Compensation Cess

Compensation Cess (GST): Overview

Compensation Cess is a tax levied under the Goods and Services Tax (GST) regime in India, introduced through the Goods and Services Tax (Compensation to States) Act, 2017. This cess aims to compensate states for any potential revenue losses they face after the implementation of GST, ensuring they receive a guaranteed 14% growth in revenue.

Purpose of Compensation Cess

The GST rollout replaced a number of indirect taxes, many of which were significant revenue sources for state governments (like VAT, octroi, etc.). To ensure that states would not face revenue shortfalls, the central government promised compensation. The cess was created as a mechanism to fund this compensation for a period of five years, which was extended later.

Applicability

Compensation cess is imposed on certain luxury goods and sin items, including:

• Tobacco products (cigarettes, cigars)
• Aerated beverages (soft drinks)
• Automobiles (especially large cars and SUVs)
• Coal
• Pan masala
• Other specific items notified by the government

This cess is not applicable to all goods and services but only to the specified items, and it is levied in addition to the GST rates.

Rates of Compensation Cess

The rates for the Compensation Cess vary depending on the type of product:

• Tobacco products: Fixed rate (e.g., ₹4,170 per 1,000 sticks for certain cigarettes) or a percentage, whichever is higher.
• Aerated waters: 12%
• Motor vehicles: Ranges from 1% to 22%, depending on engine capacity, type, and classification.

Collection and Payment

• The Compensation Cess is collected by the Central Government from manufacturers, importers, and suppliers of the specified goods.
• Businesses that supply these goods need to charge the cess in addition to the regular GST and remit it to the government.

Utilization of Compensation Cess

• The collected cess is deposited into a dedicated Compensation Fund.
• The central government uses this fund to compensate the states for any shortfall in revenue for a period of five years (from 2017 to 2022), as per the promise of 14% year-on-year revenue growth.

Extension of the Compensation Cess

Due to the financial strains caused by the COVID-19 pandemic and associated shortfalls, the GST Council extended the levy of Compensation Cess beyond five years to meet the obligations towards the states. It was announced that the cess would continue until the loans taken by the central government to compensate the states were repaid.

Compensation Cess in the Filing Process

• Businesses that deal in goods subject to the Compensation Cess must file the necessary details in their GST returns.
• They must account for the cess collected in their GST returns and pay it along with the GST on the supply of goods.

Key Points:

• Purpose: To compensate states for any revenue losses due to GST.
• Applicable On: Specific luxury or demerit goods (e.g., tobacco, aerated drinks, motor vehicles).
• Levied in Addition to GST: Compensation Cess is charged over and above the GST rates on specified goods.
• Duration: Initially intended for five years (2017-2022) but extended to repay COVID-related compensation loans.

Detailed Insights on Compensation Cess under GST

1. Legal Framework

The Compensation Cess was introduced as part of the Goods and Services Tax (GST) regime under the GST (Compensation to States) Act, 2017. The key goal was to ensure that states, especially manufacturing-heavy states that had relied on indirect taxes like VAT (Value Added Tax), do not face a drastic decline in revenues post-GST implementation.

2. Working of Compensation Cess

The GST Compensation Cess works as a compensatory mechanism for states. The collected revenue from the cess is funneled into the GST Compensation Fund, and from there, distributed to states based on the following key principles:

• 14% Growth Assurance: Each state was assured an annual growth of 14% in their GST revenues, starting from the base year of 2015-16.
• Revenue Shortfall Calculation: If a state’s actual revenue from GST falls below this expected growth level, the central government compensates the shortfall using the Compensation Cess fund.

3. Specific Goods Subject to Compensation Cess

As compensation cess is applied only to certain luxury goods and sin goods, below are examples of the specific items that attract this cess:

• Tobacco Products: Including cigarettes, cigars, and other forms of manufactured tobacco.
• Motor Vehicles: Including luxury cars, sports utility vehicles (SUVs), and high-end motorbikes.
• Pan Masala and Tobacco Substitutes: Such as gutkha and other chewing products.
• Coal, Lignite, and Peat: Used as energy sources in certain industries.
• Aerated Drinks: Including soda and other carbonated soft drinks.

The rates for Compensation Cess vary greatly based on the category of goods.

4. Structure of Compensation Cess Rates

• Tobacco and Tobacco Products: These goods attract some of the highest Compensation Cess rates, either as a fixed per-unit rate or a percentage of value. For instance, a compensation cess of ₹4,170 per 1,000 cigarettes is applied on certain cigarettes.

• Motor Vehicles: The cess rate on automobiles varies according to engine capacity and type of vehicle:

  • Small cars: 1% to 3%
  • Large cars (SUVs): Up to 22%

• Aerated Drinks: Compensation Cess at 12%.

• Coal and Lignite: Fixed at ₹400 per tonne.

5. Filing Compensation Cess

Businesses that supply goods liable for Compensation Cess must comply with certain filing and payment regulations:

• The Compensation Cess must be collected and paid at the time of supply (like GST).
• When filing their GSTR-1 (sales return) and GSTR-3B (summary return), businesses must separately account for the Compensation Cess.

This ensures that the appropriate cess amount is reflected and reconciled in their filings.

6. Compensation Fund and Distribution

The Compensation Fund acts as a pool where all collected cess is deposited. The funds are then distributed to the states based on their revenue shortfalls:

• Calculation of Revenue Shortfall: For example, if a state’s revenue target was ₹100 crore for a given period and they only generated ₹85 crore from GST, the central government would release ₹15 crore from the Compensation Fund to make up the difference.

7. Extension Beyond Five Years

Initially, the Compensation Cess was supposed to be levied only for five years, starting from the GST’s implementation in July 2017. This period was meant to end by June 2022, but due to the economic disruptions caused by the COVID-19 pandemic, the GST Council decided to extend the levy of the Compensation Cess:

• Loan Repayment: The extension is primarily meant to help repay loans that were taken by the central government during the pandemic to compensate the states for the drastic shortfall in GST revenue.

• Current Status: The cess will continue until all liabilities related to the compensation of states are cleared. No definitive end date has been provided as of now.

8. Impact on Businesses and Consumers

• Increased Cost for Consumers: Products that fall under the purview of Compensation Cess become more expensive as the cess is added on top of the GST. For example, buying an SUV may involve paying both the GST (up to 28%) and an additional 22% Compensation Cess.

• Compliance Requirements for Businesses: Businesses dealing in specified goods must ensure they are compliant with Compensation Cess regulations, including proper invoicing, collection, and remittance of the cess.

9. Transitional and Future Considerations

• States’ Dependence on Compensation: Many states continue to rely on Compensation Cess to balance their revenue needs. This has sparked ongoing discussions between the central and state governments regarding the future of compensation mechanisms.

• Debate Over Extending GST Compensation: Some states have been requesting further extensions of the Compensation Cess period to help them transition smoothly into the post-GST revenue model. This debate is ongoing within the GST Council.