The Goods and Service Tax in India was launched with the cooperation of the states and the centre. Since the taxes of both the centre and states were merged under GST, immense cooperation between the two was required for configuring the GST reform. Here, an important component of the GST implementation was the compensation by centre to states when the latter undergoes revenue shortfalls due to the implementation of GST.

Why GST compensation?

While implementing the GST in 2017, a major concern of the state governments was the possibility of revenue loss. Several states argued for compensation from the centre if the revenue from GST to them falls than that of the estimated level.

The centre initially resisted to compensation but later agreed for the first five years.

What is the purpose of the compensation?

Main purpose of the compensation clause was to incentivise states to accept and implement the GST. States have to give up the control over their major tax revenues including the state sales tax that are to be merged under GST. Effectively, states had given up their power to impose and collect taxes on goods. Hence, assuring no revenue loss after the implementation of GST became important.

In the past, the centre compensated states when the latter introduced Value Added Tax (VAT) n place of state sales tax in 2006. Hence, compensation in case of revenue loss became a conventional clause when the state is undertaking any tax reform at the insistence of the centre.

What is the statute for GST Compensation?

GST Compensation clause was inserted under the GST Act. As per the provisions of Section 7 of the GST (Compensation to States) Act, 2017, loss of revenue to the States on account of implementation of Goods and Services Tax shall be payable during transition period of 5 years. The compensation payable to a State shall be provisionally calculated and released at the end of every two months during transition period of 5 years.

How GST revenue loss is estimated?

The revenues of the states were taken based on state revenues in 2016 (here, 2016 is taken as the base year).

Revenue of the base year is estimated by including the tax revenues of the state from central sales tax, state VAT, local body tax, octroi, entry tax, taxes on advertisements, taxes on luxuries, etc. But the revenues will not include taxes related to the supply of petroleum products and alcohol for human consumption. These taxes are not merged under GST.

Besides, states were guaranteed a tax revenue growth of 14 per cent during the first five years of GST implementation. Or in other words, for the calculation of revenue loss, the tax revenue of Financial Year 2016 is taken as the base year for estimating 14 per cent growth.

Any shortfall will be compensated by the Centre using the revenue obtained from the taxes imposed as GST compensation

Periodic estimation and transfer of compensation

After estimating the compensation in a two-month provisional basis, the money should be released at the completion of every two months. Besides, a yearly calculation of the overall revenue should be done which will be audited by the CAG.

GST Cess can be levied on both intra-state and inter-state supply of some goods and services.

Since GST Compensation is for five years, the GST Cess will be applicable till July 2022.

How GST compensation revenue is obtained?

To avail the revenues for GST compensation, the centre has imposed a cess on specific products especially, those considered to be ‘sin’ or luxury goods. So, there is a GST compensation cess on these items.

GST Compensation to states

Year since GST implementation Percentage of the revenue loss to be compensated
1st year 100%
2nd year 100%
3rd year 100%
4th year 75%
5th year 50%

The proportion of compensation

The state demanded that 100% compensation for the loss should be made by the centre. But the Fourteenth Finance Commission proposed a different package which was later ratified by the centre and states. As a result, 100% compensation for the loss will be made for the first three years, 75% for the fourth year and 50% for the fifth year.

What is GST Compensation cess?

GST Compensation Cess is imposed as a levy in addition to the regular GST taxes. The cess is imposed on the supply of certain luxurious and demerit goods and services that attract 28 per cent GST. The cess rate usually ranges from 1% to 25% and is levied over and above the GST rate.

Which items attracts GST Compensation Cess?

GST cess is applicable to a variety of goods or services that are traded either intrastate or interstate trade. Entities that fall under the composition scheme need not pay the cess. The main items that attract the cess are:

  • Pan Masala
  • Aerated waters
  • Tobacco and tobacco products
  • Coal, briquettes and solid fuels made from coal or ignite
  • Motor cars and other motor vehicles
  • Any other supplies as notified from time to time.

The list of the items is changed with change in GST Council decision. Rates for the goods/services also differ.

Kerala Flood Cess

GST as a platform to meet calamity funding

          The GST Council allowed states to levy special taxes for a specified period to raise money during any natural calamity or disaster. Cess idea to overcome natural calamities was proposed after the GoM report (Group of Ministers’ report on imposing a cess in the case of calamities and natural disasters) under Bihar Finance Minister Sri. Sushil Kumar Modi.

The GoM Panel approved a levy of 1% ‘calamity cess’ by Kerala for a period of two years to fund rehabilitation work in the state hit by floods. Kerala has been allowed to levy cess at the rate of 1% for not more than two years to overcome losses from the natural calamity.

At the 32nd meeting held on January 10th, 2019, the GST Council ratified Kerala’s flood cess.

In future, if any other state wants to levy the ‘calamity cess’ it has to approach the GST Council for approval.

Rate structure of Kerala Flood Cess

‘Kerala Flood Cess’ will be imposed on value of intra-state supply of all goods by registered dealers. It should be imposed at the last supply point, on GST tax rates of 12%, 18% and 28%.  A flood cess of 0.25% will be levied on all goods coming under the fifth schedule including gold, silver and platinum ornaments.

Similarly, all services will attract one per cent cess. In another decision, the Kerala government has also decided to allow local bodies to collect entertainment tax on movie tickets up to 10 per cent. The cess became effective from 1st of July 2019.

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