections post GST

  • Tax collections in most states fell short of the assured growth from the first year of GST implementation.
  • Fortunately for the Union government, the collections from the compensation cess were adequate to make the committed transfers in 2017-18 and 2018-19.
  • Economic growth and tax collections slowed further in 2019-20, and the pandemic and the national lockdown worsened the fiscal position of the Centre and states.
  • As a result, not only did the difference between the actual and assured collection widened, but the collection of compensation cess too declined. This was a key reason for the Centre’s inability to keep its commitment to the states.
  • When it became apparent that Centre would have trouble honouring its commitment on making the transfer in uncertain economic conditions, the GST Council at its 5 October 2020 meeting decided to extend the levy of the compensation cess beyond June 2022.
  • In the interim, the shortfall was to be funded by borrowings. The GST Council will decide the period for which the cess will continue to be levied and also if the levy is to be extended to any other items or rates altered.
  • Finance minister Nirmala Sitharaman had assured states that the Centre will honour its commitment and that the cess will continue to be levied till the shortfall is fully compensated and all borrowings with interest on it are repaid.

Finance Commission estimates

  • The NK Singh-led Finance Commission, in its report, submitted to the Centre on 9 November 2020 and laid in Parliament on 1 February 2021, estimated that the shortfall of SGST for 2020-21, 2021-22 and first quarter of 2022-23 to be Rs 7.1 lakh crore and that the GST compensation cess fund will have only Rs 2.25 lakh crore from the collections during that period.
  • This would necessitate the extension of the levy beyond June 2022 till 2025-26. Incidentally, since the report was submitted to President Ram Nath Kovind, GST collections have shown signs of buoyancy.
  • The monthly gross GST collections of the Centre and states, including the cess, has exceeded Rs 1 lakh crore since October.
  • Sales of automobiles, one of the items that bear the GST compensation cess, have also recovered. If that trend continues, the actual shortfall in SGST collection might be lower than estimated by the Commission.
  • The Commission estimated that the transfer of GST compensation to the states at Rs 0.90 lakh crore for 2021-22, a little more than Rs 1 lakh crore for 2022-23, about Rs 1.27 lakh crore for 2024-25 and Rs 1.86 lakh crore for 2025-26 crore.
  • About 16.6% of the compensation due between 2021-22 and 2025-26 is to be paid to Maharashtra, 11.6% to Karnataka, 9.6% to Gujarat, 8.7% to Uttar Pradesh and 6.4% to Tamil Nadu.
  • These states are entitled to higher share in the compensation grants as their revenue losses from shifting to the GST regime from the VAT regime was higher due to the difference in the nature of the two tax.
  • The GST is a destination-based consumption tax, while the VAT was an origin-based tax on the value-added component in the manufacture and sale of a good. The VAT regime benefitted revenues of industrialised states and the GST regime takes away that advantage.

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