Mar 11, 2022

How will States get their GST compensation?

In 2017, the Goods and Services Tax (GST) replaced many indirect taxes in India like value-added tax (VAT), excise duty, service tax etc. The Centre promised compensation to the States for GST implementation because implementing GST would reduce the income that States get from indirect taxes.

In the past few months, the Central government has delayed in payment of GST compensation to the states. This was said to be due to certain reasons including low tax revenue collection from GST, and a general decrease in economic activity due to the COVID-19 outbreak. Yesterday, the GST Council meeting discussed the current issues related to GST compensation for states. The Central Government provided two options before the states to meet/cover the shortfall in the GST revenues.

What is the GST compensation law?

The Goods and Services Tax (Compensation to States) Act came into place in 2017. The Act provides compensation to states for loss of revenue arising because of implementing GST.

Under the law, compensation is provided to a state for a period of five years from the date on which the state brings its State GST Act into force, and this compensation is paid every two months. For the purpose of calculating the compensation amount in any financial year, 2015-16 is taken as the base year. The shortfall in tax is calculated assuming a 14 per cent annual growth in GST collections by states over the base year of 2015-16.

The GST compensation is paid out of a compensation cess. The compensation cess is a tax collected on certain specific goods and services like luxury goods, tobacco, pan masala etc. So, the revenue from compensation cess is used for compensating states for any loss incurred due to the implementation of GST.

At the end of the compensation period and after compensating the states, if there is any remaining money that has been collected through the compensation cess, it is distributed in the following manner: (i) 50% is shared between the states in proportion to revenues of the states, and (ii) the remaining 50% is part of the Consolidated Fund of India.

The GST Council meeting

The government said that the total shortfall in collection of GST is approximately ₹2.35 lakh crore. Out of this, a shortfall of ₹97,000 crores is because of GST implementation itself, while the rest is due to the COVID-19 pandemic. States have asked for 7 days to think about the two options that the Centre has proposed to cover the shortfall in GST revenue. The options are:

1) A special window can be provided to the states for borrowing ₹97,000 crores at a reasonable interest rate (the Reserve Bank of India will be consulted on this matter). States can repay this amount in 5 years through cess collection.

2) The second option is for states to borrow the entire ₹2.35 lakh crore shortfall under the special window.

Finance Minister Nirmala Sitharaman said that the COVID-19 pandemic is an unexpected ‘act of God’, and that the GST Compensation Act does not anticipate such a situation. In law, an ‘act of God’ refers to a natural hazard which is outside human control, for which no person can be held responsible.

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