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GST Compensation CESS

gst compensation cess

What Is GST Compensation CESS?

GST – Goods and Services Tax – was implemented in India in July 2017 to replace the country’s previous taxation system. A GST Compensation CESS is levied on goods at the consumption point, not the point of manufacture. As a result, manufacturing states worried about revenue losses, and the government agreed by establishing a Compensation CESS under the GST. Compensation CESS was pre-determined to be imposed for the initial five years of the GST law, i.e., from 1st July 2017 to 1st July 2022.

The GST – Compensation to States Act 2017 imposes a Compensation CESS under GST. As GST is a consumption-based tax system, the central government must compensate states for revenue lost due to its implementation.

Who Will Collect GST Compensation CESS?

Except for exporters and composition scheme taxpayers, all taxpayers involved in the supply of specified goods or services will be subject to the compensation CESS. This will include the compensation CESS levied on certain imported goods into India.

The collected CESS on GST is then transferred to the central government and then distributed to the state governments. If an export compensation CESS is paid on exports, the exporter is entitled to claim a refund.

List The Goods Covered Under GST Compensation CESS:

GoodsCompensation CESS under the GST
Tobacco that hasn't been manufactured (with lime tube) but has a brand name on it.65%
Tobacco that has not been manufactured (without the lime tube) – but has a brand name71%
Refuse branded tobacco61%
Cigars and Cheroots21% or Rs. 4170/thousand, whichever one is higher
Cigarillos21% or Rs. 4170/thousand, whichever one is higher
Tobacco-containing cigarettes, except filter cigarettes, with a maximum length of 65mm5% or Rs. 2076/thousand
Apart from filter cigarettes, Tobacco-containing cigarettes with a length greater than 65mm and up to 75mm5% or Rs. 3668/thousand
Cigarettes made of substitutes for tobaccoRs. 4006/thousand
Tobacco that has been branded as ‘hookah' or ‘gudaku.'72%
Tobacco chewing (without lime tube)160%
Tobacco chewing (with lime tube)142%
Tobacco-containing pan masala (gutkha)204%
All products carrying the brand name, except for pan masala, usually contain tobacco (gutkha).96%
All products do not carry the brand name, except pan masala usually contains tobacco 'gutkha'.89%
Fossil fuels, ovoids, coals, and related solid fuels made from coal, lignite, if either agglomerated or not, but excluding jet, and peat, regardless of whether agglomerated or not400/tonne
Aerated waters12%
Automobiles capable of transporting no more than 13 people, along with the driver15%
Automobiles, except the ambulances, three-wheelers, and vehicles with an engine efficiency of less than 1200cc and a length of less than 4000 mm, equipped with both an ignite combustion engines reciprocating piston engine with an electric motor automatic transmission as propulsion motors, or with a compression-ignition combustion engine [diesel- or semi-diesel] and an electric motor as propulsion motors.15%
Automobiles powered by petrol or diesel, LPG, or CNG with a maximum engine capacity of 1200cc and a maximum length of 4000mm.1%
Diesel-powered automobiles with a maximum engine efficiency of 1500cc and a maximum length of 4000mm.3%
Automobiles with a maximum engine capacity of 1500 cc17%
 Automobiles with a fuel efficiency exceeding 1500 cc20%
Automobiles with an engine capacity greater than 1500cc are collectively referred to as SUVs, such as utility vehicles.22%

How to Calculate CESS on GST:

The following factors are taken into consideration when calculating the GST Compensation CESS to be paid to the State:

  • The end of the FY, March 31, 2016, is used as the baseline year.
  • The state’s base year revenue is calculated using revenue collected from taxes levied by the local and state governments. Apart from other taxes, this includes Sales tax, VAT, purchase tax, central sales tax, customs duty, entry tax, entertainment tax, and excise duties.
  • Petroleum products and alcoholic beverages are exempt from taxation revenue.
  • For any state, the anticipated growth rate of revenue assimilated by the GST during the period of transition is assumed to be 14% per year. The projected revenue is computed by adding this growth rate to the base year revenue.
  • The state would be compensated for the variance between the expected revenue and the state’s actual total revenue received.

Every two months, provisional compensation must be determined and paid to the states. Any over or under-payments must be listed in the following months, or some situations in the successive financial year, successful completion of the official audit.

The following formula is used to determine the amount of GST compensation CESS to be distributed to each state:

Step 1: The financial year 2016-17 revenue is used as the state’s baseline revenue.

Step 2: The state’s growth rate is assumed to be 14% per year for the five years covered by the GST CESS. The projected revenue that a state would have managed to earn in the absence of GST for a given financial year is calculated using this information.

It implies that this is the revenue that a state would have earned unless GST was implemented. This calculation is made for five years, as the compensation CESS under GST is planned to be in effect for a five-year transition period.

Step 3: During the transition period, the compensation amount is determined and released every two months. This mechanism is scheduled to implement until 1 July 2022.

According to U/S 7(c) of the GST Act, 2017, the overall compensation CESS on GST payable to a state in any financial year is the variance between the state’s projected revenue for the financial year and the state’s actual revenue collected.

The amount is paid to the state governments every two months after a provisional calculation has been made. Suppose there would be any money remaining in the total compensation fund at the end of this transition period. In that case, it will be divided between the state governments and the central governments according to an appropriate formula.

How to Acquire Funds for Distributing Compensation CESS under GST:

GST compensation CESS payments for the last quarter of Financial Year 2019-20 are arrears with a rising compensation fund deficit due to the pandemic global economic slowdown. To compensate for this budget deficit, the Central Government has the following options:

  • The compensation CESS under the GST formula has been revised.
  • Increased composition CESS rate/prescription of additional commodities to be taxable under the compensation CESS
  • Take funds from the financial markets.

The states have been experiencing revenue losses for some time, and it has intensified in recent months due to the COVID-19 lockdown. The states discussed compensation CESS not being released from the Centre to the States for a long time at the previous 41st GST council meeting, which was arranged for Aug. 27, 2020. In 2020-21, the shortfall was approximated to be Rs 2.35 lakh crore. On the other side, the central government claims that only Rs 97,000 crore of the Rs 2.35 lakh crore is due to the implementation of the GST. The remainder of the shortfall is attributable to Covid-19. The Centre presented the states with two options to cover the compensation CESS shortfall at the 41st GST Council Meeting. The following are the options:

Option I: 

The centre can support Rs 97,000 crore to state governments as borrowings through a special window established by the RBI. This money can be paid back after five years of cessation collection with a reasonable interest rate payment.

Option II:

The second option is for the states to borrow directly from the RBI for Rs 2 35,000 crores.

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